The World Bank and Emerging Market Insolvency Reform

1
The World Bank and Emerging Market Insolvency
Reform

• Mahesh Uttamchandani
• Senior Counsel - Insolvency and Creditor Rights
• The World Bank

2
The World Bank and Insolvency - Financial Crises
in Emerging Markets

• 1997/98 financial crises drew attention to
• domestic and international impact of weak legal
  and institutional frameworks
• lack of understanding by market participants of
  financial system vulnerabilities
• linkages between speed of response and speed of
  economic recover
• G7/G22/APEC/Financial Stability Forum response

3
GLOBAL FINANCIAL FRAMEWORK CORE STANDARDS
ASSESSMENT AREAS
- Data Dissemination (IMF) - Fiscal
Transparency (IMF) - Monetary and Financial
Policy (IMF)
Transparency
- Banking Supervision (BCP) - Payment and
Settlement (CPSS) - Insurance Supervision
(IAIS) - Security Regulation (IOSCO)
Financial Sector
- Anti-Money Laundering (IMF/WB)
- Corporate Governance (OECD) - Accounting
Auditing (IAS/ISA) - Insolvency Creditor
Rights (IBRD)
Market Infrastructure
www.worldbank.org/ifa
4
CONTEXT The Economics of Insolvency Reform in
Emerging Markets

• Increasing the Breadth and Depth of Financial
  Intermediation
• Emerging market countries are in a global
  competition for capital that flows where it is
  most welcome.
• Willingness of lenders to lend turns on the type
  of lending allowed and flexibility in creating
  security.
• Complex forms of financing (factoring,
  distressed-debt investing) rely upon transparent
  and efficient legal systems.
• Fostering Commercial Confidence and
  Predictability
• When the insolvency system functions well,
  markets are more able to accurately prices,
  manage and resolve risk issues.

5
CONTEXT The Economics of Insolvency Reform in
Emerging Markets

• Restoring Balance to Commercial Relationships
• Well-functioning insolvency regimes encourage
  responsible corporate behavior and governance.
• Efficiently Allocating Assets and Preserving
  Stability
• Ineffective or over-regulated collateral systems
  lead to under-leveraging.
• Well-functioning liquidation regime allows for
  the orderly transfer of assets from inefficient
  entities (i.e. the bankrupt company) to more
  efficient ones.
• Reasonable methods of restructuring provides a
  safety valve for corporate distress that helps
  preserve value and reduce job-loss (and,
  therefore, state-dependency).

6
World Bank Principles - Scope
Enforcement / Insolvency
Credit Risk Management
Credit Access / Protection
IPG A1-5
IPG B1-5
IPG C1-D9

• Credit Information systems
• D O Liability
• Risk Management Practices
• Workout Framework
• Enabling Framework (i.e. tax treatment of bad
  debts, NPLs)
• AMCs systemic corrective measures

• Compatibility of Systems
• Collateral Systems
• immovable / movable
• Registry Systems (Transparency)
• Enforcement Systems
• Public Auction Collections

• Corporate Exit Mechanisms
• Liquidation
• Rehabilitation
• Quasi-formal restructuring

• Implementation
• Institutional Systems
• Regulatory Systems

7
LESSONS LEARNED Diagnostic Results in Emerging
Markets

• Creditor Rights Legislation
• Secured Transactions on Real Estate functional
• Secured Transactions on Movable Assets outdated
• Registries
• Need of Modernization (computerized systems)
• Creation of Registries for Filing Security
  Interests on Movable Assets
• Technical Assistance, IDF Projects, Policy Notes,
  Specific Strategies
• Insolvency Legislation
• Frequently Antiquated Inefficient
• Unsupportive of modern businesses, especially
  lacking rescue procedures for financially
  distressed enterprises

8
LESSONS LEARNED Diagnostic Results in Emerging
Markets

• Weak and Inefficient Enforcement Proceedings
• For Both Unsecured and Secured Claims
• Lack of Extrajudicial Enforcement Mechanisms
• Outmoded Procedural Codes and Rules
• Ineffective Court Systems
• For Both Enforcement and Insolvency Proceedings
• Inadequate Selection and Training of Judges
• Inefficient Case Administration Practices
• Inconsistency in Decision-Making / Lack of
  Transparency
• Corruption Issues / Abuses of the System
• Weak Regulatory Systems
• Absence of Procedures and Institutions to
  License, Qualify and Supervise Insolvency
  Administrators

