In Bonds We Trustee: A New Contractual Mechanism To Improve Sovereign Bond Restructurings

November 1, 2013

Governments around the world raise significant amounts of capital by issuing sovereign bonds in international financial markets. These bonds are typically purchased and traded by foreign investors who seek a profitable return on their investment. The issuing country incurs sovereign debt, which it must repay over a predetermined period of time. Occasionally, sovereigns—typically emerging market governments—become unable or unwilling to repay their sovereign debt.

A country’s ability to repay its debt is difficult to assess given the multitude of nonfinancial factors that affect the assessment. As a result, investors are vulnerable to opportunistic defaults which can deprive them of their investment. Additionally, investors cannot collect on their investment through bankruptcy proceedings because a country cannot declare bankruptcy. The financial markets have responded to this challenge with a variety of contractual mechanisms aimed at facilitating a debt restructuring, which will simultaneously lower the sovereign’s debt burden while ensuring that investors receive payment on their investment. Unfortunately, the contractual mechanisms currently utilized in sovereign bond contracts have proven to be inadequate.

This Note begins by explaining sovereign debt and the major problems with the current international sovereign bond market. Next, this Note explores the global community’s various efforts to address these problems thus far and explains why these solutions have proven inadequate. Ultimately, this Note proposes a new contractual mechanism that provides for the creation and use of a new type of trustee to monitor, enforce, and renegotiate sovereign bonds.

November 2013

No. 2