September 21, 2014
Default insurance up in the air
After the country failed to strike a deal in time to meet a midnight debt payment deadline, the International Swaps and Derivatives Association yesterday received its first request to consider whether a credit event has occurred on Argentina’s credit default swap contracts (CDS), with the ISDA expected to decide against those who bet against a default.
The leader of Argentina’s holdout creditors, New York-based hedge fund Elliott Management, also sits on an industry committee that will determine whether investors who bought credit-swaps protection on the nation’s bonds are paid out.
Elliott Management, worth US$24.8 billion and directed by the billionaire Paul Singer, denied owning CDS in a US court last year, refuting the possession of such contracts that would allow it to profit if Argentina ceased repayments. Stephen Spruiell, Elliott’s spokesman, declined to comment for Bloomberg yesterday.
Ironically, JP Morgan, the bank that bought Argentine bonds from Spanish oil firm Repsol this year, was said to be negotiating to buy out the holdouts’ defaulted debt yesterday, is also part of the 15 dealers and investors on the ISDA committee. Citigroup is another member, and is also at the table with Elliot and Aurelius Management for their bonds.
ISDA’s decision-making committee will meet at 11am in the Big Apple to clear up the situation.
Swiss bank UBS asked ISDA’s determinations committee to consider whether a “failure to pay” credit event has occurred, citing a missed deadline to deliver interest payments to exchange bondholders.
If the request is accepted, the 15-member committee will vote on whether a payment on Argentine CDS contracts can be triggered for billion-dollar compensation.
“The figure that’s dancing around is US$1 billion,” Marco Schnabl, from Skadden, Arps, Slate, Meagher & Flom — the law firm hired by Puente investment banking company to draft and submit its amicus in support of the government before the US Supreme Court — told the Herald.
The lawyer added that it was very likely the ISDA would pronounce itself the government’s argument that its situation doesn’t technically constitute a default.
According to to the Depository Trust & Clearing Corp, the ISDA could trigger more than 2,600 contracts, which insured US$1 billion up to July 25, Bloomberg reported. The swaps pay out the buyer the face value in exchange for the underlying securities or the equivalent cash when debtors breach their contracts.
CDS contracts are traded between private parties, implying no immediate monetary consequence for the country, but the repercussions might not take long to crop up, as the ruling will also allow most Argentine bondholders to demand the application of their credits’ acceleration clauses.
For its part, the country has upheld its stance that it won’t sign off on any default, maintaining its contractual obligation was fulfilled in having made a US$539 million.
For international credit rating agencies, Argentina defaulted for the second time in 12 years after last-ditch talks with what it called “vulture” creditors failed, though debt insurance prices yesterday suggested investors believed a the situation could soon be resolved.
Any such ruling by the ISDA would set off a series of insurance payments and give most of Argentina’s current bondholders the right to demand their money back immediately. The deadline to do so is August 4, according to analysts.
The cost of insuring Argentina’s debt against default fell sharply yesterday, however, data provider Markit said, as investors speculated a deal could be struck, even if only in the long term. The country’s five-year credit default swaps fell more than 400 basis points to 1,444 bps.
“It is still not clear whether the credit default swap of the country will be triggered,” said Emiliano Surballe, fixed income analyst at Bank Julius Baer. “The situation that generated the default was a lawsuit, not the failure of the country to transfer the proceeds to pay existing debt.”
Argentina parked with its bankers the US$539 million to pay its current bondholders, but US Judge Thomas Griesa’s legal ruling prevented it from doing so unless it paid off the holdout bondholders first.
“It’s probably going to be more a soft default scenario where prices will slide a bit. There is confidence in what the government is going to do,” said Rune Hejarskov, senior portfolio manager at Jyske Invest, which holds Argentine debt.
The default could get much messier and take longer to clear up if creditors force an “acceleration” for early payment on their bonds.
Some investors saw this as unlikely. “I don’t think at the moment there is a clear answer to whether bondholders will accelerate a deal. It’s probably not something most bondholders would like to see,” said Olivier De Timmerman, fixed income fund manager at KBC Asset Management in Luxembourg.
“My expectation is that they will eventually reach an agreement with holdouts. I do not think it will be in the short term, but likely after the foreclosures have expired towards the end of the year,” he added.
The bonds at the centre of the struggle had rallied strongly on Wednesday along with Buenos Aires stocks and the peso as bets on a deal rose, but traders were left up in the air after the talks fell apart.
“We expect part of (Wednesday’s) rally to come back to couple of points ... Discount bond (bonds given to investors when Argentina restructured) prices will come back a bit and we will probably see a fair value around 85.” said Hejarskov.
Even a short default will raise local companies’ borrowing costs, pile more pressure on the peso, drain foreign reserves and fuel inflation rates.
It could “complicate life for businesses like YPF, which were going to look externally for financing,” said Camilo Tiscornia, a former governor of the Central Bank.
Herald staff with Reuters