Argentina vs. the Hedge Funds: The 2014 Argentinian Bond Default

Argentinian Bond Default
Paul Singer and President Kirshner

By Andreas Kanaris Miyashiro

On July 31st 2014, Argentina automatically defaulted on $29 billion of debt following a lengthy court case in which hedge fund bondholders sued the Argentinian government. The President of Argentina at the time, Cristina Fernandez de Kirchner, argued bondholders involved in the lawsuit were predatory and exploitative. The plaintiff hedge funds argued they only aimed to uphold the ‘rule of law’. Which party was to blame for the Argentinian bond default?

Causes of the 2014 Argentinian Bond Default 

Argentinian Economic Policy in the 1990s

The root causes of Argentina’s 2014 default can be traced back to the devastating financial crisis Argentina experienced in 2001, and the Argentinian government’s long history of economic mismanagement. Argentina’s debilitating default in 2001 was precipitated by a number of damaging policies enacted by various administrations. Raul Alfonsin, president of Argentina between 1983 and 1989 presided over a closed economy. Financing the treasury’s deficit using the Banco Central de la Republica Argentina (BCRA) caused hyperinflation. Yearly inflation under Alfonsin was on average 3611 percent.

Alfonsin’s successor, Carlos Saul Menem, was forced to implement institutional reforms, including opening the economy to international trade (in relative terms), privatising national companies, and creating a currency board (the ‘convertabilidad’) which pegged the Argentinian Peso (ARS) to the US Dollar (USD). Menem’s reforms were beneficial. The currency peg, in particular, is widely recognised as having brought inflation under control. Yet Menem failed to reduce Argentina’s structural deficit, which would become the fundamental cause of the 2001 default. Argentina experienced strong GDP growth of 49.1 percent between 1991 and 2000. Yet public spending and public debt increased at an even faster rate over the same period, by 90.76% and 91.60% respectively. Fernando de la Rua replaced Menem as president in 1999, and aggravated an ongoing recession by implementing large tax increases residents could not afford. The deficit became unmanageable as a result of the government’s inability to generate sufficient revenue.

The 2001 Financial Crisis

In the final months of 2001, Argentines and Argentinian companies began rapidly withdrawing pesos and converting them into dollars. This action was prompted by the risk of a financial crisis and the possibility that convertibility policy would end which would trigger a dramatic depreciation of the peso. While the BCRA had enough dollar reserves to back every peso in circulation, it did not have sufficient reserves to match all bank deposits. As such, the Minister of Economy, Domingo Cavallo, announced a freeze on bank deposits on the 1st of December 2001, popularly referred to as the ‘Corralito’. The convertibility policy became meaningless in effect, as deposit holders could no longer access their savings. Public demonstrations and unrest followed. On December 5th, the IMF announced it would cut off its support, the Argentine government having failed to meet conditions tied to a ‘rescue’ program agreed to in September 2001. With this announcement, Argentina lost its last access to foreign capital. Protests and looting followed this revelation, leading to the deaths of 24 civilians. President De la Rua resigned shortly after these events.

His successor, Rodrigo Saa, announced Argentina would default on 93 Billion USD of sovereign debt on December 23rd, 2001. The debt was in the form of bonds under NY legal jursidiction. Political chaos ensued, with four different presidents successively attempting to hold on to power in December of 2001, after the resignation of President Saa. In January 6th of 2001, the implementation of the Law of Public Emergency and Reform of the Exchange Rate Regime ended Menem’s Convertibility Policy, leading eventually to the ARS becoming fully floating and depreciating in value dramatically. The 2001 crisis erased years of economic progress in Argentina. Argentina’s GDP in absolute terms by 2002 was only slightly higher than it had been 20 years earlier. The proportion of Argentines living below the national poverty line rose dramatically from a peak of 25.9% in 1998 to 57.5% in 2002, fuelled by an increase in unemployment from a peak of 14.8% to a peak of 22.5% during the same period. 

The Debt Restructuring Process 

In May 2003, amidst a slowly recovering economy, Nestor Kirchner took office, promising a change from the neoliberal economic policies of the 1990s. He distanced himself from institutions such as the IMF. Yet in 2005, Nestor Kirchner set out to restructure the debt that had been defaulted on in 2001, hoping to regain full access to foreign capital. This initial restructuring deal offered bondholders an opportunity to swap their bonds for new ones with a value of about 30 cents per USD in comparison with the original. The Argentinian government suggested the macroeconomic conditions of Argentina necessitated such a significant reduction in the value of the bonds. Argentina also issued a GDP warrant or ‘GDP kicker’ which amounted to a promise that if Argentina’s GDP performed better than it was projected to, bondholders would receive an extra payment, though the payment was capped at a certain amount. This initial debt restructuring proved difficult to sell to bondholders, only 75% agreed to the terms (one of the lowest percentages in debt restructuring history).

