Private law underpinnings of public

Private law underpinnings of publicdebt securities markets

Wouter Bossu and Elsie Addo Awadzi*

I. IntroductionNowadays, most States contract most of their debt in the form of so-called ‘public

debt securities.’ Historically in Europe, from the Middle Ages up to early modern

times, most sovereigns—at that time, there was little difference between the State

and its ruler—were financed by the prominent banking houses of the times, such

as the Knights Templar and the de Medici and Fugger families. From a legal

perspective, such financing was generally governed by bilateral loan agreements

between borrowing sovereign and lender. When, in the Renaissance, the legal

systems of Western Europe developed legal doctrines underpinning the incorp-

oration of loan claims in paper documents or registries, official issuers were

among the first to make use on a large scale of this innovative financial and

legal technique. This system has allowed the borrowing sovereign in particular

to access a broader group of lenders and to increase the attractiveness—and thus

reduce its cost—of public debt by organizing its smooth transferability between

investors. Since then, the vast majority of financing of most States has taken the

form of public debt securities.1

Due to the volumes outstanding, their nature as relatively low-risk investment,

and the ease with which they can be transferred between economic agents, public

debt securities have evolved into one of the most actively traded financial assets in

highly liquid markets. Increasingly in many countries, the markets for public debt

securities have evolved into the most central component of the national financial

system, and several of those markets are keystones of the global financial system.

* Wouter Bossu and Elsie Addo Awadzi are respectively senior and consulting counsel at the LegalDepartment of the International Monetary Fund (IMF). Emails: [email protected]; [email protected]. The views expressed herein are those of the authors and should not be attributed to theIMF, its Executive Board, or its management. The authors are grateful to Anna Gelpern, ThomasLaryea, Yan Liu, Virginia Rutledge, and Stefan Theys for their ever insightful comments. EricRobert and Max Bonici provided valuable research support. Any errors or omissions remain theauthors.

1 Albeit with notable exceptions, such as (i) bilateral official or private financing in times of war or tofinance commerce and (ii) multilateral financing by International Financial Institutions. Also,some sophisticated sovereigns still have recourse to non-securitized debt (eg, the GermanSchuldschein).

! The Author (2014). Published by Oxford University Press on behalf of UNIDROIT. All rights reserved.For Permissions, please email [email protected]

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Even for emerging and least developed economies, where markets may be rela-

tively less liquid, public securities markets tend to represent a significant compo-

nent of the financial system.2

Well-functioning domestic public debt securities markets are critical to any

country’s economic development and financial stability, and they are therefore

considered to be a public good. Local public debt securities markets allow the

government and State-owned enterprises to fund their operations in local cur-

rency, thus reducing the sovereign’s dependence on foreign borrowing and

vulnerability to sudden disruptions in cross border capital flows. Moreover, a

well-developed local public debt securities market constitutes the foundation

(‘benchmark’ in terms of pricing) for the local private bond market where busi-

nesses seek funding directly from investors and not from banks (representing a

form of disintermediation). This does not mean, however, that the public debt

securities markets are entirely disconnected from the banking system. On the

contrary, banks will regularly take significant amounts of public debt securities

on their balance sheets, sometimes as a result of the central bank’s monetary

policy operations and more often as market makers and ‘primary dealers’—and

well-functioning markets will assist them in managing the ensuing risks

adequately.

Robust legal underpinnings are instrumental to the soundness of public debt

securities markets. Essentially, a securities market consists of a sophisticated and

multi-layered set of legal relationships, and weaknesses affecting any of these

relationships can undermine the overall soundness of, and confidence in, the

market. Policy makers and lawyers have traditionally stressed the importance

of robust legal underpinnings for securities markets, but in the field of public

debt securities this concern has primarily focused on the public law aspects of this

problem.3 While this concern is understandable in light of the ‘public’ nature of

the issuer, it may ignore many critical or relevant legal issues—in particular, those

of a ‘private law’ nature.

The purpose of this article is to underscore the importance of sound private law

underpinnings for the orderly functioning of public debt markets, and it advo-

cates for a broader approach to public debt legal reforms that go beyond the

current focus on strengthening public law legal frameworks. Using the traditional

‘private law’ versus ‘public law’ classifications of law, the article seeks to distin-

guish between the ‘private law’ and ‘public law’ regimes applicable to domestic

public debt securities and highlights the importance of such a distinction while

2 For instance in Africa, local currency bond markets are dominated by government securities, witha share of some 89.2 per cent of total market capitalization, compared to the share of corporatebonds, which stood at just 10.8 per cent in 2010. For a fuller discussion of this phenomenon, seeYibin Mu, Peter Phelps and Janet G Stotsky, Bond Markets in Africa, IMF Working Paper WP/13/12 (2013) 10, 20.

3 A good example of this is to be found in Arindam Roy, Mike Williams, Government DebtManagement: A Guidance Note on the Legal Framework (Commonwealth Secretariat,October 2010), <http://secretariat.thecommonwealth.org/files/235301/FileName/GovernmentDebtManagementAGuidanceNoteontheLegalFramework2010.pdf>, which includes essentiallyonly one private law issue (equal treatment for all investors) in its many recommendations.

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acknowledging the complexities in such an approach in certain legal systems. The

main focus of this article is on the domestic market for debt securities issued by

sovereigns, as represented by their central or federal government. This being said,

several of the findings set out in the following discussion are likely to apply

mutatis mutandis to debt securities issued by other public entities, such as State

governments in the case of federalist systems, sub-government actors such as

provincial or municipal authorities, and parastatals and State-owned enterprises.

Moreover, the article focuses on public debt securities issued in the same juris-

diction as the issuing State, and therefore focuses on domestic law regimes

affecting such securities, but the conclusions broadly apply to debt securities

issued under foreign law as well.

The structure of this article is as follows. The second section will briefly discuss

the importance of robust legal underpinnings for sound securities markets gen-

erally and introduce conceptually the division of labour between private and

public law in regard to public debt securities markets. The next section, which

is the core of the article, will analyse in detail the private law regime relating to

public debt securities markets. The fourth section will give an overview of how

public law may have an impact on private law, and the final fifth section will

briefly conclude.

II. Robust legal underpinnings for sound securitiesmarkets

1. General introduction

Sound legal frameworks are critical to the orderly functioning of securities mar-

kets. These markets are basically organized infrastructures to exchange legal

claims—dubbed ‘assets’ by economists—between economic agents, regardless

of the legal form of the issuers—be they corporate or State actors. Accordingly,

these assets and their transfers are only as robust as they are valid and enforceable

under the applicable law. Given the organized structure of securities markets and

their relative complexity, this validity and enforceability will depend on a broad

set of legal variables.

To establish a sound legal framework for securities markets in any given juris-

diction, the following issues should generally be provided with appropriate legal

foundations:

• The nature of the securities: The law should provide clearly for the precise

definition of securities and clarify the legal status of any given type of security

for the purposes of contract enforcement as well as for regulatory purposes.

Does the definition of securities include those issued by the issuer in ques-

tion—for example, corporate, government, other public sector bodies, trusts,

and so on?

• The access to markets: How can issuers, investors, and intermediaries access

the primary and secondary markets of securities? What are the legal

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conditions for such access? Are there different access conditions for different

sub-markets?

• The issuance process: How are securities issued? Which formalities need to be

complied with for the issuance to be legally robust? When is the issuance

completed?

• Trading and holding of securities: How are securities lawfully traded? How do

investors hold securities? What is the legal relationship between investors,

their intermediaries, and the issuer? What is the impact on investors of the

insolvency of an intermediary?

• The orderly functioning of the market: Which rules aim at ensuring that secu-

rities markets function in an orderly manner? To whom do these rules apply?

• The supervision of intermediaries: How are intermediaries regulated and

supervised? Is this regulation legally robust—that is, can it withstand legal

challenges from market participants?4

• The clearing and settlement of securities trades: How are securities’ trades

legally settled between counterparties? When does such settlement become

legally definitive?

