When I recently conducted research on “Arbitration in Banking and Finance”, the following question caught my particular attention: “Is there a need for a sovereign debt tribunal?”. Some authors have answered this question in the affirmative. Others argue that “in accordance with the standard jurisdictional clauses in modern debt instruments, national courts are the proper forum for disputes arising out of sovereign debt”. Furthermore, this issue has been thrust into the limelight by the decision in Abaclat and Others v. Argentina.
This post seeks to summarize the current debate and concludes that a special sovereign debt tribunal is not likely to emerge any time soon. Rather, one can possibly expect that the number of sovereign debt cases brought before tribunals under the auspices of the International Centre for the Settlement of Investment Disputes (ICSID) will increase given the recent developments, for example, in Greece.
Until recently, Fedax v. Venezuela and CSOB v. Slovak Republic were the two main cases confirming that government debts can qualify as an investment in the sense of Article 25 ICSID Convention. In spite of these decisions, there remained considerable uncertainty whether sovereign bonds – notably those traded on secondary markets – would fall within ICSID’s jurisdiction. Scholars pointed out that such bonds would constitute commercial transactions as opposed to investments in the sense of Article 25 ICSID Convention. Besides, they would fail to meet various other requirements of an investment including a long term transfer of funds, the existence of commercial risk, as well as a territorial link with the host State.
These concerns faced a backlash in Abaclat and Others v. Argentina where the Arbitral Tribunal confirmed that sovereign bonds may constitute an investment in the sense of Article 25 ICSID Convention.
In this arbitration, investors, who had not been compensated for Argentina’s default on sovereign bonds, alleged a violation of the Italy Argentina BIT. Argentina objected to the jurisdiction of the ICSID Centre contending that sovereign bonds would not constitute an investment within the meaning of Article 25 ICSID Convention. Among others, Argentina argued that the sovereign bonds would not meet the objective criteria laid down in Salini v. Morroco. In addition, the investment would neither have been “made within the territory of Argentina”, nor “in compliance with Argentinean law” as required by Article 1 of the Italy Argentina BIT.
By a majority decision of Pierre Tercier and Albert Jan van den Berg, the Arbitral Tribunal rejected these objections and confirmed its jurisdiction. In the majority’s view, the sovereign bonds qualified as an investment in the sense of the BIT as well as in the sense of Article 25 ICSID Convention. As regards Article 25 ICSID Convention, the majority considered that the bonds were generated by a value that Argentina and Italy intended to protect under the BIT. Given the ICSID Convention’s aim to encourage private investment while giving the Parties the tools to further define what kind of investment they wish to protect, this would be relevant. The application of the Salini test, by contrast, would be contradictory to this aim. The result would remain unchanged if one were not to follow a double-barred test pursuant to which an investment has to meet the requirement of both, the pertinent BIT as well as the ICSID Convention.
The majority proceeded by confirming that the investment was made in Argentina. In doing so, it considered that the nature of the investment is decisive in order to determine its place. As regards investments of a purely financial nature, it would matter where and/or for the benefit of whom the funds are ultimately used. There would be no need that the investment be further linked to a specific economic enterprise or operation taking place in the territory of the host State. In the instant case, the bonds would have generated funds that would have been made available to Argentina and contributed to its economic development.
While the majority decision met with strong dissent by Georges Abi-Saab, it has lent additional support to the existing case law pursuant to which sovereign bonds can constitute an investment in the sense of Article 25 ICSID Convention. Given the high authoritative value of ICSID decisions, it is well possible that other tribunals will follow this decision and assert jurisdiction over disputes involving sovereign debt.
However, even if ICSID tribunals affirm their jurisdiction over sovereign debt cases, the question remains whether an ICSID tribunal is the proper forum to resolve sovereign debt disputes. Or can such disputes only be effectively addressed by the creation of a new sovereign debt tribunal?
