Ukraine Versus the Vultures
Mareeg.com-OXFORD – Amid all of its other troubles, Ukraine cannot pay its creditors. The
country needs more money, serious reform, and a rescheduling of its debt. Yet even
the best efforts by the International Monetary Fund, the United States, and the
European Union to achieve this will be hobbled by investment agreements that they
themselves have pressed on Ukraine and many other emerging economies. Indeed,
Ukraine could be left facing a string of complex and costly legal cases.
In recent years, shrewd creditor lawyers have argued that investment treaties give
bondholders the same rights as foreign direct investors, and have smuggled
sovereign-debt cases into international arbitration proceedings wherever they have
found investment treaties with broad, open-ended definitions. The recent experiences
of Argentina, Greece, and Cyprus highlight the “blowback” on sovereign-debt
The first such case was Abaclat and Others v. Argentine Republic, which started in
2008. Thousands of Italian bondholders refused Argentina’s debt-restructuring deal,
successfully arguing that the Italy-Argentina investment treaty gave them the right
to pursue compensation through investor-state arbitration.
Resolving a sovereign-debt crisis requires a collective agreement by creditors,
which can be achieved only by individual investors’ incentive to try to grab their
money and run. That is why investment treaties that leave an opening for holdouts
In national jurisdictions, a bankruptcy mechanism is used to corral creditors. But
no such mechanism exists at the international level. The IMF proposed one in 2002;
but, in the face of concerted lobbying by investors, the scheme was rebuffed and
instead an agreement was reached to use collective action clauses (CACs) in debt
The Eurogroup, for example, has declared that all eurozone sovereign bonds issued
after January 1, 2013, should include CACs, which render a government’s
debt-restructuring proposal legally binding on all bondholders if a majority of
bondholders accept the deal. When these clauses work, they streamline debt
In the Greek case, CACs were retroactively inserted into all Greek-law debt. This
allowed for a faster and more orderly restructuring than otherwise would have been
possible. The troika – the IMF, the European Central Bank, and the European
Commission – encouraged the Greek government to insert the collective action
clauses. Yet now that very maneuver is being challenged as expropriation in
The same could easily happen to Ukraine, which has ratified more than 50 investment
treaties. Their relevant clauses are similar – often identical – to those in
Greece’s investment treaties, enshrining broad, open-ended definitions of investment
that do not exclude sovereign debt. Moreover, many of the treaties provide investors
with direct access to arbitration.
So what can be done? For starters, the countries that have investment treaties with
Ukraine can add annexes making it explicitly clear that sovereign debt is excluded.
Renegotiating more than 50 treaties would be unwieldy, but Ukraine would benefit
enormously by renegotiating just one: the US-Ukraine investment treaty.
By some estimates, more than 20% of Ukrainian government debt was recently purchased
by a single American investment fund, Franklin Templeton Investments, specializing
in distressed debt. So, before the blowback begins, policymakers would do well to
heed the strong precedent for excluding sovereign debt from a US investment treaty.
Although US investment treaties are uniform on most issues, they have remarkably
diverse approaches to sovereign debt. Chapter 11 of the North American Free Trade
Agreement explicitly excludes sovereign debt. Similarly, the US-Uruguay Bilateral
Investment Treaty and the US-Peru Trade Promotion Agreement both have annexes that
effectively exclude sovereign debt.
For US policymakers, the decision to add an annex excluding sovereign debt is a
tough choice. On the one hand, US investment treaties are designed to secure the
strongest possible protection for US investors overseas. To remove investment
protection – at a time of instability and insecure property rights, no less – is
antithetical to the purpose of such treaties.
Given the political and security imperatives of the crisis in Ukraine, however, the
alternative is worse. Doing nothing means allowing US investment funds to pursue
enormous compensation cases – likely in the billions of dollars – against a future
Ukrainian administration, which, even in the best-case scenario, will be on weak
domestic political footing and already saddled with an unpopular austerity program
and loan-repayment schedule. This outcome would be more than a public-relations
nightmare; with Russia beckoning, it might well hasten geostrategic disaster.
Ideally, the world would have a well-functioning international mechanism for
sovereign-bond restructuring. We are far from that. Yet before the cameras turn away
from Ukraine, officials and leaders can ensure that a future administration there is
not left facing bondholders one by one in international arbitration proceedings.
The US and Western Europe have an overriding strategic interest in patching this
hole in the international financial architecture, and preventing their private
investment funds from aggressively seeking compensation from a future Ukrainian
administration. To do otherwise risks far more than financial loss.
Ngaire Woods is Dean of the Blavatnik School of Government and Director of the
Global Economic Governance Program at Oxford University. Taylor St. John is
Senior Researcher in the Global Economic Governance Program, Oxford University.
Spource: Project Syndicate