• Regulation of financial institutions: How does prudential regulation of banks

(including capital adequacy, reserve, and other liquidity requirements)5 as

well asset allocation rules for insurance firms, investment, insurance, and

pension funds affect their participation in the securities market and poten-

tially create captive markets for government securities?

2. Division of labour between public law and private law

For all types of securities, these issues will be governed by a combination of public

and private law. As a concept, private law governs relationships between persons

and entities acting as equals—that is, without relationship of authority. It typic-

ally covers the body of law pertaining to contracts, torts, property, and obligations

(including agency). Public law generally deals with the so-called public order and,

in particular, regulates, as an act of authority, government activity or the eco-

nomic activity of private persons.6 Thus, applying this perspective to securities

4 A good example of the risks caused by regulation in the absence of a robust legal basis can be foundin Phillip Goldstein et al v SEC, 451 F3d 873, 883 (DC Cir 2006), in which the court struck down aSecurities and Exchange Commission (SEC) regulation on mandatory hedge funds registration onthe ground that the SEC lacked legal authority.

5 Also in the case of the USA, the Volcker Rule restricts proprietary trading for banks in general butmakes exemptions in the case of trading US government debt in the secondary market.

6 In certain jurisdictions, particularly common law traditions, the distinctions between private andpublic law may be less obvious with perhaps little or no consequences for private persons for aslong as the totality of the rights they provide are available to them. In civil law traditions, however,the dichotomy may be a bit more real with implications including access to different courts for oneor the other category of law. In jurisdictions such as the USA, the distinction between private lawand public law may be a bit muted as discussions tend to focus more on federal law versus state lawdistinctions. In yet other jurisdictions, the elevation of certain private rights such as property andfreedom of contract rights to constitutional (public law) status tends to blur the lines between theprivate-public law categories even more.


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markets generally, the legal nature of securities, the relationships between issuers,

investors, and intermediaries, and the contractual relationships between counter-

parties will typically be governed by private law. In contrast, market access rules,

conditions for issuance to the public, and rules aimed at the orderly functioning

of markets will be enshrined in public law.

More than for any other type of securities, the legal framework for public debt

securities markets will be governed by public law. This is to a large degree

explained by the public law nature of the issuer—that is, the State. As will be

discussed in more detail later in this article, in addition to the ‘traditional’ regu-

lation of transactions in the secondary market by statutes and secondary regula-

tions promoting orderly markets and protecting (non-sophisticated) investors,

the authorization for the State to contract debt and issue securities, and the

conditions and modalities under which such securities can be issued, will typically

be explicitly established by normative instruments, and the issuance of securities

in the primary market will be governed by governmental regulations. All of these

legal instruments pertain to the legal framework through which the State organ-

izes its own activities and governs its subjects and thus belong to the realm of

public law. Typically, the sources of the public law regime applicable to public

debt securities include constitutions, public debt management legislation (how-

ever called), public finance legislation and budget rules, and regulations issued by

the government or the Minister of Finance.

This being said, as illustrated further in this article, private law plays an equally

important role, albeit not exclusively, in defining the rights and obligations under

contracts for the issuance, transfer, holding, and other dealings (for example,

settlement) in public debt securities. Generally speaking, the private law regime

would play a role in determining the very legal status of such securities as con-

tracts capable of enforcement as well as the rights of investors under the securities

contracts to repayment of their principal (or face value of their securities), as well

as coupons if so agreed, and their rights to approve any restructuring of the terms

of the issue (where provided for). The private law regime pertaining to public debt

securities will also affect the State as issuer, investors who have purchased such

securities in the primary and secondary market, as well as intermediaries that have

facilitated access to these markets and the settlement of obligations therein.

Sources of the private law regime in this context include general principles of

contract law, principles of agency law, contractual mechanisms pertaining to

clearing and settlement of public debt securities transactions, and contractual

arrangements affecting dealings in such securities including rules on collateral,

intermediation, and other relevant arrangements in relation to the securities.

The complexities inherent in maintaining tight private law, versus public law,

classifications are pronounced in the case of public debt securities. As with any

form of securities, the delineation between public law and private law is not

always easily discernible. While private law plays a fundamental role in determin-

ing the rights of investors under public debt securities, public law may underpin

those rights given the ‘public’ nature of the issuer whose powers, rights, and


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obligations are often largely determined by public law. For instance, while public

debt securities incorporate contracts, the very source of their legal validity may lie

more in public law (as spelled out in legislation affecting State borrowing) than in

contract law. In some cases, tensions have arisen between public and private law

regimes affecting public debt securities, with purely contractual considerations

under private law sometimes giving way to public interest considerations.

Thus, the boundaries of the private law regime are an important subject of legal

and policy discussion. A solid understanding of the private law aspects of public

debt securities markets will support the authorities in strengthening their legal

frameworks and private investors in understanding their risks. Inattention to

private law aspects of public debt securities may become particularly problematic

if and when a counterparty in the market is unable to perform on its obligations—

for instance, in the case of the sovereign when it enters into material risk of

default. In such a circumstance, investors in public debt securities need to under-

stand the full scope of their rights vis-a-vis their counterparty. Private law assumes

a prominent role in shaping the options for investors/creditors in the context of

enforcement of their rights against counterparties, public debt restructuring, and

related matters.7 The remainder of the article intends to provide intellectual

underpinnings for a stronger policy focus on this subject. While the concepts

and legal principles discussed in this article may provide generalizations based on

common or civil law traditions or private versus public law categorizations,

broadly speaking, they may not necessarily hold true for all jurisdictions given

peculiar institutional and legal frameworks. Nonetheless, the authors hope that

the conclusions of this article will provide the impetus for further research into

such sui generis frameworks where they exist.

III. Private law underpinnings of public debt securitiesmarkets

1. Public debt securities incorporate contracts

Debt securities generally incorporate a bundle of rights representing a loan/

borrowing agreement and a contractual claim on repayment of principal and

(where applicable) interest. Since the Renaissance, the leading legal traditions

of Western Europe have developed doctrines (for example, on valeurs mobilieres,

wertpapiere, or negotiable instruments) that accept and govern the incorporation

of contractual debt claims in ‘securities.’8 Building upon this premise, these doc-

trines have developed a set of principles pursuant to which the contractual claims

incorporated in ‘securities’ can be transferred by merely transferring the

securities—that is, without applying the rules and formalities prescribed by the

7 This article will use the terms investor and creditor interchangeably.8 See, eg, the Customs of Antwerp (as codified in 1582), Title LIII, Articles 6–9, governing the

‘brengers brief,’ that is, bearer debt certificates.


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more traditional civil/common law concepts of cession de creances or assignment.

The two main forms in which ‘securities’ can be issued, held, and transferred are

(i) bearer certificates and (ii) registered securities (see discussion later in this

article).9

This principle of incorporation of contractual claims applies also to public debt

securities.10 As early as the sixteenth century, public borrowing agreements were

concluded in the form of debt securities.11 In the nineteenth century, the issuance

of public debt in the form of securities was generalized among advanced econo-

mies. The fact that the issuance of public debt securities is authorized and regu-

lated by public law does not imply that the claims incorporated in the security are

entirely governed by public law and, hence, lose their contractual nature. While

this principle has not been seriously contested, several public debt laws have

explicitly recognized the contractual nature of domestic borrowing by the

State, including in the context of public debt securities.12

By consequence, while State borrowing agreements and the resulting credit

claims may have public law features, they are also, at least to a certain extent,

governed by private contract law. Given this principle, which private contract law

rules are likely to apply? As will appear from the questions below, in many jur-

isdictions the response to this question is far from straightforward.

