Policy Approaches to Corporate Restructuring Around the World:

What Worked, What Failed? By

Stijn ClaessensUniversity of Amsterdam

For presentation at the conference

Corporate Restructuring: International Best Practice World Bank Washington, D.C. March 22-24

Structure of Presentation

1. Introduction and Initial Conditions

2. Overview of Approaches Used

3. The Outcomes in Corporate Restructuring

– NPLs and financial measures

– Operational restructuring measures

4. Policy Lessons

Introduction• Review lessons from eight financial crises involving

corporate distress over past decade– Brazil, Czech Republic, Indonesia, South Korea,

Malaysia, Mexico, Thailand, Turkey • Assess which policies were effective/ineffective given

country circumstances, and why • Note: do not review the causes or initial conditions

– Causes ought to condition responses, however– Initial conditions, e.g., fiscal headroom, foreign

exchange exposures, etc., determine scope for actions

Initial conditions: pre-crisis corporate sector financial conditions

Indonesia Korea Malaysia Thailand Brazil CzechRepublic

Mexico Turkey

Leverage Interest coverage ROA

Data one year prior crisis: Asia 1996, Czech Republic 1996, Turkey 2000, Mexico 1994, Brazil 1998.

Approaches used for corporate restructuring

1. Government-sponsored, voluntary workouts schemes

2. Court-supervised restructuring and bankruptcy

3. Restructuring by public asset management companies

4. Voluntary workouts outside government-sponsored and

in-court frameworks

5. Other, supporting policy changes

Government-sponsored voluntary workouts schemes

• London type schemes adopted by 6 out of 8 countries (Brazil and the Czech Republic not)

• Enhanced in various ways:– Did all (or most) financial institutions sign on to the

accord under regular contract or commercial law? – Was formal arbitration with deadlines part of the accord? – Could penalties for failure to meet deadlines be imposed

under the accord?

• Not all countries had these three features in place (immediately): lessons were learned over time

Features of out-of-court corporate restructuring processes: Asia

Indonesia Rep of Korea Malaysia Thailand Name of initiative or coordinating body

Jakarta Initiative Task Force (JITF)

Corporate Restructuring Coordination

Committee (CRCC)

Corporate Debt Restructuring

Committee (CDRC)

Corporate Debt Restructuring

Advisory Committee (CDRAC)

Basic approach Forum for negotiations,

followed by adoption of time-bound

mediation procedures

Forum for negotiations,

superseded in the Fall of 2001 by a

legal approach (Law on Corporate

Restructuring)

Forum for negotiations

Forum for facilitation,

superseded by contractual approach, i.e., Debtor -Creditor Agreements (DCAs)

Mid-1999

Mid-2003

Mid-1999

Mid-2003

Mid-1999

Mid-2003

Mid-1999

Mid-2003

All or most financial institutions signed on to accord

No No Yes Yes Yes Yes Yes Yes

Accord provides for formal arbitration with deadlines

No Yes No Yes Yes Yes Yes Yes

Accord imposes penalties for noncompliance

No No Yes Yes No No Yes Yes

Features of out-of-court corporate restructuring processes: Non-Asia

Czech Republic Turkey Mexico Brazil Name of initiative or coordinating body

None Istanbul Approach UCABE None

Basic approach Forum for negotiations,

superseded in the Fall of 2001 by a

legal approach (Law on Corporate

Restructuring)

Promoted a voluntary debt workout

program for the largest 40

corporations (only approx 10% of all

bank lending)

When the crisis hit

1997 Feb 2001 1994 Jan 1999

Reference points End-1999

End-2003

End 2001

End-2003

End 1994

End 2003

End 1998

End 2003

All or most financial institutions signed on to accord

NA NA No Yes No No NA NA

Accord provides for formal arbitration with deadlines

NA NA No Yes No No NA NA

Accord imposes penalties for noncompliance

NA NA No Yes No No NA NA

Strengths determined restructuring

• Korea, Malaysia stronger framework than Thailand initially, Turkey quickly strengthened, Indonesia less, Mexico least

• Number of cases and speed of restructuring depended in part on the strength of framework

• Much restructuring was still cosmetic, with soft terms, few debt-equity conversions and limited operational restructuring; many cases reverted

• And out of court needed well-functioning bankruptcy system as threat and to finalize deals

Court-supervised restructuring and bankruptcy/insolvency

• Initial weaknesses in bankruptcy regimes made court-supervised restructuring unattractive; exceptions were Korea and Malaysia

• Limited use due to pro-debtor bias in legal system aggravated by limited efficacy of judicial system

• Some legal deficiencies corrected, more in East Asia and Turkey, less so in Latin America