Consequently, the Argentine government offered a second debt restructuring deal in 2010, with improved terms. 93% of bondholders accepted the new deal (the ‘holdins’) while 7% (the ‘holdouts’) refused to agree to the new terms. Since 2001, Argentina only made interest payments to the ‘holdins’ while refusing to pay the ‘holdouts’ who refused the restructuring deals. In 2005, after the first round of restructuring, Argentina’s congress passed law 26,017 (nicknamed the ‘lock law’) which prevented the government from settling in court or out of court with holdout creditors. The law was suspended during the second round of debt restructuring in 2010, but reinstated subsequently.

The Pari Passu Lawsuit and the 2014 Default

A group of hedge fund investors, led by Aurelius Capital Management LP, and Elliot Management Corp.’s NML Capital Ltd. sued the Argentinian government on the basis of violating the pari passu clause included in the bond agreements. A pari passu clause indicates that bondholders must be treated equally. These hedge funds were ‘holdouts’ and were not paid interest by the Argentinian government. They argued this unequal treatment constituted a breach of pari passu.

Judge Griesa of the South District Court of New York made several rulings in favour of the holdout creditors. Griesa’s reasoning proved controversial and the correctness of his ruling has been a matter of academic debate. Some commentators suggest Griesa’s ruling unfairly forced Argentina into a default, and that he did not take into account the deleterious effects of his ruling. However, though Griesa’s ruling proved damaging to Argentina, his reasoning had a basis in the terms of the bond agreements.

The specific wording of the 1994 Argentine Fiscal Agency Agreement (FAA), which governed the bond agreements was at the heart of Griesa’s rulings. A traditional pari passu clause consists of one sentence, and is typically interpreted as only covering a credit ranking obligation which protects the legal ranking of the credit. The pari passu clause in Argentina’s 1994 FAA, in contrast, consists of two sentences. The second sentence guarantees that ‘The payment obligations of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness’. In 2011 and 2012 respectively, Judge Griesa and the Second Circuit Court of Appeals ruled that this element of the clause covered a payment ranking obligation (Spencer, 2014). In effect, this ruling stated that the Argentinian government had breached pari passu by paying some creditors (the holdins) while refusing to pay others (the holdouts). The ‘lock law’ passed in 2005 in particular was referenced as evidence that the Argentinian government had been willing to pay some bondholders, but not others. Furthermore, the ruling confirmed the holdouts had a right to refuse the Argentinian government’s restructuring offers given that a collective action clause was not included in the 1994 FAA. A collective action clause (CAC) states that if a certain number of creditors (usually a majority or supermajority) accept a debt restructuring agreement, that holdouts must also join the debt swap agreement. In sum, the particular terms of the FAA, which governed the bond agreements supported Judge Griesa’s decision.

As a remedy to the violation of pari passu, Judge Griesa ordered in 2012 that the holdouts should be paid no later than the date of the next installment of payments to the holdins. Argentina unsuccessfully appealed the decision multiple times, and even took the case to the Supreme Court in 2014 (which refused to hear it). Judge Griesa’s ruling stood. During the appeals process, Judge Griesa issued a stay of his remedy order, which was lifted once all avenues for Argentina to appeal were exhausted.

Despite Griesa’s order, the Argentinian government attempted to pay the holdins, while continuing to refuse payment to the holdouts. Argentina deposited $539 million in the Bank of New York Mellon (BONY), the designated depository for the bond payments. Due to Griesa’s order, the bank was legally unable to transfer these payments to the holdins, as the deposits for holdouts had not been made. The Argentinian government’s attempt to pay the holdin creditors triggered a 30 day grace period, after which they would enter default. The Argentinian government opened a fund at the Banco de la Nación Argentina, and invited holdin creditors to open accounts in which they would be paid interest payments. This attempt to avoid utilising BONY to pay creditors was unsuccessful, and resulted in Argentina being declared in contempt of court. Having failed to come to an agreement with the holdouts, Argentina automatically defaulted on July 31, 2014 on $29 billion of debt.