9
India Focus on Implementation

• Core Weaknesses of the Indian Insolvency System
• Companies Act of 1956 governing liquidation has
  worked far too slowly, taking, on average, ten
  years.
• Sick Industrial Companies Act 1985 (SICA)
  governing restructurings has been an abject
  failure as it has been allowed to be completely
  abused by debtors seeking to delay creditors.
• Asset stripping in the Indian economy has been
  rampant.
• Lack of adequate credit bureau information to
  track delinquent debtors
• Lack of sanctions against management has resulted
  in poor corporate governance in insolvency
  situations.

10
India Focus on Implementation

• Improvements to the Regime Have Focused on
  Implementation and Practical Solutions
• Securitization and Reconstruction of Financial
  Assets and Enforcement of Security Interest
  (SARFAESI) Act, 2002 allows secured creditors to
  seize, manage and sell collateral upon
  non-payment of debt after simple notice.
• Specialized debt recovery tribunals (DRT) created
  for banks/financial institutions to recover loans
  created in 1993 but modified to work more
  effectively in 2000.
• New Credit Information Companies Act of 2005
  covers the rights and responsibilities of credit
  bureaus to both maintain accurate credit
  reporting and safeguard customer confidence.

11
India Focus on Implementation

• Improvements to the Regime Have Focused on
  Implementation and Practical Solutions (Contd)
• Companies Law currently being revamped pursuant
  to proposals from the Irani Committee and
  expected to come before Parliament soon
• Creditor committees to supervise company
  restructuring
• Restructuring managers and liquidators to be
  qualified professionals
• Special courts of qualified judges to be created
  and to be empowered for fast-track dispute
  resolution.
• Strict penalties being introduced for
  asset-stripping, mismanagement and other offences.

12
Context for Insolvency Systems
Regulatory
Legal
Institutional
13
The World Bank and Insolvency - Financial Crises

• 1997/98 financial crises drew attention to
• domestic and international impact of weak legal
  and institutional frameworks
• lack of understanding by market participants of
  financial system vulnerabilities
• linkages between speed of response and speed of
  economic recover
• G7/G22/APEC/Financial Stability Forum response

14
FINANCIAL SECTOR ASSESSMENT PROGRAM and REPORTS
on STANDARDS and CODES (ROSCs) Bank-Fund
Country Work
Area of Assessment
Type (Agency Resp.)
Board Presentation
Follow-up actions
R O S C B I N D E R
IMF Board Art. IV
Country Dialogue Technical Assistance/ Lending
Operation Capacity Building/ Policy Reform
- Data Dissemination (IMF) - Fiscal
Transparency (IMF)
Stand Alone (Fund)
- Monetary and Financial Policy - Banking
Supervision (BCBS) - Insurance Supervision
(IAIS) - Security Regulation (IOSCO) -
Payment Settlement (CPSS) - Anti-Money
Laundering (IMF/WB)
FSSA
FSAP (Bank Fund)
World Bank Board CAS
FSA
- Corporate Governance (OECD) - Accounting
and Auditing (IAS/ ISA) -
Insolvency/Creditor Rights (WB)
Stand Alone (Bank)
ESW
Note ROSCs Reports on the Observance of
Standards and Code FSAPFinancial Sector
Assessment Program FSSA Financial
Sector Stability Assessment FSA Financial
Sector Assessment ESW Economic
and Sector Work CAS Country Assistance
Strategy
15
GLOBAL FINANCIAL FRAMEWORK CORE STANDARDS
ASSESSMENT AREAS
- Data Dissemination (IMF) - Fiscal
Transparency (IMF) - Monetary and Financial
Policy (IMF)
Transparency
- Banking Supervision (BCP) - Payment and
Settlement (CPSS) - Insurance Supervision
(IAIS) - Security Regulation (IOSCO)
Financial Sector
- Anti-Money Laundering (IMF/WB)
- Corporate Governance (OECD) - Accounting
Auditing (IAS/ISA) - Insolvency Creditor
Rights (IBRD)
Market Infrastructure
www.worldbank.org/ifa
16
Historical Overview
HISTORICAL OVERVIEW