• But effectiveness of insolvency systems remains low, with long periods and high costs

Features of in-of-court: creditors rights weighted by judicial efficiency

Indonesia Rep of Korea Malaysia Thailand 1999 2003 1999 2003 1999 2003 1999 2003 Creditor rights score 2 2 3 3 1 2 3 3 Rule of Law Indicator 3.98 3.98 5.35 5.35 6.78 6.78 6.25 6.25 Effective creditor rights 7.96 7.96 16.05 16.05 6.78 13.56 6.25 6.25 Czech

Republic Turkey Mexico Brazil

1999 2003 2001 2003 1994 2003 1999 2003 Creditor rights score 2 3 2 2 0 0 0 1 Rule of Law Indicator n.a. n.a. 5.18 5.18 5.35 5.35 6.32 6.32 Effective creditor rights n.a. n.a. 10.36 10.36 0 0 6.32 6.32

Judicial system remains bottle-neck in many crisis countries

Economy Actual time (years)

Actual cost (% of estate)

Goals of Insolvency Index

Court Powers Index

High Income Countries (OECD)

1.8 7 77 36

Middle Income Countries

3.4 16 48 60

Indonesia 6 18 35 100

Korea 1.5 4 91 67 Malaysia 2.2 18 52 33 Thailand 2.6 38 62 33

Czech Republic 9.2 38 22 0 Brazil 10 8 24 67

Mexico 2 18 61 67 Turkey 1.8 8 51 67

Restructuring by public asset management companies

• All East Asian countries, Mexico, Turkey and Czech Republic established an AMC or (used) a deposit insurance, for buying NPLs from banks

• Purposes of AMCs differed: some were setup largely to support banking system; others also had asset disposal and/or restructuring tasks

• Asset disposition was slow in most cases – Difficulty in valuing assets, thin markets for

selling assets, fears of selling too cheaply, and social and political pressures slowed down

Most AMCs ended up with large role in restructuring

• Regardless of purposes, most AMCs ended up restructuring, especially large, difficult firms

• With large holdings and some special powers, most AMCs played a large role in restructuring and could set pace and intensity of restructuring

• Social impact, political connections or fear to reveal “skeletons” slowed restructuring, however

• E.g., in Mexico there were essentially no assets sales when FOBAPROA was AMC

Restructuring by AMCs was often poor

• As in other countries, AMCs often delayed, rather than sped up operational restructuring

• Many concerns throughout whether AMCs facilitated sufficiently deep corporate restructuring

• Holdings by AMCs remained large in most countries for several years after crisis, four Asian AMCs still held some $150 billion in mid 2002

• Disposition accelerated, however, over time, and restructuring improved in quality

Holdings of NPLs and powers: Asian AMCs

Korea: KAMCO

Malaysia: Danaharta

Indonesia: IBRA (a)

Thailand: TAMC

Holdings (billions of $)

$91.75 $12.6 $39.41

$18.23

Purchased (as a percent of total NPLs)

79.31 41.5 91.72 57.9

Disposed (as a percent of NPLs acquired)

59% 100.00 70% 73%

Special powers None Appointment of special administrator

for business restructuring. Foreclose on

collateral.

Power to seize debtor assets

TAMC administered business restructuring

largely bypasses court processes.

Foreclose on collateral.

Holdings of NPLs and powers: Non-Asia AMCs

Czech Republic CKA

Turkey SDIF

Mexico FOBAPROA, IPAB (since

1999)

Brazil Banco Central

do Brasil

Holdings (billions of $) 8.09 9.27 1.06

n.a.

Purchased (as a percent of total NPLs)

- 81.3% 10% n.a.

Disposed (as a percent of NPLs acquired)

23% 22.7% 10% n.a.

Special powers Power to seize debtor assets.

Participates in any bankruptcy estate in its capacity as a privileged creditor for the amounts it paid to depositors.

IPAB get priority in assets recovery for the amounts it has paid as deposit insurance agency.

n.a.

Other forms of government-directed corporate restructuring

• Korea: five plus three program, for 6-64 chaebols – Elimination of cross guarantees, capital structure

improvement, lowering of leverage to 200%, tighter exposure limits for financial institutions, streamlining business lines and increased transparency

– Still required lead banks to act, which was an issue• Korea: Big Five chaebols, Capital Structural Improvement

Plans (CSIPs), with business assets swaps and mergers– For two too large to fail/ignore chaebols did not work,

used new funds raised by affiliated Investment Trust Companies to finance their cash-flow needs

Voluntary workouts outside government-sponsored and in-court frameworks

• In most countries, smaller firms more adversely affected by shocks and credit crunch than larger

• Special programs (forced roll-over, trade and working capital financing, SME workouts programs) helped

• M&A, triggered by policy changes, helped with financing, less so with restructuring directly

• Over time, foreign entry helped with enhancing institutional quality, especially in financial sector

Other, supporting policy changes

• Many countries did not have or slowly adopted proper loan classification and loan-loss provisioning rules, e.g., no “forward-looking criteria”

• Many other tax, legal and accounting rules hindered– E.g., tax losses only allowed with write-offs; treatment of

mergers as taxable event; debt to equity conversions only allowed for shareholder loans; etc.