Resolution of the Debt

Following the 2014 default, the group of holdout bondholders and the Argentinian government refused to negotiate with each other. The situation shifted, however, due to the result of the Presidential election in October 2015. The opposition leader, Mauricio Macri of the centre-right Republican Proposal party, defeated Cristina Fernandez de Kirchner’s chosen successor, Daniel Scioli by a narrow margin. Macri’s inauguration, in November of 2015, promised an end to the Kirchner-Kirchner administration’s populist economic policies. Macri promised to remove the protectionist policies and unsustainable subsidies introduced by Nestor and C. F. Kirchner, and to allow Argentina to regain access to international credit markets.

As such, Macri endeavoured to come to an agreement with the holdouts after his inauguration. The Argentinian government’s hand was strengthened by two factors. Firstly, the ‘Rights Upon Future Offers’ (RUFO) clause in the FAA governing the Argentinian bonds had expired subsequent to the default in 2014. According to the the Kirchner administration, the existence of this RUFO cause had precluded the possibility of offering the holdouts a higher payment than that which holdins had agreed to, as the RUFO clause guaranteed that any improved offer extended to holdouts be extended to holdins (though the correct interpretation of the RUFO clause is a matter of debate, as discussed later). Secondly, Judge Griesa, hoping to encourage a swift resolution of the dispute, threatened to lift his injunction, which had prevented the Argentinian government from making payments to holdins. Had the injunction been lifted, there would no longer be an incentive for the Argentinian government to pay the holdouts.

In March 2016, a settlement was finally achieved. Argentina agreed to a $4.65 billion cash payment to its main holdout creditors. A second settlement was reached in November of 2016 to pay a further $475 million to remaining holdout creditors. This amounted to 75 percent of the total outstanding payment including principal and interest. It is difficult to determine what return each holdout hedge fund made in this settlement, given that the price at which the hedge funds bought the distressed bonds on the secondary market was never disclosed. There is little doubt that holdout creditors turned a considerable profit, however. The Wall Street Journal estimates Elliot Management corp., one of the lead holdout hedge funds in the debt dispute, received between 10 and 15 times of the firm’s original investment in the bonds.

Players in the 2014 Default and Analysis

The ‘Vulture Funds

While financial mismanagement on the part of the Argentinian government may have had a role in precipitating the 2014 debt crisis, there is little doubt the party mainly responsible was the holdout bondholder group. These holdouts consisted of a group of hedge funds, led by Aurelius Capital Management LP, and Elliot Management Corp.’s NML Capital Ltd. Hedge funds such as these are often referred to as ‘vulture funds’ on the basis of their business practices. The business model of vulture funds involves buying distressed debt in the form of defaulted or soon-to-default bonds, then using legal expertise to extract the maximum possible return through the debt restructuring process. The bonds which vulture funds purchase are not restricted to those issued by corporations. Often the bonds comprise sovereign debt, as was the case in the Argentinian debt dispute. Vulture funds purchase the sovereign debt of states in financial difficulties at significantly discounted prices on the secondary bond market, then seek to enforce the full amount of debt against the state in question. Usually, this involves ‘holding out’ on debt restructuring offers, and suing the state in hopes of reclaiming the full value of the bonds.

Paul Singer, the head of Elliot Management Corp., is known as one of the pioneers of the ‘vulture fund’ investment model. Singer and the heads of other ‘vulture’ funds such as Mark Brodsky, a former employee of Singer who heads Aurelius Capital, have a clearly defined business model. Their purchase of distressed Argentinian bonds was not a one-off, but rather their latest attempt to repeat a proven lucrative strategy.

During the 1990s, Paul Singer oversaw Elliot Management’s purchase of $30 million of Congolese debt through the Kensington International division of the hedge fund, at a considerably discounted price. The firm spent several years trying to recoup the bond’s original returns by suing state-owned companies of the Republic of Congo, and succeeded in winning $100 million in a UK High Court decision. In 1996, Elliot Management bought Peruvian debt, which had already been defaulted on for $11.4 million. Elliot Management successfully sued the Peruvian government for $58 million in 2000 on the basis that they had breached the pari passu clause of the bond agreements.

Ethics Analysis of Hedge Fund Acts

The behaviour of Elliot management, Aurelius Capital, and other plaintiffs in the Argentinian debt lawsuit is ethically questionable for a number of reasons.

