Top Advisers Call For Simplification As Intricate Debt Deals Proliferate Since 2020

The proliferation of intricate debt, whether loans backed by collateral or bonds linked to economic growth or exports, has exploded since 2020, driven by aid cuts by rich nations, high borrowing costs and risk aversion due to everything from Covid-19 to Russia's invasion of Ukraine.

But top advisory firm Lazard has warned in a paper published on Thursday that the shift - praised by some investors as an innovative way to diversify borrowing - could come with a sting in the tail.

"We need to simplify the whole thing, because it is becoming really complex, and inevitably, at some point, the borrowing countries will pay the price of that," said Pierre Cailleteau, managing director at Lazard.

The shift is particularly pronounced in smaller, riskier nations known as "frontier" economies.

Some complex instruments emerged to speed up debt restructurings, for example in Zambia, where bond payouts were linked to improvements in debt sustainability, and in Sri Lanka, where they were tied to GDP performance.

Meanwhile, Angola, Nigeria and Senegal have tapped total return swaps — effectively borrowing against their own debt — as an alternative to international bonds.

The IMF has warned these can be opaque and complicated liabilities.

Investors underestimate risks

Uncertainty over whether multilateral lenders retain preferred creditor status - which shields them from losses when countries default - adds to the concerns.

"The combination of a lack of clarity on the hierarchy of claims and the introduction or the proliferation of those types of contingent instruments makes in fact the debt very difficult to analyse for the creditors, to determine where they are in the hierarchy of claims," Cailleteau said. "This is changing the dynamics of debt."

Zambia is in the process of buying back its contingent bond.

The World Bank has pushed for "radical transparency" on debt, and increasing debt complexity - especially the use of State Contingent Debt Instruments - has been a top agenda item at recent meetings of the International Monetary Fund and the World Bank in Washington.

Cailleteau said debt transparency should be mandatory in order to access financing from the IMF - typically the lender of last resort for countries in debt distress - and other multilateral development banks.

"We need to make transparency enforceable," said Cailleteau.

He added the premium demanded by investors on emerging market debt was near record lows — a sign, he said, of "some degree of exuberance" that may be underpricing the risks.