Greece is going to close its banks and stock market until it sorts out how to prevent its citizens from withdrawing their assets from their financial intermediaries post haste. This is a pretty old school technique - the US did some of these to prevent panic withdrawals during the Great Depression, and the UK did the same during the currency crisis of 1968, during which it also shut the London Gold Market for two weeks. New technology has made these holidays less oppressive - ATMs with withdrawal limits were kept open when Cyprus did this. But it is still quite the heavy hand of the state, and one of the first resorts when a bank run is really on. As they say, developing.
In my last post—also a shameless plug for my recent article, “Boilerplate Shock”—I argued that boilerplate terms governing securities could serve as a trigger that transforms an isolated credit event into the risk of a broader systemic failure. I’ll now briefly explain why I see this danger—which I call “boilerplate shock”—as a general problem in securities regulation, not just some quirky feature of Eurozone sovereign debt (the focus of the paper and post). Any market where securities are governed by uniform boilerplate terms is vulnerable to boilerplate shock.
The nature of this phenomenon—systemic risk—is of course familiar, but its source in contract language is a little unintuitive. How could private contracts unravel an entire securities market or the world economy?
Coordination around uniform standards.
In the back of our mind most of us probably still conceive of contracting as an activity that occurs among two, or perhaps a few, individuals or firms. But when standard terms are used by virtually all actors within a given market, it’s worth considering the collective impact of those terms as a distinct phenomenon.
Coordination’s benefits are well known. Consider uniform traffic signals. But coordination can also compound the effects of bad individual decisions.
As Charles Whitehead has argued, widespread “destructive coordination” among banks during the precrisis days helped generate systemic risks. When the credit markets froze, for example, firms using the same risk management formulas reacted in the same way at the same time. This helped transform isolated events into systemic ones—e.g., Lehman, the canonical example of a failure that triggered a de facto coordinated panic.
A similar risk, I argue, is present where participants in a securities market rely on the same standardized contract terms. Whether they were intended to or not, these terms will often control what happens in the event of certain legal emergencies, like a country departing the euro or Lehman declaring bankruptcy.
For example, if an effort by Greece to pay its bonds in “new drachmas” is rejected because of Boilerplate Contract Terms A and B, the market will surely be concerned that Terms A and B also govern the bonds of similarly situated borrowers, like Spain, Italy, etc. You’ll see that the borrowing premium the “peripheral” euro countries (the uppermost five lines: Ireland, Italy, Greece (biggest spike), Portugal, Spain) paid versus richer euro countries (Germany, France, the Netherlands, the three lowest lines) zoomed higher as worry over a Greece exit gripped markets in late 2011/early 2012, and again (to a lesser extent) because of Cyprus exit talk in early 2013:
Bloomberg. Click to enlarge.
Moreover, this panic occurred against a backdrop of unduly rosy assumptions (namely, that a departing euro country could convert its bonds into a new currency and thereby avoid default, a likely contagion trigger). I argue that the uniformity of boilerplate across these bonds would intensify these problems significantly since it’s likely to result in a declaration of default.
To my mind, this demonstrates that boilerplate securities contracts, in the aggregate, can be systemically significant. “Boilerplate Shock” introduces this concept and offers a modest proposal to mitigate its dangers in the Eurozone.
Beyond the euro, what about the risks of boilerplate shock in general?
Boilerplate shock is probably an inherent and permanent risk in any securities market.
Securities contracts are quintessential candidates for boilerplate. They are used by sophisticated parties for repeat or similar transactions and are drafted quickly—sometimes in three and a half minutes. The (correct) assumption is that they are more efficient for the parties that use them.
I’d like to begin thinking about how contracts can be drafted with a view to systemic risk mitigation, or at least to avoid exacerbating existing risks. But I think this is a hard problem that lacks an off-the-shelf solution:
- The nature of the risk is that it is a byproduct, not the result of intentional choices about risk allocation. This is the reason for the information-forcing default rule I propose in the Eurozone.