Paul Singer and Elliot management, as well as other hedge funds involved in the debt dispute demonstrated a clear willingness to cause harm in search of large profits. Their investment model explicitly targets distressed debts of developing countries, and aims to interfere in the debt restructuring process. In the Argentinian debt dispute, these hedge funds constituted only 7 percent of bondholders, yet they refused to accept ‘haircut’ bond restructuring offers and entered a lawsuit derailing the bond restructuring process for every bondholder. Accepting a lower return than the original value of the bonds would hardly have damaged the bond holding hedge funds, given they bought the bonds at a heavily discounted price in the secondary market. Nonetheless, they triggered a process that led to Argentina having little choice but to default. Argentina’s default in 2001 was devastating. Protests and riots in response to the default and the freeze on bank deposits caused the deaths of 24 civilians. Default caused an economic collapse, which was devastating to the most vulnerable and poorest segments of Argentinian society. As previously mentioned, the proportion of Argentines living below the national poverty line rose dramatically from a peak of 25.9% in 1998 to 57.5% in 2002. The 2014 default proved far less destructive than the 2001 default, yet it still damaged an Argentinian economy suffering from contraction, high inflation, and dwindling foreign reserves in the BCRA.

The Hedge Fund Response

Mark Brodsky, head of Aurelius Capital, defended his fund’s business practices, arguing they serve to reinforce the ‘rule of law’ and enforce justice. Brodsky has repeatedly suggested that in a sense, the practices of vulture funds keep the ‘corrupt’ political leaders of developing countries in check.

Refuting the Hedge Fund Response

Brodsky’s argument is disingenuous and refutable. Default is a relatively common occurrence for sovereign governments, particularly those of developing countries. The risk of default is a risk investors take into account. Consequently, developing countries pay risk premiums far above safe assets such as U.S. treasury bonds. Owning the sovereign debt of developing countries therefore is lucrative even in the short term, but risky. As Joseph E. Stiglitz, a Nobel Laureate in economics, points out, the vulture funds’ insistence that Argentina pay the face value of the bonds plus past interest is problematic given these facts. The past interest of the Argentinian bonds included country-risk premiums to offset the probability of default. Griesa’s ruling suggests that in the case of the Argentinian debt, there was no default risk to be compensated, as the country was always obligated to pay its debt in full.

Furthermore, restructuring of debt subsequent to default is standard practice. Debt restructuring might be thought of as a process in which debtors and creditors cooperate for their mutual benefit. Creditors get something rather than nothing, even if it is a ‘haircut’ of the original value of the bonds. The debtor countries, meanwhile, hope to regain access to foreign credit in the future. Debt restructuring is a process essential to dealing with crises in the international financial system. Rather than enforcing the ‘rule of law’, vulture funds’ practices subvert normal practices that govern sovereign debt. Stiglitz suggests Judge Griesa’s decision, and the position of the vulture funds ‘defies a basic tenet of modern capitalism: insolvent debtors need a fresh start.’

This idea of a fresh start is reflected in the United Nations Conference on Trade and Development (UNCTAD) Principles on Promoting Responsible Sovereign Lending and Borrowing, adopted in 2012 following a resolution by the UN General Assembly. The Principles suggest that creditors and sovereign debtors share responsibility for preventing unsustainable debt situations. Principle 7 is in particular applicable to the Argentinian debt dispute. It states when a sovereign debtor is clearly unable to service its debts, creditors should act in a cooperative manner that promotes the adoption of a swift resolution to the problem. Clearly, on the basis of this principle, the behaviour of vulture funds is abusive, as they deliberately obstruct the debt restructuring process. In 2014, the UN general assembly resolved to establish a stronger ‘Multilateral Legal Framework for Sovereign Restructuring Processes’. This set of rules, which expanded on the principles laid out by the UNCTAD, was adopted on 10 September, 2015. Unfortunately, since principles established by the UNCTAD and the UN general assembly are non-binding ‘soft’ laws (unlike those established by the UN Security Council), the abusive nature of vulture funds’ behaviour could not have been used as an argument by the Argentinian government to prevent the NY court decision. UN General Assembly resolutions merely command a ‘political weight’. Given Puerto Rico’s recent debt dispute with vulture funds there seems little hope new UN rules will have a significant mitigating effect in practice.

In sum, there is widespread consensus that the conduct of vulture funds is predatory, in the case of the Argentinian debt dispute and beyond. The business practices of vulture funds obstruct the ability of governments and creditors to resolve debt crises to create the best possible outcomes. In doing so, they risk causing severe economic harm which has a human cost.