• Corporate governance changes important, but slow– Source of vulnerabilities and required for restructuring

– But implementation still incomplete

Regulatory and loan restructuring frameworks, as of early 1997 and 2003

Country Loan classification Loan loss provision Interest accrual Overall index Early

1997 2003 Early

1997 2003 Early

1997 2003 Early

1997 2003

Indonesia 2 2 1 3 1 2 1.3 2.3 Rep of Korea 2 2 3 3 3 4 2.7 3.0 Malaysia 2 2 1 2 3 3 2.0 2.3 Thailand 1 2 1 2 1 4 1.0 2.7 Country Loan classification Loan loss provision Interest accrual Overall index 1999 2003 1999 2003 1999 2003 1999 2003 Czech Rep. 2 2 2 2 n.a. n.a. n.a. n.a. Turkey 0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. Mexico 1 2 2 1 n.a. 1 n.a. Brazil 3 3 2 2 n.a. n.a. n.a. n.a.

Corporate governance changes

Indonesia Rep of Korea Malaysia Thailand 1996 Mid-

2003 1996 Mid-

2003 1996 Mid-

2003 1996 Mid-

2003 One-share, one-vote 1 1 1 1 1 1 0 1 Proxy by mail 1 1 0 1 0 1 0 1 Shares not blocked 1 1 0 0 1 1 1 1 Cumulative voting 1 1 0 1 0 0 1 1 Equity rights score 4 4 1 3 2 3 2 4 Czech Republic Turkey Mexico Brazil 1996 Mid-

2003 1996 Mid-

2003 1996 Mid-

2003 1996 2003

One-share, one-vote 1 1 0 1 0 1 0 1 Proxy by mail 0 0 0 1 0 0 0 0 Shares not blocked 0 0 0 0 0 1 0 0 Cumulative voting 1 1 0 1 0 0 0 0 Equity rights score 2 2 0 3 0 2 0 1

Other tax, accounting, legal and regulatory changes

• Need a broad set of options, not only debt rescheduling and principal and interest reductions, but also debt-for-equity swaps, assets sales, securitization, asset spin-offs

• Relative importance varies over time and with demand base of investors and type of assets to be restructured

• But tools often missing. Lack of Corporate Restructuring Vehicles (CRVs) and venture funds, equity partnerships, and other tools especially hindered restructuring

– Korea assigned only in 2000 CRVs a formal role in out-of-court restructuring, no CRVs established until 2002

Outcomes in corporate restructuring

• Financial restructuring measures: NPLs and financial indicators

• NPLs rose initially sharp, with lag depending on reporting standards; slow decline after that

• NPL share fell only in East Asia after 1999; only in 2001 Korea and Malaysia NPLs in single digits

• In other countries, NPLs were already high due to high interest rates: also foreign exchange effects

• In Mexico took long time for NPLs to come down

Share of NPLs, including NPLs

transferred to AMCs (percent)

0

10

20

30

40

50

60

NP

L/T

otal L

oan

s, P

ercen

tag

e

Indonesia Korea Malaysia Thailand

0

10

20

30

40

50

60

NP

L/T

otal L

oan

s, P

ercn

tag

e

Czech Turkey Mexico Brazil

Financial indicators: leverage and interest coverage

• Leverage initially saw a sharp increase, in part due to foreign exchange shock and rescheduling

• Only a slow decline afterwards, showing financial restructuring can take many years

• Structure of financing lengthened, for good and bad reasons (reschedulings, bonds)

• Interest coverage was worse in East Asia, but had been declining in other countries before crises

• Interest coverage still low in many countries years after crisis and many distressed corporations

Leverage

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Deb

t/T

otal C

ap

ital

Indonesia Korea Malaysia Thailand

0

0.1

0.2

0.3

0.40.5

0.6

0.7

0.8

0.9

1

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Deb

t/T

otal C

ap

ital

Czech Turkey Mexico Brazil

Interest coverage

0

1

2

3

4

5

6

7

8

9

1994 1995 1996 1997 1998 1999 2000 2001 2002

Inte

rest

Co

vera

ge R

ati

o

Indonesia Korea Malaysia Thailand

0

1

2

3

4

5

6

7

8

9

1994 1995 1996 1997 1998 1999 2000 2001 2002

Inte

rest

Co

vera

ge R

ati

o

Czech Turkey Mexico Brazil

Financially distressed corporations (percent with IC < 1)