In civil law countries, the relevant provisions of the Civil Code—such codes

apply typically to the State unless otherwise provided by public law—are likely to

apply, unless the terms and conditions of the borrowing agreement stipulate

otherwise (with the exception of public order prescriptions). In civil law countries

with a commercial code, two questions arise. First, does this code include rules on

borrowing agreements? Second, if so, do these rules also apply to borrowings by

the State? In some countries, the response to the latter question will depend on

whether the State is to be considered as a merchant in its commercial relationships

with third parties.13

In common law countries, the question arises as to whether the relevant

common law principles and doctrines also apply to borrowings contracted, and

securities issued, by the State. Some have argued that, in the United Kingdom

(UK), common law principles are so entrenched that they apply to the actions of

all persons including those of the sovereign.14 Also in some common law

9 Another form consists of securities ‘to order’, which are transferred by way of endorsement.10 This has been expressly recognized by the US Supreme Court in Perry v USA 294 US 330 (1935)

[Perry], discussed later in this article.11 The losrenten developed by the Dutch provinces and cities in the sixteenth and seventeenth

centuries are famous examples of public (perpetual) bonds issued in registered form.12 See, for instance, Articles 2 and 4 of the Mexican Ley General de Deuda Publica (31 December

1976), which use the terms ‘contract’ at several instances. Section 44.3 of the Canadian FinancialAdministration Act (R.S.C., 1985, c. F-11) includes similar language.

13 Typically that would not be the case for the State proper. Some state-owned entities, such as centralbanks and state-owned enterprises, might in contrast be considered as merchants under commer-cial law.

14 See Ronald Hamowy’s expose on ‘F.A. Hayek and the Common Law’ (2003) 23(2) Cato Journal241, 242


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jurisdictions, the concept of ‘statutory covenants’ imposed by legislation on gov-

ernment contracts could apply to public debt securities. As was held by the US

Supreme Court, albeit in relation to US state law, legislation could create ‘purely

financial obligations’ for the State in relation to state bonds, in favour of

bondholders.15

In mixed/hybrid law countries where the legal system reflects a substantial

synthesis between civil and common law traditions,16 traditional notions

appear to be fading and the issues identified earlier in common law countries

versus civil law ones may well play out in varying degrees.17

For those federal states, whose private law is governed at state-level—as

opposed to the federal level—the question may arise as to the law of which

state applies to contracts incorporated in federal public debt securities.18

The exact extent to which the typical contractual features of public debt secu-

rities are governed by respectively public and private law will differ from juris-

diction to jurisdiction. For instance, in France, the characteristics of public debt

securities, including the terms of the securities and payment of coupons, are

defined by a (public law) decree issued by the Minister of Finance.19 In other

jurisdictions, these issues would instead be governed by (private law) contractual

terms and conditions, even though the latter have a firm public law basis.20

A practical manifestation of this issue concerns the manner in which the con-

tractual terms and conditions of a State borrowing agreement are incorporated in

public debt securities. Even if some of the key aspects (for example, the currency

and maximum amount) of the loan agreements are governed by public law in-

struments, the borrowing sovereign will need to establish other essential param-

eters (for example, interest rate, duration of loan, repayment schedule) of those

agreements in the form of contractual terms and conditions. States use different

legal techniques to establish a formal legal link between public debt securities and

their contractual terms and conditions. For instance, bearer bonds often include a

printed cross-reference to underlying contractual documents. Other sovereigns

15 See United States Trust Co v New Jersey 431 US 1 (1977) [United States Trust].16 Such as in Israel, Mauritius, Scotland, South Africa, Sri Lanka, the Canadian province of Quebec,

and the US state of Louisiana, among many others.17 See Vernon Valentine Palmer, ‘Mixed Jurisdictions’ in Jan M Smits (ed), Elgar Encyclopedia of

Comparative Law (2nd edn, 2012) 590.18 In some federal States such as the USA, ‘federal common law’ is a distinct source of law that may

well have private law ramifications.19 Article 1 of the Decret no 2012-1518 (29 decembre 2012) ‘relatif a l’emission des valeurs du

Tresor.’20 For example, Japan’s ‘Principal Terms and Conditions for the Sale of Japanese Government

Securities’ <http://www.boj.or.jp/en/mopo/measures/term_cond/yoryo30.htm/> accessed 15September 2013, which were revised on 5 October 2012, appear to be a notification issued bythe Minister of Finance with underpinnings in the public debt legislation although the notificationitself has no force of law per se. The Netherlands’ regime is also almost exclusively contractual innature, which entails that Dutch public debt securities are governed by their contractual terms andconditions as well as by the relevant provisions of the civil code (<http://www.dsta.nl/Actueel/Leningvoorwaarden/Staatsleningen_DSL_s> accessed 15 September 2013).


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have adopted the private market practice of information memoranda, offering

memoranda and prospectuses.21 In such case, the information memorandum

includes the general principles, while the detailed terms and conditions of the

loan agreement are incorporated in the prospectus.22

In this respect, the relationship between public law and private law is neither

binary nor antagonistic, and many States skilfully combine both frameworks to

provide robust legal underpinnings to their public debt securities. Some States use

private contract law mechanisms to incorporate public law instruments in the

terms and conditions of their public debt securities. For instance, the US Treasury

issues ‘private law’ offering announcements stipulating (in a footnote) that the

public debt security in question will be governed by the terms of the said an-

nouncement and a general rule book issued in the form of a public law regula-

tion.23 Other States do the converse and grant their contractual terms and

conditions an explicit public law underpinning. For instance, UK law provides

that ‘the Treasury may create and issue such securities, at such rates of interest and

subject to such conditions as to repayment, redemption and such other matters

(including provision for a sinking fund) as they think fit.’24 In France, there is no

such general link, but the statute states explicitly that the repayment of public

borrowing is effectuated ‘pursuant to the borrowing agreement.’25 In Belgium, the

Royal Decree governing the issuance of government bonds states that the bonds

will be governed by the same Decree, general rules regarding such bonds and ‘the

terms and conditions incorporated . . . in agreements.’26 Even in the USA,

the public law instrument dictates that ‘the provisions in this part, including

the appendices, and each individual auction announcement govern the sale and

issuance of marketable Treasury securities.’27

21 An important legal driver for such an approach is that many sovereigns are exempted by law fromthe general disclosure requirements of securities laws. Thus, while such States are not obliged toissue a prospectus, they often still aim to provide investors with information through voluntarilyissued prospectuses or similar documents such as information memoranda.

22 On the interaction of these instruments, see the UK’s Information Memorandum Relating to theIssue, Stripping and Reconstitution of British Government Stock <http://www.dmo.gov.uk/documentview.aspx?> ‘This Memorandum supplements, and is subject to, the specific termsand information set out in the prospectus or notice relating to each particular issue of Stock.’As an example of an issue governed by the prospectus rather than the information memorandum,see section 16 of this Information Memorandum in regard to the maturity of British public debtsecurities.

23 This general rule book consists of the Uniform Offering Circular for the Sale and Issue ofMarketable Book-Entry Treasury Bills, Notes, and Bonds, 31 CFR Part 356, as amended<http://www.treasurydirect.gov/instit/statreg/auctreg/auctreg.htm> [UOC], which is issued inthe form of a circular of the US Treasury. The interaction between the offering announcementand the UOC is similar to the one discussed in the previous footnote for the United Kingdom. Themore detailed offering announcement supplements the general UOC. See, eg, section 356.30 (a) ofUOC in regard to payment of principal and interest.

24 See section 12(2) of the 1968 National Loans Act, 1968 (1968 Chapter 13).25 See Article 26(4), in fine, of the Loi Organique no 2001-692 (1 August 2001) ‘relative aux lois de

finances.’26 See Article 2 of the Belgian Royal Decree on Linear Obligations (16 October 1997). This is but-

tressed by Article 1 of the Law on Public Debt Securities (2 January 1991).27 UOC (n 23) s 356.1.


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2. Contractual capacity of the issuing state

Given that public debt securities include contractual obligations, two important

questions arise as to the concept of contractual capacity. The first question is

whether, and to which extent, the State (as principal) has legal authority

to borrow and legal capacity to issue public debt securities. The response to

this question is paramount because a lack of capacity can be invoked by the

prima facie debtor to seek to declare the borrowing agreement null and void.28

Many, if not most, jurisdictions apply the rule that private persons or entities have

the authority to pose any legal act that is not prohibited by law—this rule is

typically subject to only a few exceptions aimed at protecting the vulnerable

(for example, minors). In contrast, public law entities (including States) are

often subject to the public law rule that they can only pose those acts that are

explicitly or implicitly authorized by law. In regard to borrowing, the legal au-

thorization of a State is typically enshrined in the following two legal

instruments:29

• Constitutions: Some constitutions include the direct and immediate author-

ization for the State to borrow. For instance, under New Zealand’s

Constitution Act (Part 6, section 47), the Minister of Finance is authorized

to borrow debt but only if it appears to the Minister to be necessary or

expedient in the public interest to do so.