• 1999 Task Force Working Groups (70 experts)
• 1999-2000 Vetting Process / Regional Workshops
• Asia, Central Europe/Baltics, Latin America,
  Africa Arab States
• 75 Countries 700 public/private sector
  specialists
• International Feedback through web-site
• 2001 (Apr) Board Meeting / DC Meeting
• 2001 (July) ICR ROSC Assessments / TA
• 2003-05 Principles review and revision
• International Forum on Insolvency Risk Management
  (FIRM) - 1/03
• Sustained Dialogue G-20, APEC, FAIR, FILA,
  Judges Forum, IAIR

17
Historical Overview (contd)

• 2003-05 Principles review and revision (Contd)
• UNCITRAL Legislative Guide finalized in 2005
• UNCITRAL Guide and WB Principles express the same
  standard in different formats.
• Joint effort with UNCITRAL and IMF to create
  unitary working document Revised Principles and
  ICR Standard.
• Revised document completed and posted for comment
  on WB website between December 2005 and March
  2006.
• Integrated document represents a single, unified
  standard for ICR systems.

18
The World Bank Insolvency Initiative
19
Process on Principles

• Task Force Working Groups (70 intl experts)
• Working Group Reports
• Consultation Drafts
• Regional Workshops (5)
• Asia, Central Europe/Baltics, Latin America,
  Africa Arab States
• 75 Countries (60 developing)
• Over 700 participants (public and private sector
  specialists)
• International Feedback through web-site
• Final Principles Report
• World Bank Executive Directors
• Joint Bank/Fund Development Committee (Ministers
  of Finance)

20
Challenge for Today

• Develop effective systems of enforcement and
  insolvency that foster strong credit cultures and
  enable economies to promptly respond to default
  conditions insolvency in a way that promotes
  maximum economic growth and competition
  domestically and internationally, aligned with
  the commercial expectations of todays rapidly
  changing global business environments.

21
Challenge for Today

• Development of Effective Systems
• Elevate awareness and understanding
• Strengthen capacity
• Systems that respond to domestic needs
• Redefining insolvency viability
• Innovative rescue solutions (accelerated
  procedures)
• Financing vehicles more flexible instruments
• Promote participation in global markets
• Adopting international best practice
• Attracting foreign direct investment

22
Modern Credit Systems

• Credit is lifeblood of modern commerce
• Depends on willing lenders
• In turn depends on types of lending allowed by
  law and reasonable assurance of repayment to
  lenders
• Reasonable assurance often entails security
• Increasing significance of collateral
• Collateral provides greater assurance of recovery
• Ineffective security systems lead to
  underutilized asset values
• Increasing role of foreign credit/capital

23
Emerging Market Characteristics

• Weak Financial Systems
• Weak Capital Markets
• Ineffective Corporate Governance
• Corporate financial distress at high levels
• Ineffective Legal Institutional Systems
• Accounting practices out-of-step with IAS
• Illiquid markets for assets and investors
• Inadequate social safety nets (political
  obstacles)

24
Emerging Market Development

• Lessons Private Sector Growth
• Good structural policies and institutions
  complement macroeconomic policies
• Basic infrastructure of a market economy calls
  for effective legal framework and reliable
  institutions to enforce the law

25
Linkage Between Credit and Enforcement Systems

• General Principle
• Credit is the lifeblood of modern commerce. All
  countries should adopt a regularized system of
  credit supported by reliable enforcement
  mechanisms that provide continuity in the
  treatment of creditor rights. A countries credit
  system should embrace the broadest range of
  credit transactions, coupled with an efficient,
  inexpensive, transparent, predictable and
  enforceable system of taking a security interest
  in property. Creditor rights regimes should be
  complemented by and harmonized with a countrys
  insolvency laws.

