Recent proposals have called for a sovereign debt restructuring mechanism (SDRM) to adjudicate disputes between sovereign debtors and their creditors. The goal is to develop an explicit framework for dealing with troubled loans to sovereign debtors, which up to this point the financial community has dealt with on a largely ad hoc basis. The goal is to mitigate the inefficiencies associated with default, in much the same way as domestic bankruptcy procedures are intended to mitigate the consequences of default by private entities within a given jurisdiction. 2 As things stand, to the extent that creditors have any legal recourse when faced with sovereign default, they have had to work within the judicial systems of their own localities. An international bankruptcy mechanism could, in principle, mitigate four deficiencies of the status quo.
First, even in the most sophisticated financial centres, legal precedent and codified law provide only very limited guidance about how to deal with sovereign debt. US law, for example, contains detailed provisions and provides rich precedent about how to deal with corporations, individuals, and state and local governments in default, but has little to say about how to deal with foreign governments.
Second, by virtue of the sovereignty of the debtor, these legal systems have little leverage over sovereign debtors anyway. They are also likely to lack jurisdiction over other creditors as well. Hence national legal systems have little ability to reorganise debts, seize assets or impose new management, the standard remedies in the case of domestic bankruptcy.
Third, to the extent that these legal systems impose decisions on sovereigns in default, debtors may see them as biased in favour of creditors who, since they are often a constituent force in the creditor nation, may be expected to have more political clout.
Fourth, the legal systems of some potential creditor countries (e.g. the United States and United Kingdom) have much more experience in dealing with sovereign debt than others. The status quo may favour potential private lenders from these countries relative to others, reducing global competition in the provision of loans.