Ethics Analysis of Argentinian Government Acts

Cristina Fernández de Kirchner referred to the holdouts as ‘vultures’, and painted them as enemies of the ‘motherland’ who threatened Argentina’s welfare for profit. The holdouts’ behaviour was no doubt predatory. However, Kirchner’s own policies, and those of her husband and predecessor, Nestor Kirchner also need to be subject to ethical appraisal. The economic policies which N. and C.F. Kirchner cultivated is highly relevant to the bond dispute because the debt restructuring deals created in 2005 and 2010 (in which bondholders were asked to accept very small returns on their investments) were justified on the basis of Argentina’s fragile macroeconomic position. Furthermore, some commentators and academics suggest the decision to default taken by C.F. Kirchner was a political decision rather than a necessary one given the country’s negotiating position. If it was the case the Kirchner-Kirchner administration handled the Argentinian economy irresponsibly, prioritising their own popularity over the welfare of Argentinian citizens, then this significantly weakens their claim that the ‘vulture’ hedge funds were the only culpable party in the crisis.

Argentinian Economic Policy under the Kirchner-Kirchner Administration

At first glance, it might appear that Nestor Kirchner presided over the Argentinian economy in a markedly more effective manner than his predecessors. Between 2003, the year which marked the beginning of N. Kirchner’s term, and 2007, GDP grew between 8 and 9% annually, the official exchange rate stayed below 3.36 ARS per USD, and the official inflation rate remained between 4% and 12%. These statistics suggest the economy experienced rapid and strong recovery.

Economic Populism

However, these signs of growth obscured economic imbalances, which became increasingly damaging during C.F. Kirchner’s term beginning in 2007. The Kirchner-Kirchner administration’s economic outcomes proved broadly in line with Dornbusch and Edward’s four stages of economic populism, modelled on the populist policies and outcomes of various Latin American regimes. In Dornbusch and Edward’s model, an initial stage of seemingly sustainable economic growth characterised by an increase in output, and high real wages and employment is succeeded by a second stage of economic deceleration, a third stage characterised by shortages and inflation, and a fourth stage in which the populist policies are inevitably revealed to be a failure. In sum, the Kirchner-Kirchner administration’s economic policies were designed in a way that prioritised short-term outcomes. The policies benefited the administration’s electoral ambitions, but had deleterious effects in the long-term.

The Kirchner-Kirchner administration’s fiscal policy failed to solve Argentina’s structural deficit problem. Despite explicit and implicit tax increases, many implemented without Congressional approval using the ‘Economic Emergency Law’, Nestor and C.F. Kirchner continued to drive up the fiscal deficit by increasing government spending. There was a 26% yearly nominal growth rate in government spending between 2003 and 2014, or 5.2% in real terms. While official statistics showed an improvement in debt to GDP ratio during the Kirchner-Kirchner tenure, these figures were obfuscated because debts owed to holdout bondholders was removed from official records. Increasing fiscal deficits in this manner was particularly ill-advised in light of Argentina’s limited access to international credit markets following the default in 2001. For a short time, the Kirchner-Kirchner administration opted to finance its debt through its main domestic creditor, the BCRA, as well as through political allies of President of Venezuela Hugo Chavez in lieu of foreign creditors. Considering Argentina’s history of defaulting on its debts, and the devastating effects of the 2001 crisis, the Kirchner-Kirchner administration’s failure to reign in the fiscal deficit was irresponsible.

Price Controls

Both Nestor and C.F. Kirchner also implemented damaging price controls, which distorted relative prices, particularly in the utilities sector. Following the massive loss of wealth in 2001, Nestor Kircher refused to update the price of utilities in line with inflation. Price controls for energy, for example, drove the prices of domestic oil, natural gas, and electricity prices lower than international prices and in some cases below production costs, deterring investment in the sector. UBS economist Jared Kulesz described Argentina’s energy policy under C.F. Kirchner as ‘energy consumption- promoting / production-discouraging’. Consequently, Argentina went from being a net exporter of energy to a net importer. The need to import energy would become an increasing burden over time, particularly following the 2014 default.

