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June 20, 2014 5:26 pm
In the early stages of Argentina’s second debt restructuring in 2009, Amado Boudou, then economy minister, said that the country needed to be able to “tell friend from foe” in the forthcoming negotiations.
The man who went on to become Argentina’s vice-president in 2011 was referring to the group of so-called holdout creditors – known locally as the ‘”vulture funds” – who did not participate in the country’s first attempt to renegotiate its defaulted bonds in 2005.
The restructuring was crucial to Argentina’s attempts to return to international markets after being blocked since its $100bn debt default in 2002. But a confident Mr Boudou at the time dismissed a settlement with the holdouts as “neither a necessary nor sufficient condition” for Argentina’s successful return to markets.
Those words came back to haunt Argentina this week.
A US Supreme Court ruling on Monday gave the holdouts the upper hand in the decade-long battle. The US high court rebuffed Argentina’s arguments that previous lower court rulings in favour of the holdouts misread the country’s bond agreements and violated its sovereign immunity.
The decision left Argentina facing the prospect of having to pay the holdouts in full before it could legally make any payments to other bondholders, which are due on June 30. Otherwise, Argentina would default for a second time in less than 15 years.
“Traditionally, sovereigns have had a lot of power during debt restructurings,” says Arturo Porzecanski, director of the International Economic Relations Programme at American University.
“But after this week, if became clear that sometimes creditors win. This ruling has elevated the status of creditors.”
The ruling has potentially dire consequences for Argentina. But it also raises important questions about future restructurings involving sovereign debt in the US.
One fear is that if Argentina holdouts are paid in full it would reduce the incentive for investors to jump in early in future debt restructurings. In fact, following the court’s announcement, the International Monetary Fund warned that the ruling may prove challenging for some countries when they run into difficulty.
“The fund is considering very carefully this decision and, as we have said before, we are concerned about possible broader systemic implications,” the IMF said.
Other analysts say the ruling may encourage countries to simply bypass the US as a destination for future debt offers and migrate to jurisdictions, such as the UK, that remain friendlier to sovereigns.
The holdout creditors in the case of Argentina are comprised mostly of hedge funds, led by Paul Singer, the billionaire investor. But the group also includes retail investors and pensioners in countries, such as Italy, that have filed class action lawsuits and quite possibly, may get a ruling, too.
President Cristina Fernández responded to the ruling with a combative televised speech to the nation saying the country would not yield to “extortion.”
But after a frantic attempt on Tuesday to skirt the Supreme Court’s order by moving the domicile of Argentine restructured bonds from New York law into local law, the government changed tack and agreed to meet the holdouts in New York next week.
I was beginning to get worried that the sky was going to fall on the sovereign debt market. But then I saw freaking Ecuador coming to market and being received with open arms
- Javier Kulesz, Nomura
The hedge funds have said they would consider accepting new bonds as payment from Argentina in exchange for their defaulted debt, people familiar with the funds’ strategy said.
“Argentina has been playing poker, but now everybody knows they have a very weak hand going into these negotiations with the holdouts,” says Javier Kulesz, at Nomura’s emerging market group.
Regardless of the outcome of next week’s negotiations, Mr Kulesz says there are already indications that the fallout for broader sovereign debt sales in the US will be limited because it is viewed as an extreme and isolated case. In addition, many of these countries offer high yields and that trumps danger in the current environment.
For one, Argentina’s case, which has been dubbed the sovereign debt trial of the century, has done little so far to discourage some of the world’s poorer countries and even serial defaulters, from turning to the US to raise funds.
The day after the Supreme Court ruling on Argentina, Ecuador, which defaulted on its foreign debt in 2008 and once called its creditors “monsters”, sold $2bn worth of bonds in the US. There was no shortage of demand: the sale attracted more than $5bn in orders.
“I was beginning to get worried that the sky was going to fall on the sovereign debt market. But then I saw freaking Ecuador coming to market and being received with open arms,” says Mr Kulesz.
Even if the US market stays open for these sovereign borrowers, they may have to pay investors more in future deals. Another ramification of Argentina’s travails could be the onslaught of legal provision in bond contracts, shielding borrowers from the risks that bedevilled Argentina in its legal journey all the way to the supreme court.
In exchange for a higher degree of protection to sovereigns, “we may see investors asking for higher yields,” says Charles Patrizia, a partner at Paul Hastings, the law firm. “Lawyers, bankers and borrowers adjust to new realities quickly.”
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