26
Modern Credit Systems

• Credit is lifeblood of modern commerce
• Depends on willing lenders
• In turn depends on types of lending allowed by
  law and reasonable assurance of repayment to
  lenders
• Reasonable assurance often entails security
• Increasing significance of collateral
• Collateral provides greater assurance of recovery
• Ineffective security systems lead to
  underutilized asset values
• Increasing role of foreign credit/capital

27
Security Devices Enforcement Mechanisms

• Broadest range of security devices
• Movables, immovables, future property rights
• Effective enforcement systems
• Reinforce and stimulate domestic credit practices
• Encourage foreign direct investment
• Serve as disciplinary mechanisms for incompetent
  borrowers
• Foster consensual resolutions by providing more
  predictable backdrop

28
Cornerstones of Confidence Transparency
Accountability
Principal Conclusions

• Establish minimum standards of transparency
• Information fosters cooperation
• Participants need sufficient information of
• A borrower's operations and related financial
  criteria
• The enforcement process -- both judicial or
  non-judicial
• Accounting auditing practices
• Corporate law and regulation should guide the
  conduct of the borrower's shareholders,
  management and directors
• Law imposed impartially consistently

29
Cornerstones of Confidence Certainty
Predictability
Principal Conclusion

• Recognizing that individual countries make
  different policy choices regarding their
  substantive and procedural laws and the
  allocation of risk among all participants, these
  rules must be clearly specified and consistently
  applied.
• Well-defined and predictable risk allocation
  rules and consistent application of laws should
  encourage investment
• A procedure that is unfriendly to investors but
  consistently applied is preferable to uncertainty
  because it provides a framework for managing risk
  through price adjustment

30
Context for Insolvency Systems
Regulatory
Legal
Institutional
31
Risk Assessment Continuum
Enforcement Insolvency
Financial Distress
Credit Access

• Credit Assessment
• Information
• Identify Security
• Negotiation
• pricing
• Contracting
• Registry
• Monitoring

• Risk Assessment
• Information
• Identify Options
• Negotiation
• pricing
• Amend Contracts
• Possible action
• Monitoring

• Enforcement
• Formal Insolvency
• Liquidation, Rescue
• Security Rights
• Information
• Negotiation (Plan)
• Implementation
• Monitoring

Source The World Bank
32
Principles on Creditor Rights and Enforcement
(IPG 1-5)
General Principles

• A modern, credit-based economy requires
  predictable, transparent and affordable
  enforcement of both unsecured and secured credit
  claims by efficient mechanisms outside of
  insolvency, as well as a sound insolvency system.
  These systems must be designed to work in
  harmony. (IPG 1)
• Unsecured Debt (IPG 2)
• Secured Debt Creation, recognition, enforcement
  of (IPG 3-5)

33
Principles for Legal Framework(Design
Considerations Policy Objectives)

• Legal Framework (policy choices)
• General principles (IPG 6-16)
• Rehabilitation (IPG 17-23)
• International Considerations (IPG 24)
• Credit Culture and Corporate Workouts (IPG 25-26)
• Design considerations
• Integration, Capacity, Operational integrity,
  Global outlook
• Policy objectives
• Efficiency, Predictability, Transparency,
  Accountability

34
Implementation (Institutional Framework)

• Role of Governing/Judicial Authority (IPG 27)
• Performance Standards/Qualifications (IPG 28)
• Court Organization (IPG 29)
• Resourcing, operations, court procedures
• Transparency and Accountability (IPG 30)
• Judicial decision-making Enforcement (IPG 31)
• Integrity of Governing Authority (IPG 32)
• Rules to avoid conflicts and conduct that
  undermine public confidence

35
Implementation(Regulatory Framework)

• The regulation of an insolvency system is
  essential to assure the competence of office
  holders and other participants, to ensure the
  efficiency and effectiveness of the system, and
  to maintain the integrity of and public
  confidence in the system.

36
Regulatory Framework

• Hallmarks of a properly regulated system
• Clarity, transparency fairness, predictability,
  accountability
• Public confidence and credibility
• Regulatory Elements
• Integrity of Participants (IPG 33 35)
• Role of Regulatory or Supervisory Bodies (IPG 34)

37
Obstacles To a Strong Regulatory Framework

• Economic The state budget cannot support an
  agency dedicated solely to regulating insolvency
  administrators
• Technical assistance available from multi-lateral
  and bi-lateral agencies to help set-up agencies.
• Levies can be used to fund the operating costs of
  the agency
• Political Such regulation is inconsistent with
  modern capitalism and is a breeding ground for
  corruption
• Even the most robust forms of capitalism require
  some state regulation.
• Weigh the possibility of corruption within the
  agency against the likelihood of corruption
  without it.

