Argentina is in a quandary. Prior to its 2005
sovereign-debt exchange, its legislature enacted a “lock law,” which barred the
way to any future offers to holders of bonds on which Argentina defaulted in
2002. While the lock law helped to boost the participation rate in the 2005
exchange, holdout creditors remained, and have pursued
litigation to force
repayment.
In late November, Thomas Griesa, a United States
federal judge in New York, ordered Argentina to deposit the $1.33 billion owed
to holdouts into an escrow account by December 15. Griesa lifted the stay on
his order from February 2012, following indications from Argentina’s government
that it intended to ignore the ruling – including public statements calling the
holdouts “vulture funds” and a vow by President Cristina Fernández de Kirchner
never to pay. The ruling, pending appeal, leaves Argentina with three options:
violate its own law, violate US law, or default again.
In his ruling, which was based on the pari
passu (“equal footing”) clause included in the bonds, Griesa included
the Bank of New York Mellon (the bondholders’ trustee) among entities that act
“in active concert and participation” with Argentina, and cautioned it against
transferring funds if Argentina ignores the order. As a result, if Argentina
chooses to pay exchange bondholders as usual, BNY Mellon may refuse to transfer
the funds, triggering a technical default.
But time to search for loopholes is limited. While the
US Second Circuit Court of Appeals has granted Argentina an emergency stay
order, temporarily lifting the threat of default, Argentine officials will need
to present their arguments before the court in February.
The decision ensures normal debt payments by Argentina
in December. But, beyond that point, Argentina’s government may face a dilemma:
By continuing to make payments, it would be committing to comply with a ruling
that is widely viewed as excessive and unfair; but refusing to pay would
undermine the appeals process by exposing Argentina’s unwillingness to abide by
an adverse ruling. Indeed, the government’s harsh rhetoric has given it little
leeway. As in poker, it will have to pay to see the next card.
But Argentina does have options. While the required
escrow deposit is not an actual payment to holdouts, given that the guarantee
would be recovered if the appeals court ultimately ruled in Argentina’s favor,
it could be considered a contingent payment in violation of the lock law. The
government could easily avoid this by obtaining parliamentary agreement to
suspend the law temporarily, as it did in 2010, when a second sovereign-debt
exchange was conducted. Indeed, reopening the exchange, an option already being
assessed, remains a natural alternative to Griesa’s maximalist interpretation
of pari passu – though it may be too late to pursue this
route.
By contrast, refusing to comply with the ruling would
likely inhibit BNY Mellon from executing the payments, making it virtually
impossible to pay the warrant to exchange bondholders on time. But, even in
this case, a technical default – which would further reduce Argentina’s
already-limited access to international funds – could be avoided by re-routing
payments on the exchange bonds to the United Kingdom, elsewhere in Europe, or
Argentina (the most likely option). According to the bonds’ collective action
clause (CAC), this would not amount to a default if 75% of bondholders accepted
the change of venue.
To be sure, the bondholders might refuse, given that,
if they individually declared the exchange bonds to be in default, they could
demand in court immediate payment in full of the remaining debt. But they might
not if it meant that Argentina, unable to cover the accelerated payments, would
be forced to repudiate the debt – leaving the bondholders with nothing.
In the absence of a sovereign bankruptcy procedure, a
coordinated solution – which debt exchanges and CACs are designed to facilitate
– is the best option. But Griesa’s ruling undercuts prospects for cooperation.
After all, investors are more likely to reject a longer period of lower
payments on exchange bonds if they can seek immediate and full retribution for
the original debt.
Indeed, not even the risk of receiving nothing ensures
that bondholders will not revert to the old bonds. And, beyond the much debated
– and, in my view, overstated – aggregation problem, lowering the cost of
“holding out,” as Griesa’s ruling does, would impede the success of CACs.
Unless Argentina puts forward an alternative payment
proposal, the US Court of Appeals (and, possibly, the US Supreme Court) will
have to choose between the holdouts’ “all” and Argentina’s “nothing.”
Suspending the lock law and reopening the exchange could provide a basis for
revision of the case – and lead to a ruling that begins to fill the gaps in the
international financial architecture. At a time when new sovereign-debt
restructurings are distinct possibilities, such action is crucial.
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