A fair hear­ing for sovereign debt

Financial Mirror (Cyprus) - - FRONT PAGE -

Last July, when United States fed­eral judge Thomas Griesa ruled that Ar­gentina had to re­pay in full the so-called vul­ture funds that had bought its sovereign debt at rock-bot­tom prices, the coun­try was forced into de­fault, or “Griesafault.” The de­ci­sion re­ver­ber­ated far and wide, af­fect­ing bonds is­sued in a va­ri­ety of ju­ris­dic­tions, sug­gest­ing that US courts held sway over con­tracts ex­e­cuted in other coun­tries.

Ever since, lawyers and econ­o­mists have tried to un­tan­gle the be­fud­dling im­pli­ca­tions of Griesa’s de­ci­sion. Does the author­ity of US courts re­ally ex­tend be­yond Amer­ica’s bor­ders?

Now, a court in the United King­dom has fi­nally brought some clar­ity to the is­sue, rul­ing that Ar­gentina’s in­ter­est pay­ments on bonds is­sued un­der UK law are cov­ered by UK law, not US ju­di­cial rul­ings. The de­ci­sion – a wel­come break from a se­ries of de­ci­sions by Amer­i­can judges who do not seem to un­der­stand the com­plex­i­ties of global fi­nan­cial mar­kets – con­veys some im­por­tant mes­sages.

First and fore­most, the fact that the Ar­gen­tine debt ne­go­ti­a­tions were pre­empted by an Amer­i­can court – which was then con­tra­dicted by a Bri­tish court – is a stark re­minder that mar­ket-based so­lu­tions to sovereign-debt crises have a high po­ten­tial for chaos. Be­fore the Griesafault, it was of­ten mis­tak­enly as­sumed that so­lu­tions to sovereign-debt re­pay­ment prob­lems could be achieved through de­cen­tralised ne­go­ti­a­tions, with­out a strong legal frame­work. Even af­ter­wards, the fi­nan­cial com­mu­nity and the In­ter­na­tional Mon­e­tary Fund hoped to es­tab­lish some or­der in sovereign-bond mar­kets sim­ply by tweak­ing debt con­tracts, par­tic­u­larly the terms of so-called col­lec­tive-ac­tion clauses (which bind all cred­i­tors to a re­struc­tur­ing pro­posal ap­proved by a su­per­ma­jor­ity).

But sim­ple mod­i­fi­ca­tions like con­tract amend­ments will not over­come the sys­tem’s de­fi­cien­cies. With mul­ti­ple debts sub­ject to a slew of some­times-con­tra­dic­tory laws in dif­fer­ent ju­ris­dic­tions, a ba­sic for­mula for adding the votes of cred­i­tors – which sup­port­ers of a mar­ket-based ap­proach have pro­moted – would do lit­tle to re­solve com­pli­cated bar­gain­ing prob­lems. Nor would it es­tab­lish the ex­change rates to be used to value debt is­sued in dif­fer­ent cur­ren­cies. If th­ese prob­lems are left to mar­kets to ad­dress, sheer bar­gain­ing power, not considerations of ef­fi­ciency or eq­uity, will de­ter­mine the so­lu­tions.

The con­se­quences of th­ese de­fi­cien­cies are not mere in­con­ve­niences. De­lays in con­clud­ing debt re­struc­tur­ings can make eco­nomic re­ces­sions deeper and more per­sis­tent, as the case of Greece il­lus­trates.

This brings us to the sec­ond les­son of the Bri­tish rul­ing. With the stakes so high and the sys­tem so bro­ken, debt mar­kets have lit­tle rea­son to re­main in the US. Amer­ica has al­ways prided it­self on the strength of its “rule of law,” a sell­ing point that has made Wall Street host to the largest sovereign-debt mar­ket. But Griesa’s rul­ing, based on a pe­cu­liar – and in our view, in­de­fen­si­ble – in­ter­pre­ta­tion of cer­tain terms in Ar­gentina’s con­tract, showed that US com­mer­cial in­ter­ests can dom­i­nate its courts’ de­ci­sions.

The vaunted Amer­i­can rule of law no longer looks so ro­bust. Per­versely, it protects the strong against the weak. The Griesafault is only the lat­est of many de­ci­sions and legal changes that have re­vealed what one might call a symp­tom of “cor­rup­tion, Amer­i­can-style,” in which lob­by­ing and cam­paign con­tri­bu­tions com­pro­mise the en­tire sys­tem, even when no in­di­vid­ual of­fi­cial is on the take. The US would be wise to re­act be­fore the sovereign-debt mar­ket mi­grates from New York.

China should stand ready to pick up the slack. Its sav­ings now far out­strip those of the US, and it is striv­ing to make Shang­hai a global fi­nan­cial cen­ter. That am­bi­tion has be­come more at­tain­able in view of the dam­age to the US sys­tem’s cred­i­bil­ity in the af­ter­math of the 2008 fi­nan­cial cri­sis. But, if Shang­hai is to emerge as a leader in sovereign lend­ing mar­kets, China should be aware of the short­com­ings of legal frame­works else­where, and de­sign a more ef­fi­cient and eq­ui­table al­ter­na­tive.

The fi­nal, over­ar­ch­ing mes­sage of the Bri­tish court’s de­ci­sion is one that all coun­tries should heed. There is an ur­gent need to re­new the United Na­tions’ ef­forts to cre­ate a multi­na­tional legal frame­work for sovereign-debt re­struc­tur­ing. Though the US is striv­ing to un­der­mine th­ese ef­forts, the UK rul­ing re­minds us that Amer­ica’s judges are not the world’s judges.

That last rev­e­la­tion may not make Wall Street happy; but, for the many coun­tries around the world that rely on sovereign debt, it is very good news in­deed.

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