I would contest they had a fully functioning government. For instance, they never were able to establish the Supreme Court of the CSA; they were unable to defend their own claimed borders; they continually lost territory they claimed, and lost it from the very beginning, and were not ever in control of the governments of two of their constituent states; they never achieved diplomatic recognition, outside of the doubtful claims of recognition by the papal state and an insignificant duchy in central Europe.
The confederacy never met essential attributes of nationhood - they were, at best, an unsuccessful separatist movement.
And Lord Palmerston was in the minority of the British Cabinet, at that time, on that issue.
I think you're setting too high a standard here.
By 19th century standards they were perhaps better off than many nation states you could shake a stick at.
The lack of a Supreme Court is not especially troubling considering they were at war. The United States itself took some time to set up its own during peacetime in 1789-1793. The CSA in any case had inferior courts, and that sufficed for their purproses at the time. In any case, a Supreme Court is not a requirement by any reasonable standard for sovereignty. It only comes up here at all because the CSA constitution called for one.
As for borders: 1) The USA in 1789 was hardly able defend its own claimed borders; it had no presence to speak of on the Great Lakes or the Mississippi; likewise Russia hardly had control of its vast borders for most of the 19th century, yet no one questiosn that they were a nation state. 2) The status of Missouri and Kentucky is not clear-cut, since neither had a clear vote for secession that was fully recognized in the state - but rather rump conventions held in exile from the state capital. 3) The CSA certainly had reasonable control exercised over its territory until Union forces began invading in earnest in 1862 - with the possible exception of sparsely inhabited and remote areas of western Virginia. But then the same thing can be said of the US itself, which was unable to prevent CSA incursions into Indian Territory and New Mexico Territory - or, for that matter, the eleven states which seceded. By your definition, the USA itself in 1861 has difficulty meeting that definition.
If you look at the most commonly accepted definitions of sovereignty in political science, the CSA fulfilled them, certainly by 19th century standards, whether we like it or not. It had defined borders; it had a government; it had a capital; it had an army and a navy; it had court system and a postal service; and it certainly exercised reasonable control throughout its claimed territory (until the final stages of the war) save possibly for some barren stretches of Texas and unionist counties in western Virginia - but then the USA itself had the same difficulty in much of the western territories.
Diplomatic recognition is another question. But then the US had the same difficulty in the first years of the Revolution, as did many Latin American states after first rebelling against Spanish control. The CSA lacked de jure recognition as a nation state by other states, but it certainly fulfilled the de facto defintion - and it was, after all, recognized as a belligerent by Great Britain.
The confederacy never met essential attributes of nationhood - they were, at best, an unsuccessful separatist movement.
I tend to disagree on the first clause despite my lack of sympathy for neo-Confederate apologetics (on ample display in this thread). As for your second clause, that's ultimately what they wound up as.