Boilerplate Shock: Sovereign Debt Contracts as Incubators of Systemic Risk

Abstract

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 consequential.

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 2007-2009 financial crisis. By common account, these terms — which require that the bonds be paid in euro and that any dispute be resolved under a stipulated source of law, often foreign — are beneficial or at least benign. They are more rigid than is currently appreciated, however, and are in standard use in many 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 transmit 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. Currently, the law lacks even a vocabulary to describe this phenomenon, let alone a mechanism to manage it. This Article proposes a new rule to address the challenge of what might be called “boilerplate shock” in the eurozone and argues for expanding the study of contract externalities to include their impact on financial markets.

Keywords: sovereign debt, financial regulation, systemic risk, securities regulation, monetary law, Greece, 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, Grexit

JEL Classification: K00, K22, K23, K33, K41, E42, E44, E52, E58, E62, F02, F33, F34, F42