Restructuring Euro Area Sovereign Debt: Have the Options Narrowed?

Abstract

ABSTRACT This article examines the intersection between two key attributes of sovereign debt governance in the Euro Area. First, sovereigns mostly issue bonds governed by their own law. This ‘local law advantage’ should make debt restructuring comparatively easy, as the sovereign can change the law to reduce its debt. The second attribute is the so-called ‘Euro CAC’, which is a contract-based restructuring mechanism mandated by the Treaty Establishing the European Stability Mechanism (the ESM Treaty). The Euro CAC lets a bondholder supermajority approve a restructuring and bind dissenters. Since 2013, nearly all Euro Area sovereign debt has included the clause. Many believe the ESM Treaty requires governments to use the Euro CAC to restructure. But if so, the Treaty is a suicide pact, for the design of the Euro CAC is flawed. In a meaningful subset of cases, the clause will not provide adequate debt relief. This article makes two primary contributions. First, using an Italian restructuring as an example, it explains why the ESM Treaty does not, in fact, require the use of the Euro CAC. Second, it examines the legal constraints—the most pertinent of which derive from the European Convention on Human Rights—that do restrict the use of local-law advantage.