• Legislation: In other countries, the constitution, quasi constitutional norms

(such as special majority laws), or even ordinary legislation, prescribe that

the State must be authorized by statute to borrow.30

28 Lack of capacity as a justification for nullity of public debt was, for instance, invoked by theEcuadorian Comision de Auditoria Integral del Credito Publico in its 2008 report on the legalanalysis of its external commercial debt. See <http://www.auditoriadeuda.org.ec/index.php?option=com_content&view=article&id=94&Itemid=62>.

29 In theory, it might also be possible to provide some form of authorization in an internationaltreaty. In the case of nineteenth-century Egypt under the Ottoman Empire, the Treaty of London(15 July 1840) conferred a distinct sui generis political and legal position to Egypt—that is, a highlyautonomous country that is only nominally under the suzerainty of the Sublime Porte. In hisFirman (decree) of 13 February 1841 implementing this Treaty, the Ottoman Sultan authorizedEgypt to contract domestic public debt on its own authority. See W Kaufmann, The Egyptian StateDebt and Its Relation to International Law (FC Methieson and Sons 1892) 9–10.

30 In regard to a constitutional requirement for legislation, see Article 1, section 8 of the USConstitution, pursuant to which Congress is authorized ‘to borrow money on the credit of theUnited States,’ and Article 115 of the Basic Law for the Federal Republic of Germany, whichprovides that borrowing by the federal government shall require authorization by a federal law.In regard to a special majority law requirement for legislation, see Article 26.4 of the French Loiorganique no 2001-692 (1 August 2001) ‘relative aux lois de finances.’ Under section 11(1) ofSingapore’s Government Securities Act (Chapter 121A) (Act 1 of 1992 as revised in 2002), ‘[t]heParliament may, by a resolution under Article 144(1)(a) of the Constitution with which thePresident concurs, authorise the amount of borrowing by the issue of Government securities inSingapore under this Act, and may, from time to time, vary that amount.’ Similar provisions existunder section 3(1) of the Local Treasury Bills Act (Chapter 167) (Ordinance 4 of 1923 as revised in2002) under which ‘Parliament by resolution authorizes the borrowing of moneys under this Actand the President has given his concurrence under Article 144(1)(a) of the Constitution for suchborrowing.’


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Obviously, while authorizing borrowing, those legal instruments can also

impose constraints and conditions for such borrowing. For instance, section 10

of the Jamaican Public Debt Management Act 2012 provides that ‘[t]he Minister

may borrow money . . . for the following purposes only . . . (a) finance the fiscal

budget; (b) to refinance any maturing or outstanding public debt.’31 Section 12 of

the same law also imposes ceilings on public debt as follows: ‘[L]oans raised in any

financial year shall not, in the aggregate, exceed the sum of . . .’. The legal effects of

such limitations on the validity of public debt securities issued in contravention of

such limitations will be discussed later in this article.

The second question is which individual or body has capacity to borrow and issue

public debt securities on behalf of the State. As legal entities, States are not capable

of acting on their own but need to act through ‘organs’—either a decision-making

body or an individual representative—acting as their agents. Thus, in any given

jurisdiction, the question arises as to who is lawfully authorized to issue public debt

securities: the minister of finance, the central bank, or a separate public debt man-

agement agency? The decision as to who should receive such powers is ultimately a

choice of policy and politics, but the law should be clear as to who can issue public

debt securities on behalf of the State. A related legal question is how the agency

power of the competent agent is established: by contract or by statute? The short

survey in Box 1 indicates that most borrowing authorities are established by stat-

ute.32 Another relevant issue is whether the agency power is general or limited. The

survey suggests that legislative practice in this regard is mixed.

3. The creation of public debt securities in the primary market

As they incorporate contracts, the creation of public debt securities would gen-

erally be governed by the basic rules of general contract law. At what point in time

then is the borrowing agreement formed? In some legal traditions, it may be when

the offer of the lender has been accepted by the borrower. In others, it may only

occur when the lender has actually transferred the loaned amount to the bor-

rower.33 However, this principle only applies in so far as public law does not

derogate from contract law.34 In this regard, the determination of what is a valid

31 See also section 9 of Tanzania’s Government Loans, Guarantees and Grants Act of 1974, asamended in 2003, which provides that ‘[s]ubject to the provisions of this Part the Ministermay, for and on behalf of the Government, from time to time raise, in the manner provided forin this Part, loans from within Tanzania of such sums as in the opinion of the Minister arenecessary to defray expenditures which may be lawfully defrayed.’ (emphasis added)

32 In fact, this principle applies mainly with respect to government borrowing qua principal. In manycountries, central banks are authorized by statute to act as ‘fiscal agent’ for the government,including in the field of issuance of public debt securities. The interaction between the Stateand its fiscal agent is often governed by an agreement between the two entities.

33 This is the case under the French civil code where loan/borrowing agreements are ‘contrats reels’that only come into existence by the execution of the primary obligation of the lender to transfer tothe loaned amount. Before that, there is only a (binding) promise to lend.

34 An interesting example of such derogation is to be found in section 5 of the UK’s National DebtAct (1889), which stipulates that ‘[t]reasury bills shall bear the name of one of the Secretaries to theTreasury, and that name may be affixed or impressed by machinery or otherwise in such manner asthe Treasury may direct from time to time by regulations.’


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offer for public debt securities and its acceptance would largely be determined by

public law, particularly primary legislation and/or secondary regulation regulat-

ing the conduct of the ‘primary market,’ dealing, inter alia, with the structure of

the issuance process and who may participate to it.

What then, if any, is the legal interaction between primary market regulations

issued by the government and the general rules of the civil code or the common

law? While this interaction may differ from country to country depending on the

public law regime, an offer for public debt securities typically involves a bid

Box 1: Who borrows on behalf of the State: a short survey

Minister of Finance with the consent of the Head of State: In the USA, the Secretary of

the Treasury is authorized to borrow on the credit of the US government and issue

bonds, albeit with the approval of the President (section 3102, Chapter 31, US Code).

A similar rule applies in Mexico, where the Secretary of the Treasury may issue gov-

ernment bonds with the consent of the President (Article 5.II of the Ley General de

Deuda Publica). More generally, the law states that the federal government can only

‘contract financing’ through the Secretary of the Treasury (Article 17). In Canada,

the Financial Administration Act authorizes the Minister of Finance to borrow

money for the government in financial markets, including by issuing securities,

provided that such borrowing is authorized by statute and the ‘Governor in Council’

(sections 43 and 44).

Minister of Finance: In South Africa, section 66(2)(a) of the Public Finance

Management Act (1999) gives the Minister of Finance powers to commit the

National Revenue Fund to future financial commitments by borrowing money, issuing

a guarantee, indemnity or security, or entering into any other binding transaction. In

Singapore, section 11(1A) of the Government Securities Act authorizes the Minister of

Finance to borrow on behalf of the government by the issuance of government secu-

rities. Under section 11(2), the Monetary Authority of Singapore may, on behalf of the

Minister, undertake the issue and management of government securities. In Malaysia,

section 2(1) of the Treasury Bills (Local) Act 1946 (revised as of 2006) provides that

‘the Minister of Finance may borrow moneys by the issue, from time to time as he may

deem expedient, securities in the form of entries in the records of the Bank under

subsection 7(3).’

Ministry of Finance: In the UK, the 1968 National Loans Act authorizes HM Treasury

to borrow and issue debt securities (section 12).

Central Bank: In Tunisia, Article 40 of the Law on the Central Bank of Tunisia au-

thorizes the central bank to issue public debt securities expressed in foreign currency in

its own name but on behalf of the State. This provision also establishes a special ac-

counting treatment for such securities as well as guarantees for the central bank to

ensure repayment by the State. Tunisia recently committed in the context of its

International Monetary Fund-supported program, to supplement the provisions of

Article 40 by clarifying that the central bank is acting as an agent when executing

sovereign debt instruments issued in foreign currency through international markets

and that such debt is a liability of the central government.


