Sovereign Damage Control

Italy changed its debt contracts, Belize passed new debt legislation, and Taiwan sued Grenada this year, all in response to a string of court rulings in New York that tried to make Argentina pay its debts from its financial crisis in 2001. The court rulings have gone to unprecedented lengths to isolate Argentina but are unlikely to make the country pay. The rulings, however, do threaten collateral damage to other countries and parts of the financial system. The lawsuit—NML Capital Ltd. et al. v. Republic of Argentina—promises to shift the balance of power from sovereign debtors to their creditors. The shift would come courtesy of one obscure debt contract term, the pari passu clause, that has gained destructive power in a case where the government and its creditors are uniquely willing to test the limits of the law. The impact may be magnified against the background of public debt distress in Europe, new emerging-market restructurings, and regulatory focus on clearing and payment systems