- The risk is also an externality: it is severe because of its collective impact. The parties do not bear the primary risk that uniform contracts will result in a meltdown, and in the unlikely event a crash happens (1) no individual party will be to blame and (2) at least one party to the initial transaction (the initial purchaser of a bond, for example) will probably no longer hold the asset, because most systemically significant securities are actively traded on the secondary market.
But banning or discouraging boilerplate is not the answer:
- The risk that a bunch of assets governed by the same terms will plummet in value is not only an externality. Risk allocation among parties might improve if scrutiny of existing securities boilerplate improves. The terms can evolve.
- A requirement to craft unique, artisanal terms—disclosures, subordination provisions ("flip clauses"), choice of governing law—for each individual securities transaction would be criminally inefficient.
- A requirement to craft unique contract terms might even be unjustified on risk-management terms alone, because it would increase drafting errors.
It's tricky to mitigate the risks of securities boilerplate.
Some options for places to start:
- Validation by third parties: perhaps issuers could use risk-rated contract templates. For example, see credit ratings…but see credit ratings.
- Culture: inculcate systemic risk mitigation as a professional norm among private sector lawyers? In principle, this could work. The number of lawyers who draft these contracts is pretty small. In practice, one could envision many complications.
- Insurance: encourage the development of derivatives to account for the possibility of boilerplate shock? Like some of the other solutions, this one presumes some agreement on what terms create the risk of boilerplate shock. It could also encourage new forms of moral hazard.
- Mandatory regulation: some public entity could be tasked with the mission of proactively identifying and combating the risk of boilerplate shock in contract practices. Arguably a natural choice given that the risk is an externality. Nevertheless, I’m a little skeptical. First of all, who would do it? A domestic regulator, like the SEC or CFTC, that might be dodged on jurisdictional grounds? An international institution, which is arguably more subject to capture? More generally, regulation seems like a heavy-handed first choice.
In sum, when standardized and aggregated, choices that determine legal risks—e.g., contract terms designating governing law, payment priority—can create the same hazards as choices about business risks. This suggests that contract terms should be taken seriously as possible sources of systemic risk alongside more familiar sources, like leverage and credit quality.
Securities contracts as a source of systemic risk—what do you think?
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© Disney, “Duck Tales”
I expressed concern in my last post that uniform contract terms could destabilize securities markets in unexpected ways. In a recent paper, I dub this risk “Boilerplate Shock.” The paper uses boilerplate terms in Eurozone sovereign bonds as a case study, but I argue that any market in which a lot of securities are governed by uniform contract terms is vulnerable to boilerplate shock. In this post, I will focus on the Eurozone and my proposed solution to the risk of boilerplate shock there.
One major problem is that no one really knows how to deal with sovereign debt obligations denominated in a currency that still exists but is no longer used by the debtor. A partial breakup of the European Monetary Union would trigger some question marks in commercial law and private international law (among other things).
In the Eurozone sovereign lending market, bond contracts typically contain standardized language specifying:
(a) choice of governing law (often foreign), and
(b) currency of payment (euros).
The combined effect of these clauses, I argue, is to render any country that departs the euro more likely to default on its debt. Whatever the impact of the departure itself, a forced default would make things much worse for Europe and the world economy.
Leading scholars have concluded or strongly suggested that a sovereign that changes currencies can redenominate (convert) its bonds to its new currency even where the contract is governed by foreign law (e.g., Philip Wood (p. 177), Michael Gruson (p. 456), Arthur Nussbaum (pp. 353-59), Robert Hockett (passim)). As a descriptive matter, I believe this to be a mistaken interpretation of New York (and probably English) private international law and commercial law (see “Boilerplate Shock” pp. 47-67). But normatively, I agree: a sovereign should be able to redenominate its bonds under certain circumstances. Among other things, the alternative would make currency union breakups far more dangerous than they already are.
- The prevailing consensus underestimates the risk that a departing Eurozone member’s attempt to redenominate its sovereign bonds into a new currency will be ruled a default.
