By Dr. Manish Sinha
Following the tortuous but ultimately avoidable default of Argentina on its national debt, its second in twelve years, the International Monetary Fund (IMF) urged governments to revisit the way sovereign bond contracts are structured. At the heart of its malcontent was the ability of a small group of hedge funds or “holdout” creditors, which had previously acquired a small percentage of its older debt on the secondary market, to successfully block attempts by the nation and majority bondholders to successfully restructure Argentina’s debt repayments. Argentina was thereby forced into default. After torpedoing the concomitant aims of Argentina and the majority of investors, the IMF stressed the imperative need to avoid a repeat occurrence.
Argentina, Latin America’s third largest economy, has been a relatively frequent defaulter on its sovereign debt. It has defaulted eight times in its 198-year history since securing independence from Spain and five times (1955, 1976, 1989, 2001 and now 2014) during the past half-century. Whilst default for the country is regrettably not entirely unusual, the latest incarnation is certainly the most peculiar, underpinned by a maelstrom of conflict, confusion and chaos. Through a tumultuous decade-long litigation process Judge Thomas Griesa, presiding over the U.S. Court for the Southern District of New York, empowered a tiny group of creditors – holding 7 percent of specifically formerly issued debt – to push Argentina into a financial corner from which there was no escape. The issue was not Argentina’s ability to pay revised terms upon its restructured debt, but the legal decision to prevent the remaining 93 percent of bondholders being paid prior to the aforementioned dissenting minority. By succeeding in blocking the payout to other bondholders, the few overcame the many and brought the country to its knees. Despite the court’s judgment, the game of bluff and roulette might not yet be over.
Today’s peculiar situation evolved in the following bizarre manner. Subsequent to its 2001 default of $100 billion of bonds, Argentina’s bonds were trading at deep discounts and $1.3 billion were acquired by a small group of hedge funds anticipating significant future returns. However, due to subsequent payment difficulties in 2005 and 2010, Argentina offered the holders of its defaulted debt new “exchange” bonds that paid approximately 35 cents for each dollar of original ones. Investors who accepted this proposition would lose 65 percent of their original investment, whereas investors who declined would lose one hundred percent. Strangely, just 93 percent of investors accepted the offer whereas 7 percent did not, presumably believing they could force Argentina to pay more. Their argument centered upon a very simple concept: all bondholders should be of equal ranking, technically referred to as “pari passu”, and therefore Argentina could not technically choose which bondholders to pay. Either it had to pay what all bondholders were contractually due – the exchange bondholders and the remaining 7 percent – or none at all.
This particular feature is much rarer in modern issues where so-called “collective action clauses” nullify the opportunity for a minority group of debt holders to foil a whole, largely consensual, debt restructuring. It should be noted that Argentina’s role during this legal process was not one of complete innocence. Whilst appealing for Supreme Court intervention on one hand, they also affirmed that they would not respect an unfavorable Supreme Court opinion. Indeed, before the Supreme Court even heard the case, it transpired they were instigating measures to circumvent a potentially negative ruling on their part. Such clandestine behaviour and intransigence was not well received.
Of the hedge funds that had acquired the older debt, one of the most aggressive was Elliot Management, which has spent almost ten years suing Argentina. In 2012, a subsidiary of the fund resorted to rather unconventional measures in an attempt to recoup losses: the fund seized an Argentinian boat, the Libertad, parked off a Ghanian port using its valuation of $10 to $15 million as partial payment. The Argentinian government did not succumb to such unscrupulous tactics and the boat was eventually released. Ultimately, however, in 2012 Judge Griesa ruled that the holdouts were indeed pari passu with the exchange bondholders. Furthermore, he declared that any financial institution that helped Argentina pay the exchange holders in preference to the holdouts would be in contempt of court.
The choice for Argentina was stark: it could either pay $15 billion to the holdouts or default upon the exchange bonds, despite its ability to pay them, and pay nobody. Argentina chose to default which, after a decade of litigation, is a lose-lose-lose situation for all. Neither the 7 percent of holdouts nor the 93 percent of exchange bondholders received anything and Argentina was forced into a default it wished to avoid, had the holdouts agreed. Not that this saga is over – at the time of publication, Argentina still might strike a deal with the holdouts or with the exchange bondholders (but not both). In one alternative, the holdouts may secure some type of settlement and in the other the holdouts could get nothing with the exchange holders agreeing to yet another exchange. The holdouts might not be able to prevent such a deal if the bonds are set up exclusively in Argentina, outside the jurisdiction of Judge Griesa; however at the time of writing this was also ruled illegal by the judge. In response, President Cristina Fernandez's government executed a law to replace the bond’s original trustee, Bank of New York Mellon Corp., which oversaw bond payments with state-controlled Nacion Fideicomisos, thereby keeping payments beyond Griesa’s reach. Whilst a judge’s decision to hold a foreign government in contempt of civil court is indeed rare, they can issue sanctions to force compliance, which has thus far not been forthcoming by Griesa. How this unfortunate and winding saga will conclude is currently impossible to predict but Argentina would most likely need to remedy the situation should they wish to access the global markets again.