The Kirchner-Kirchner administration also utilised price controls to engage in hapless attempts to reduce inflation. In 2005, Nestor Kirchner implemented controversial price freeze agreements with business leaders, which he renewed in 2006 to ensure stable prices for upcoming presidential elections for October 2007 in which his spouse Cristina Fernandez would run. As economists such as Edmund Phelps, a Nobel prize winner, point out, price controls are a short term solution to inflation with damaging repercussions in the long term, including negative effects on investment, and misallocation of resources. Worse, N. Kirchner’s price controls were carried out in a spontaneous manner. Roberto Lavagna, Argentina’s former economy minister ousted in November 2005, claimed that Guillermo Moreno, who oversaw price controls on behalf of N. Kirchner, had no ‘fixed rules’ in implementing price controls: ‘They simply call you up on the telephone. Businesses get calls at 6am asking them to lower the prices of their sausages.’ The Kirchner-Kirchner administrations attempts to manipulate the economy were reflected in changes in The Economic Freedom of the World Index (Fraser Institute). Argentina’s ranking in economic freedom fell from 32nd (out of 153 countries) in 2000, to 149 (out of 152) in 2012.

Interfering with CPI Measurement

In the absence of an effective strategy to control inflation, and as macroeconomic imbalances began to emerge in 2007, the Argentine government opted to interfere with the CPI (consumer price index) to obscure true rates of inflation. Clearly, the motivation for such interference was the upcoming October 2007 election. Currency devaluations are extremely damaging to incumbent leaders, greatly increasing the likelihood they will lose their positions (Frankel, 2005). In 2007, inflation in Argentina was recorded officially at 8.5%, but was shown as 25.7% by private estimates and other official measures (such as those calculated by Argentinian provinces). Post-2007, the Kirchner administration also seems to have interfered with official GDP estimates. Coremberg (2014) finds that by 2012, the official government GDP figure is overestimated by 12.2%. In February 2013, following a warning in 2011, the IMF ‘censured’ Argentina due to the country’s failure to provide accurate GDP and CPI data.

Capital Controls

The Kirchner-Kirchner administration also presided over a damaging loss of BCRA foreign reserves. It is common that Argentinians react to inflation by buying US dollars, which are less inflation-prone. In 2011, C.F. Kirchner introduced capitol controls, designed to protect the government’s stock of foreign reserves. These set of controls, nicknamed, ’El cepo’ (or ‘the clamp’) required individuals to ask permission of the tax agency (AFIP) to buy USD. The AFIP then would decide how many USD, if any, the individual in question would be able to buy based on the income reported in their tax statement. The capital controls backfired. A parallel foreign-exchange market was created in which pesos were sold at a lower ‘blue-dollar’ rate instead of through official channels using the official exchange rate. Even worse, investors abroad became less willing to invest in Argentina due to the risk of repatriating their funds. The main problem became not the amount of USD leaving the country, but the lack of incoming USD supplied by foreign investors. The result was the BCRA losing more reserves with the capitol controls in place than in the devastating 2001 crisis. The loss of BCRA foreign reserves was particularly problematic given that Kirchner planned to use a portion of the reserves to pay ‘hold-in’ creditors.

In sum, Nestor and C.F. Kirchner economic policies were explicitly populist. Populism is most precisely defined as a ‘thin-centered ideology that considers society to be ultimately separated into two homogeneous and antagonistic groups, “the pure people” and “the corrupt elite”, and which argues that politics should be an expression of the volonté general (general will) of the people’ (Cas Mudde, 2004). Populism is not in itself unethical. However, Nestor and C.F. Kirchner prioritised their populist brand, which had proven successful in winning a coalition of voters (predominantly the Argentinian ‘underclass’) over managing the economy effectively.

Was Default Necessary?

It is a matter of academic debate whether Judge Griesa’s decision necessitated default. Some academics and commentators suggest the decision to default by C.F. Kirchner was a political one, as bowing to the demands of holdouts would prove deeply unpopular, particularly among Kirchner’s base of support.

In theory, the Argentinian government could have exercised the option of paying the holdouts, who were due $832 million in overdue capital and interest payments. This amount could have been paid using the BCRA’s foreign reserves, though this option may have been untenable as a result of the drain in foreign reserves experienced by the BCRA during C.F. Kirchner’s term in office. Alternatively, government revenue could be used to pay the holdouts. $832 million was equivalent to 0.9% of yearly tax revenues using the official exchange rate. This amount could feasibly be raised by the Argentinian government using the 2001 Economic Emergency Law, which provided a means whereby the Argentine president could implement economic laws without congressional approval. This law had been exercised on several occasions by Nestor and C.F. Kirchner.