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submitted by a prospective investor or its intermediary for such securities de-

pending on the rules governing access to the primary market. While the State

indicates in advance (by way of announcement) to the market how much it

intends to borrow through the issuance of the particular security, this generally

does not constitute an offer. The courts have often distinguished between an

invitation to treat such as arises in a tender or auction where the person

making the invitation merely intends to invite offers that they could accept or

reject, on the one hand, and binding offers where the person making the invita-

tion indicates that they are willing to accept the highest tender, on the other.35

The eligibility of bids would be established by conformity with (typically public

law) primary market rules, which, for instance, prescribe that bids must be in

specific minimum quantities and submitted in a particular manner and on a

particular day and time. The acceptance of bids is ultimately the decision of the

State as issuer or its lawful agent (for example, the central bank). The process of

determining which bids to accept is automated in certain jurisdictions based on a

pre-determined criteria underpinned by the public law regime affecting public

debt. A number of interesting legal issues arise in relation to offer and acceptance

in the primary market. For instance, the State or its lawful agent may wish to

accept a particular bid only partially. Also, bids submitted separately by related

persons may sometimes be treated by the State or its agent as bids by a single

bidder for purposes of enforcing any limitations on single bids or to control

collusion among bidders. Needless to say, these matters could very well lead to

disputes as to the eligibility of a bid and whether bids were rightfully rejected.

Public law rules governing the primary market must provide very clearly for these

matters.

Generally speaking, public debt securities are typically deemed issued when the

government or its lawful agent accepts a bid and the securities are allotted and

registered in favour of the bidder (in the case of registered securities). Each bid

accepted constitutes a government securities contract legally enforceable within

the terms and conditions agreed and within the context of applicable public law

relating to government securities. This discussion shows the importance of a clear

definition of the sources of private and public law regimes that affect rights and

obligations in the primary market for public debt securities. Public debt managers

must be well aware of the complex legal issues that may arise in the primary

market and endeavour to provide adequately and clearly for such issues to

manage potential legal risks for the government as issuer as well as for market

participants.

4. The legal form of public debt securities

Jurisdictions have developed various legal forms within which debt and other

securities can be held. As alluded to earlier, the first two legal forms of securities

that were developed by legal and financial practice were bearer and registered

35 See English case of Spencer v Harding (1870) LR 5 CP 561 and Payne v Cave (1789) 3 TR 148.

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securities. Bearer certificates take the form of a paper certificate, and the claims

incorporated in the security are transferred by the physical—‘from hand to

hand’—transfer of the paper certificate (for example, from seller to buyer) of

which the bearer at any material time is entitled to the rights of repayment and

other rights under the security. Registered securities are solely represented by

inscriptions in a register operated by the issuer or its agent, and the claims

incorporated in the security are transferred by recording the transfer in the regis-

ter. The legal owner of the securities on record (on the register) at any point in

time is entitled to exercise the rights attached to those securities. Some countries

have recently developed a third, fully dematerialized, legal form of security, which

only exists in the form of a credit balance on a securities account. This form of

security must be distinguished from a fourth form, which equally consists of a

credit balance on a securities account as well as a holding of what were originally

bearer or registered securities through so-called ‘fungibility’ regimes.36

Nonetheless, these two latter types of securities have many features in common

and, due to the fact that they are by definition held through a professional inter-

mediary, are called ‘intermediated securities.’

In light of this discussion, what is then the legal form of public debt securities?

Jurisdictions vary considerably in the manner in which they prescribe this aspect

of such securities. A first group of jurisdictions have adopted sui generis ‘public

law’ legislation governing the form of public debt securities. In some of these

jurisdictions, legislation establishes a fully dematerialized form (for example,

Belgium37), while in others the statute endorses the use of more traditional

forms (for example, registered securities in the USA).38 In some of these juris-

dictions, legislation imposes a single form, whereas in others the borrowing

authority has the choice as to the form of any given issue.39

This being said, in many jurisdictions, the public law rules are silent on the legal

form of public debt securities. Consequently, given that a considerable number of

jurisdictions have comprehensive legal frameworks governing the legal form of

securities generally, the question arises whether this general, private law frame-

work will also apply to public debt securities. In this regard, three common

problems arise:

• Several countries have a specific stand-alone law on securities. In such a case,

the question arises whether, and to which extent, such a law is applicable to

public debt securities. A good example is Peru, where a general ‘securities law’

36 A good example of such ‘fungibility’ regime is provided by the Belgian Royal Decree no 62(10 November 1967) on the custody of fungible financial instruments and the settlement oftransactions in such instruments.

37 See, eg, the Belgium Law on Public Debt Securities (2 January 1991), which also allows to issue inthe form of registered securities. Note that there are other countries, such as France, wheredematerialized securities are not considered to be a separate legal category but are either beareror registered securities.

38 US Code, section 3121.39 See, eg, ibid s 3121(a)(6), pursuant to which the Secretary of the Treasury may prescribe the form

of obligations.

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applies to public debt securities but only to the extent the specific public law

legislation governing the issuance and circulation of such securities does not

include more specific rules.40

• In other countries, the general securities framework is enshrined in civil or

commercial codes. Is this general framework applicable to public debt secu-

rities? Naturally, the response to this question will depend on the particular

wording of the legislation, and it is difficult to draw broad general conclu-

sions. This being said, commercial codes are rarely applicable to the State (see

earlier discussion).

• A third issue arises when the legal form of securities is determined by com-

pany law. Given that most private law issuers take a corporate form, many

company laws include rules on the types of securities that companies may

issue. It is to be expected that the State is excluded from the personal scope of

application of company laws. This being said, company laws may be relevant

in case public debt laws explicitly cross-refer to company laws in establishing

the legal form of public debt securities.

The relevance of the exact determination of the applicable rules on the form of

public debt securities is most salient in case the intermediary through whom

investors hold such securities becomes insolvent.41 In such a case, investors will

need to determine the legal principles applicable to their securities holding. The

key question is whether they will merely hold contractual rights against the estate

of the insolvent intermediary, in which case they are likely to suffer significant

losses or, alternatively, they hold rights in rem allowing them to carve out

their securities from the estate and recover most if not all of their holdings.

The legal ramification of the holding structure often flows from the legal

form of the security. For instance, securities in registered form imply by definition

a direct holding link between investor and issue and exclude a risk of the

investor on any intermediary. In contrast, securities held through a ‘fungibility

regime’ are subject to such risk, which must be appropriately recognized and

addressed.

In this regard, the International Institute for the Unification of Private Law’s

(UNIDROIT) Convention on Substantive Rules for Intermediated Securities

(Geneva Securities Convention) is an extremely useful legal instrument to safe-

guard investors in intermediated public debt securities against the insolvency of

their intermediaries.42 In this light, States aiming to strengthen their securities

holding legislation by way of adopting the Geneva Securities Convention should

40 See Peruvian Law no 27287 ‘de Titulos-Valores.’ Article 275 of this law is not a public law instru-ment governing access and functioning of securities markets but, rather, governs the private lawaspects of securities.

41 See W Bossu, ‘Securities Holding Regimes and Bank Resolution Law: Cold War, PeacefulCo-existence or Friendly Alliance?’ (2010) 3/4 Uniform Law Review 665.

42 Convention on Substantive Rules for Intermediated Securities<http://www.unidroit.org/english/conventions/2009intermediatedsecurities/convention.pdf> accessed 31 May 2013 [GenevaSecurities Convention].

