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A blog on financial markets and their regulation
The ongoing sovereign debt crisis in Europe and elsewhere has made it necessary for finance professionals to understand the legal niceties of sovereign defaults. I have been reading Michael Waibel’s book Sovereign Defaults Before International Courts and Tribunals, Cambridge University Press, 2011 which covers sovereign defaults and international law over the last two centuries.
Chapter 4 of the book dealing with “Monetary reform and sovereign default” is particularly interesting in the context of the current difficulties in the euro zone. From my point of view, the problem with this chapter (and the book in general) is that it is too narrowly focused on the law – the book discusses the legal arguments and outcomes of a legal dispute extensively, but it has very little discussion about the underlying financial transaction or the movement of exchange rates. This makes it difficult to understand the economic significance of many of the disputes.
One of the interesting things that I learnt from this book is that defaulting on a debt does not violate any international law at all. Mere non payment of debt when it falls due is only a breach of contract; there is a violation of international law only if the sovereign repudiates the debt. Waibel quotes Feilchenfeld’s very elegant phrasing of this distinction: “… international law will guarantee to the creditor the existence of debt and of a debtor, but not the existence of a good debt or a rich debtor”. (page 299)
The book devotes a whole chapter to the doctrine of “financial necessity” as an excuse for non performance of an obligation. It quotes the judgement of the tribunal in the Russia Indemnity Case (Russia v Turkey) that the states’s “first duty was to itself. Its own preservation was paramount” (page 97). Similarly, another tribunal held that “the duty of a government to ensure the proper functioning of its essential public services outweighs that of paying its debts” (page 98).
As a practical matter, this principle is of help to a sovereign only if its debt is governed by its own ‘municipal law’. (International law uses the term ‘municipal law’ to denote everything except international law – it includes national, provincial and local laws). For example, until the restructuring earlier this year, most of the Greek debt was governed by Greek law; but post restructuring, most of the debt is now governed by English law.
When sovereign debt is governed by foreign law, the sovereign usually is bound by the jurisdiction of a foreign court and the dispute is then resolved according to the ‘municipal law’ of that financial centre – usually London or New York. One of the developments in international law during the last century has been the progressive erosion of sovereign immunity in international law when it comes to sovereign debt. This trend is very nicely discussed by Panizza, Sturzenegger, and Zettelmeyer in a recent paper in the Journal of Economic Literature (“The Economics and Law of Sovereign Debt and Default”, Journal of Economic Literature, 2009, 47:3, 1-47).
In short, the only relevant law appears to be the ‘municipal law’ under which the debt was issued – international law is by and large irrelevant. For any financial institution that has bought a lot of local law sovereign debt of almost any sovereign in the world, this is not very good news.