October 23, 2014
Argentina debt case weakens incentives to settle
A legal clause that is the key to smoothing future debt restructurings could be undermined by a US court ruling that Argentina must pay creditors holding its defaulted debt.
The case has implications for emerging markets, source of protracted and painful past defaults, and for Europe, where the rules setting up the eurozone’s bailout fund state that government bonds must carry Collective Action Clauses from 2013.
Known as CACs, the clauses make a restructuring binding for all creditors if agreed by a specified majority — usually 75 percent. They are intended to eliminate the risk that some investors will shun offers and take legal action to squeeze cash from the debtor, often dragging the process out for years.
But “Argentina vs NML Capital” revives the threat that such holdouts will stall future debt restructurings. The US court ruling upheld the principle of pari passu, meaning debtors cannot pick and choose between creditors.
In Argentina’s case, that means the hedge funds which brought the litigation, and which refused to participate in two debt restructurings accepted by 93 percent of bondholders, must be paid what they are owed alongside those who did take part.
That has galled investors who took a 70 percent writedown on Argentine debt during the 2005 and 2010 swaps. The Argentine debt did not have a CAC, but the ruling could make it harder to secure the majority needed to trigger CACs in future.
“Such a ruling creates a big incentive to be a holdout going forward,” said Bart van der Made, lead portfolio manager at ING Investment Management, which swapped its Argentine bonds.
“If you think there’s a judge waiting around the corner who says you will be paid in full and with past due interest — well, in that case, everyone will hold back and you won’t hit the 75 percent approval rate required to (trigger) the CAC.”
As the process drags on, more interest accrues, pushing the debt up further and impelling the borrower to concede more to creditors — some of whom may have bought their debt at vastly discounted prices — to secure a deal.
Perhaps emboldened by the Argentine case, hedge funds last week proved reluctant to participate in a Greek bond buyback, the timetable for which had to be extended after Greece initially fell short of its target despite generous pricing.
Greece retroactively inserted CACs into its domestic bonds to enable a successful swap in March, but still has 6.4 billion euros of foreign law bonds, the terms of which can’t be altered.
Some of these will have been tendered in the new buyback, but many hedge funds say they plan to hold on to their Greek debt in expectation they will be repaid at par later.
Analysts at JP Morgan advised Greece prior to the buyback to enforce its CACs, estimating that by doing so debt relief would be double what it would get if it allowed some creditors to hold out.
Alexandre Tombini, the central bank governor of Brazil, itself a past debt defaulter, has said the rulings against Argentina set a bad precedent.