The Argentinian government claimed that paying the holdouts in order to avoid default was untenable, as it would trigger the Rights Upon Future Offer (RUFO) clause included in the 1994 FAA. The RUFO clause guarantees that if Argentina voluntarily makes an offer to holdout creditors better than restructuring offers accepted by holdins, this offer would be automatically extended to holdin creditors. According to the Argentinian government, if the holdout creditors were paid in full, this would trigger the RUFO clause and allow holdin creditors to claim the original bond amount. This amount of debt would, of course, be too much for the Argentinian government to afford.

However, it is not entirely clear that paying a cash deposit to the holdouts in compliance with Judge Griesa’s ruling would trigger the RUFO clause. The specific wording of the RUFO clause included in the 1994 FAA suggests it would be triggered only if the Argentinian government were to voluntarily offer a new agreement to the holdouts. A cash deposit to the holdouts mandated by the courts arguably might not constitute a voluntary offer of a new bond agreement, so the RUFO clause might not be triggered by such an action. This is a point of scholarly debate, and given that a typical RUFO clause would have the effect of triggering a full payment of all bondholders, the Argentinian government’s reluctance to pay the holdouts in full seems justified.

The Role of the US Executive Branch

Scholars have noted that President Obama had the power to intervene in the Argentinian debt dispute. Under the ‘comity’ principle enshrined in the US constitution, Obama, as head of the executive branch, could have prevented the dispute from continuing by informing Judge Griesa that the lawsuit brought by the holdouts was interfering with his sole authority to conduct foreign policy. If Obama had chosen to take this course of action, the lawsuit would have ended, and Argentina would have avoided default. The principle of ‘comity’ was utilised by George W. Bush, who blocked Paul Singer’s seizure of Congo-Brazzaville’s US property during Elliot Management’s debt dispute with the Democratic Republic of Congo.

The Obama administration voiced sympathy for Argentina’s position in the debt dispute. Obama’s treasury deputy, Steven Rattner, described the vulture fund’s actions as ‘extortion’. Nevertheless, Obama failed to act. A number of factors may have led him to make this decision. One possible factor is Paul Singer’s standing as a powerful Republican Party donor; Obama may have been concerned that Singer would retaliate by attempting to block the Democratic policy agenda using his influence. The decision to intervene in the debt dispute might also have been difficult to sell to the public, and would require considerable political capital. Whatever the reason for his lack of action, President Obama should be recognised as being to some degree culpable for the Argentinian default.

Conclusion and Policy Recommendations

The Argentinian default in 2014 brings into sharp focus the need for policy reforms to prevent predatory behaviour of vulture funds, and ensure debt restructuring deals occur swiftly. Unfortunately, instituting reforms on sovereign debt restructuring is fraught with difficulties.

Collective Action Clauses

Studying Argentina’s debt dispute, it might seem that a simple solution would be for countries issuing debt to ensure the fiscal agency agreements (FAA) they issue governing bond agreements include collective action clauses (CACs). CACs state that if a majority or supermajority of creditors accept a debt restructuring deal, then all creditors must do so. As Griesa’s ruling illustrated, the inclusion of a CAC in the Argentinian FAA would have prevented hedge funds from holding out on debt restructuring.

However, the possible inclusion of CACs in bond agreements creates difficulties for both debtors and creditors. Creditors may only accept the inclusion of CACs if the supermajority required to force through a debt restructuring deal is a very high percentage. If debtor countries accept this provision, it might make the CACs all but useless. If a debt restructuring dispute occurs, the percentage of creditors holding out on debt restructuring might prevent such a supermajority from being achieved. Meanwhile, debtor countries may be hesitant to include CACs in bond agreements considering this might incur a higher cost of credit. There is some evidence to suggest the inclusion of CACs in bond contracts only has minor impacts on borrowing costs. However, there is a general consensus that countries which adopt CACs for the first time are signalling an increased probability of default, which would result in higher debt costs.

Another difficulty with the inclusion of CACs in debt agreements, as Anne Krueger, former deputy managing director of the IMF notes, is that CACs will not work across different credit instruments. Even if the same CAC were inserted in every sovereign bond, other types of major debt, which also need to be subject of restructuring, such as syndicated bank debt or trade credit, would not be subject to CACs. Even if only the issue of bonds is considered, the complexity of creating and exercising CACs is staggering. Argentina issued about 152 classes of bonds governed by the laws of eight different jurisdictions. If CACs had been included in these bond agreements, a consensus would have to be reached on each of the bond issues this entailed separately. Hal S. Scott, Nomura Professor of International Financial Systems at Harvard Law School concludes that in relation to the issue of sovereign debt restructuring, ’a common set of procedures can only be provided by statutory or common (judge-made) law; contract will not work’.