- Since the bonds of other struggling euro countries are largely governed by the same boilerplate terms ((a) and (b) above), this misapprehension has the potential to be particularly damaging. In addition to surprising the market (which appears to incorporate this consensus), it is likely to spread beyond the immediate debtor to the bonds of similarly situated countries that have issued under the same terms.
- Same for CDSs (which are likewise often governed by foreign law, usually New York).
- Thus, given the widespread use of terms (a) and (b), a ruling that a departing country cannot pay its euro-denominated contracts in a new currency could cause the market to demand unsustainable premiums from other weak debtors.
- This could cause Eurozone countries to lose market access. Greece is not TBTF in any sense, but some of its neighbors are—and are also too big for the EU (including the ECB) and IMF to bail out. Italy (the world’s 9th largest economy) and Spain (13th) come to mind.
Thus, if my commercial law/private international law analysis is right, these boilerplate contracts could end up playing quite a big role in the event of any euro breakup.
To mitigate this risk of boilerplate shock, I suggest a new rule of contract interpretation. The proposal is detailed at pp. 67-71 of the article. I suggest commercially significant jurisdictions adopt it by statute. Here is a quick summary.
Any sovereign that:
- Belongs to an international monetary union, and
- Issues bonds in the currency of that monetary union subsequent to the adoption of this rule, and
- Leaves the monetary union and introduces its own currency,
shall retain the right to redenominate its bond obligations into its new currency, UNLESS the sovereign has affirmatively waived the right to redenominate its bonds.
You’ll notice this is a default rule—merely a presumption of the right to redenominate—not a mandatory rule. It is also prospective-only: it does not apply to existing issuances. It also does not protect sovereigns that issue in foreign currency (e.g., Argentina), only those that are monetary union members and issue in the common currency (e.g., France).
The reason for these limitations is to minimize unintended consequences and near-term disruption to the market, but also to embody the relatively modest objectives of the rule. It is an information-forcing default rule that is intended to facilitate better risk management by parties. It is not a “save the world” rule.
The challenge, as I’ll discuss in my next post on the paper, is not that redenomination would be ruled impermissible when it ought to be available (otherwise, that might suggest a mandatory “pro-redenomination” rule). It is that the likely effect of these boilerplate terms—to prohibit redenomination—was almost certainly not bargained for and is largely unknown to parties. This market failure has, in turn, created latent risks to the broader financial system and the existing legal tools are poorly suited to address them.
By now, the risk that a distressed European nation such as Greece might leave the Eurozone and thereby spark global economic calamity is well known. Regular readers of this blog may even privately relish the prominence of the issue. Not since the days of the gold standard has international monetary policy come so close to being a socially acceptable topic of dinner conversation.
As I noted in my first post, observers rightly perceive the Eurozone sovereign debt crisis to be driven by political and economic forces. But many consequences of a euro breakup would be determined by law, including sources of American (specifically New York) private law.
This is a complex issue. I try to address it more fully in a new article, "Boilerplate Shock," which I've just posted on SSRN.
In brief, and to continue picking on Greece, one key question in the event of a euro breakup would be: would a court recognize an attempt by Greece to convert its euro-denominated debt into its new currency, or would it instead insist that Greece pay in euros, the currency of contract? The answer is important because, as a practical matter, requiring payment in euro would be tantamount to forcing a default.
That's the familiar narrative, anyway. And I agree. But I believe that the ubiquity of boilerplate terms in these bonds—specifically, clauses selecting governing law (usually foreign) and currency of payment (euro)—is likely to make any dispute over redenomination even more damaging than this suggests.
In the article, I argue that the sparse literature on the question of redenominating sovereign bonds overlooks some sources—especially cases interpreting New York contract law and private international law—that, if extended to Eurozone sovereign bonds, could surprise the market and cause serious global repercussions. I argue that the reason for this is not only that the dominant view overlooks what are likely controlling sources of law. It is that standardization of contract terms across the Eurozone sovereign lending market makes the stakes of surprise that much higher.