0

5

10

15

20

25

30

35

40

45

19951996

19971998

19992000

Indonesia Korea Malaysia Thailand

Operational restructuring measures

• Financial restructuring only a means to achieving improved operational performance

• Financial structure can create incentives for deeper, more sustainable operational restructuring

• Can be through changing management, bringing in new owners, changing financial structures

• Much financial restructuring was response to systemic crisis, and while it achieved temporary financial stabilization, was not always sustainable or promoted real, operational restructuring

Return on assets

• Longer-run decline in ROAs in many countries • After sharp decline following crisis, some quick

rebound, followed by varying pattern to more “normal” ROAs: East Asia strongest recovery helped by global conditions (except Malaysia to lag)

• But profitability and cash flow of corporations in many of the crisis-affected countries remained low, even negative in Brazil, Turkey

• Large corporate restructuring deals continued to emphasize financial over operational restructuring

Return on assets

-15

-10

-5

0

5

10

15

RO

A

Indonesia Korea Malaysia Thailand

-15

-10

-5

0

5

10

15

RO

A

Czech Turkey Mexico Brazil

Policy Lessons

1. An efficient insolvency system

2. Loss absorption capacity

3. A proper framework for financial institutions

4. Limits on the role of banks and the state

5. A menu of approaches

6. Corporate governance and other reforms

7. Broader lessons on corporate restructuring

An efficient insolvency system

• An efficient court-supervised process is a necessity– The effectiveness of out-of-court system depends on

formal court system

– In-court more generally needs to be a credible threat

– While formal bankruptcy regimes can be more quickly improved, and have been in many countries, legal enforcement remains often limited

– In the meantime, London-type approaches, can be useful, but regime needs to be tight

Loss absorption capacity

• Loss-absorption capacity is necessary, with private sector incentives and no perverse links

– To restore bank capital adequacy, recapitalization by private sector is preferred, but rarely sufficient

– Government resources linked to actual restructuring, as was done in some countries, can strengthen incentives

– Proper incentives also means limited ownership links and limits on borrowing from related financial institutions

– More broadly, need to consider links between financial and corporate sectors, by political system and otherwise

A proper framework for financial institutions

• To facilitate restructuring, need to have a proper incentive framework at the level of individual loans

– Includes proper accounting, classification, and provisioning rules, and tight exposure limits

– Other barriers such as tax and accounting rules and certain legal rules to be addressed

• And a proper incentive framework for institutions – Prudential and legal systems need to limit forbearance

and ensure that undercapitalized financial institutions are properly disciplined while giving incentives for banks to come to grips with their problem loans

Limits on the role of banks and the state

• Consider upfront how to limit role of banks and state, while inevitable, in restructuring

– Banks, state-owned or under extensive safety net, and AMCs played a large role, but slow to divest assets

– At best commercial banks and AMCs are used for financial restructuring, not for operational restructuring

– More and earlier involvement of outside investors is necessary to achieve deep operational restructuring

• Encourage quick divestiture by LCC/LLP, with full disclosure

• AMCs to divest within set time limits

A menu of approaches

• To dispose of assets, a menu of approaches should be available to banks, AMCs, investors

– When large-scale disposal of assets is difficult, if asset prices are depressed or because of political sensitivities, solutions can be mixed public-private arrangements and other ways to effectively reprivatize assets.

• More differentiation by the type of assets

– Type of assetslarge corporations, small firms, consumer credit, real estate requires different approaches in terms of speed/forms of asset disposition and restructuring

Corporate governance and other reforms

• Corporate governance reforms to accompany – Strengthen corporate governance, especially enhanced

rights for public (minority) shareholders

• Many other reforms are necessary as well– Liberalization of rules governing FDI and investments

– Foreign participation in financial system especially

– Mergers and acquisitions to be facilitated

– Adoption of international accounting standards and enhanced disclosure (of NPLs especially)

– Prohibitions on anti-competitive business practices

Broader lessons on corporate

restructuring • Preserve private sector incentives to restructure

weak financial institutions and NPLs – A consistent framework with sufficient loss-absorption – Private agents to face right sticks and carrots

• Use crisis to start deeper structural reforms

• Be not only cognizant of political economy factors, but adjust pro-actively and up-front– Be aware of political economy factors behind the causes

of a crisis and its resolution – Change ownership structures so that recovery is expedited

and more sustainable outcome results