A fair hearing for sovereign debt
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.