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Montag, 8. Februar 2016

Buy The Dip: Argentina special edition

February 08, 2016

Buy The Dip: Argentina special edition

As I've mentioned, sovereign debt restructuring is one of my favourite topics. And Argentina is probably the most riveting example of why it's such a fascinating subject. 

But this delightful saga could now be drawing to a close. Last week Argentina reached an agreement with some of its Italian creditors, and two out of six hedge funds that have been hounding it through courts across the world for well over a decade. The last four - including Argentina's nemesis Elliott Management - will hopefully reach an accord with Buenos Aires soon. Here's a hot-off-the-press paper by Juan Cruces and Tim Samples on settling the "trial of the century" for sovereign debt.

So in honour of this fin de siecle I thought I'd tell the story with GIFs. (NB, this is not a definitive or comprehensive account. If you want the nitty-gritty then check outAlphaville's Pari Passu Saga section, lovingly curated by Joseph Cotterill).

The genesis dates back several decades. But the early 1990s is probably the best place to start. After being wracked by one of its lamentably common financial and economic crises, Argentina in 1991 pegged its currency to the dollar, finally taming inflation and helping the economy grow strongly. 
The country even weathered the regional shock of the Mexican Tequila crisis. But some of the economy’s fundamental problems remained unresolved, and the government kept on borrowing from foreign lenders keen to benefit from the country’s turnaround.

It couldn't last. Argentina fell back into a recession by the end of the decade, and the currency peg went from a pillar of the economy to one of its major weaknesses. The economy kept deteriorating as the IMF advised the government to belatedly tighten its belt, and by 2001 the economy was in freefall (a detailed account can be found in this IMF paper). In December the government imposed strict controls on the banking sector, and by the end of the year Argentina defaulted on its debts. 

Sovereign defaults are always painful, but it was particularly so in Argentina. The currency peg was abandoned with in weeks, chunks of dollar bank deposits were seized and an already-painful economic crisis worsened further. By 2003 the economy had stabilised and a new government led by Nestor Kirchner took power, but he had little interest in even talking to bondholders whose debts Argentina had defaulted on. 
In fact, it wasn’t until 2005, when the Argentine economy had recovered quite strongly, that the government finally made a harsh take-it-or-leave-it offer to its creditors. Given that it was four years since the default most creditors resignedly accepted the punitive terms.
But the haircut was so brutal (roughly 70 per cent was wiped off) that a significant minority of creditors have consistently refused to exchange their old defaulted bonds into new less valuable ones. They preferred to hold out for a better deal, and became known as the holdouts.
The holdouts included many ordinary retail investors, from local Argentines to Italian pensioners. But among the most formidable was a clutch of hedge funds and hard-nosed “distressed debt” investors that already had plenty of experience suing recalcitrant countries. 
Chief among them was Elliott Management, an infamously aggressive hedge fund led by Paul Singer, that had already successfully extracted money from countries like Peru through some nifty legal jujitsu. It was distinctly unimpressed by Argentina’s shenanigans, and began a lengthy, expensive and explosive litigation process against the government.
But suing countries is no picnic, even if you don't mind being called a “vulture fund”. States enjoy sovereign immunity, and while they often waive that when they borrow abroad, actually seizing any of their assets if they renege is nigh-on impossible. Most of a country’s assets are held locally, and most of its overseas possessions - such as foreign reserves held abroad, embassies etc - are still protected by sovereign immunity.

Still, holdouts can still make life very difficult for a country that refuses to repay them. For example, a country cannot return to the international bond market, and holdouts can still scour the planet for assets that aren't protected by sovereign immunity and attempt to seize them.
Hilariously, Elliott in 2012 managed to get the Ghanaian authorities to hold anArgentine three-masted  naval ship that was visiting the African country. While it was owned by the Argentine navy, it was only used for training purposes and goodwill visits, so the local courts granted Elliott a temporary injunction against the ARA Libertad (and its 200 crew).
The UN International Tribunal for the Law of the Sea soon ruled that the Libertad should enjoy sovereign immunity. But Elliott had enjoyed a breakthrough legal ruling in New York that turned the Ghanaian incident into an amusing sideshow and rattled the entire world of sovereign debt.
The vast majority of bonds have a clause called “pari passu”, which means creditors should be treated equally. In practice it had for centuries only mattered in corporate debt, but Elliott argued that it should be interpreted to mean that Argentina could not continue to pay creditors that exchanged their defaulted bonds for new bonds in 2005 and 2010, and continue to jilt the holdouts. 
Sensationally, US district court judge Thomas Griesa - fed up with Argentina after years of having to deal with these lawsuits - not only agreed with Elliott, but slapped an injunction against anyone “aiding or abetting” Argentina to evade his order.
This was the nuclear option, in practice amounting to an financial blockade of Argentina.  The banks and payment agents that normally transferred the country’s bond payments from Argentina to bondholders in the US or Europe were suddenly prevented from doing so. In other words, it was a big win for Elliott.