38
ROSC Assessment(Table 1)
24
Total
6
2
10
39
Importance of Effective Insolvency Systems
40
Context for Insolvency Systems
Regulatory
Legal
Institutional
41
World Bank Principles - Scope
Enforcement / Insolvency
Credit Risk Management
Credit Access / Protection
IPG A1-5
IPG B1-5
IPG C1-D9

• Credit Information systems
• D O Liability
• Risk Management Practices
• Workout Framework
• Enabling Framework (i.e. tax treatment of bad
  debts, NPLs)
• AMCs systemic corrective measures

• Compatibility of Systems
• Collateral Systems
• immovable / movable
• Registry Systems (Transparency)
• Enforcement Systems
• Public Auction Collections

• Corporate Exit Mechanisms
• Liquidation
• Rehabilitation
• Quasi-formal restructuring

• Implementation
• Institutional Systems
• Regulatory Systems

42
RISK ASSESSMENT CONTINUUM
Increasing financial distress
Risk Evaluation Process
Credit Access
Risk Management
Resolution / Recovery

• Credit Assessment
• Information
• Identify Security
• Negotiation
• pricing
• Contracting
• Registry
• Monitoring

• Risk Assessment
• Information
• Identify Options
• Negotiation
• pricing
• Amend Contracts
• Possible action
• Monitoring

• Enforcement
• Formal Insolvency
• Liquidation, Rescue
• Security Rights
• Information
• Negotiation (Plan)
• Implementation
• Monitoring

43
Nigeria Goals for Insolvency Reform

• Foster commercial confidence and predictability
• Markets more accurately price, manage, resolve
  default risk
• Establish a predictable backdrop for
  negotiations
• Reduce asset deterioration and promote credit
  access
• Safety valve for corporate distress
• Salvage viable businesses and preserve jobs
  (rescue)
• Efficient transfer of assets (bankruptcy)
• Vital to balance in commercial relationships
• Encourage responsible corporate behavior
  governance
• Penalize owners and managers who lack financial
  discipline or behave irresponsibly

44
World Bank Insolvency Reform Lessons Learned (1)

• Not so special after all?
• Virtually no correlation between having a
  specialized bankruptcy court and a system that is
  perceived by users as being more predictable and
  transparent.
• Lesson Courts that are specialized in name
  only, do not add value.

45
World Bank Insolvency Reform Lessons Learned (2)

• Time is money
• Strong correlation between systems that work
  quickly and those that are cost-effective.
• Lesson If we can remove inefficiencies from the
  system that cause delays, we can increase the
  returns of all creditors.

46
World Bank Insolvency Reform Lessons Learned (3)

• Great minds think alike
• Strong correlation between judicial competence
  and trustee/administrator competence.
• Lesson Insolvency administrators and insolvency
  judges can mutually reinforce competence.

47
Nigeria ICR ROSC Preliminary Findings

• Legislative Drafting is not the Cure-All
• The regulatory and judicial institutions
  designed to implement the Companies and Allied
  Matters Act do not work.

48
Nigeria ICR ROSC Preliminary Findings

• Large Disconnect Between Perceptions of Providers
  and Clients.
• Corporate Affairs Commission Registry
• Courts

49
Nigeria ICR ROSC Preliminary Findings

• Law is Only Part of the Solution
• Basic structural problems within
• Nigeria often act as an obstacle
• to improving the lending
• environment.

50
The Way Forward

• Finalize draft recommendations
• Convene Stakeholders Committee
• Work with Stakeholders Committee to finalize
  recommendations for delivery to government.
• Work with government to implement recommendations.

51
Importance of the financial reporting
infrastructure not just accounting and auditing
standards
Financial Reporting Infrastructure
Statutory Framework
Monitoring Enforcement
Education Training
Accounting Standards
Auditing Standards
Accounting Profession Ethics
52
All supporting pillars need to be strengthened
Financial Reporting Infrastructure
Statutory Framework
Monitoring Enforcement
Education Training
Accounting Standards
Auditing Standards
Accounting Profession Ethics