At first glance, the idea of a special sovereign debt tribunal is appealing. Also in the field of commercial arbitration, new arbitral institutions have emerged that are specifically designed for the settlement of banking and finance disputes. Earlier examples of special institutions with an exclusive mandate for the settlement of disputes in the financial and banking sector include the London City Dispute Panel, Diriban (for interbank settlement) or Euroarbitration. The latest development in this field was the creation of the “Panel of Recognized International Market Experts in Finance” (P.R.I.M.E. Finance), an institution for the resolution of complex financial disputes by means of arbitration or mediation. It was created in early 2012 and has its seat in The Hague, The Netherlands.
Do sovereign debt disputes merit even greater attention and require a special dispute resolution institution as well?
In the absence of a public international insolvency law and uniform rules on sovereign debt treatment in case of sovereign debt crises, I question the need for a special sovereign debt tribunal. The resolution of sovereign debt disputes faces complex substantive challenges regardless of which institution will administer the case. These challenges include, among others, so-called “holdouts” from sovereign debt restructuring and the so-called “moral hazard problem”.
Holdouts designate situations where creditors do not participate in sovereign debt restructuring, i.e., changes in the originally envisaged payment terms of sovereign debt which are undertaken in order to create a more manageable liability profile or to reduce the debt’s net present value. To the extent that investors can expect to recover a higher amount of money in arbitral proceedings than by agreeing to the modified terms of the investment, they have little incentive to participate in sovereign debt restructuring. This is problematic for two reasons: First, an effective sovereign debt restructuring presupposes the participation of a high percentage of creditors. Otherwise, sovereign debt restructuring risks failure, which usually goes to the detriment of the population of the insolvent State. Second, the enforcement of a limited number of creditor rights to the detriment of other creditors compromises the principle of inter-creditor equality.
A related challenge for any deciding tribunal lies in the so-called “moral hazard problem”. According to the definition offered by Paul Krugman, “moral hazard” describes “any situation in which one person makes the decisions about how much risk to take, while someone else bears the cost if things go badly”. Such situations of moral hazard may easily arise if creditors can be assured of recovering the full value of sovereign bonds in an arbitration. These creditors will have little incentive to evade unwarranted risks, since the consequences will be borne by others, including the taxpayers of the countries financing the bailout of the insolvent State.
It seems unlikely that these challenges can be effectively countered solely by creating a sovereign debt tribunal, as recently suggested.
Above all, the mere creation of a sovereign debt tribunal would fail to solve the above-mentioned substantive challenges unless it would come along with a set of substantive rules on public international insolvency law. Even if such rules existed, the problem would remain how such rules would interact with existing international investment agreements which explicitly mention sovereign bonds as protected investments. What would be the benefit of creating a sovereign debt tribunal if bondholders were not barred from asserting contractual or treaty claims before other fora?
Apart from this, it seems hardly likely that States will reach consensus on a sovereign debt tribunal and a possible convention on international public international insolvency law in the near future. Notably, previous attempts to create similar tribunals have failed. Prominent examples include the League of Nations Loans Tribunal and the IMF Sovereign Debt Rescheduling Mechanism (SDRM), which both never became reality.
In conclusion, it seems that, apart from proceedings before national courts, ICSID arbitration is – for the time being – one of the few available avenues to be pursued by creditors in case of sovereign debt crises. While the exact contours of ICSID’s jurisdiction over disputes involving sovereign debt are yet to be defined in greater detail, the decision in Abaclat and Others v. Argentina provides strong authority for the assumption that at least some of these disputes will continue to be resolved within the framework of the ICSID Convention in the future. ICSID’s affiliation with the World Bank Group is an institutional advantage, since it gives strong incentives to comply with awards voluntarily. Moreover, ICSID awards enjoy a high degree of publicity and, thus, contribute to legal certainty and to the development of further case law. Contrary to the suggestions of some authors, there is no proof that the neutrality of ICSID tribunals is affected by the lending activities of the World Bank.