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ensure that public debt securities are brought under the material scope of appli-

cation of the implementing legislation.43

5. Transactions in the secondary market

Which rules govern the transactions with public debt securities in the secondary

markets? Once public debt securities have been issued by the State, they start to live

their own life and be traded and transferred between private investors. The most

common transactions are ‘outright sales’ whereby ownership in the securities is

transferred from seller to buyer, but public debt securities are also used to collat-

eralize counterparty exposures by way of pledge and ‘transfer of title’ arrangements,

including repurchase agreements (‘repos’). It is true that many jurisdictions estab-

lish public law rules for secondary markets in public debt securities. These rules,

which tend to be similar in some respect and different in others relative to general

securities markets rules, govern issues such as access to the market, duties of market

participants, market practices, prohibition of certain transactions (for example,

short selling prohibitions), reporting requirements, and so on.

The issue we are most interested in here concerns the legal validity and enforce-

ability of the earlier-mentioned transactions. The legal robustness of the sales and

collateralization of public debt securities is subject to private law, namely contract

law and other relevant laws, such as insolvency law, and possibly also more specific

sets of legislation, such as payment system or financial collateral laws. The quality of

these laws will have a direct impact on the attractiveness of holding and trading

public debt securities. While outright sale contracts pose few problems, many jur-

isdictions have traditional rules that have hindered the effective collateralization of

public debt and other securities, and they have undertaken legislative reform action

to modernize their frameworks.44 In this regard, UNIDROIT’s Geneva Securities

Convention and the Principles on the Operation of Close-out Netting

Provisions45 also include rules buttressing the legal robustness of transactions in,

and collateralization of, intermediated securities. These UNIDROIT instruments may

offer useful guidance to countries contemplating law reform in this field, and Box 2

will set out some key features of both the Convention and the Principles.

6. Clearing and settlement of secondary market transactions

In a similar vein, transactions concluded in the secondary market need to be settled

so as to perform the counterparties’ contractual obligations. Given the very high

43 Article 1(a) of the Geneva Securities Convention, ibid, defines ‘securities’ as any shares, bonds, orother financial instruments or financial assets (other than cash) that are capable of being creditedto a securities account and of being acquired and disposed of in accordance with the provisions ofthis Convention. This definition allows for the inclusion of public debt securities in the coverage ofthe Convention.

44 The main problems were the overly formalistic rules on pledge and the hostility towards the use ofownership rights as collateral, with the ensuing risk that transfer of title arrangements could berequalified as invalid pledges.

45 Principles on the Operation of Close-out Netting Provisions <http://www.unidroit.org/english/studies/study78c/main.htm> accessed 15 September 2013.

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Box 2: Key Features of Geneva Securities Convention and Principles on the

Operation of Close-out Netting Provisions

The Convention seeks to help protect rights and interests of persons that acquire or

otherwise hold intermediated securities. These are defined as securities credited to a

securities account or rights or interests in securities resulting from the credit of secu-

rities to a securities account maintained by an intermediary (including bonds). The

Convention does not apply to the issuance process of securities (Article 6).

Relevant key provisions of the Convention include:

(i) The credit of securities to a securities account confers to the account holder the

right to receive and exercise any rights attached to the securities (Article 9), even

though the Convention does not affect any right of the account holder against

the issuer of the securities, or determine whom the issuer is required to recog-

nize as the bondholder (Article 8).

(ii) Intermediaries must take appropriate measures to enable their account holders

to receive and exercise the said rights. (Article 10);

(iii) The acquisition and disposition of securities by an account holder is

effected through credit and debit respectively of the account, and such

acquisition/disposition is effective against third parties without further steps

(Articles 11);

(iv) It provides for the duties of intermediaries to protect securities credited to a

securities account, give effect to any instructions given by the account holder

and generally uphold the rights of the account holder under applicable law, the

account agreement or the uniform rules of a securities settlement system

(Article 10). It also provides for priorities among competing interests (Article

19), loss sharing in case of insolvency of the intermediary (Article 26); and

insolvency of a system operator or participant (Article 27).

The Principles provide harmonized legal principles for the operation of close-out

netting provisions entered into by eligible parties in respect of eligible obligations.

Their scope covers contractual provisions contained in a single agreement or in several

interrelated arrangements including master-master agreements.

The Principles apply to bilateral or multilateral as well as direct or indirect settlement

obligations of counterparties, including public authorities (governmental or central

bank) under eligible transactions, which include obligations arising under contracts

between eligible parties for the sale, purchase and delivery of securities, among other

things (Principles 2, 3, 4).

In relation to the State as counterparty, the Principles seek to address concerns as to

whether the enforceability of the close-out netting provision is likely to raise issues of

public interest e.g. systemic risk, or whether claims for the repayment of public funds

made available to a private market participant can be protected in the event of the

insolvency of the latter.

Implementing States are free to choose any suitable method for implementing the

Principles, including through the enactment of specific legislation, the application of

general principles of law or the removal of restrictions to the enforceability of close-out

netting provisions in the context of insolvency proceedings.

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number of transactions in sophisticated public debt securities markets, many of

these markets offer to market participants the possibility to clear their transactions

before proceeding to settlement. Whether or not transactions in public debt secu-

rities are cleared, they will need to be settled by transfers of securities within

securities settlement systems and, if the transaction involves a ‘cash leg’ (for ex-

ample, in case of an outright sale or a repo), they will need to transfer cash in inter-

bank payment systems. A discussion of the intricacies of the legal robustness of

clearing, payment, and securities settlement systems goes beyond the scope of this

article. It suffices here to bring the reader’s attention to the fact that the most acute

concern is with the ‘definitive character’—grammatically erroneously referred in

some instances to ‘finality’—of netting of transactions and securities and cash

transfers in such systems. To achieve this action, many jurisdictions require the

establishment of statutory safe harbours for such systems from ‘claw back’ and

‘zero-hour’ rules featuring general insolvency laws (see Article 27 of the Geneva

Securities Convention, which provides such protection for covered securities trans-

fers). While such law reform is generally undertaken with a wide perspective of

enhancing the broad legal robustness of clearing, payment, and securities settlement

systems, it also has beneficial side effects on the trustworthiness of post-trading

infrastructure of public debt securities specifically and, hence, on the attractiveness

of such securities as an investment class.

IV. Impact of public law on private lawAs earlier discussed in this article, the interaction between public law and private

law in relation to public debt securities directly affects the scope of rights and

obligations of counterparties. More specifically, while private law is generally

applicable, this principle is limited by specific public law mechanisms and frame-

works. In addition to the previously covered topic of the incorporation of con-

tractual terms and conditions, a few other scenarios of the impact of public law on

private law are discussed in the following sections.

1. Public law constraints and validity of borrowing agreement

The enforceability of a borrowing agreement entered into by a State may be

impacted by public law, including constraints on a State’s borrowing power. In

certain jurisdictions, public law may invalidate purported State borrowing in

violation of statutory provisions, including debt ceilings and approval require-

ments.46 Such provisions may impose a tacit ‘caveat emptor’ duty on a prospective

investor to verify whether relevant provisions of the public debt legal framework

46 The Brazilian Fiscal Responsibility Law, Supplementary Law 101 (4 May 2000) Article 33, s 1,provides that public debt contracted in violation of the provisions of that law will be considerednull and void and must be cancelled through the refund of the principal without payment ofinterests and other financial charges. Also, section 26 of Sierra Leone’s Public Debt ManagementAct (2011) provides that ‘[g]overnment shall not be bound by the terms of any loan contracted orpurported to be contracted for or on its behalf by any person other than the Minister or a publicfigure, authorized in writing in that behalf by the Minister.’

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have been complied with by the State and its agents in the issuance of the secu-

rities. However, while in other jurisdictions, the public law regime may appear to

commit the State unconditionally to its debt obligations,47 the question of what

legal implications arise in the event that debt obligations are contracted unlaw-

fully may still be a matter of concern, especially where the public law regime does

not explicitly provide for such action.

2. ‘Pari passu’ provisions under public law

In recent times, so-called ‘pari passu’ provisions, which had traditionally been a

‘contractual’ fixture under government bond prospectuses, are beginning to

emerge in public debt legislation.48 The significance of this phenomenon is that

it may suggest that all government debt liabilities, regardless of the contractual

terms and conditions under which they arise, may rank equal for all purposes

including repayments. The practical implications of such statutory provisions for

investors may become apparent in the context of future government debt restruc-

turing where questions may arise as to the right of all government creditors on pro

rata debt repayments. Future court decisions in this regard would likely involve

not only pure legal interpretation of such statutes but also key public policy

considerations as to the possible fiscal implications of such provisions.

