Argentina’s Return to Default?
The U.S. Supreme Court’s rulings in favour of Argentina’s holdout creditors has thrown our sovereign debt restructuring mechanisms into doubt, says Brett House.
Deputy chief economist, Scotiabank
Today the U.S. Supreme Court delivered landmark rulings against Argentina in a pair of legal battles with creditors holding foreign-law bonds on which the country defaulted in 2001 in the midst of its massive economic and political crisis.
In the most closely watched of the two cases, the Supreme Court denied Argentina’s request to hear an appeal of a lower-court decision that Argentina cannot make debt-service payments on the bonds it restructured in the wake of its default unless it also makes payments to creditors who refused to accept Argentina’s restructuring terms.
In a second related—but less consequential—case, the Supreme Court found that the U.S. Foreign Sovereign Immunity Act (FSIA) does not prevent defaulted creditors from seeking information on Argentina’s foreign assets. The Court held that while such assets may be protected from seizure or “attachment” by virtue of sovereign immunity, these protections do not apply to attempts to discover the existence of such assets under subpoena.
Four years after its default, Argentina offered a take-it-or-leave-it deal in 2005 to its defaulted bondholders: a one-time offer to exchange their impaired bonds for new paper worth between 25 and 35 percent of the nonperforming debt. To encourage participation in the debt exchange, the Argentine Congress passed a law in February 2005 that forbade the government to make payments on any bonds not tendered, to later reopen the exchange or to settle with nonparticipating creditors one-by-one on the side.
About 76 percent of eligible bondholders accepted the 2005 debt exchange, but a collection of speculative hedge funds and retail investors decided to hold out for a better deal. Some pursued litigation against Argentina in the New York courts, under whose law most of the defaulted bonds had been issued.
That litigation has been wending its way through the US legal system ever since and Argentina has been locked out of international capital markets. It can’t issue new bonds in New York or London because existing judgments in favour of the holdouts and new legal actions would immediately lead to the seizure of the proceeds from any new debt issuance.
For a few years after the default, being shutout of international borrowing didn’t matter much: Argentina’s 2002 decision to stop pegging the peso at parity to the US Dollar and the subsequent devaluation spurred demand for Argentine exports. Chinese appetite for Argentine soya and other agricultural commodities also took off. For a few years, Argentina’s balance of payments was financed without issuing foreign-law bonds.
Argentina also managed to tap some foreign capital through domestic debt issuance. Bonds issued under Argentine law and related debt service payments made inside Argentina are shielded from litigation by foreign holdout creditors—but they also lack the protections offered by New York or English law. The terms of a bond issued under Argentine law can be changed by fiat of the Congress in Buenos Aires.
Greece’s 2012 restructuring showed how limited the protections are for holders of domestic debt. In February 2012, the Greek Parliament passed an act that allowed it to add collective action clauses to the 92 percent of its debt issued under Greek law, which enabled a supermajority of creditors to impose the March 2012 Greek debt exchange on individual holdouts. Given Argentina’s even more fraught financial history and the vulnerability of domestic debt to unilateral restructuring, only limited foreign capital has been interested in Argentina’s domestic bond issues.
In the last couple years, however, Argentina’s finances have become tighter. Foreign reserves have fallen sharply and demand for Argentine exports has been curtailed. Domestically, a combination of, inter alia, the authorities’ impetuous and heterodox economic policies, high inflation and political meddling with the integrity of the government statistical agency have together conspired to drive capital flight.
In view of Argentina’s worsening balance of payments, the authorities have in recent years taken measures to regularize the country’s financial relationship with the rest of the world. Despite its promises never to do so, Argentina re-opened its 2005 debt exchange to holdout creditors in 2010 and pushed participation up to 93 percent of eligible debt. Only a few weeks ago, in May 2014, Argentina concluded an agreement with bilateral official Paris Club creditors (i.e., industrialized country governments) to settle debt in arrears through a 5-year payment schedule.
With the U.S. Supreme Court’s refusal to hear Argentina’s appeal of the lower court ruling, these conciliatory steps are set to be put into jeopardy. Argentina has warned that, under its legislation prohibiting payment to the remaining holdout creditors, the Supreme Court’s decision will force it to default on its restructured debt rather than concurrently begin servicing nonparticipating creditors.
Beyond Argentina’s specific situation, the refusal to hear the appeal has potentially far-reaching implications for sovereign-debt restructuring practices around the world. The case hinged on the pari passu provision included in most sovereign bond contracts and in the debt on which Argentina defaulted in 2001.
This clause provides for equal-treatment of creditors across bond series, but its exact meaning has never been pinned down. New York Federal trial judge Thomas Griesa and the Second U.S. Court of Appeals both ruled that Argentina’s unwillingness to pay defaulted holdout creditors while servicing newer debt issued in the 2005 and 2010 exchanges violated the spirit of pari passu. The Second Circuit further rejected what it called Argentina’s “blanket assertion” that a decision against the country would drive it into a new economic crisis. By indicating its refusal today to hear Argentina’s appeal, the Supreme Court indicated that it would not overturn these rulings.
That leaves Argentina with two choices: either start servicing pre-2001 defaulted bonds held by holdout creditors or, to avoid such payments, default on its 2005 and 2010 restructured debt and undo all the efforts the authorities have recently made to return to global markets.
Argentine President Cristina Fernandez de Kirchner is due to address the U.S. Supreme Court ruling in a televised address at 8pm EDT tonight. Given her personal stake in this case, she’s likely the take the more combative option.
More broadly, the U.S. Supreme Court’s decision throws restructuring of NY-law sovereign debt into question. If holdout creditors have a right to be paid when restructured debt is serviced, then any holdouts from past debt restructurings now have a channel to seek payment. Looking forward, the incentive for any bondholder to participate in future restructurings of NY-law debt is compromised.
Regardless of what Argentina decides to do, American legislators will have to act urgently to clarify the meaning of pari passu in order to preserve New York’s pre-eminent role as a centre for sovereign debt issuance.