To the extent that ICSID tribunals will assert jurisdiction over disputes involving sovereign debt, they will face the challenge of protecting investors’ rights without undermining the equally important goal of sovereign debt restructuring. As of now, international investment law provides hardly any guidance as to how this conflict of interest might be solved. Will ICSID tribunals find a BIT violation on the merits? If yes, will they award only partial compensation to creditors of sovereign States? Will the economic situation of the pertinent State be taken into account in assessing the legitimate expectations of investors? It will have to be seen how ICSID tribunals will respond to these challenges of sovereign debt arbitration. The decision on the merits in Abaclat and Others v. Argentina could be an important contribution to the development of case law in this regard.
Dr. Inka Hanefeld, LL.M. (NYU)
Hanefeld Rechtsanwälte, Hamburg, Germany
 See for example C.G. Paulus, A Resolvency Proceeding for Defaulting Sovereigns, IILR (2012), 1 (12) proposing a Sovereign Debt Tribunal.
 See M. Waibl, Sovereign Defaults before International Courts and Tribunals (Cambridge, 2011), p. 316.
 Abaclat and Others (Case formerly known as Giovanna A Beccara and Others) (Claimants) and the Argentine Republic (Respondent), Decision on Jurisdiction and Admissibility, ICSID Case No. ARB/07/5, 4 August 2011.
 Fedax N.V. (Claimant) and The Republic of Venezuela (Respondent), Case No. ARB/96/3, Decision of the Tribunal on Objections to Jurisdiction, 11 July 1997.
 Ceskoslovenska Obchodni Banka, A.S. (Claimant) versus The Slovak Republic (Respondent), Case No. ARB/97/4, Decision of the Tribunal on Objections to Jurisdiction, 24 May 1999.
 Cf. K. Halverson Cross, Arbitration as A Means of Resolving Sovereign Debt Disputes, 17 No. 3 Am. Rev. Int’l Arbitration (2006), 335 (348 ff.).
 See M. Waibl, Sovereign Defaults before International Courts and Tribunals (Cambridge, 2011), p. 226 ff.; M. Waibl, Opening Pandora’s Box: Sovereign Bonds in International Arbitration, 101 Am. J. Int’l L. (2007), 711 (719). For a different view see D. Strik, Investment Protection of Sovereign Debt and its Implications on the Future of Investment Law in the EU, 29 No. 2 Journal of International Arbitration (2012), 183 (192 f.).
 Para. 341. See also Salini Costruttori S.p.A. and Italstrade S.p.A. v. Kingdom of Morocco (ICSID Case No. ARB/00/4), Decision on Jurisdiction of 23 July 2001, para. 52.
 See paras. 341, 365, 364, 371, 374, 375, 378.
 See e.g. Abaclat and Others (Case formerly known as Giovanna A Beccara and Others) (Claimants) and the Argentine Republic (Respondent), Decision on Jurisdiction and Admissibility, ICSID Case No. ARB/07/5, 4 August 2011, Dissenting Opinion of Georges Abi-Saab.
 S. Cirelli, Arbitration, Financial Markets and Banking Disputes, 14 Am. Rev. Int’l Arb. (2003), 243 (254); G. Affaki, A banker’s approach to arbitration, in: G. Kaufmann-Kohler and V. Frossard, Arbitration in Banking and Financial Matters, ASA Special Series No. 20 (2003), 63 (67).
 G. Affaki, Nouvelles réflexions sur la banque et l´arbitrage, in: Liber Amicorum Serge Lazareff, 2011, p. 42; G. Affaki, A banker’s approach to arbitration, in: G. Kaufmann-Kohler and V. Frossard, Arbitration in Banking and Financial Matters, ASA Special Series No. 20 (2003), 63 (66).
 www.euroarb.org. See A. Hirsch, Presentation of “Euroarbitration”: European Center for Financial Dispute Resolution, in: G. Kaufmann-Kohler and V. Frossard, Arbitration in Banking and Financial Matters, ASA Special Series No. 20 (2003), 55 (55 f.).
