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Corporate finance and public finance have a history of sharing market infrastructure, legal forms, and colorful terms (as when an infamous distressed debt trader used “United States’ security” to mean junk). The history of sharing invites reasoning by analogy, which often morphs into genealogy and positions 19th century London as the primordial soup for today’s market institutions. It is a sensible research strategy—London was and is a fruitful place—but formal similarities sometimes obscure critical context and alternative genealogies, leaving lawyers to ponder apparently meaningless clauses and pointless transactional techniques. Enter historians.

Marc Flandreau has a large body of solo and co-authored work about the London Stock Exchange, whose dominant market position and evolving governance practices over the course of the 19th century backstopped financial globalization, colonial expansion, and economic development. Two of Flandreau’s recent papers resonate in particularly intriguing ways with contemporary challenges. Both deal with the problem of inter-creditor equity and seemingly ineffectual contracts. This review will focus on the first, more developed paper. The second is mentioned briefly in closing—” target=”_blank” rel=”noopener noreferrer”>watch this space.

In The Puzzle of Sovereign Debt Collateral, Flandreau, Stefano Pietrosanti, and Carlotta Schuster revisit secured sovereign lending in the 19th and early 20th centuries. Formal hypothecations grew in popularity over time and were commonplace in sovereign debt as late as the 1920s, even as market participants and officials publicly acknowledged that creditors had no way of seizing revenues, or repossessing and monetizing physical assets. Secured sovereign debt went into hibernation with much of the sovereign bond market after the Great Depression, but has re-emerged recently with a wave of commodities-based lending in Africa, Asia, and Latin America.

Authoritative accounts of sovereign hypothecation to date have focused on enforcement—asset seizure—reasoning by analogy to corporate debt. They explain it either as “contracting for intervention” (ceding sovereignty to the proverbial gunboats) or as a lawyer-assisted mirage, unenforceable pablum fed to gullible Englishmen by unscrupulous borrowers in faraway lands.

Flandreau and co-authors highlight multiple problems with these accounts. Among these, the British government publicized and adhered to a policy against intervening on bondholders’ behalf save for carefully delineated exceptions (notably Egypt). Gunboat enforcement was rare, and did not target collateral as such. On the other hand, market participants and their fancy lawyers could not have been unaware of high-profile English court decisions blocking creditors’ attempts to grab collateral, even when it was stashed next door to the London courthouse. All the press and market chatter surrounding the court proceedings seems at odds with the “snookered bondholder” theory of sovereign hypothecation. Most curiously, 55 out of 67 contracts purporting to effect hypothecation between 1849 and 1875 had no terms at all for collateral seizure or sale; about a dozen specified such procedures, and did so in some detail. In other words, 19th century English lawyers knew how to write a conventional pledge, but chose not to.

The authors’ alternative hypothesis is that information production—not repossession and liquidation—was the main point of secured sovereign debt. Market participants harnessed the legal technology of secured credit to build robust information-forcing architecture in the age of absolute immunity, when lending to governments was “a blind date.” Contracts included elaborate language for continuous project and fiscal revenue reporting, and mobilized networks of public and private agents charged with monitoring the collateral. The press reported and the London Stock Exchange posted regular updates in prescribed form, accessible to bondholders as a group. Pricing data suggests that creditors valued seemingly unenforceable asset and revenue pledges. When the Economist exposed flagrant misreporting in a Honduras railway loan purportedly secured by physical assets, neither the government nor the stock exchange proposed to bolster creditors’ ability to seize collateral. Instead, the London Stock Exchange began requiring underwriters to attest to information accuracy.

Flandreau and colleagues describe an intricate web, in which “the information modules put together under [apparently unenforceable] hypothecations could be plugged into other institutions, creating positive externalities” for capital mobilization and economic development. Then and now, project finance, secured credit, fiscal monitoring, reputation-building, market gate-keeping, and contract discipline interact in multiple complex ways. Corporate precedent is relevant, but not for its emphasis on enforcement: “[T]o the extent that sovereign collateral mirrored the features of corporate finance, it was through the creation of information governance and liability.”

From today’s public finance perspective, this research calls for a more nuanced institutional examination of recent controversies surrounding Sri Lanka’s pledge of Humbantota Port assets to Chinese lenders, Chad’s oil-backed debt to Glencore, Finland’s insistence on collateralizing its lending to Greece, and official bilateral lenders’ use of offshore escrow accounts. Meanwhile, shedding light on the sovereign hypothecation puzzle might be useful in another way: prompting scholars to revisit the information function of collateral in corporate debt.

In closing, a heads up. A decade ago here, I reviewed a delightful article (part of a larger influential body of work) attempting to trace the origins of another seemingly ineffectual contract contraption, the pari passu (equal step) clause in sovereign debt. A new work in progress by Marc Flandreau reconsiders and brings new evidence to the perennial contest over the meaning and function of sovereign pari passu clauses. He rejects the dominant policy view of sovereign pari passu undertakings as (poor) safeguards against formal subordination, and argues that the much-maligned ratable distribution reading that got Argentina and others in trouble may be right after all.

The analysis again hinges on the role of the London Stock Exchange. Recall the dominant view that, with no sovereign bankruptcy court to stop new borrowing, block enforcement, define the estate and distribute it ratably among similarly situated creditors, the modern pari passu clause is at best unwieldy and likely ineffectual. Enter the stock exchange which, in Flandreau’s account, had a comprehensive view of the sovereign debtor’s finances, and counted all or nearly all its creditors among its members. The stock exchange could also shut defaulting debtors out of the market altogether. Under these conditions, the exchange could in fact effect ratable distribution of the debtor’s payments, and even make bondholders (its members) that get preferential payments from the debtor fork over their gains for pro rata sharing with the rest of the creditors. Note that such inter-creditor obligations might not even appear in the debt contract—but might be found in the rules or norms of the stock exchange. More broadly, Flandreau’s 2022 piece takes issue with the “contract paleontology” approach to interpretation that I found delightful in 2012, and offers an alternative institutional roadmap with causal links running in unconventional directions. Since neither pari passu nor public-corporate finance comparisons are going anywhere, watch for new versions.

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Cite as: Anna Gelpern, All Roads to the Stock Exchange, JOTWELL (Jan. 23, 2023) (reviewing Marc Flandreau, Stefano Pietrosanti, and Carlotta E. Schuster, The Puzzle of Sovereign Debt Collateral: Big Data and the First Age of Financial GlobalizationCEPR Discussion Paper No. DP17286 (2022); Marc Flandreau, Pari Passu Lost and Found: The Origins of Sovereign Bankruptcy 1798-1873INET Working Paper No. 186 (2022)), https://corp.jotwell.com/all-the-roads-to…e-stock-exchange/.