Orderly sovereign debt restructuring procedures for the euro area

The case of Greece has reveiled an institutional gap remains in the institutional framework of EMU: an orderly insolvency mechanism for sovereign states. After weighing the pros and cons of such a mechanism, requirements are devised to max-imise the advantages and minimise the potential drawbacks. Overall, an insolvency procedure for sovereign states needs to be effective, reliable and fair. It should limit the negative effects of a default for the debtor country, but must not provide incentives for the debtor country to default strategically. Bearing these requirements in mind and based on a combination and change of existing proposals, this study pro-poses an insolvency regime for sovereign states, but one only as an ultima ratio. As a rule, the debtor country starts the procedure - and is then supported by ESM bridge financing and can benefit from a moratorium on debt service, litigation and enforcement in order to sustain basic government functions. These support measures are time-limited and go hand in hand with a robust reform programme of the ESM to avoid problematic incentives for fiscal policy. The ESM can also trigger the procedure under restrictive conditions as an ultima ratio, if the debtor country clearly delays this step. The ESM treaty (also) has to be changed to ensure that the insolvency mechanism is triggered, if a country applies for ESM loans but proves to be insolvent instead of illiquid. Finally, if an ESM programme for a formely illiquid country ends unsuccessfully, an insolvency procedure is triggered automatically. [...]