So – now that the dust has for the time being settled from the November/December 2012 drama surrounding the US Court ruling(s) regarding Argentina’s payment on defaulted bonds, I wanted to take a comprehensive look at the issue so that we can all be ready for action come the February appeal. Feel free to skip sections and comment liberally – this is a complex snaggle, so I’m going to cover some basics, identify key players, and basically bore the pants off of you to lay the groundwork for a titillating February.
Bonds are IOUs with legal contracts that enforce payment. They can be issued by governments (national or local) or companies, and are a way to raise money by borrowing from lenders. The bond issuer is the seller, borrower, and debtor, whereas the holder of the bond is also called the buyer, lender, or creditor.
The issuer repays the borrower over a fixed period of time via a series of interest payments and then repayment of the principal, or the initial borrow amount, at the end of that time period when the bond matures. The interest rate reflects the perceived riskiness of the issuer, with US bonds paying a very low interest rate whereas Argentine bonds pay quite a high interest rate.
When an investor buys a bond, he can either hang on to it and collect the interest payments and then principal, or he can resell it in the secondary market, meaning resell it on the open market for whatever people are willing to pay. Bonds are called debt or “fixed income” investments because unless the issuer defaults, an investor will earn the sum of the interest payments and principal over the fixed period of time.
When a country defaults on its debt, it is essentially glorified bankruptcy but without the agreed upon legal steps to follow. A country that defaults is incapable or unwilling to service their debt, or make scheduled interest and principal repayments to bondholders. The country must then undertake some combination of borrowing money on strict terms from an international body like the IMF and attempting to negotiate with bondholders a restructuring (sometimes called a haircut) whereby they pay back a percentage of the money owed.
Emerging economies access international capital markets and investors by issuing debt, or selling bonds, in hard currencies like US dollars and Euros, rather than in their local currency (Argentine pesos, Indonesian rupiahs, Thai baht, etc). These dollar bonds are issued under US law rather than local law, making the currency and enforcement of payment less risky and thus more attractive to a wider pool of investors.
The “Reader’s Digest” version of what went down
In 2001, Argentina defaulted on US $95 billion worth of debt in what is still the largest sovereign default in history (I’m not counting you, Greece).* In 2005 and again in 2010, it offered holders of defaulted bonds the option to swap for restructured bonds that paid 30 cents per dollar, or 30% of the value of the original bonds – the harshest restructuring since World War II. Between the 2005 and 2010 swaps, holders of 91% of the defaulted debt had participated in the restructuring and accepted the lower payment.
That created two categories of bondholders: the 91% who accepted restructured debt and the holdouts, who did not. And many of the holdouts resold the already defaulted bonds on the secondary market, creating everyone’s favorite category of holdouts: the vultures, investment funds that bought this defaulted holdout debt and are trying to get back the full value.
Keep in mind – these are US dollar denominated bonds issued by the Republic of Argentina under New York law.
Remember the Libertad, that fun military frigate that was impounded in Ghana from October – December 2012? It was held because billionaire Paul Singer’s NML Capital, a subsidiary of the hedge fund Elliot Management Corp and vulture fund numero uno, obtained an injunction from a Ghanaian court based on the money owed on the defaulted bonds. Holdouts have been trying since 2001 to recoup the money owed, but Mr. Singer takes the cake on creativity with his efforts to seize planes, ships, and even money held by the US Federal Reserve. For more, read this article.
Pari Passu, or throwback to Kindergarten
On the less Bond film-esque side, NML Capital has been going after Argentina in New York on the grounds that paying holders of restructured debt while not paying holdouts violates the pari passu clause, dictating that all bondholders must be treated equally. For a detailed analysis, please read this. On October 26, a US Court of Appeals in New York upheld the ruling that Argentina was indeed in violation of pari passu and was legally obligated to pay holdouts.
But the real kicker was delivered on November 21 by Federal Judge Thomas Griesa, who ruled that Argentina must pay holdouts the full value (principal plus interest) if they were going to make payments on the restructured debt. Critically, Griesa specified that third parties would be in violation of the law by helping Argentina skirt this ruling, meaning banks and financial institutions.
Essentially Argentina was given the choice to pay US $1.3 billion to holdouts and vultures, or default on its restructured debt. Conundrum.
On November 27, Fitch downgraded Argentina from a B to CC.
On November 28, a temporary reprieve was granted in the form of a stay on Griesa’s ruling, putting the final decision off until an appeal to be heard on February 27, 2013. This allowed Argentina to make its December interest payments.
A Hot Mess
The ramifications of the upcoming ruling in February are exceptionally significant to investors, financial institutions, and emerging markets alike.
While the court case is NML Capital vs. Argentina, the court has permitted the additional parties listed below to present arguments in support of Argentina’s appeal. Each party will be represented by the listed legal heavyweight.
Whew. That was boring. Singer has the right idea, seizing ships in Ghana is way more entertaining.
In addition to this case, third party financial institutions and holders of restructured debt are appealing to New York courts (as opposed to the Federal level) that this issue should be decided in New York rather than the court system it is currently in.
So what is currently brewing is a perfect storm, or veritable orgy of great legal minds arguing a case with the potential to force Argentina into default again and change the financial landscape of New York.
Catch me next week when I’ll sift through the potential outcomes of this
economic stimulus package for the legal industry excellent use of time and money.