International Agreements

The UN’s establishment of a ‘Multilateral Legal Framework for Sovereign Restructuring Processes’ is an important step forward in creating international guidelines for solving sovereign debt disputes. However, the fact that these rules are non-binding in practice means there is little hope they will deter the unethical practices of vulture funds.

A more promising proposal was the Sovereign Debt Restructuring Mechanism (SDRM) introduced by the IMF in 2002. The SDRM, had it been adopted, would have constituted an amendment to the IMF’s articles of agreement. Since membership of the IMF is nearly universal, and is also contingent on accordance with the articles of agreement, the SDRM might have had far more practical efficacy than the UN’s rules.

The SDRM would have provided a universal platform to negotiate debt restructuring including the following provisions:

  • Mandatory rules on supermajority voting among creditors (in essence establishing the same rules of voting as a CAC)
  • Mandatory stay of litigation each time a debt restructuring process is triggered
  • stop-gap funding designed to ensure that national governments of debtor countries continued to be able to function fully during debt negotiations.

All IMF members would be obligated to institute these rules in the form of national legislation.

In sum, the SDRM proposed by the IMF would have provided powerful mechanisms to streamline debt restructuring processes. However, the proposal never was implemented, due to a lack of political will from member countries. The US, notably, was opposed to the measure.

National Laws

Though international agreements are the ideal mechanism to prevent cases similar to the 2014 crisis in Argentina, national laws can lead to incremental progress. In the absence of an effective international agreement, countries which commonly have jurisdiction over sovereign debt should establish laws that prevent the standard operating procedures of vulture funds.

The UK was the first country to attempt this. In May of 2010, the UK Parliament passed into law the ‘Debt Relief (Developing Countries) Act’, which was made permanent in April 2011. The law prevents companies from taking sovereign nations to UK court if the companies intend to enforce payment on sovereign debt in excess of what has already been agreed upon by other creditors. Unfortunately, the law is only applicable to countries which are eligible for the ‘Heavily Indebted Poor Countries Initiative’ (HIPC), a program established in 1996 by The World Bank, the International Monetary Fund (IMF) and other multilateral, bilateral and commercial creditors whose missions are to provide debt relief to poor countries with unmanageable or unsustainable debt burdens. As Renaud Vivien of the Committee for the Abolition of Illegitimate Debt pointed out, speaking at a UNCTAD panel, vulture funds increasingly and cunningly target countries ineligible for the HIPC program. Even relatively wealthy countries are potential targets of vulture funds.

In light of this, Belgium’s ‘Anti-Vulture Funds Law’ passed in July 2015 is a better model for future legislation that wish to stymie the operation of vulture funds. The law prevents companies from bringing sovereign countries to Belgian court if the companies have sought to gain an ‘illegitimate advantage’ over debtors.

‘Illegitimate advantage’ exists when two conditions are met. The first is that ‘the fund (or any other person) has purchased the State debt at a price manifestly disproportionate with either its face value or the amount that it seeks to be repaid’. The second condition is when one of a number of ‘special circumstances’ is present, including the following:

  • The State was in (or very close to) a situation of cessation of payments when the debt was purchased
  • The fund is incorporated in a blacklisted tax haven jurisdiction
  • The fund systematically initiates court proceedings to obtain payment
  • The State did restructure its debt but the fund refused to participate in the restructuring
  • The fund abused the weaknesses of the State
  • The full repayment of the claimed amount would have a clear adverse impact on the budget of the State and would be likely to compromise the socio-economic development of its population

In contrast to the UK Debt Relief Act, the Belgian Anti-Vulture Funds Law has a wide scope sufficient to prevent the predatory behaviour of vulture funds. The Anti-Vulture Funds Law in itself is likely to have very limited impact, as Belgian courts rarely have jurisdiction over sovereign debt disputes. Nonetheless, the law is a model for how developed countries could prevent vulture funds from utilising their court systems in search of profits. Developed countries, most notably the US (which has jurisdiction over the largest amount of sovereign debt of any country), should follow Belgium’s example.




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