The Argentine government - since 2007 led by Cristina de Fernandez Kirchner, Nestor’s wife - therefore basically had to choose between paying both its exchange bondholders AND the holdouts, or none. Needless to say, she was unhappy. 
The implications were far greater than Argentina, however. Griesa’s acceptance of Elliott’s pari passu interpretation turned a sleepy boilerplate Latin legal clause intosovereign debt dynamite, and the possibility of actually preventing agents like custody banks that transmit bond payments from doing so to ensure holdouts get paid rattled many lawyers and academics. Those that already worried about the messy world of sovereign debt restructuring were apoplectic. 
Some of the initial fears have not been realised - at least not yet. The sovereign debt industry has rallied to plug some of the holes opened up by the Argentine litigation, tweaking the recommended pari passu clause in new government bonds being issued to neutralise the threat of Elliott-style litigation, and introducing and strengthening “collective action clauses” that ensure that a restructuring deal by most creditors binds all of them. Most people agree this is a jolly good idea.

Still, these changes only affect new bonds, and there are still hundreds of billions of bonds out there that could be hostage to a similar situation. And the tweaks made little difference to Argentina. After the US Supreme Court decided not to rehear the case,  Argentina again offered to pay Elliott only the same as other bondholders (ie the massive haircut). Singer’s hedge fund was unimpressed.
When they failed to reach a deal with Elliott, Argentina in 2014 decided that it would rather default again on all its creditors than pay the hated vulture funds. 
And thus Argentina defaulted for the eighth time in its history. The economy was dinged, and the already rancorous relationship between the Kirchner government and the holdouts grew even more poisonous. Negotiations were put on ice, barbs were traded. Essentially it was a cold war where Elliott sought to tighten the noose, and Argentina sought ways to avoid Griesa's order. The exchange bondholders were the innocents caught in the crossfire. 
But last year Cristina de Fernandez Kirchner had to step down after serving the two maximum terms in office, and sensationally the centre-right candidate, Mauricio Macri, won the presidential election. He promised to resolve the holdout stand-off as soon as possible, ending the festering conflict and reopening international debt markets to Argentina once more.

Macri has moved quickly. Last week Argentina reached a $1.35bn settlement with an Italian bondholder group that represented about 50,000 Italian savers, and a separate deal with two hedge funds, Montreux Partners and Dart Management. 
Argentina’s most implacable foes - Elliott Management and its sidekick Aurelius - have yet to strike a deal. But the fact that Ken Dart, another famously tough distressed debt investor, thought Argentina’s deal was good enough is encouraging. 
Some of the wider issues raised by the Argentine saga are not going to go away quickly, but at least it looks like this particular debacle might soon be consigned to the sovereign debt restructuring history books. It’s been quite a ride.

What I was up to last week:

"Electronic trading brings with it a number of new risks, and we need to continue to strengthen the resiliency of electronic markets." The head of one of the biggest high-frequency trading firms warns that exchanges need to stiffen their firewalls to prevent algos gone wild from wreaking havoc.

The commencement of an arbitration claim in a neutral forum will thwart the Humala administration’s attempt to unjustly erase this debt from Peru’s history." Gramercy has now lodged a $1.3bn claim against Peru. 

"Cause backwards is awesome." I counted and went through some of the 349 letters sent to the SEC over IEX's exchange status application.

This cycle the narrative has been that central banks have got the ball, know what they’re doing and can keep the game going as long as they want. But humans have not found a way to abolish cycles.” A look at the impact of Japanese negative interest rates on global government bond markets.

"I had been planning to do a big piece on Go, portraying it as a board game version of Rorke’s Drift, an isolated outpost of human ingenuity resisting the hordes of computer Zulus. Oh well." I wrote up part of last week's newsletter for Alphaville.