If Greece's attempt to redenominate its bonds is declared a default, then the fact that the operative terms in Italian, Spanish, Irish, etc. sovereign bonds are the same or similar makes markets likely to demand unsustainable premiums from those countries. Capital and investor flight could be very rapid. We have seen several previews of this movie over the past few years in the Eurozone, and each time official-sector bailout institutions have saved the day. But the European Union/European Central Bank and IMF probably do not have the resources to stop a broad-based bank run of this nature, to say nothing of the political support necessary to attempt it.
Maybe none of that will happen. Nevertheless, the potential for uniform contract terms to create risk not just to individual third parties but to securities markets seems likely to grow at least as fast as those markets. Using Eurozone sovereign bonds as a case study, I introduce the term "boilerplate shock" to describe the potential for standardized contract terms—when they come to govern the entire market for a given security—to transform an isolated default on a single contract into a threat to the market of which it is a part, and, possibly, to the economy in general. My larger objective here is to foster a discussion of the potential for securities law and private-sector securities lawyers to manage (or alternatively, to contribute to) systemic risk.
I've posted an abstract below and will be returning to the subject. I look forward your comments.
Boilerplate Shock abstract:
No nation was spared in the recent global downturn, but several Eurozone countries arguably took the hardest punch, and they are still down. Doubts about the solvency of Greece, Spain, and some of their neighbors are making it more likely that the euro will break up. Observers fear a single departure and sovereign debt default might set off a “bank run” on the common European currency, with devastating regional and global consequences.
What mechanisms are available to address—or ideally, to prevent—such a disaster?
One unlikely candidate is boilerplate language in the contracts that govern sovereign bonds. As suggested by the term “boilerplate,” these are provisions that have not been given a great deal of thought. And yet they have the potential to be a powerful tool in confronting the threat of a global economic conflagration—or in fanning the flames.
Scholars currently believe that a country departing the Eurozone could convert its debt obligations to a new currency, thereby rendering its debt burden manageable and staving off default. However, this Article argues that these boilerplate terms—specifically, clauses specifying the law that governs the bond and the currency in which it will be paid—would likely prevent such a result. Instead, the courts most likely to interpret these terms would probably declare a departing country’s effort to repay a sovereign bond in its new currency a default.
A default would inflict damage far beyond the immediate parties. Not only would it surprise the market, it would be taken to predict the future of other struggling European countries’ debt obligations, because they are largely governed by the same boilerplate terms. The possibility of such a result therefore increases the risk that a single nation’s departure from the euro will bring down the currency and trigger a global meltdown.
To mitigate this risk, this Article proposes a new rule of contract interpretation that would allow a sovereign bond to be paid in the borrower’s new currency under certain circumstances. It also introduces the phrase “boilerplate shock” to describe the potential for standardized contract terms drafted by lawyers—when they come to dominate the entire market for a given security—to transform an isolated default on a single contract into a threat to the broader economy. Beyond the immediate crisis in the Eurozone, the Article urges scholars, policymakers, and practitioners to address the potential for boilerplate shock in securities markets to damage the global economy.
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The AALS Section on Financial Institutions & Consumer Financial Services and Section on European Law are pleased to invite you to attend their joint program, Taking Stock of Post-Crisis Reforms: Local, Global, and Comparative Perspectives on Financial Sector Regulation, at the AALS 2014 Annual Meeting in New York City, on Friday, January 3, at 10:30 a.m. – 12:15 p.m.
The program will feature three paper presentations:
- Arthur Wilmarth (George Washington University), Citigroup: A Case Study in Managerial and Regulatory Failures, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2370131
- Hilary Allen (Loyola University New Orleans), Why Wall Street Isn’t in Jail: The Unpunishable Moral Failures that Helped Cause the Financial Crisis, and How to Address Them in the Future, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2336678
- Kazi Sabeel Rahman (Harvard University), Managerialism, Structuralism, and Moral Judgment: Law, Reform, Discourse, and the Pathologies of Financial Reform in Historical Perspective, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2368292
Anna Gelpern (Georgetown) and Robert Hockett (Cornell) will serve as panel discussants, and Peter Lindseth (University of Connecticut) will moderate the discussion.
