Casting doubt on debt deals
After Argentina defaulted on its debt in 2001 in what was then the world’s biggest sovereign default, it gave its creditors an offer they could refuse: to swap their non-performing bonds for new government securities that were worth some 70 per cent less. Most creditors accepted the offer.
But some US bondholders, mainly hedge funds, declined. Instead they held out for full repayment that always seemed unlikely. For more than a decade the “holdouts” waged an unsuccessful legal battle to force the Argentine government to pay up. Until last month, when a US court found in their favour.
Thomas Griesa ruled that the terms of the Argentine debt required equal treatment for all bondholders. This meant those who had accepted the earlier debt restructuring should be treated equally with the holdouts – who should be repaid in full. Having gone broke three times in the last three decades, Argentina finds itself in a difficult position. A failure to pay both classes of bondholders means it risks a fourth debt default. Yet if it settles with those who rejected the restructuring, and does so on terms better than for those who accepted the original bond exchange, it could face litigation from the latter group. A stay on the court order is in place until February.
What happens to Argentine debt matters, not just because a further default would be a damaging blow to the world economy, given its fragile state. It is significant also because Judge Griesa’s decision creates some uncertainty about the restructuring of international sovereign debt. It raises questions whether the pari passu clause – the equal standing of creditors – such as applies to international organisations (like the International Monetary Fund and the World Bank) that have traditionally enjoyed preferential rights in any sovereign debt restructuring. Their senior creditor status has minimised the risk of financial loss in a debt default situation. Because the Argentine debt was issued under US legislation, it is subject to the US courts. In addition, Argentina failed to include a collective action clause provision in the original bonds. This allows a supermajority of bondholders to agree to a debt restructuring that is legally binding on all holders of the bond. The law is not on Argentina’s side.
Brazil’s central bank governor Alexandre Tombini has said the US court decision sets a bad precedent by rewarding holdout creditors, and claims it could hit euro- zone countries facing their own sovereign debt crises. However, much of the recent sovereign debt issuance in Europe has included collective action clauses and from January all new euro-area government securities issued will include that provision. Unlike Argentina, that will allow no scope for minority creditors to block a necessary debt restructuring.