Boilerplate Shock: Sovereign Debt Contracts as Incubators of Systemic Risk
Gregory H. Shill
New York University School of Law
October 15, 2014
89 Tulane Law Review __ (2015, Forthcoming)
U Denver Legal Studies Research Paper No. 14-16
Scholars generally assess the usefulness of standard-form securities contracts from the perspective of the firms that use them. But these firm-centric accounts overlook the cumulative impact of standardization on markets. Where the market in question is critical to the financial system, this oversight can be quite dangerous.
This article examines the coordinated use of two standard contract terms in European sovereign bonds, a market viewed by many as the greatest source of global economic instability in the five years following the 2007-09 financial crisis. By common account, these terms — which require that the bonds be paid in euro and that any dispute be resolved under foreign law — are beneficial or at least benign. They are more rigid than is currently appreciated, however, and are in standard use in the correlated contracts that govern Eurozone sovereign debt. Among other things, the collective character of these terms means that a single, unexpected default might touch off cascade effects — a “run” — on other Eurozone sovereign bonds and perhaps financial markets more broadly.
The latent potential of networks of standard contracts to drive systemic risk has fundamental repercussions not only for the multitrillion-dollar sovereign lending market, but for the design of securities contracts and the project of systemic risk mitigation more generally. Indeed, tenuous assumptions about the boilerplate terms that govern these debts reveal a perilous gap in financial regulation: when standard terms in securities contracts become ubiquitous, their ability to inflict severe and unexpected harm extends beyond the parties involved in any given dispute to those governed by similar terms in correlated contracts and possibly the financial markets writ large. Currently, the law lacks even a vocabulary to describe this externality, let alone a mechanism to manage it. This article proposes a new rule to address the problem of what might be called “boilerplate shock” in the Eurozone, and beyond that market argues for expanding the focus of financial regulation to encompass the potential of private contracts to become incubators of systemic risk.
Number of Pages in PDF File: 66
Keywords: sovereign debt, financial regulation, systemic risk, securities regulation, monetary law, commercial law, contract design, boilerplate, bond, conflict of laws, eurozone, private international law, sovereign default, euro, European Union, EMU, lex monetae, ISDA, derivative, law of money, currency
JEL Classification: K00, K22, K23, K33, K41, E42, E44, E52, E58, E62, F02, F33, F34, F42Accepted Paper Series
Date posted: March 3, 2014 ; Last revised: October 17, 2014
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