Withdrawal of pandemic support could create ‘perfect storm’ for corporate distress

Withdrawal of pandemic support could create ‘perfect storm’ for corporate distress
CE Oltenia, one of Romania's top power producers, has embarked on a major restructuring programme that was recently approved by the European Commission. / CE Oltenia
By Clare Nuttall in Glasgow February 3, 2022

Dire forecasts of a huge hike in insolvencies during the pandemic have not yet been realised in emerging Europe, but experts on a webinar marking the launch of the European Bank of Reconstruction and Development’s (EBRD’s) new report on business reorganisation warned that the gradual withdrawal of pandemic support measures could yet create a ‘perfect storm’ for corporate distress.

Against the background of unprecedentedly difficult conditions for companies in a whole range of sectors, the authors of the ‘EBRD Business Reorganisation Assessment Report’ and fellow panelists stressed the importance of having procedures in place for companies that encounter difficulties. 

“Strong interventive frameworks that support businesses as well as banks and investors are absolutely vital for a thriving market economy,” said EBRD president Odile Renaud-Basso.

“The economic crisis taught us insolvency is not only about liquidation of failing businesses. We need to make all efforts to remove the stigma around insolvency, recognise all businesses may face difficulties at some stage and most businesses deserve a chance to make a fresh start,” Renaud-Basso added.

“One of things makes a country investor-friendly is a shared understanding of what happens when company enters distress. Helping countries build robust insolvency systems which provide efficient options to reorganise is crucial for banks’ activities. Countries with systems in place are also better placed to weather storms and recover after a financial crisis,” said Ramit Nagpal, deputy general counsel at the EBRD.

Worse to come? 

So far there has not been an increase in non-performing loans (NPLs) and bankruptcies in the EBRD’s countries of operations, said the bank’s chief economist Beata Javorcik. In fact, she cited Eurostat data showing that the number of bankruptcies in the new EU member states in 2021 and 2020 was lower than in pre-pandemic times.  

However, she added, “This is not surprising given that many government introduces emergency measures to protect businesses from insolvencies but of course the measures are going to be withdrawn and we are likely to see NPLs and businesses that will need restructuring.”

Mahesh Uttamchandani, global manager for financial inclusion and infrastructure at the World Bank Group, also noted the $10 trillion stimulus globally and pointed out that in previous crises there was a time-lag between the peak of the crisis and the peak of insolvencies and NPLs that followed it. After the international financial crisis, this time-lag was around 13 quarters for advanced economies and 11 quarters for emerging markets. 

“By that metric we may still be feeling the after-effects of the crisis in a few quarters, and may see [a] rise in numbers of cases [of restructuring and NPLs],” Uttamchandani said. Globally, around 155 countries engaged in some kind of reform related to insolvency and debt repayment in 2020, and about 80% of those countries put in place measures to delay payment of overdue loans, or limiting the ability of creditors to commence insolvency proceedings. “As these measures begin to recede, we may be left with a pent-up stock of loans that are not officially non-performing, but that are troubled or underperforming or on the cusp of becoming non-performing,” he warned. 

“In Europe among the existing stock of NPLs going into the pandemic there was a decrease in the asset performance of those loans. There is some aspect of asset deterioration we need to keep an eye on and that, coupled with the withdrawal of economic support and receding of legal forbearance, might produce a perfect storm of distress.”

Moreover, in an update on the economic situation in the region, Javorcik noted that while most of the EBRD’s countries of operation “enjoyed quite a good result last year … clouds are now gathering on the horizon”. She listed the low vaccination rates in the region, rising inflation and the slowdown in growth in western Europe, which "does not augur well for exports” as risk factors.

Top performers 

The Business Reorganisation Assessment Report launched on February 1 ranks economies according to how supportive their legal rescue framework is. Unsurprisingly, the top performers were four EU member states: Greece, Poland, Lithuania and Romania. 

“EU member states have been under encouraged to look at this area because they had to transpose the preventive restructuring directive introduced in 2019 to support business reorganisation, explained Catherine Bridge Zoller, senior counsel at the EBRD and one of the report’s authors, presenting the results. 

Among the other states in the region, Kosovo, the newest state in emerging Europe, was in fifth place, with Moldova and Albania not far behind. "Kosovo, Albania and Moldova have in our view quite progressive legislation, the most progressive we could identify outside the EU,” said Zoller. On Kosovo, the highest ranked country outside the EU, she commented: “Kosovo has a really good solid legal framework, the legislation is comprehensive and Kosovo is also quite exemplary in having a tailored procedure for SMEs.” The country does, however, score very poorly on transparency. 

All the economies in which the EBRD invests have a legal framework for business reorganisation in distress. However, there were also wide variations in different countries’ handling of insolvency. “In some countries the process is very simple and linear like Tajikistan and Mongolia. Others like Poland and Uzbekistan have four or five procedures,” said Zoller.

The research was launched at the beginning of the coronacrisis in 2020, and is based on a survey of 500 experts including lawyers, bankers and accountants. 

Policy recommendations 

Some of the specific issues identified in the research included the lack of hybrid reorganisation procedures, and that voluntary restructuring or workouts are uncommon in many economies. There is also a stigma surrounding bankruptcy procedures. 

The report urged national governments to provide more long-term solutions for business rescue, including through increasing flexibility in business reorganisation and supporting hybrid procedures, where the terms of the reorganisation are negotiated out of court, a press release from the EBRD said.

One of the issues indemnified was the lack of information in a large number of the states in the EBRD’s region of operations. “Data transparency is really important for more informed policymaking. Without that, [it is] hard to say what effect a legislative amendment or new law has on the businesses sector, and for promoting market confidence,” noted Zoller. 

Of the countries surveyed, 11 scored 0 points on transparency. At the other extreme, six scored 10 out of 10, having taken steps such as investing into an electronic insolvency register.

Commenting on the steps the EBRD would like to see, Zoller first listed transparency which, she said, "will help national authors and regulators understand insolvency systems better, and where the value leakage is, what the recoveries are.” 

There should also be a focus on the timeliness of insolvency procedures, she added: “It's value destructive to go through very lengthy insolvency procedures. It should be a quick in and out.” 

Finally, she said, “It is also important to invest in capacity building, as insolvency is a specialist area. You need commercial law judges focussed on business and a thriving profession of insolvency practitioners to work on reorganisation plans and provide advice to debtor businesses. You need to think carefully about the whole ecosystem.” 

 

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