Immediately following the joint program, at 12:15 p.m. on January 3, 2014, The Section on Financial Institutions & Consumer Financial Services will host a luncheon with keynote remarks by Sean Hagan, General Counsel of the International Monetary Fund.
Over at Opinio Juris, I have an essay up reviewing Katerina Linos's excellent book on The Democratic Foundations of Policy Diffusion. It is part of an online symposium with lots of august participants, as well as an august author, so do give it a look. Here's a taste:
Katerina Linos knows the – always surprising to me, but repeatedly tested by political scientists – fact that countries adopt the policies of their similar, often nearby, neighbors. In The Democratic Foundations Of Policy Diffusion, she argues that there is good news underlying this trend of cross-border adoption. Rather than being a function of bureaucrats forcing, say Swiss health care models down the throats of American citizens, she shows that, across countries, and even among Americans themselves, 1) citizens prefer policies that are proposed with evidence of foreign and international organization endorsement; and 2) politicians invoke this sort of evidence when trying to mobilize support for their programs.
This might strike your average American, who, if she is anything like me, is hardly maximally cosmopolitan, as implausible. How many voters, let alone the median American voters political scientists think about the most, care about how they do things in Canada, or can be bothered to find out? Will they really choose the suite of policies proposed by the leader who does the best job invoking the recommendations of the United Nations on the campaign trail?
Call for Papers
AALS Joint Program of the Financial Institutions & Consumer Financial Services Section and the European Law Section
Taking Stock of Post-Crisis Reforms: Local, Global, and Comparative Perspectives on Financial Sector Regulation
AALS Annual Meeting, January 3, 2014
New York, New York
The AALS Section on Financial Institutions & Consumer Financial Services and Section on European Law are pleased to announce that they are sponsoring a Call for Papers for their joint program on Friday, January 3, at the AALS 2014 Annual Meeting in New York, New York.
The topic of the program and call for papers is “Taking Stock of Post-Crisis Reforms: Local, Global, and Comparative Perspectives on Financial Sector Regulation.” The financial crisis of 2008 was truly a global crisis, and the world continues to face a wide range of post-crisis economic and political challenges. Today, several years after the market turmoil began, both the United States and the European Union are in the midst of major regulatory reforms in the financial services sector. The effects of these financial regulation reforms however, remain unclear. Structural reform in the U.S. is thus far limited to a yet-to-be finalized "Volcker Rule," while in the U.K. and the Eurozone, respectively, Vickers- and Liikanen-style "ring-fencing" remain incomplete if not inchoate. Debate in the U.S. still rages around whether and how smaller "community banks" should be regulated differently from megabanks, while the E.U. continues to debate whether to form a "banking union" at all and, if so, what it might or could entail, given various political constraints. Meanwhile, the U.S. Federal Reserve continues to innovate in the realm of monetary policy in the absence of functional fiscal policy, while the European Central Bank moves furtively toward acting as a full Fed-style central bank capable of backstopping sovereign debt instruments and providing real liquidity. Where might these multiple developments be ultimately heading, and what might the Americans and Europeans learn from each other as they grope tentatively forward? What broader implications do they raise for political accountability and legitimacy in a post-crisis world?
Form and length of submission
The submissions committee looks forward to reviewing any papers that address the foregoing topics. While the preference will be given to papers with a clearly comparative focus, the committee’s overall goal is to select papers that will facilitate discussion of, and comparisons between, American and European approaches to various aspects of financial services regulation. Potential topics include macro-prudential regulation, consumer protection, monetary policy, regulation and supervision of financial intermediaries, structural reforms, and related issues of political accountability and legitimacy.
Abstracts should be comprehensive enough to allow the committee to meaningfully evaluate the aims and likely content of papers they propose. Eligible law faculty are invited to submit manuscripts or abstracts dealing with any aspect of the foregoing topics. Untenured faculty members are particularly encouraged to submit manuscripts or abstracts.
