For 12 years, Argentina has waged an intense legal battle in US courts against a group of New York hedge funds. These holdout creditors, led by NML Capital, refused to take writedowns in the debt restructurings that followed the country’s $95bn default in 2001. They have since sued for full repayment. Buenos Aires refused and, for a long time, its defiant strategy worked. But now it has run out of time.

Last week, a US judge ordered that a payment Argentina had made to holders of its restructured bonds was illegal as it did not include full payment to the holdouts too. This decision leaves Argentina with a stark choice. It can settle with the holdouts and resume payments on its restructured bonds – which entered into technical default yesterday (with a 30-day grace period). Or it can continue to refuse to settle with the holdouts, although that would also mean defaulting on all its foreign debt at the end of July.

The second, nuclear default option is not wholly mad. Afterwards, Argentina could restructure all its foreign debt into local law, so removing the US legal purchase the holdouts have had until now. It would also allow Cristina Fernández, the president, the satisfaction of declaring a moral victory against “vulture creditors” and a US legal ruling her government derides as “biased” and “absurd”. Goodbye and good riddance.

But the costs of this course of action would be huge. A general default would lock the country out of US financial markets for years at a time when it is seeking fresh international credit to fund development of its vast shale gas reserves. Trade finance would probably shrink. The economy is also fragile and a general default, the second in 15 years, could precipitate a full-blown crisis. Although Ms Fernández is a volatile and unpredictable figure, this is the last thing she wants before next year’s elections.

That leaves settling, which has its own problems too. For one, it could open Argentina to a slew of me-too claims from holdouts not party to the NML case. Buenos Aires says these would total $15bn. Even if an exaggeration, me-too claims would still tear a chunk out of Argentina’s $28bn of foreign reserves. A more serious problem is the so-called RUFO clause in Argentine restructured bonds. This stipulates that Argentina cannot give any investor a better deal than the 30 cents on the dollar it paid to the 93 per cent of bond holders who ceded to a restructuring. Paying holdouts in full could therefore require Argentina to offer the same to everyone, an unconscionable expense.

It is an invidious choice. Neither decision is optimal. Still, settling and moving on best serves Argentina’s immediate interests. The outline of a possible solution can be glimpsed. Argentina could meet the holdouts’ $1.5bn claim with fresh bonds, rather than cash from scanty foreign reserves. The bonds would be issued on a deferred basis, so as to skirt the RUFO clause which expires at the end of this year. All holdouts should be invited to join, to settle the problem for good. There could even be a fresh cash element to the issue.

Whether all this can be agreed before Argentina enters formal default is another matter. Indeed, this unfortunate case continues to highlight the urgent need for a better sovereign debt restructuring process. The collective action clauses since introduced to many bond contracts, which force obstinate holdouts to accept majority writedowns, are no fail-safe. Certainly, Argentina’s uniquely recalcitrant position has precipitated the situation and only made matters worse. But we are where we are, and at the moment it is a state of confusion. You can be sure the well-paid lawyers of highly incentivised hedge funds will continue to exploit the confusion in other debt workouts, and perhaps other jurisdictions, while it remains.


Letter in response to this editorial:

Best policy response on Argentina is: do nothing / From Dr Jerome Booth

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