How Neutral is the Law of Sovereign Debt Restructuring?

Abstract

The myth of neutrality permeates many spheres of international law. In the law of sovereign debt restructuring, it is under pressure, especially in the aftermath of the Global Financial Crisis. The key assumption is that the status quo allows the market to freely develop its own standards, and use contracts to autonomously structure their bargains. Secondly, the actors of sovereign debt restructuring (such as the Institute of International Finance) are sometimes labelled as hybrid public-private entities. This aims at legitimating them as neutral, by implying that they fairly and adequately take into account and balance all the interests at stake. Thirdly, the procedure followed by the International Monetary Fund (IMF) during a restructuring is supposed to be neutral, and follow the same steps for all countries affected. This paper critiques each of these assumptions. Firstly, it takes issue with the notion that the current framework for sovereign debt restructurings is purely an offspring of the practices of market actors. Free markets and freedom of contract are commonly held as the keystones of neutrality: the entities active on a market are free to shape their economic bargains in the manner that best suits their needs and interests. Without external, top-down imposition of rules, these rational actors will come to an efficient contractual settlement of their transactions. In the sovereign debt restructuring field, this translated into the adoption and diffusion of collective action clauses (CACs). Commonly used in corporate bonds under English law, such provisions allow a majority of bondholders to bind all of them to a change of bond terms. Both in 2001-3 and in 2014-5, when, respectively, the IMF and the UN General Assembly debated the establishment of public international law mechanisms to restructure sovereign debt, the political response was to point to CACs as the most feasible alternative, which had come about from the market itself. This brought to an end a momentum which could have led to significant legal reforms on both occasions. However, the contractual solution based on CACs was not the natural outgrowth of the markets. It was a considerable effort on the part of the US Treasury (and others) that spurred the introduction and subsequent reform of CACs. In 2015, the final outcome was left to a representative of private actors, the International Capital Market Association, in order to present the clauses as a market standard. In reality, the objective was to preserve the US’ role in international financial markets by keeping New York law and its courts in charge of sovereign debt disputes. The problems arising from the extraterritorial reach of Judge Thomas Griesa’s orders for Argentina’s restructured bondholders are clear indicators of the magnitude of the power that a contractually-designated domestic court enjoys, instead of a potential international forum. Secondly, the paucity of international fora, and the rapid changes in the form of sovereign debt (from syndicated bank lending to bonds) have resulted in the legitimation of new institutions. The paramount example is the Institute of International Finance. It played a major role in the restructuring of Greek sovereign debt in 2012. The Institute likes to define itself as a neutral forum which facilitates the exchange of information, a public-private entity which fairly represents the interests of all stakeholders. Nevertheless, a careful analysis of its history, membership, and internal functioning demonstrates that private interests have an overwhelming power. Furthermore, the bigger financial institutions enjoy a more favourable projection than the other members. Thirdly, the procedure that the IMF follows during sovereign debt crises is supposed to be neutral, and assess the sustainability of public debt based on financial data. As a technocratic institution, the Fund purports to establish policies and apply them equally to all countries in need of assistance. However, the recent report by the Independent Evaluation Office has unmistakably shown the different treatment that was reserved to the Eurozone. The urge to safeguard the monetary union led to a significant change in IMF policies. The deference to European authorities not only alienated the other members which had suffered from a harsher treatment in the past, but also resulted in a postponement of the restructuring which proved problematic for Greece. In conclusion, the complexity of the law of sovereign debt restructuring conceals its lack of neutrality. This applies to the content of the law (the contractual approach), the actors involved (the Institute of International Finance), and the processes followed (the IMF’s handling of crises). In a changing geopolitical landscape, the imbalances of such non-neutral system might be radically challenged.