The initial review of the papers will be blind. Accordingly the author should submit a cover letter with the paper. However, the paper itself, including the title page and footnotes must not contain any references identifying the author or the author’s school. The submitting author is responsible for taking any steps necessary to redact self-identifying text or footnotes.
Papers may be accepted for publication but must not be published prior to the Annual Meeting.
Deadline and submission method
To be considered, papers must be submitted electronically to Saule Omarova at email@example.com and Peter Lindseth at firstname.lastname@example.org.
The deadline for submission is September 3, 2013.
Papers will be selected after review by members of a Committee appointed by the Chairs of the two sections. The authors of the selected papers will be notified by September 30, 2013.
The Call for Paper participants will be responsible for paying their annual meeting registration fee and travel expenses.
Full-time faculty members of AALS member law schools are eligible to submit papers. The following are ineligible to submit: foreign, visiting (without a full-time position at an AALS member law school) and adjunct faculty members, graduate students, fellows, non-law school faculty, and faculty at fee-paid non-member schools. Papers co-authored with a person ineligible to submit on their own may be submitted by the eligible co-author.
Please forward this Call for Papers to any eligible faculty who might be interested.
While Americans worry that there isn't enough accountablility being imposed on banks for the financial crisis, the Times observes that European banks are forking over billions in penalties to their regulators. LIBOR is one thing, there's an insurance product that is causing no end of headaches, and:
European banks are expected to pay a total of about $25 billion for settlements and client compensation, so far. HSBC has to write the biggest check, paying $1.9 billion for lapses in its anti-money laundering controls. (A number of banks, however, have made provisions for potentially larger amounts.)
ING Bank, part of the Dutch financial giant ING Group, reached a $619 million settlement for allegation of sanction violations in June. Standard Chartered, based in London, agreed to pay a total of $667 million in two separate money-laundering claim settlements in August and December.
To be sure, American regulators haven't exactly eased off on sanctioning boycott avoiders. But this action in Europe is all worth keeping an eye on, if only for the possibility that financial regulation could go the way of antitrust or accounting, where global standards are set by European regulators. It is too soon to suggest that something like this is happening yet, and there is a great deal of work being done on harmonizing global standards so that European rules do not get applied extraterritorially. But it isn't outside the realm of possibility.
Here is a highly productive way for business law professors to procrastinate from grading exams:
The National Bureau of Economic Research just circulated a new version of a paper that provides a medieval complement to the law & finance literature and to Gilson's lawyer as transaction cost engineer idea. The paper by Davide Cantoni and Noam Yuchtman presents evidence that the training of commercial lawyers by new universities contributed to the expansion of economic activity in medieval Germany. Here is the abstract:
We present new data documenting medieval Europe's "Commercial Revolution'' using information on the establishment of markets in Germany. We use these data to test whether medieval universities played a causal role in expanding economic activity, examining the foundation of Germany's first universities after 1386 following the Papal Schism. We find that the trend rate of market establishment breaks upward in 1386 and that this break is greatest where the distance to a university shrank most. There is no differential pre-1386 trend associated with the reduction in distance to a university, and there is no break in trend in 1386 where university proximity did not change. These results are not affected by excluding cities close to universities or cities belonging to territories that included universities. Universities provided training in newly-rediscovered Roman and Canon law; students with legal training served in positions that reduced the uncertainty of trade in medieval Europe. We argue that training in the law, and the consequent development of legal and administrative institutions, was an important channel linking universities and greater economic activity.
A very interesting read.
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We'll outsource to DealBook:
The Lloyds Banking Group, partly owned by the British government after receiving a bailout, on Monday became the first bank in Britain to cut past bonuses because of losses that turned up later.
The bonus clawback of about £2 million ($3.2 million) applies to five former or current executive directors, including a former chief executive, and eight other managers. Eric Daniels, who left the bank as chief executive last year, would have to give up 40 percent of the share bonus he was awarded for 2010, or about £580,000, Lloyds said.
