For more than a decade, Argentina’s torturous 2001 debt default has served as a poster child for the political risks inherent in the emerging-market sovereign debt asset class.
Now this reputation could rank pari passu with Argentina’s emerging status as a game-changer for global sovereign debt restructuring in the years ahead.
In a jaw-dropping ruling on Friday, the US federal appeals court unexpectedly stated that holdout creditors must be paid at the same time as creditors that participated in the two Argentina restructuring deals in 2005 and 2010, in a victory for the likes of hedge fund Elliott Management, which demand full debt repayment.
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| Argentina's foreign minister launched a diplomatic offensive in New York in late-October, urging top U.N. officials to pressure Ghana to release an Argentine naval training vessel seized after creditors won a court order to keep the ship in port. |
Argentine credit risk sky-rocketed upon the announcement, since the government has already made clear it won’t honour holdout creditors. The ruling has sent shock waves in the sovereign debt community amid uncertainty about whether Argentina will continue to pay international obligations due in December – the sovereign has been faithful to all payments on the bonds issued in the swaps – and the precedent established for sovereign debt restructuring, more generally, given the court’s ruling that all creditors, participants of the swap as well as the holdouts, must enjoy "equal treatment".
Argentina can appeal to the Supreme Court and the case has now been sent back to Judge Thomas Griesa to propose a payment formula and address injunctions to intermediary banks. The jury is out on the debt-repayment road ahead. Analysts at Barclays outlined the following road map:
| We see the possibility that these...events, disregarding their timing, happen: 1) The initial Judge Griesa ruling is upheld in essence. This would mean that Argentina would no longer be able to make payments on the restructured 2005 and 2010 bonds and GDP warrants in the United States. It is impossible to say how much time it will take to propose a payment formula (‘X%’) and address the injunctions applied to third parties and intermediary banks. 2) The US Supreme Court rejects the writ of certiorari petition. The third important assumption is about timing, given the above mentioned assumptions hold true. The administration has recently said that they would make a petition to request a "writ of certiorari" (the Supreme Court to review the case). We think that this means that: 3) The administration waits until the last minute to file for "writ of certiorari" of the US Supreme Court. However, the question of the stay on District Court order is critical to determine timing issues |
Timing is crucial. Argentine officials have said the ruling has no practical significance and the "status quo" remains, suggesting that a stay of proceedings exists, note the BarCap analysts, adding:
| ...We remain concerned about the December payments as we cannot be certain that such a ‘stay’ would remain in force if Judge Griesa returned the formula to the court of appeals and it was approved. However, in this event, the administration could file simultaneously, together with the petition for a writ certiorari, an application for a stay to the Supreme Court. And this stay could remain valid, if approved, until the writ certiorari petition was either accepted or rejected. This underscores the fact that investors should not be complacent with the timing of the process, and that a rapid resolution that benefits holdouts should not be ruled out at this point of time. |
If the court continues to rule in the holdout creditors' favour, then the administration has the following two options:
| 1) Default: The administration decides that it will not concede to holdouts, and the trustee or payment agent in the US are not allowed to make payments on the restructured securities due to the court order. This would trigger CDS as it would be considered a “default event” under the Trust Indenture of 2005 and 2010 restructured securities. |
Option two seems unlikely, given the Lock Law, implemented by the Néstor Kirchner administration, which bars repayment to holdouts. What's more, Argentina has been flirting with re-accessing the international capital markets since spring 2010 as the administration is running out of domestic financing sources.
After raiding capital providers in Argentina – the social security system, state-owned banks, the central bank itself, even the push to re-nationalize Repsol's YPF stake – the government is running out of financing options amid weak bank-lending, high inflation and an imbalanced economy. It, thus, has an incentive to resolve the debt saga to eventually access international debt markets.
As a result, a third option is perhaps more likely: using payment intermediaries outside the US to pay creditors. However, there are a number of risks:
| Eventually, holdouts would likely file a similar “pari passu” case in other jurisdictions around the globe, forcing the administration to retreat to Argentine jurisdiction. And this takes us to the next question: can the administration actually pay external law bonds inside Argentina? It is possible that investors could be asked voluntarily to open an account locally in Caja de Valores. But if a small number of bondholders did not agree with this, they would have the ability to push the Republic into default, which would also trigger CDS. And it does not take much to assume that the current plaintiffs could be that “small number of bondholders”. This implies that the strategy of changing the location of the payment agent, while technically viable, would likely force the Republic inside its own jurisdiction at the end of the road. And paying inside its jurisdiction would likely mean a higher probability of default and the triggering of CDS contracts at some point in the future. |
Amid the debate about the mechanics of repayment, it’s important to remember the historic backdrop. Argentina’s debt swap was a huge success for the issuer, given the competitive coupon and the large principal write-down, serving as a boost to the country’s debt dynamics and the administration’s populist – and disingenuous – stance that its repayment ability was limited. The 2001 default and 2005 debt swap were seen as an unambiguous victory for the sovereign, and a blow to the IMF, in an era where sovereigns could dictate the rules of the game, while raising questions as to the ability of foreign courts to impose pro-creditor decisions.
Friday's ruling thus seemingly rebalances the Argentine sovereign-creditor relationship. The ruling surely incentivizes Argentina to re-engage with a 2009-era push for a creative resolution of the holdout question, and it’s difficult to imagine any administration having the political appetite to repeal the Lock Law that prohibits the issuer from re-opening the debt swap to repay holdouts directly. One suggestion mooted in the past is the creation of a trust fund to deposit the holdouts’ claims, against which they would receive tradable paper and interest payments that would be discounted by the same amount as in the 2005 swap.
There is one last intriguing option, however, according to BarCap:
| Another possible alternative would be a voluntary swap into local law bonds. Such a swap could be set up rather fast locally, but could potentially imply default as some bondholders might become holdouts. And given the impossibility of paying in the United States, it would imply default on those holdouts. Alternatively, using CACs [collective action clauses], by the petition of the Republic, with a “special majority” (because it would be a “Modification of a Reserved Matter”) of 85% of the bondholder support, bondholders could change the governing law of the 2005 and 2010 restructured securities. In such an event, as in Greece, the use of CACs would imply that CDS would trigger, according to ISDA [International Swaps and Derivatives Association], but the Republic could remain current on new local debt. |
Nevertheless, the 85% threshold for bondholder support surely makes this option unrealistic.
Bottom line: if Judge Griesa's ruling is upheld, and the US Supreme Court rejects Argentina’s petition, the government will seek to avoid default as well as direct payments to holdouts. In this event, the government will have to find a creative payment solution, outside the US, which, in any case, will trigger CDS, reckons BarCap. In other words: a messy and seemingly ever-lasting debt saga is on the horizon if holdouts have to file pari passu claims in every non-US jurisdiction the Argentine's payment agent is domiciled.
Analysts are also trying to make sense of the ruling's impact on global sovereign debt restructuring, given the the legal interpretation of pari passu in Argentine bond documentation and the questioning of US sovereign immunity laws. This all comes amid a push for new sovereign debt restructuring principles, by the Institute of International Finance. The Argentine ruling thus surely galvanizes investors' desire for foreign-law bonds to have rigorous collective action and pari passu clauses, with so-called aggregation clauses, allowing for majority amendment across multiple bond series – which the legacy Argentine bonds lacked.
All these questions add more certainty to the now seemingly toxic asset class of sovereign debt. Ugly, complex stuff.