During tumultuous fiscal years of the past few decades, the World Bank, acting in its capacity as lender of last resort, granted unsecured loans to debt-ridden sovereign nations. Instead of taking a lien over the state’s assets, the World Bank protected its interests via a broadly-worded Negative Pledge Clause embedded in Section 6.02 of the Loan General Conditions. This clause ensures that any lien created on any public assets as security for external debt that results in a priority for a third-party creditor will equally and ratably secure all amounts payable by the borrowing state. In short, should such a lien be granted, the World Bank shares in the amounts paid out to the third party creditor, thus preventing the creditor from enjoying senior creditor status and undermining the value of any later-granted lien.
Including the Negative Pledge Clause in the World Bank loan agreements helps mitigate the World Bank’s risk of providing unsecured loans by ensuring that a developing nation will not give a later creditor priority over its assets. However, the barrier that the Negative Pledge Clause constructs around a state’s ability to engage with other creditors is so formidable that the clause can end up preventing the state from attracting commercial investment for project financings. As currently drafted, the Negative Pledge Clause dissuades commercial lenders from investing in exactly the kinds of projects that might further development and enrich a nation (thus strengthening the nation’s ability to pay back its debts). This is not only unfortunate for the developing countries involved, but also challenges the raison d’être of the World Bank, a multilateral institution designed to promote development.
When it comes to promoting development-friendly projects, the World Bank and developing nations should share a similar goal: encourage infrastructure projects that enrich poor nations, making such nations more likely to repay their prior debt obligations and lessen their future dependence on developing-bank funds. However, in order for a developing nation to become a full member of the world economy, it must be able to act and grant security like other commercial borrowers. Unfortunately, the current Negative Pledge Clause, while established for some important and legitimate reasons, has worked to stifle such development.
There are two simple ways in which the Negative Pledge Clause could be reformed to ameliorate this problem. First, the World Bank should clarify the ambiguities in the language and scope of the Negative Pledge Clause. In particular, it should pin down the meaning of the terms “ownership” and “control,” which go straight to the heart of what sort of companies would be considered state-owned enterprises, and therefore fall within the restrictions imposed by the Negative Pledge Clause. Such certainty would cut down on the additional costs and inefficiencies connected to the quasi-security structures that creditors erect in an attempt to shield their investments from the ambiguous strictures of the Negative Pledge Clause. Given the current need to promote liquidity and foreign investment in developing countries, the World Bank should choose narrow interpretations of these terms that will free entities lurking in that gray area of potential state control or ownership from the constraints of the Negative Pledge Clause.
Second, the World Bank should amend Section 6.02 to incorporate an exception for project financings into the Negative Pledge Clause. It is a simple calculation—allowing project financings to be secured by a lien on the project and its related revenue streams would increase the amount of funds available for the creation of these new works. If the project financing is successful, the creditors will be paid off according to plan and the developing state gains a valuable asset, thus increasing its financial stability and base to repay the World Bank loan. If the project financing is unsuccessful, the creditors can foreclose on an asset and revenue stream that might not have otherwise existed without the creditor’s investment.
The current Negative Pledge Clause is not protecting the World Bank against the kinds of third-party financings that would threaten the bank’s ability to be repaid. On one hand, the current Negative Pledge Clause heightens the uncertainty and transaction costs of intrepid investors willing to risk their investment on an asset already encumbered by the Negative Pledge Clause. On the other hand, the Negative Pledge Clause dissuades certain other investors from lending funds to attractive projects. The reforms proposed here would tailor the Negative Pledge Clause to better fit the mission of the World Bank and the development needs of the borrower country, thus leading to successful fiscal interventions and, ultimately, more prosperous nations.