Notable and quotable:

"Employees at the world’s largest hedge fund carry around iPads with an app called 'Pain Button.' It tracks negative feelings like 'angry,' 'frustrated' and 'sad' with the twist of on-screen dials." Rob Copeland and Bradley Hope have an annoyingly riveting account of the schism at the top of Bridgewater, and it's chockfull of hilarious anecdotes.

"The looming question for the global economy, however, is how China might deal with a vast pool of bad debts." Good piece on the global mountain of non-performing loans - soon to be swelled further by China - by NYT's Peter Eavis.
"Here’s a truth bomb about what Smart Beta can’t do for you. Live with it." Smart Josh Brown take on an investing strategy exploding in popularity.
"So whilst we are not saying to rush out and buy bank shares here, we are saying that selling bank debt in the best capitalised, least risky banks, is not supported by fundamentals." Michael Holman argues that the capitulation in financial stocks and debt last week was overdone.

"I believe Hong Kong’s Currency Board system is the strongest form of fixed exchange rate mechanism in the world." Invesco's chief economist doesn't see any dangers lurking in the Hong Kong currency peg.

We have set aside a pot of money for test trading. With deep learning, if all goes well, it will go into test trading, as other machine-learning approaches have.” MIT Technology Review also takes a look at AI and investing.

"Academics and practitioners can continue to debate the reasons why momentum exists, but the debate as to its existence and whether it can be captured should be put to bed at this point." Cliff Asness takes his old tutor Eugene Fama to task

You’re seeing experimentation from people with much larger portfolios, where they’re taking a portion of their money and putting them in these offerings to try them out." It's not just the more modest savers that are experimenting with robo-advisors.

"Today, looking at the market fundamentals in place, I believe we have reached a new point in the global energy story: The endgame in the decline of the price of oil." Guggenheim's Scott Minerd is optimistic that energy prices have bottomed out.

"The road to redemption for oil, and commodities in general, remains paved with potholes, but for optimistic investors with a long-term view perhaps the downbeat sentiment is beginning to bottom-out, creating potential value opportunities for investors." So does Schroders, it seems.

"Yes, global aging may someday drive U.S. interest rates structurally higher. But “someday” remains at least a decade away – for two reasons." Pimco's Matthew Tracey and Joachim Fels on demographics and the savings glut.

Of course . . . it is interesting." Danske Bank is now worth more than Deutsche Bank, in part thanks to adapting reasonably well to Denmark's NIRP.

"Central bankers have since 2008-9 abdicated their responsibility for monetary activism to a monster that existed only in their imagination." And here Martin Sandbu looks at NIRP in the wake of Japan's move.

"The market shut down. Our entire private equity pipeline dried up.” Apollo's Josh Harris on how the leveraged finance markets have clogged up.

"The Fed did not make a mistake at its December meeting. It made a mistake over the entire past year and now we are seeing the fruition of this error." Western Kentucky University's David Beckworth argues the real mistake was even talking about hiking

"This environment should improve the opportunity set for global macro strategies that make-relative value trades on currencies, interest rates, commodity prices and equity markets globally." AllianceBerntein's alternatives heads look at what hedge fund strategies should do best in 2016.

"Obviously, anything can happen, be it further bad news on growth or sharp increases in real interest rates. But, in terms of their expected value, stocks are not overpriced today." Olivier Blanchard, fresh from leaving the IMF, turns to equity analysis.  

"There are several tail risks that the markets should have on their radar this year but don’t." But the head of equities at Columbia Threadneedle warns that the era of abnormally low volatility is over.

It’s hard to see any meaningful economic growth coming out of Puerto Rico in the foreseeable future." No one seems to like Puerto Rico's GDP warrants. Personally, I think its odd that people think it will be impossible for the island to grow a measly 2.5 per cent from 2022 onwards. Many thought Argentina's GDP warrants were worthless as well, but they turned out to be a goldmine.

"Ein Unglück kommt selten allein." Fascinating Bank of England look at a 1930s banking crisis in Germany, and the lessons that still resonate today.

"He was convinced and I became convinced that we could build what we'll call a velvet rope agency offering and offer it to a select few buy-side institutions." Virtu is offering to trade on behalf of some big asset managers.

"We nailed it for our biggest return of the year." Meet CargoMetrics, a new asset manager that crunches satellite signals and shipping data to trade. 

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