The New York courts' interpretation of the pari passu clause could have serious implications, not just for Argentina, but for sovereign restructurings the world over.
Argentina’s default of nearly $100bn in 2001, and the saga that followed, have shown the world two things. First, that sovereign debt restructurings can provide excellent scripts for Hollywood-style dramas, complete with grand populist speeches, naval ship seizures and impending national catastrophe. Second, lack of clarity and extraterritorial powers must be addressed urgently.
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The US Supreme Court’s recent decision not to review a previous interpretation by the New York courts of the pari passu clause raises a number of concerns. From a broad point of view, the outcome of such a decision feels unfair: the so-called ‘vulture’ funds, led by NML Capital, which are suing Argentina to be paid in full, obtained the defaulted debt at a heavily discounted price. On a more technical note, the ruling raises concerns over what should underpin sovereign defaults and the restructuring of their debt.
If Argentina was to fully pay all holdout creditors, as well as creditors that accepted a haircut over a decade ago, it would deplete half of its foreign exchange reserves, according to Buenos Aires. This would put the country in severe economic peril. It would also breach a restructured bonds clause that prohibits Argentina to offer better terms to other creditors. The US courts will also force financial intermediaries to help holdout creditors get hold of Argentine assets. What is being decided in the US will have an impact on sovereign restructurings the world over.
As some have pointed out – more recently Columbia University’s Jose’ Antonio Ocampo and Martin Wolf in the Financial Times – a country that defaults must be allowed to get back on its feet. Rigid interpretations of pari passu clauses may disrupt future restructuring negotiations – why would any creditor accept a haircut if holdouts may be repaid in full in the future? This would also disrupt secondary market pricing and make an already chaotic restructuring process even more problematic, if not impossible.
The relatively recent voluntary introduction of collective action clauses has helped in some cases, but their implementation still requires more painful back and forth between parties. More needs to be done.
In June 2014, the International Monetary Fund issued a proposal to clarify the terms of its involvement in sovereign defaults. It may now be time to resume proposals for a sovereign debt restructuring mechanism. With the recent ruling, the US, which was opposed to this approach at the time of the Argentine restructuring, may have just forced it back on the table.