Something close to a plurality of corporate scholars are working on papers related to the financial crisis in the United States. I think it is much less likely that we will see something similar with the potentially even more dramatic European financial crisis. Here's why:
- A lot of what is happening in Europe is politics and markets, not law. For sovereign debt, lawyers put together the instruments, and creditors can in theory (but not in practice) sue on default. Ditto for the credit default swaps. But the decisions about whether to issue them, whether to buy them... those aren't legal decisions, they are market ones. And they are the ones of interest in the crisis.
- Similarly, the decision to bail out Greece isn't a matter of a European agency acting creatively. Instead, every member of the EU passed a law permitting a bailout. Again, there's not much to chew on there in terms of administrative law.
- Of course, it isn't like there is no law to apply. What the EU and the ECB do is governed by law ... but that's European law, it's hard, and I doubt American academics will have much to say about it.
- There are some questions of interest, of course. Consider MF Global’s bankruptcy filing, which has some stuff on how its exposure to European debt wasn’t working for its regulators or Moody’s. Might be something interesting there for lawyers. But generally, I'm not holding my breath.
- I predict the sovereign debt experts in the academy - your Gulatis and your Gelperns - will have plenty of wisdom to impart, by the way. But that's only a smidge of the corporate law academy, rather than, like, most of it.
There are two important forms of adjudication in international economic law. One may be found in the WTO, the other in the welter of treaties that permit resort to tribunals in international investment law, which often reference an ad hoc right of review, often to a tribunal set up by ICSID. This matters to foreign investors because it means that if the country in which they have invested treats them, say, differently than domestic investors, they needn't go to the local court, but can drag the sovereign into arbitration in DC, or Stockholm, or Paris, or wherever the investment treaty provides for a remedy. At the annual meeting of the American Society of International Law, there was some sense of ferment in this latter form of adjudication.
- You can't appeal an adverse decision in these cases - or can you? The very technical and limited means that you could use to complain about a ruling - a decision was never issued, or the panel was constructed incorrectly - has recently, maybe, given way to "the panel didn't explain its decision," which is sort of close to "didn't explain why our argument wasn't correct." If a right of appeal exists in this sort of law, it looks a little less like arbitration and a little more like, well, law.
- What is the same treatment as between foreign and domestic investors anyway? Is it the same thing as the national treatment principle in the WTO? There was a panel at ASIL considering that very question, which I'm pretty surprised is still an open one. My own view is that international finance is well on its way to adopting a national treatment principle sotto voce, but if various courts think that the principle means very different things, then finance's legal achievement will be limited.
- And it's not even clear whether there's a common approach to fee and cost shifting in investment law. Consider Susan Franck's recent paper, here's the abstract, which is a good way to familiar yourself with the latest greatest:
International investment and related disputes are on the rise. With national courts generally unavailable and difficulties resolving disputes through diplomacy, investment treaties give investors a right to seek redress and arbitrate directly with states. The costs of these investment treaty arbitrations — including the costs of lawyers for both sides, as well as administrative and tribunal expenses — are arguably substantial. This Article offers empirical research indicating that even partial costs could represent more than 10% of an average award. The data suggested a lack of certainty about total costs, which parties had ultimate liability for costs, and the justification for those cost decisions. Although there were signs of balance and a preference for parties to be responsible for their own costs, there was neither a universal approach to cost allocation nor a reliable relationship between cost shifts and losing. Awards typically lacked citation to legal authority and provided minimal rationale, and the justifications for cost decisions exhibited broad variation. Small pockets of coherence existed. Tribunals typically decided costs only in the final award; and as the amount investors claimed increased, tribunal costs also increased. Such a combination of variability and convergence can disrupt the value of arbitration for investors and states. In light of the data, but recognizing the need for additional research to replicate and expand upon the initial findings, this Article recommends states consider implementing measures that encourage arbitrators to consider specific factors when making cost decisions, obligate investors to particularize their claimed damages at an early stage, and facilitate the use of other Alternative Dispute Resolution (ADR) strategies. Establishing such procedural safeguards can aid the legitimacy of a dispute resolution mechanism with critical implications for the international political economy.
