Guest post: Argentina’s day in court [corrected]
By Samuel George of the Bertelsmann Foundation
On February 18 the Republic of Argentina submitted a petition to the US Supreme Court requesting a judicial review of a 2012 decision from the New York Second Circuit Court. That ruling found illegal Argentine payments on restructured sovereign debt if the country did not also service investors who had not accepted the haircut on the non-performing bonds.
If the Second Circuit Court ruling stands, it will set a precedent that holdouts could eventually be paid in full. Bondholders may become increasingly reluctant to accept haircuts on sovereign securities, thus complicating the ability of a distressed country to restructure its debt.
For this reason, the US issued an amicus curiae to the circuit court in favour of Argentina and France previously entered a similar amicus to the Supreme Court at an earlier stage; both may issue similar supportive briefs to the Supreme Court in the coming weeks.
The international financial community may not be inclined to cry for Argentina. The truth is a series of unorthodox policy decisions has led to mounting macroeconomic pressure in the country. However, this particular legal case has implications that extend well beyond Buenos Aires. It is especially crucial to modern-day peripheral Europe.
The Argentine case
In 2001, Argentina executed the largest sovereign default in history, walking away from more than $80bn in international debt. Between 2005 and 2010, the country offered bondholders swaps that initially paid around 30 cents on the dollar. (These coupons were packaged with GDP warrants that ensured that if Argentina grew, so too would the payout on its restructured debt. As the Argentine economy has expanded over much of the last decade, these coupons have increased in value—perhaps reaching as much as 50 cents on the dollar.)
Holders of about 93 per cent of the securities accepted the exchange and Argentina has serviced this restructured debt without interruption since 2005.
However, holders of roughly 7 per cent of the notes, accounting for more than $10bn in debt, refused the swap. These holders, frequently hedge funds that scooped the issuances at bottom dollar as the Argentine economy deteriorated, have pursued lengthy legal battles demanding that Buenos Aires pay face value plus interest on outstanding obligations.
On November 21, 2012, Judge Thomas Griesa of the Second Circuit Court decided in favour of 19 holdout plaintiffs, led by Elliot Management, and ordered Argentina to pay them $1.33bn.
The judge put teeth into his decision with an unusual interpretation of the pari passu (equal rate) clause. According to the ruling, servicing the restructured debt (again, about 93 per cent of the total) without paying the holdouts would imply subordination of the latter group. Judge Griesa consequently declared any further payment on restructured debt, without honouring debt held by the holdouts, illegal.
The decision could unravel any hope of Argentina’s re-joining the international monetary system. Lost amid the negative coverage of the Argentine government is the fact that it has consistently serviced the restructured debt.
Retiring this debt is a crucial step that Argentina must take to re-enter global financial markets. Its current inability to access international capital has severely distorted the country’s economy. Because the government cannot finance a significant deficit, Buenos Aires has overvalued the domestic currency while implementing capital controls and limiting imports.
The Argentine central bank has exhausted a significant portion of its reserves by defending the overvalued peso. When these reserves hit a seven-year low in January, the central bank could no longer afford to intervene as strongly, and the currency was allowed to plunge nearly 13 per cent over two days.
If Judge Griesa’s ruling is upheld, Argentina’s options are bleak. Either Buenos Aires can pay the holdouts in full, and thus face a cascade of similar claims from other funds, or it can choose not to pay anyone and default again, ripping open the wounds the country has tried to heal since 2001.
Complicating the future of sovereign debt
Legal systems often rely on precedent, and Judge Griesa’s decision could set a dangerous one. If holders of stressed sovereign bonds believe they may eventually cash in the securities at face value, the incentive to accept a haircut diminishes.
Judge Griesa’s critics allege that the ruling undercuts the financial community’s most trusted strategies for managing a structured default. Since 2005, international sovereign debt issued in New York has regularly contained collective action clauses, which allow a qualified majority of bondholders to accept a write-down for all bondholders—thus limiting the influence of minority holdouts.
But much of Argentina’s stressed debt was issued prior to 2005. Buenos Aires and other governments in similar positions have relied on voluntary swaps that exchange old securities for new securities at market value with the addition of a collective action clause.
Lenders will not accept a swap at market value if they think they can hold out for face value. Moreover, as economists such as Nouriel Roubini and José Antonio Ocampo have argued, the potential of a full payoff will diffuse enthusiasm for exercising the collective action clauses anyway.
This could have immediate reverberations in Europe, where the eurozone’s survival may depend on haircuts to the sovereign debt of peripheral countries. For example, IMF support to Greece is contingent upon reduced debt-to-GDP ratios. Greece, in turn, has sought to meet this requirement in part through bond buybacks, offering 34 cents on the euro.
To avoid triggering credit default swaps, Greece has pursued such haircuts on a “voluntary” basis. As in Argentina, Greece’s ability to end the debt crisis will depend on bondholders’ willingness to accept the write-downs—something they may now be less inclined to do.
By accepting this case, the Supreme Court would have the opportunity to reflect on the ruling’s greater implications. That countries with as disparate governments as Argentina, the United States and France agree on this issue suggests that the court ought to take a closer look.
Samuel George is a project manager specialising in Latin America at the Washington, DC-based Bertelsmann Foundation.
Correction: This post has been corrected to show that France’s amicus curiae brief was filed to the US Supreme Court rather than to the Second Circuit and that Judge Griesa ordered a $1.33bn payment to 19 plaintiffs rather than to Elliot Management alone.
Related reading:
Guest post: Argentina and Detroit – different (zip) codes, beyondbrics
Slow painful ending for ‘trial of the century’, beyondbrics
Guest post: don’t throw Argentina under the bus, beyondbrics
Guest post: Argentina threw its creditors under the bus, beyondbrics
Debt holdouts put Argentina on spot, FT
Back to the future with pari passu, FT Alphaville
Guest post: Argentina and Detroit – different (zip) codes, beyondbrics
Slow painful ending for ‘trial of the century’, beyondbrics
Guest post: don’t throw Argentina under the bus, beyondbrics
Guest post: Argentina threw its creditors under the bus, beyondbrics
Debt holdouts put Argentina on spot, FT
Back to the future with pari passu, FT Alphaville
Wasn das für ein milchreisiger Quax ?
AntwortenLöschenSchwadroniert da daher und ist noch nicht mal Trocken hinter de ohren.