Constant dripping wears away the stone… including sovereign debt

The sovereign debt crises in the Eurozone, in Argentina, or in Ukraine have highlighted that the current international legal regime on sovereign debt is ill equipped to resolve the bankruptcy of nation states. Yet, when it comes to possible reforms, policy-makers and experts have been divided over two opposing solutions: A contractual one, which favors contractual clauses enabling a majority of the creditors of a sovereign bond to restructure it, and a statutory approach, based on a new multilateral treaty and corresponding domestic legislation. Neither of them holds much promise.

The former solution has been the means of choice for the past decade or so, in line with the neoliberal mainstream that has favored private over public settings. Nevertheless, not only does each variation of these contractual clauses, even the most recent ones, have practical shortcomings; the contractual approaches also limit the ability of democratically elected decision-makers to impose on creditors a restructuring they believe to be in the public interest. Statutory solutions might provide a better starting point for democratic decision-making. But the current geopolitical situation hardly seems to allow for measures involving potential sovereignty costs for states.

A regulatory approach for the New Sovereigntist Age

Today, however, a third way between these two alternatives is emerging: The current Yale Journal of International Law online special issue on sovereign debt restructuring calls for, and develops, an incremental approach to the regulation of sovereign debt restructurings. This post opens a blog symposium in which we discuss the proposed incremental approach to sovereign debt workouts. In presenting the incremental approach as an alternative to contractual or statutory approaches, we hope to devise a new, potential avenue for regulatory progress in other areas. Thinking about such avenues seems to be the order of the day in what has been branded here as the new sovereigntist age, i.e. in a time where the rules, convictions and forms of international cooperation that characterized the postwar international order see themselves challenged by authoritarian leaders, non-state actors, and parts of the public. The special issue explores the potential of incrementalism as a principled, yet flexible strategy at the example of sovereign debt restructuring.

The point of departure of the incremental approach to sovereign debt restructuring is an analysis of the contemporary challenges surrounding sovereign debt restructuring. Many stakeholders lament that sovereign debt restructurings are frequently “too little, too late”. “Too little” means that sovereign debt restructurings in the past have not always stabilized the financial situation of a country. Often, they have been tailored in accordance with debt sustainability analyses based on overly optimistic growth projections. “Too late” refers to frequent debtor and creditor procrastination in recognizing that a restructuring is needed. Governments shy away from acknowledging the truth about their debt situation because it is politically costly – debt restructurings always come with unpopular political conditionality. Likewise, creditors might prefer to drag as they face costly write-downs from a restructuring. On top of “too little, too late”, so-called holdout creditors refuse to participate in debt restructurings at the expense of all other creditors. Instead, they might sue the debtor state for the full nominal amount of the outstanding debt they often acquired at huge discounts after the beginning of the crisis. Even though it is still all but a piece of cake to enforce financial claims against states, the ensuing legal uncertainty is often costly for the debtor state and might delay its return to the market. If the situation remains as it is, we are stuck with a more or less dysfunctional regime that creates uncertainty by leaving creditors and debtor states often in the dark about the solution of a debt crisis. Meanwhile, the people of debtor states have paid a high price for multiple rounds of suboptimal restructurings.

The centerpiece of the incremental approach

At the same time, both contractual and statutory solutions had reached a dead end. In this situation, the United Nations General Assembly adopted a resolution in September 2015 that set out Basic Principles on Sovereign Debt Restructuring Processes. It is the centerpiece of the incremental approach. The idea behind it is that an array of principles would establish fairer and more predictable framework for the negotiation of debt restructurings and their outcomes. These principles include well-known principles of international law, such as good faith, transparency, equitable treatment, sovereign immunity, etc. The principles originate in a proposal by UNCTAD published earlier last year. Ultimately, the incremental approach relies on the cooperation of stakeholders in negotiations, courts, and domestic legislatures to avert harmful developments. Legislation against abusive creditor holdouts in the UK and in Belgium give rise to the hope that this is a far cry from wishful thinking.

The special issue of Yale Journal of International Law, edited by Juan Pablo Bohoslavsky and Matthias Goldmann, provides necessary background analysis for these principles. It expands in some detail on their legal status, content and operation. The special issue is based on a profound analysis of the current situation (Gelpern). It is organized around the key principle of sovereign debt sustainability, a concept that has gained more and more traction during the past decades. Further contributions discuss the role of legitimacy and impartiality (Lienau), good faith (Goldmann), and the significance of debt sustainability indicators (Riegner). Special attention is given to human rights. One contribution studies the impact of inequality on human rights enjoyment during and after debt crises (Bohoslavsky), while another contribution engages with the debate about business and human rights, analyzing the role of voluntary human rights codifications (Bradlow). Renowned Helsinki-based international lawyer Jan Klabbers provided some concluding thoughts on the difficulties of establishing an international organization for debt restructuring. In the subsequent posts of this symposium, discussants will respond to incremental approach and the contributions in the special issue, and assess whether this is a viable third way for advancing progressive regulatory policies, or whether such policies should be advanced at all. We look forward to the debate.

Matthias Goldmann is Junior Professor for International Public Law and Financial Law at Goethe University Frankfurt and Senior Fellow at the Max Planck Institute, Heidelberg. An earlier version of this post was published on the Oxford Business Law Blog.

Cite as: Matthias Goldmann, “Constant Dripping Wears Away the Stone… Including Sovereign Debt”, Völkerrechtsblog, 23 January 2017, DOI: 10.17176/20170206-021505.