3. Taxation

Tax laws are a key feature of the public law regime, which potentially affects in-

vestors’ rights under public debt securities. Tax laws impact net returns under such

securities either due to withholding taxes on interest income or tax on capital gains

from a sale of public debt securities in the secondary market. Tax liabilities in the

form of stamp duty may also apply in respect of transfers of public debt securities in

the secondary market. In the case of a transfer of public debt securities by way of gift

or inheritance, the beneficiary of such a gift may also be liable to pay gift tax or

estate tax as the case may be. Important legal issues for the investor include the

47 For instance, section 6(2) of Mauritius’s Public Debt Management Act (2008), which provides that‘[a]ny debt incurred by the general Government . . . shall constitute a debt due by the State andcarry an absolute and unconditional commitment by the Government to the timely payment of theprincipal of the debt and the interest on it, in accordance with the terms and conditions underwhich the indebtedness was contracted.’ See also section 27 of Tanzania’s Government Loans,Guarantees and Grants Act (1974), as amended in 2003, which provides that ‘[n]o person lendingany sum of money to the Government shall be bound to enquire whether all the conditions forraising a loan provided for in section 4 and section 7 have been complied with and for theavoidance of doubts it is hereby declared that where a loan whether a foreign loan, or localloan has been raised by the Minister for and on behalf of the Government, the Governmentshall be bound by the transaction and section 16 shall apply in relation to the loan notwithstandingthat any provision of the proviso to section 4 of the proviso to section 7 has been contravened’.

48 See, for instance, Jamaica’s Public Debt Management Act (2012), which provides that ‘[a]llliabilities in the form of public debt, and in the form of obligations under guarantees authorizedunder this Act, rank pari passu.’ Also, section 6(4) of Mauritius’s Public Debt Management Act(2008), which provides that ‘[n]otwithstanding any other enactment, all Government debt, re-gardless of its nature or the date it was incurred, shall have equality of status in relation to claims inrespect of payment of the principal and interest, and shall constitute a first claim against theaccount into which the funds are deposited.’

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extent to which the tax regime applicable to the investment in public debt securities

is known upfront. Do the prospectus or other terms and conditions of the securities

spell out the tax regime applicable to the securities? If so, is the tax regime applicable

to the security fixed for the life of the security or is it subject to change on a

retrospective basis with general changes in the tax regime? Can new taxes or

levies be imposed on the investment on a retrospective basis? Are there variations

in the tax regime for different categories of investors such as residents and non-

residents, on the one hand, and for corporate entities and natural persons, on the

other, and how do these different tax treatments impact investors’ rights and

ultimately the development of a buoyant public debt securities market?

4. Unilateral modification of contractual terms

One critical question that flows from the applicability of private law to borrowing

agreements of the State is whether the latter can unilaterally modify the contrac-

tual terms and conditions during the duration of the contract—for example, on

the grounds of the public interest. Under general contract law, the modification of

contractual terms and conditions tends to require the prior consent of all parties

to the contract. Similarly, under public debt securities contracts, terms and con-

ditions of the offer typically require prior approval of either all or a qualified

majority of bondholders for modifications of key terms.49 However, can legisla-

tion derogate from this principle?

Given its ordinary role as guardian and enforcer of private rights through the

maintenance of the rule of law and a judiciary, the circumstances (if at all) under

which the State could itself arrogate unto itself the power to override private

rights is one that remains unresolved. Some theorists have argued in favour of

the theory of necessity under which unilateral acts of the sovereign may be

justified. The former US president Thomas Jefferson is believed to have said

that ‘strict observance of the written law is doubtless one of the high duties of a

good citizen, but it is not the highest. The laws of necessity, of self-preservation, of

saving our country when in danger, are of higher obligation.’50 Ultimately, the

answer to the question posed earlier differs from country to country.

In several countries, it is an accepted legal principle that contracts may not

derogate from legislation of ‘public order.’ In this regard, it is the legislature itself

that determines whether or not a particular set of legislation is of ‘public order.’

By consequence, in such countries, it is legally accepted that the legislature can by

‘public order’ legislation modify the contractual terms and conditions of borrow-

ing agreements during the duration of the contract. While such modifications do

49 This issue would be governed by so-called collective action clauses inserted in the contractualdocumentation of the securities.

50 As quoted in GN Magliocca, ‘The Gold Clause Cases and Constitutional Necessity’ (2012) 64(5)Florida Law Review 1, taken from ‘Letter from Thomas Jefferson to John B. Colvin’ (20 September1810), reprinted in 4 The Founders’ Constitution 127.

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not occur often, they tend to be used by States in unsustainable debt situations.51

An example is the 2012 Greek Bondholder Act (Law 4050/2012), which provides a

mechanism for the government to retroactively impose on existing government

bond contracts ‘collective action clauses’ by which a specified majority of bond-

holders could approve a proposed restructuring of the terms of those bonds,

including on payments due under the bonds. For reasons such as these, investors

in public debt have often requested that borrowing States issue their debt in

foreign jurisdictions with a reputation of being creditor friendly, such as the

UK or New York State.

In other countries, however, the public law regime may protect against unilat-

eral contract modification. For instance, section 6(2) of the 2008 Mauritius Public

Debt Management Act provides that ‘[a]ny debt incurred by the general

Government or a public enterprise and which is wholly or partly guaranteed by

the Government shall constitute a debt due by the State and carry an absolute and

unconditional commitment by the Government to the timely payment of the princi-

pal of the debt, and interest on it, in accordance with the terms and conditions under

which the indebtedness was contracted.’52

In the case of the USA, the public law regime at the highest level, the

Constitution, offers protection to creditors against unilateral contract modifica-

tion by the State. Section 4 of the Fourteenth Amendment to the US

Constitution—often called the ‘full faith and credit’ clause—provides that

‘[t]he validity of the public debt of the United States, authorized by law, . . . shall

not be questioned.’ While the legal ramifications of the provision has been the

subject of much academic discourse, the US Supreme Court ruling in the 1935

case of Perry v United States53 emphatically declared that public debt obligations

assumed by the federal government cannot be invalidated and that contractual

rights of private parties under public debt lawfully contracted may not be inter-

fered with by Congress.54 In this case, a holder of a US government bond (the

‘Liberty Bond’), which promises payment of principal and interest ‘in United

States gold coin of the present standard of value’, was refused payment under the

‘gold clause’ by the Treasury in reliance on a joint resolution passed by Congress

on 5 June 1933,55 nullifying all such ‘gold clauses’ to avert hardship from debt

51 The main reason for this is the lack of insolvency mechanism for States, such as the oneproposed in S Hagan, ‘Designing a Legal Framework to Restructure Sovereign Debt’ inCurrent Developments of Monetary and Financial Law, vol. 4 (International Monetary Fund2005) 195.

52 Emphasis added.53 Perry (n 10).54 Also, the court reasoned that, ‘[b]y virtue of the power to borrow money ‘on the credit of the

United States’, Congress is authorized to pledge that credit as assurance of payment asstipulated—as the highest assurance the Government can give—its plighted faith. To say thatCongress may withdraw or ignore that Congress may withdraw or ignore that pledge is to assumethat the Constitution contemplates a vain promise, a pledge having no other sanction than thepleasure and conveniences of the pledgor.’ Ibid.

55 The Joint Resolution purported to nullify the ‘gold clause’ in favour of discharge of the bondobligations by payment in coin or currency of the face value of such bonds.

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servicing in the aftermath of the Great Depression and the deflation that ensued.

The US Supreme Court held that the government’s purposed payment of the

bondholder the simple face value of the bond was a repudiation of the ‘gold

clause’ and unconstitutional, although Congress was within its power to regulate

the use of gold in monetary transactions.