- Daniel Drezner argues that Europe is likely to come out of the current crisis pursuing even more integration, and I must say, I'm betting on that as well. It's all well and good to decry the loss of control over monetary policy that the Euro represents, but it's also quite the form of status quo bias (and the decrying is the province of the always far-seeing macroeconomists, for that matter). In fact, I can't really see how seeking the Euro breakup is different than arguing that Massachusetts ought to be able to mint its own fiat Romneys, or whatever, oh, and also reinstall border controls and implement free trade policies with other states in its own unique fashion. And if that seems silly, why would Portugal want to do the same thing?
- Stephen Bainbridge is now distinguished, and not just by his impressive holiday recipes.
- And Brian Galle opens what - as he himself will tell you - is a sure to be transfixing series of posts on unemployment insurance, which I'm sure he seeks to own the way I own American foreign investment regulation.
My efforts to prepay my summer rent in Berlin have been a fascinating tour of modern payment systems and foreign currency risk. Here’s the scoop: my rent is due in full June 1st. My landlord would like the money early and agreed to pay the transfer fees if I could prepay. One additional complication, I need to use my University’s credit card.
Xoom is just one of a bevy of new payment systems that have emerged in the last several years. Glompetitor Tim Zinnecker has already pointed out the great article in Wired magazine two months ago on the future of payment systems. When I agreed to prepay, I thought the fees I saved would more than offset the time value of money. What I didn’t anticipate was that little ‘ole me would also be subject to foreign currency risk; I guess I need to read Kim Krawiec’s posts over at the Glompetition on the Greek debt crisis on a more regular basis. In all seriousness, I do feel blessed though that my personal stakes in the foreign currency swings are so trivial (so far) compared to what many in Europe are going through.
I've been working away on a draft symposium piece for the NeXus Journal at Chapman where I present a model of deregulation that explains banking deregulation in Sweden leading up to that country's financial crisis in 1990. The model may also help us understand how the deregulation of Freddie & Fannie, the repeal of Glass Steagall, and bank OTC derivatives trading contributed to our own financial crisis.
The piece is called Deregulation Pas de Deux: Dual Regulatory Classes of Financial Institutions and the Path to Financial Crisis in Sweden and the United States and can be downloaded here. Here's the abstract:
This article presents the following model of two regulatory classes of financial institutions interacting in financial and political markets to spur deregulation and riskier lending and investment, which in turn contributes to the severity of a financial crisis:
1) Regulation creates two categories of financial institutions. The first class faces greater restrictions in lending or investment activities but enjoys regulatory subsidies, such as an explicit or implicit government guarantee, while the second class is more loosely regulated and can make riskier loans or investments and earn additional profits.
2) These additional profits leads to calls for deregulation to enable the first class to participate in lucrative lending or investment markets.
3) Deregulation allows the first class of institution either to compete with the second class in formerly restricted markets or to invest in the second class, in either case, while retaining its regulatory subsidy.
4) Deregulation spurs additional lending in two ways:
i) subsidy leakage, which occurs when the first class can use subsidized funds to make riskier investments (including investments in the second class) without regulation compensating for moral hazard; and
ii) displacement, which occurs when subsidized competition pushes the second class into riskier market segments.
5) Additional lending increases leverage in the financial system and fuels a boom in an asset market.
6) Asset prices collapse and threaten the solvency of financial institutions.
This model explains financial deregulation in Sweden in the 1980s, which led to a 1990 bank crisis. The model also provides a framework for scholars to examine whether deregulation in the United States involving the following dual classes of institutions contributed to the current crisis:
¶ GSEs (Freddie Mac and Fannie Mae) and sponsors of “private label” mortgage-backed securities;
¶ Commercial and investment banks with respect to the Glass-Steagall repeal; and
¶ Banks and hedge funds with respect to OTC derivatives.
The model would support the premises of the proposed Volcker Rule, which would restrict investment activities of banks, but suggests that imposing those restrictions may not be sustainable in the long run.
Comments are welcome!