Constant Dripping Wears Away the Stone: An Incremental Approach to Sovereign Debt Restructuring

The Yale Journal of International Law has just published an online special issue on sovereign debt restructuring. It calls for, and develops, an incremental approach to the regulation of sovereign debt restructurings.

It is almost common sense that the current regime for negotiating sovereign debt restructurings requires improvement. ‘Too little, too late’ has become the slogan of many stakeholders in politics, the financial industry and academia who believe that the current state of affairs is unsatisfactory. ‘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.

So far, so bad. Which solutions impose themselves? An international treaty most probably is not, as desirable as it might be. The current geopolitical situation hardly seems to call for measures involving potential sovereignty costs for states. New contractual clauses allowing for restructurings by a majority of creditors have been the means of choice for the past decade or so. Nevertheless, each variation of these contractual clauses, even the most recent ones, has shortcomings. Holdout creditors usually find ways to get around these clauses and to acquire a blocking minority. For the Eurozone, this has become all the more likely as the ECB, by now an important creditor in the Eurozone, will not participate in a vote, thus further reducing the volume of bonds required to gain a blocking position. 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.

In this situation, the United Nations General Assembly adopted a resolution last September that set out Basic Principles on Sovereign Debt Restructuring Processes. The idea 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.

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 Finnish international lawyer Jan Klabbers provided some concluding thoughts on the difficulties of establishing an international organization for debt restructuring.

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.

Matthias Goldmann is a Junior Professor of International Public Law and Financial Law at Goethe University Frankfurt and a Senior Research Affiliate Max Planck Institute, Heidelberg.