Deal with Holdouts Marks the End of Argentina’s Debt Crisis

By Carlos Salguero

EspañolArgentina’s latest default in  2014 caused a financial earthquake. The US Supreme Court ruled in favor of investment funds Elliott Management Corp, Aurelius Capital Management LP, and NML Capital Ltd, which acquired sovereign bonds in default after the economic crisis of 2001 at only 20 cents on the dollar.

The news, of course, was not well received by then President Cristina Kirchner, above all because it laid bare her administration’s inability to solve such a sensitive and costly problem.

She systematically refused to negotiate with the holdouts, which she contemptuously nicknamed “vultures” and “economic terrorists.” And she incensed her followers with the slogan “homeland or vultures,” a strategy certainly ineffective in sealing a deal.

In July 2014, then Finance Minister Axel Kicillof assured that the holdouts “would never get” more than 30 cents on the dollar for the bonds — and Argentina again fell into default! This time, it was on the “holdings,” the bonds for which investors had received swaps in 2005 and 2010.

The 2001 default affected Argentinean bonds issued under different jurisdictions, including New York. In 2005, the Argentinean government offered a first debt swap at 30 cents on the dollar, plus a coupon tied to the GDP, arguing that the level of sovereign debt should be sustainable under the prevalent macroeconomic conditions.

But this debt restructuring reached only 75 percent of bondholders, one of the lowest acceptance rates in such deals. Later, in 2010, a second offer was well received by 93 percent of the bondholders, in similar conditions. The remaining 7 percent went ahead with claims through the courts; these were the holdouts.

The Argentinean government’s behavior led the plaintiffs to file a lawsuit for the breach of the pari passu or impartiality clause. The main problem centered around a law passed by the Argentinean Congress which prohibited the government from extending new offers to dissident creditors.

The law, enacted on February 10, 2005, sought to limit the rights of those bondholders who did not accept the first debt restructuring agreement in 2005. But given its poor acceptance, it was temporarily suspended by Congress so that the second debt swap could be carried out in 2010. The most burdensome consequence of the legislation was ultimately the different classification of bonds: holdings and holdouts.

In December 2011, New York District Court Judge Thomas Griesa issued a ruling in which he argued that the Argentinean law violated the pari passu clause. Kirchner’s government appealed the ruling, but in October 2012 the Court of Appeals unanimously upheld Griesa’s verdict. However, Griesa was asked to clarify the formula by which the holdouts payment would be defined. It would have been logical for Argentina to also offer a discount payment.

Simultaneously, on October 2, the Elliott Group convinced a court in Ghana to confiscate the Argentinean navy vessel Fragata Libertad, complicating negotiations even more.

The Argentinean government, mired in pedantry and blinded by irritation, far from trying to solve the problem decided not only to dismiss the judge’s proposal, but also to publicly announce that it would not pay or abide by the court’s decision.

Judge Griesa’s response was much harsher than anticipated: he ordered Argentina to pay up immediately the entire holdout debt along with the GDP coupon payment due on December 15, 2012.

It was a truly unusual ruling for a judge who had acted with some equanimity over the past 10 years. The normal course of action would have been to force the vulture funds to accept the same discount as those who accepted the swap and permanently close litigation for the holdouts. Bonds, after all, are already issued with clauses forcing everyone to accept a restructuring if a minimum number of investors accept it.

[adrotate group=”8″]That was the opinion of the IMF’s Executive Board on October 6, 2014. In their own publication, they pledged to push for a reform of international sovereign bond contracts that addresses collective-action problems in debt renegotiation. At the same time, the agency acknowledged that the current legal framework may not be sufficiently robust to prevent dissenting creditors, commonly known as holdouts, from undermining the restructuring process.

Today, sovereign bonds include not only collective action clauses, but what is known as “super aggregation clauses.” This determines that, if a minimum number of bondholders accept restructuring, the rest of bondholders are bound by the terms of the agreement. The mechanism was used recently in the process of restructuring Greek debt. Thus the possibility that a “vulture” fund can buy a significant percentage of debt, of any title, without being obliged to accept the general law, is eliminated.

However, the Argentinean case has a firm verdict upheld by the US Supreme Court, and the country has the obligation to pay creditors the total nominal debt plus interests. The total debt in default to be paid to Italian, German, Argentinean, and unidentified bondholders among others is of the order of US$18.8 billion.

There is no doubt that the agreement reached on February 18 between Argentina’s Finance Minister and the mediator appointed by the court, who has not been endorsed by Congress, is not the best possible solution. The government will have to disburse between 15 and 20 times the invested capital. This, however, marks the end of Argentina’s financial isolation from the possibilities offered by international markets.

The challenge is now to impose a pragmatic limit on government debt to prevent cronyism, superfluous expenses, and the waste so deeply ingrained in Argentinean history.

Carlos Salguero holds a PhD in Economics and a Masters in Business Administration from ESEADE. He is a professor at Universidad Católica de La Plata and an alumnus of Argentina’s Military Naval School.

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