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AmericasOctober 1 2014

On the ropes: can Argentina recover?

A controversial US ruling against Argentina has shaken the world of sovereign debt restructuring and provided so-called vulture funds with a sharp new litigation strategy. As both multilateral organisations and private sector professionals attempt to stop a lawsuit pandemic, The Banker takes an in-depth look at the key issues. 
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On the ropes: can Argentina recover?

A wave of litigation against emerging market sovereigns is expected in the wake of the controversial US ruling against Argentina that led the country to default at the end of July.

Already Import-Export Bank of Taiwan is suing the Caribbean island of Grenada using the same legal argument used against Argentina. And many more cases could be on the way as the ruling serves as a precedent on litigation involving New York law-governed bonds. According to the International Monetary Fund (IMF), there is currently $900bn-worth of sovereign bonds governed by legislation other than that of the issuing countries. Just under half of this is governed by New York law.

At the same time, a furious debate has erupted over the interpretation of the pari passu clause in bond contracts, which was the crucial point in New York’s Southern District judge Thomas Griesa’s ruling against Argentina. Furthermore, the world of debt restructuring has been turned upside down, with arguments on one side for all bonds to contain stronger collective action clauses (CACs) to help push through restructuring agreements, but with commentators on the other side warning that such bonds will be more expensive to issue.

Wading in

Everyone is getting involved in the debate, from the IMF and the UN, to the International Capital Market Association (ICMA). Even the Catholic Church has become unwittingly embroiled in the controversy, with Argentina's president Cristina Fernández de Kirchner saying she would raise the matter during her planned visit to see Pope Francis in September.

The Argentine problem dates back to its default on $100bn of international debt in 2001. This not only caused huge economic hardship in the country, but also brought about a fierce battle with creditors that held out of both the 2005 and 2010 restructurings, in which more than 90% of investors accepted a 70% loss on their bonds.

So-called vulture funds – which typically buy discounted bonds in the market with a litigation strategy in sight – carried on the fight for full repayment. Eventually, a group of them, led by Paul Singer’s NML Capital and Aurelius Capital Management, got a court decision in early 2012. Mr Griesa ordered Argentina to pay $1.3bn to the plaintiffs – their original claims plus accrued interests and legal fees – and blocked bond trustees from distributing payments to exchange bondholders until the hedge funds were fully paid. In other words, bondholders who accepted heavy losses in the 2005 and 2010 restructurings would not get paid until the holdouts received their funds.

As a result in June this year Argentina missed a $539m interest payment to exchange bondholders as bond trustee Bank of New York Mellon failed to distribute funds. Resisting Mr Griesa’s ruling and failing to settle the matter with the hedge funds, a month later the country was in technical default.

Equal treatment

The case’s global relevance is centred on interpretation of the pari passu clause, which is typically included in bonds to ensure equal treatment to creditors – meaning the issuer cannot subordinate certain bondholders’ claims to others – and whether the clause should also implicitly provide a right to rateable payment, meaning payment of all claims at the same time.

In the Argentine case, Mr Griesa chose the latter interpretation: if holders of restructured notes are paid, holdout investors also ought to be paid simultaneously. The Import-Export Bank of Taiwan versus Grenada case is the first known copycat lawsuit. Many more can potentially follow given the widespread use of New York legislation on international sovereign bonds, as well as the existence of pari passu clauses in bonds the world over that are open to interpretation.

Duke University professor Mitu Gulati and University of North Carolina associate professor of law Mark Weidemaier argue that the word ‘payment’ – which was loosely included in the Argentine notes – had started to become more common in pari passu clauses since the 1990s, regardless of whether explicitly used to provide a right to rateable payment or not. ‘Payment’ was mentioned in pari passu clauses in the majority of international bonds issued between 2000 and 2013, the academics found. The results match similar research by the IMF of post-2011 bonds, confirms Sean Hagan, general counsel and director of the IMF’s legal department.

A counterbalance to this problem is offered by CACs that force restructuring on holdouts if a certain quorum is reached among the other creditors. But their use is still limited.

“There are a lot of bonds out there that have no CACs and poorly drafted pari passu clauses, such as Argentina's,” says Leland Goss, managing director of ICMA. “Many don’t agree with Mr Griesa’s interpretation as it goes against legal experts’ views, but it is also one of the two possible interpretations that are reasonable to take.” 

Controversial ruling

A timeline of events 

February 23, 2012

Judge Thomas Griesa of the New York Court’s southern district decides that Argentina violated holdout creditor rights following its 2001 default. The decision is the result of a $1.3bn lawsuit by holdout hedge funds lead by Paul Singer’s NML Capital and Aurelius Capital Management. Mr Griesa orders Argentina to pay the plaintiffs their full claims and blocks bond trustees from distributing payments to exchange bondholders.

