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 Credit Access / Protection Credit Risk Management Enforcement / Insolvency IPG A1-5 IPG B1-5 IPG C1-D9 • Compatibility of Systems • Collateral Systems • immovable / movable • Registry Systems (Transparency) • Enforcement Systems • Public Auction & Collections • 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 • 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 (Cont’d) • 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. Tax & other laws State Governmental & Political Mortgage laws Secured Creditors Bank Regulators Collaterallaws Creditors Contract/Commercial Environmental, Company, Tariff & others Employees Labor laws Enterprise Company laws Professionals Shareholders Securities laws Insolvency System Administrative Directors etc Others laws Economic & Commercial Cultural & Social Courts Bankruptcy Commercial & Civil Agency 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; FSAP=Financial 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 (cont’d) • 2003-05: Principles review and revision (Cont’d) • 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+ int’l 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 thatfoster strong credit culturesand enable economies topromptly respondto default conditions & insolvency in a way thatpromotesmaximum economic growthandcompetitiondomestically and internationally, aligned with the commercial expectations of today’s rapidly changingglobal 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 anefficient, inexpensive, transparent, predictableandenforceablesystem of taking a security interest in property. Creditor rights regimes should be complemented byandharmonized witha country’s 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 rulesand 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 throughprice adjustment

30. Tax & other laws State Governmental & Political Mortgage laws Secured Creditors Bank Regulators Collaterallaws Creditors Contract/Commercial Environmental, Company, Tariff & others Employees Labor laws Enterprise Company laws Professionals Shareholders Securities laws Insolvency System Administrative Directors etc Others laws Economic & Commercial Cultural & Social Courts Bankruptcy Commercial & Civil Agency 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 requirespredictable, transparent and affordable enforcementof 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 thecompetenceof office holders and other participants, to ensure theefficiency and effectiveness of the system, and to maintain theintegrityof andpublic confidencein 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. 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. Obstacles To a Strong Regulatory Framework

38. ROSC Assessment(Table 1) Total 24 6 2 10

39. ECONOMIC GROWTH Efficient Allocation of Resources Improved Access to Credit Value Preservation Insolvency and Cr. Rights Private Sector Growth Financial Sector Development Financial Stability Importance of Effective Insolvency Systems

40. Tax & other laws State Governmental & Political Mortgage laws Secured Creditors Bank Regulators Collaterallaws Creditors Contract/Commercial Environmental, Company, Tariff & others Employees Labor laws Enterprise Company laws Professionals Shareholders Securities laws Insolvency System Administrative Directors etc Others laws Economic & Commercial Cultural & Social Courts Bankruptcy Commercial & Civil Agency Context for Insolvency Systems Regulatory Legal Institutional

41. World Bank Principles - Scope Credit Access / Protection Credit Risk Management Enforcement / Insolvency IPG A1-5 IPG B1-5 IPG C1-D9 • Compatibility of Systems • Collateral Systems • immovable / movable • Registry Systems (Transparency) • Enforcement Systems • Public Auction & Collections • 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 • 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 ofassets (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.