 Cf. J. Simoes, Sovereign Bond Disputes Before ICSID Tribunals: Lessons From the Argentina Crisis, 17 L. & Bus. Rev. Am. (2011), 683 (687).; M. Waibl, Sovereign Defaults before International Courts and Tribunals (Cambridge, 2011), p. 14.
 Cf. J. Simoes, Sovereign Bond Disputes Before ICSID Tribunals: Lessons From the Argentina Crisis, 17 L. & Bus. Rev. Am. (2011), 683 (718); M. Waibl, Opening Pandora’s Box: Sovereign Bonds in International Arbitration, 101 Am. J. Int’l L. (2007), 711 (758).
 See K.P. Gallagher, The New Vulture Culture: Sovereign Debt Restructuring and Trade and Investment Treaties, The IDEAs WORKING PAPER SERIES, Paper no. 02/2011, p. 8; S.L. Schwarcz, “Idiot’s Guide” to Sovereign Debt Restructuring, 53 Emory L.J. (2004), 1189 (1193 ff.).
 P. Krugman, The Return of Depression Economics and the Crisis of 2008 (New York, 2009), p. 63.
 M. Waibl, Sovereign Defaults before International Courts and Tribunals (Cambridge, 2011), p. 300; O. Lienau, Who is the “Sovereign” in Sovereign Debt?: Reinterpreting a Rule-of-Law Framework From the Early Twentieth Century, 33 Yale J. Int’l L. (2008), 63 (95 ff.); S.L. Schwarcz, “Idiot’s Guide” to Sovereign Debt Restructuring, 53 Emory L.J. (2004), 1189 (1194 ff.).
 See for example C.G. Paulus, A Resolvency Proceeding for Defaulting Sovereigns, IILR (2012), 1 (12) proposing a Sovereign Debt Tribunal. See also C.G. Paulus and S.T. Kargman, Reforming the Process of Sovereign Debt Restructuring: A proposal for A Sovereign Debt Tribunal, Workshop on Debt, Finance and Emerging Issues in Financial Integration, Financing for Development Office (FFD), DESA, 8 and 9 April 2008, available at: http://www.un.org/esa/ffd/events/2008debtworkshop/papers/Kargman-Paulus-Paper.pdf (last visited: 08 August 2012), p. 3.
 Cf. M. Waibl, Sovereign Defaults before International Courts and Tribunals (Cambridge, 2011), p. 324 ff.; K. Halverson Cross, Arbitration as A Means of Resolving Sovereign Debt Disputes, 17 No. 3 Am. Rev. Int’l Arbitration (2006), 335 (363).
 Cf. International Monetary Fund, Sovereign Debt Restructuring Mechanism – Further Considerations, Prepared by the International Capital Markets, Legal, and Policy Development and Review Departments in consultation with other Departments, 14 August 2002, available at: http://www.imf.org/external/np/pdr/sdrm/2002/081402.pdf (last visited: 08 August 2012).
 Cf. M. Waibl, Sovereign Defaults before International Courts and Tribunals (Cambridge, 2011), p. 319.
 Cf. C.G. Paulus, A Standing Arbitral Tribunal as a Procedural Solution for Sovereign Debt Restructurings, in: C.A. Primo Braga / G.A. Vincellette, Sovereign Debt and the Financial Crisis – Will this Time be Different (Washington, 2010), p. 317 (320 f.) contending that the World Bank Group is “a source of perceived bias”.
 Cf. M. Waibl, Sovereign Defaults before International Courts and Tribunals (Cambridge, 2011), p. 301 ff.
 Cf. D. Strik, Investment Protection of Sovereign Debt and its Implications on the Future of Investment Law in the EU, 29 No. 2 Journal of International Arbitration (2012), 183 (196).