A Sovereign Debt Restructuring Framework for the Euro Area

In a new paper, which was recently published in the Fordham International Law Journal, we discuss the legal framework for sovereign debt restructuring in the euro area—both de lege lata and de lege ferenda. Sovereign debt restructurings remain exceptional events that come with profound implications for financial stability and monetary policy transmission. However, they may be necessary as part of a financial assistance program to a euro area Member State, as was the case for Greece in 2012. Indeed, the European Stability Mechanism (ESM), the euro area’s lender of last resort to sovereigns, may only lend to countries with sustainable debts. Thus, if a Member State’s public debt is deemed unsustainable, an orderly debt restructuring may be warranted so as not to overstretch the ESM’s (limited) resources and ensure adequate burden-sharing between the official and the private sector.

This paper seeks to contribute to the ongoing policy discussion on how to enhance the functioning of the Economic and Monetary Union (EMU) by exploring the legal aspects of sovereign debt restructuring in the euro area. The idea behind this paper is our conviction that the unparalleled degree of legal, political, and economic integration between euro area Member States would allow for a more progressive approach to enhancing government debt restructuring procedures than is currently foreseen at the European, or even at the international level for that matter. Drawing upon the International Monetary Fund’s experience, it analyses whether and how the procedures for sovereign debt restructuring in the euro area can be made more orderly, fair, and predictable.

We conclude that policymakers should consider the inclusion of enhanced single-limb Collective Action Clauses (CACs) as well as certain technical amendment clauses that address remaining holdout inefficiencies. The first version of the euro area CAC, which was introduced in 2013, deviated from the international standard, as it did not allow for full aggregation of bondholder votes across all series. Thus, the euro area always faced a residual risk of holdouts blocking individual bond series, as was for instance the case for certain English-law bonds during the Greek debt restructuring of 2012. The recent Eurogroup agreement of June 2019 on a revised ESM Treaty, which makes single-limb CACs mandatory in the euro area is a step into the right direction, although tricky technical details of the new CAC are yet to be decided by the Economic and Financial Committee.

Besides CACs, the paper reviews legal mechanisms to immunise ESM funds from holdout attachment as well as (temporary) stays on debt enforcement actions by opportune investors during restructuring negotiations, also taking account of recent innovations in the context of the Puerto Rican debt restructuring. Finally, we review broader statutory changes to the current framework. Specifically, two options for a sovereign debt dispute resolution mechanism are discussed: (i) a separate chamber at the Court of Justice of the European Union (CJEU) and (ii) a sovereign debt arbitration mechanism. With respect to the latter, we also discuss CETA, the free trade agreement between the EU and Canada, which includes provisions on sovereign debt restructuring and investor-state dispute settlement. The rationale behind the establishment of such tribunals would be to centralise dispute settlement in the context of sovereign debt restructurings, thereby forestalling negative externalities from fragmented judicial decisions on bondholder claims.

We conclude that the euro area’s crisis management framework, with the ESM at its centre, needs a balanced and solid debt restructuring framework. Policymakers need to tools to address deep debt crises in order to avoid that they jeopardise the stability of the European currency area as a whole. Of course, one should not fall prey to the illusion that inefficiencies, risks, and deadweight losses associated with government debt restructurings can be ‘regulated away’. However, an informed discussion about the ways in which the existing framework can be improved seems indispensable to ensure a more resilient, transparent, and legitimate framework to address sovereign debt crises in the euro area.

Sebastian Grund is a Fulbright Scholar at Harvard Law School and worked previously as a Policy Expert at the European Central Bank. The views expressed herein are solely his own.