June 30, 2014

Argentina misses a $539m interest payment to exchange bondholders as bond trustee Bank of New York Mellon fails to distribute funds. The US Supreme Court refused to hear Argentina’s final appeal earlier that month, making Mr Griesa’s order effective. Argentina enters a 30-day grace period before falling into technical default.

July 30, 2014

The grace period ends; Argentina falls in technical default as it does not reach a settlement with holdouts.

August 7, 2014

Argentina seeks to institute proceedings against the US before the International Court of Justice (ICJ) in The Hague regarding the dispute with the holdouts. The US will have to accept the jurisdiction of the ICJ to begin proceedings.

August 21, 2014

Kyle Bass’s Hayman Capital Management, George Soros’s Quantum Partners and other exchange bondholders file a lawsuit in the London’s Chancery Court against bond trustee Bank of New York Mellon’s London unit for failing to distribute $298m in interest on their euro-denominated holdings.

August 29, 2014

The International Capital Market Association (ICMA) issues a streamlined, new version of collective action clauses and a new standard pari passu clause to facilitate future sovereign debt restructurings.

September 9, 2014

The United Nations agree to launch negotiations on a multilateral legal framework proposed by the G77 plus China on sovereign debt restructurings. This is not binding for the 193 nations part of the international organisation but carries political weight.

September 11, 2014

Argentina passes a law that authorises a debt swap that would put some restructured bonds under Argentine law; Mr Griesa had said this is in breach of court orders. Argentina’s Banco Nacion would serve as bond trustee. Fintech Advisory, a hedge fund owned by Mexican tycoon David Martínez Guzmán who has long-term interests in the country, publicly states that it would accept the swap. The offer left other investors cold.

September 30, 2014

A coupon payment of $200m is due.

October 2014

The International Monetary Fund plans to release sovereign debt restructuring legal framework in October, on which it has consulted with ICMA.

Mr Griesa’s ruling is indeed controversial. Argentina had explicitly subordinated the holdouts to the holders of restructured debt through the so-called lock law, issued in 2005, breaking the right to equitable treatment. His interpretation of Argentina’s pari passu as right to rateable payment, however, was a stretch, according to many.

Philip Wood, head of Allen & Overy’s global law intelligence unit and visiting professor in international financial law at Oxford University, finds this reading puzzling. He says that unless such a right was explicitly mentioned, the clause had never meant that. Allen & Overy partner Yannis Manuelides puts it in very practical terms: if that was the spirit of the clause, the issuer would have had to come up with a long list of exceptions. “What happens if there is an epidemic in Argentina and they need to import some vaccine, can’t they pay for the vaccine until they pay the holdouts?” he asks.

There is further controversy. As it stands, the New York ruling blocks bond trustees from distributing interest payments to exchange bondholders, irrespective of whether these are governed by New York law or not. Kyle Bass’s Hayman Capital Management, George Soros’s Quantum Partners and others have since sued in the UK’s High Courts bond trustee Bank of New York Mellon’s London unit for failing to execute $298m-worth of payments on the investors’ English law-governed exchange bonds.

The order also blocks payments on $8.4bn-worth of exchange bonds governed by Argentine law. New York-based Citi acts as bond trustee on the notes and has urged the Second Circuit Court of Appeals in New York to reverse Mr Griesa’s ruling as the bank says it faces being sued by Argentina if it cannot process a $5m payment due on September 30, according to the bank’s lawyer, Karen Wagner. Hayman Capital has also requested the US judiciary to hear a legal argument to exclude non-New York law bonds from the order. As The Banker went to press, the extraterritoriality issue remained unresolved.

Markets and multilaterals

International organisations joined the discussion in an effort to contain a potential pandemic of lawsuits against struggling economies. The IMF has drafted a sovereign debt restructuring framework that it plans to release this month, while the UN’s involvement went as far as agreeing to launch negotiations on a proposal by the G77 plus China on sovereign debt restructurings, something that is not binding but carries political weight across its 193 nations.

Multilaterals having their say in capital markets, however, is not welcome by all. The IMF’s own proposal for a sovereign debt restructuring mechanism at the time of Argentina’s 2001 default was eventually blocked; the US government was against it, and it is also opposed to the recent UN proposal.

Many investors remain unconvinced. “I don’t see how the UN thought it had any perspective on this,” says Hans Humes, president of Greylock Capital, an investor in distressed emerging market debt that holds both exchange and holdout Argentine bonds. He is also a member of the Institute of International Finance’s group for the Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets, as well as the institute’s group on Reconciliation of Past Due Sovereign Debt. “I’ve been part of [similar] discussions and it’s always distressing when you realise that people who want to create policy have no direct experience [in restructurings],” he says.

