The Impact of Foreign Governing Law on European Government Bond Yields
54 Pages Posted: 10 Mar 2014
Date Written: March 8, 2014
The European debt-crisis and Greece’s government debt restructuring in 2012 in particular, have highlighted the importance of the law governing bonds for investors and authorities alike. Sovereign bonds issued under foreign law are generally harder to restructure given the issuers’ limited ability to change bond terms without the consent of a qualiﬁed majority or even the entirety of bondholders. In contrast, local law bonds can be restructured by simply changing domestic law. This paper examines the impact of the governing law on European government bond yields between 2008 and 2012. We ﬁnd strong evidence to suggest that bonds issued under foreign law trade at a premium when political risk and restructuring risk are at their greatest. We find that the size of this premium can be used as a direct measure of restructuring or ‘breach-of-contract’ risk in government bond markets. We find that the average premium paid for foreign law bonds, as compared to bonds governed by local law, peaked at 262bp in terms of yield during the height of the crisis, when the very future of the Eurozone was at stake. However, by the end of 2012 investors seemed once again to be factoring a very low level of restructuring risk, despite the fact that between 88% and 100% of each Eurozone members’ debt is currently issued under local law. Our view is that investors in Eurozone government debt would do well to remember the phrase: ‘caveat emptor’.
Keywords: Foreign governing bond law, Eurozone government bonds, Eurozone crisis
JEL Classification: F34, G01, K00
Suggested Citation: Suggested Citation