In an era where sovereign debt distress has become commonplace, this week’s ruling on Argentina’s protracted bond restructuring just made the outlook more complicated for creditors and debtors alike.
The ruling by U.S. Federal judge Thomas Griesa has raised the spectre of a technical default next month by Argentina, which has been ordered to immediately make full payment to funds that had shunned its past debt restructuring rounds.
The ramifications of the case will ripple far beyond Buenos Aires and New York.
The ruling is of course a blow for Argentina which terms these holdout funds “vultures” and has vowed not to pay them a penny.
It is bad news for other bondholders who accepted a restructuring of old Argentinian debt after the country’s $100-billion (U.S.) smash in 2002, agreeing to write off – or take a haircut, in bond parlance – on 70 per cent of the debt.
Above all, it is fuelling unease that creditors will have little incentive to agree to future restructurings or haircuts if a sovereign runs into trouble.
“The wider implications of this legal ruling will send shock waves through all future restructurings,” says Greg Saichin, head of emerging debt at Pioneer Investments, who considers the ruling negative for Argentina as well as for other sovereigns that could require a debt workout in future.
“A lot of sovereign debt in emerging markets is done under U.S. law, and from Russia to Brazil all these emerging countries will see a precedent in this ruling for what they want to do next,” Mr. Saichin said.
That is a real issue, with debt levels deemed unsustainable in many euro zone states and increasing numbers of poor developing nations from Africa to central America issuing debt on international bond markets, most of it, like Argentina’s, governed by U.S. law.
The case also reopens questions over the restructuring that cut Greek sovereign debt by €100-billion ($130-billion), handing creditors losses of around 75 per cent. A minority of investors in Greek bonds issued under foreign law held out, and some €6-billion worth of those bonds are still outstanding.
Argentina’s government says forcing it to treat holdout investors pari passu – on equal terms – with holders of restructured debt will exacerbate future sovereign debt crises by “making voluntary debt restructuring essentially impossible.”
“No one in their right minds would participate in such a process now,” Economy Minister Hernan Lorenzino told reporters.
Not everyone agrees the ramifications will necessarily be that wide.
First, most concerns revolve around older debt like Argentina’s because bonds issued before 2004 usually lack collective action clauses (CAC) that make a restructuring agreement binding on all creditors.
Greece, for instance, activated a collective action clause forcing holdouts who owned bonds issued under Greek law to take part. But others note that Greece paid out €435-million to holders of a bond issued under foreign law, averting litigation by another group of holdouts.
“Over time, all emerging market sovereign debt will contain collective action clauses. In the meantime debtors will seek to avoid U.S jurisdictions when considering restructurings,” said Richard Segal, emerging markets analyst at Jefferies.
That might be hard for any emerging economies that run into trouble in servicing existing bonds, said a one fund manager who asked not to be named.
“It will clearly have secondary and tertiary impact on countries that have not gone through a restructuring or who do not have collective action clauses in their documents,” he said.
As to the fairness of the ruling, NML Capital and Aurelius Capital Management, the hedge funds that brought the case against Argentina, might say sovereigns would have less incentive to default in the first place if they knew they would eventually be held accountable for old debt.
Many, including fund manager Sam Finkelstein at Goldman Sachs Asset Management, appear to have some sympathy with that view.
“The legal ruling empowers creditors and can thus be interpreted as a victory for sovereign creditors,” he said.
Vivienne Taberer, a portfolio manager at Investec Asset Management, disagrees. While some sovereigns are just unwilling to pay, others really are unable to do so and restructuring is the only option.
“If Greece hadn’t had CACs in place it wouldn’t have been able to restructure debt at all,” she said. “You want to make it difficult for sovereigns to restructure and walk off, but you don’t want to make it impossible to restructure debt into something that’s more viable for them to pay.”
That was the case with Argentina in 2002 and Greece in 2012. It is also likely that Argentina, a country of 40 million people, will be tipped into bankruptcy if all holders of restructured debt also demand to be paid in full.
Many also point out that Argentina’s is a unique case with few creditors willing to litigate for a decade or with as much ferocity as NML and Aurelius did. NML also recently won a court order to detain an Argentine ship in Ghana in lieu of debt.
Argentina, with its history of multiple defaults, may elicit less sympathy than most.
“It’s not simple for a creditor to be a holdout,” said Rodrigo Olivares, a sovereign debt expert at Queen Mary University in London. NML “has been litigating for 10 years. They have tried to seize everything from satellites to ships. The message is: This is not for me or you.”