The good guys

But it is not only multilaterals that have offered solutions. ICMA is concerned about the instability the current situation has brought to the bond markets: with holdouts now having greater chances of success, there is little incentive to accept losses on defaulted bonds, which would stall further the already challenging restructuring process.

“The way Argentina’s holdouts have gone about being repaid, which is their legal right, ended up with a court providing a remedy that has affected all bondholders, some of whom are the ‘good guys’ who took the haircut several years ago,” says Mr Goss. ICMA promptly issued a standard pari passu clause that would not be subject to the right of rateable payment interpretation. In an attempt to further democratise the restructuring process and improve their effectiveness, ICMA also released a new streamlined version of CACs.

Currently, investors can exercise blocking votes across different bond series because of the presence of layered aggregation clauses in CACs, under which votes are taken across individual bond series, as well as among all bondholders. Holdouts can block a restructuring by taking a significant position in one particular bond issue, even if that issue is a small proportion of the sovereign’s total debt. Under the new rules, CACs will provide a single aggregated mechanism that can force a restructuring on all when the voting threshold of 75% of the outstanding principal amount is reached.

Mr Bass, founder and principal of Texas-based Hayman, says that these measures will be particularly useful for New York law-governed bonds. Unlike in the UK and other jurisdictions, there is no legislation limiting vulture funds’ legal strategies in the US.

“I think that all this idea of profiteers and vultures benefiting at the detriment of poor people has to come to an end and I think it will,” says Mr Bass. “I don’t think you can see anti-vulture funds legislation in the US but what you see are efforts by ICMA to put into place its own definition of pari passu and [encourage the use of streamlined] CACs into all new sovereign bond offerings.”

Argentina has said that paying NML and the other hedge funds would trigger additional holdout lawsuits and that if the country were to pay all creditors, including exchange bondholders, it would deplete half of its foreign exchange reserves, bringing about further economic troubles. Market sources estimate total claims to be much lower.

What now?

If clearer, simpler clauses could help future deals, their full effects would only be felt in a decade given the amount of outstanding bonds without them, according to some experts. Sovereigns may also fear alienating investors by introducing new rules. “If there are conditions that are only worsening the situation for the creditor [such as the new CACs], it’s obvious that investors in those country bonds will request a very different interest rate,” says one commentator.

In the meantime, sovereign debt restructurings will continue to be fought in the courts of law. Argentina alone has attracted a phenomenal amount of litigation. Nicola Stock, president of the Italian arm of lobby group Task Force Argentina, which represents a large group of local holdout retail investors, has done the maths. “There isn’t only [the lawsuit by] NML, but also 111 class actions [against Argentina] with the New York courts; 108 individual cases again in the New York tribunals; hundreds of lawsuits in Frankfurt; and three arbitration procedures at [the International Centre for Settlement of Investment Disputes], including ours,” she says.

Other sovereigns have taken a more pragmatic approach to holdout fights. Ecuador, for example, often labelled a serial defaulter, settled with such creditors after its 2008 default so that the country could re-enter the international capital markets, notes Mr Humes. “It just negotiated and put [the issue] behind it,” he says.

Nobody can see this happening in the Argentine case in the immediate future. In the restructured bonds, the rights upon future offers (RUFO) clause, which prohibits the country from allowing better terms to any other creditor, will be valid until the end of the year. And both sides continue to accuse the other of lacking real commitment to the process. Robert Cohen, a partner at law firm Dechert who is advising NML Capital, recently reiterated this point in a press briefing with journalists; as has Argentine finance minister Axel Kicillof in his opinion piece for The Banker.

Until now, Argentina has peppered the battle with populist rhetoric, which included accusing Mr Griesa of making “imperialist” remarks; while the holdouts’ quest to expose alleged corruption resulted in 141 and counting subpoenas issued to Delaware-based companies, as well as international banks searching for evidence against the Argentine government.

“As crazy as this sounds, I think both sides played it well,” says Mr Bass. “[And] I think it will end up settling. I don’t think [Argentina] will end up paying the full amount, but I do think that once RUFO expires and given the elections – primaries in August and general elections in October 2015 – the party of the people that gets credited with settling the vulture issues will have a lot of political wind at its back.”

Whether played well or badly, this battle has shaken the market. It has provided a sharp legal strategy that other distressed debt investors are likely to exploit over the next decade. But it has also brought new life to the much-needed international debate on sovereign debt restructurings.

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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