Interestingly, in the view of the US Supreme Court, the very doctrine of sov-

ereignty did not give the government the power to override the rights of private

persons but, rather, the obligation to respect those rights. The private nature of

contractual rights and obligations under public debt and its dominance over the

so-called necessity theory was underscored by the Court when it opined that,

‘[w]hen the United States, with constitutional authority, makes contracts, it has

rights and incurs responsibilities similar to those of individuals who are parties to

such instruments’ and that ‘[t]he right to make binding obligations is a power of

sovereignty. The sovereignty of the United States resides in the people, and

Congress cannot invoke the sovereignty of the people to override their will as

declared in the constitution.’56

Similarly, in the later case of United States Trust Company v New Jersey,57 the US

Supreme Court held that a state cannot refuse to meet its contractual obligations

to private creditors under a bond issue simply because it would prefer to spend

the money for the greater good of the community and that a higher level of

scrutiny was needed for situations where laws modified the government’s own

contractual obligations. Rejecting arguments on the grounds of ‘reasonableness’

and ‘necessity’ of the repeal, the court stressed that given that the State was a

contractual party, repudiating (through the legislative process) its financial obli-

gations to spend money in the public interest would make nonsense of the rights

of state creditors under the Contracts Clause of the US Constitution. The US

Supreme Court’s ruling provides useful guidance on the key legal issues under US

law, even if only applicable at the state level.

5. Capital controls and selling restrictions

Capital controls and selling restrictions may limit market access of (potential)

buyers in the public debt securities market. Capital control laws could impose

quantitative and other restrictions (such as type of securities that could be

56 Perry (n 10) [emphasis added]. The Court, however, averted a full-blown controversy when itstopped short of declaring the enforceability of the ‘gold clauses’ against the Treasury and in anyevent held that the unconstitutionality of the repudiation by the Treasury did not entitle theplaintiff to recover more than the loss he had actually suffered. President Roosevelt had apparentlypublicly declared that he would not comply with any court order that would lead to ‘an economiccatastrophe.’ For a fuller discussion, see Magliocca (n 50) 5, quoting Elliott Roosevelt (ed), F.D.R.:His Personal Letters,’ 1928–1945 (Duell, Sloan and Pearce 1950) 456–60.

57 United States Trust (n 15). In this case, the state of New Jersey had issued bonds in the 1960s tofinance the construction and maintenance of a bridge by an independent port authority and hadcontractually promised the bondholders that the toll revenue (used to collateralize the bond)would not be used to finance rail operations. During the energy crisis of the 1970s, New Jerseypassed another law to allow financing of railway operations. The bondholders successfully sued toprevent this from happening on the grounds that the repeal of the original legislation violated theContract Clause in that it impaired their rights to payment on the bonds.

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acquired) against certain types of foreign investors. Such controls are often moti-

vated by policy objectives of managing foreign currency reserves and, in some

cases, mitigating the possible destabilizing effects of exchange rate or financial

market volatility from so-called ‘hot money.’ While many emerging economies

have historically maintained capital controls of some sort, the trend is generally

towards easing such controls, although in many jurisdictions some controls

remain. Examples in Ghana and India are shown in Box 3. The relevance of

such controls from the perspective of this article is that they could affect the

Box 3: Selling restrictions in Belgium and capital controls regimes in Ghana

and India

Belgium: In a 1994 Eurobond offering, the Belgium government imposed the following

sales restriction under the Royal Decree authorizing the offering and as an express term

of the bond prospectus:

‘The Bonds may not be offered or sold, directly or indirectly, to residents of, or corpor-

ations or other legal entities having their domicile in, the Kingdom of Belgium except,

provided that the offer or sale does not constitute an offer to the public of the Kingdom

of Belgium, to (i) a bank . . . (ii) a broker, similar intermediary or institution of inter-

national standing whose business involves dealing in securities or managing customers

funds . . . and (iii) an insurance company.’

In an European Court of Justice ruling of 26 September 2000 (Commission v Belgium,

C-478/98), the Eurobond sales restriction was declared to be an unlawful restriction on

the free movement of capital and therefore incompatible with Article 56 of the Treaty of

European Union, which prohibits all restrictions on the movement of capital and

payments, unless justified under the Treaty.

Ghana: Ghana has progressively relaxed capital controls including restrictions on non-

resident investments in public securities. Under Ghana’s Foreign Exchange Act, 2006

(Act 723) and guidelines and notices issued by the Bank of Ghana, non-resident for-

eigners may now invest in government public securities without prior approval of the

Bank of Ghana except that they are restricted to investments in maturities of three years

or above. In practice, this has meant that while non-resident foreigners cannot partici-

pate in the primary market for treasury bills and other public debt securities with

maturities below three years, they may be able to purchase longer dated securities in

the secondary market with remaining maturities of less than three years.

India: India uses a combination of capital controls and a special levy on foreign invest-

ments in publicly issued (including government) securities to control capital flows.

India has progressively relaxed capital controls including restrictions on non-resident

investments in public debt securities. Under India’s 1999 Foreign Exchange

Management Act and its Regulations, foreign institutional investors may invest in

government public debt securities within quantitative limits prescribed from time to

time, subject to prior registration by the Securities and Exchange Board of India and

prior approval from the Reserve Bank of India. A special withholding levy also applies

to foreign investments in public debt securities as well as in corporate bonds.

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extent to which foreign or non-resident investors may participate in the public

debt securities market and sometimes also the extent to which proceeds and

returns from such investments may be repatriated. In this regard, the critical

point is that capital control laws and regulations are of ‘public order’ nature

and thus override private law rights and obligations stemming from the acquisi-

tion of, or other transactions related to, public debt securities.

Sometimes, governments attempt to achieve similar or related policy objectives

through private law instruments. Selling restrictions—contractual prohibitions

to sell the security to certain types of investors—in relation to public debt secu-

rities may have effects on the rights of investors to access such securities similar to

those associated with capital controls.58 Such restrictions may sometimes apply to

certain categories of domestic investors for reasons including differential tax

treatment of investment income. The legal implications for an investor arising

from violation of such restrictions often include nullity of the sales contract. Box 3

highlights Belgium’s experience with selling restrictions imposed on Belgium-

domiciled investors for tax purposes. As was the outcome of the Belgian experi-

ment, such private law approaches could be considered a form of capital control

and, in the case of Belgium, held to be unlawful in the context of the Treaty on

European Union, a peculiar outcome that might apply only to members of

currency unions or other international treaty arrangements.59

V. ConclusionsThis article stresses that, even though public debt securities and their markets

require an explicit legal basis in public law, private law is very important in

shaping the legal contours of those securities and markets. This point is not

theoretical but has direct practical consequences in determining rights and obli-

gations of investors and traders in public debt securities. Given their importance

as a financing vehicle of the State and as a fundamental asset class, policy makers

and government lawyers should therefore pay due regard to the design of both the

public and private law foundations—as well as their mutual interaction—of

public debt securities and their markets. In spite of their importance for public

and private welfare, it is the authors’ contention that the legal frameworks of

many public debt securities markets are often surprisingly underdeveloped.

In this regard, any international initiative aimed at improving private law

frameworks underpinning public debt securities markets deserves to be com-

mended. As discussed earlier, through the Geneva Securities Convention and

its Principles on the Operation of Close-out Netting Provisions, UNIDROIT has

58 In theory, selling restrictions may also be imposed for regulatory reasons and not for capitalcontrol purposes. This may be the case where for instance the terms of a sovereign bond issuedunder the laws of a certain foreign jurisdiction restricts retail investors in such foreign marketsfrom acquiring the bonds, in order to avoid registration required under securities law (such asthose that apply under the US Securities and Exchange Act (1933), section 5, and Regulation S,which may apply once the bonds are offered to such investors.

59 Treaty on European Union [2010] OJ C83/13.

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made a most useful contribution in this regard. This being said, this contribution

has essentially been indirect, in the sense that the said instruments aim at enhan-

cing legal underpinnings of securities markets more broadly. An interesting ques-

tion to explore is whether going forward, a concerted effort drawing on the

expertise of international institutions, such as UNIDROIT, the International Bank

for Reconstruction and Development, and the International Monetary Fund, to

create substantive guidelines for the private law framework of public debt secu-

rities markets for advanced, emerging, and developing economies alike merits

consideration.

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