Argentina’s Default, Vulture Funds and Sovereign Debt Restructuring

Oscar Ugarteche and Ariel Noyola Rodríguez | Guest Blog | September 23, 2014

On September 9, 2014, the United Nations General Assembly passed a resolution to create a new multilateral legal framework for sovereign debt restructuring processes. The resolution, drafted by Bolivia on behalf of the Group of 77 (consisting of 133 member-countries) plus China, was approved with 124 votes in its favour. There were 41 abstentions and only 11 members (including the US, the UK, Japan, Canada and Israel) voted against it. The resolution notes that “sovereign debt crises are a recurring problem that involves very serious political, economic and social consequences, and that the restructuring processes of sovereign debt are a frequent phenomenon in the international financial system.”

Although the UN General Assembly resolutions are not binding but it can pave the way for building a new framework since the existing international financial system doesn’t have “a sound legal framework for the orderly and predictable restructuring of sovereign debt.”

The resolution further states that the sovereign right of any country to restructure its debt “should not be frustrated or impeded by any measure emanating from another state” or “by commercial creditors, including specialized investor funds such as hedge funds, which seek to undertake speculative purchases of its distressed debt at deeply discounted rates on secondary markets in order to pursue full payment via litigation.”

The international media has widely reported on the ongoing conflict between NML Capital (a hedge fund) and Argentina. This conflict has highlighted the current ad-hoc procedure and fragmented legal framework to deal with debt workouts.

The creation of a rule-based multilateral framework will immensely help countries like Argentina to restructure their sovereign debts and avoid the onslaught from vulture funds which are seeking huge profits on debt they bought at rock bottom prices when the countries are in the crisis.

The vulture funds constitute the most aggressive sector of global finance capital. They have put various sovereign governments (Republic of Congo, Panama, Peru and Argentina) up against the wall. Their modus operandi consists of demanding repayment in full with interest on debt bought at great discounts during the crisis. In the case of Argentina, nearly 92 percent creditors accepted the terms of debt proposed by the government after the financial crisis of 2001. Nevertheless, 0.45 percent of the remaining 7 percent creditors that did not come to an agreement (holdouts) bought bonds for some $40 million and are now seeking to cash in at over $1.3 billion.

The experiences of Congo, Panama, Peru and now Argentina make evident that the vulture funds purchase the sovereign debt paper when the debtor country has finalized its debt conversion scheme and is rearranging all payments. They purchase debt instruments at a fraction of the previous value that are held out from the debt workout just when the final arrangements are being worked out and they do not inform the local authorities about their purchase. Such entities then sue the debtor country for 100 percent of face value plus interest, commissions and penalties. In the case of Argentina, the rate of return is over 1600 percent. In the case of Peru, the return was quadruple digit as it involved back interest payments from 1983 to 2000 plus penalties.

At the end of June 2014, a New York’s Second District Judge Thomas Griesa ruled in favour of NML Capital and against the Republic of Argentina. The issue at stake was whether a hedge fund that bought debt papers three years after restructuring has the right to claim same terms as the rest of creditors. The NML Capital argued that the “pari passu” clause provided under the bonds requires Argentina to make payments to it if any payment is made under the exchange bonds.

The court has forbidden Argentina to pay interest on its restructured debt to other creditors unless it also pays the NML Capital and other holdout creditors who refused to join in the restructurings. This ruling led to the nation’s second default in a dozen years. Another key problem is that in the original debt restructuring, creditors received new instruments with a strong haircut that made the payback possible for Argentina, while the old instruments do not have any debt reduction.

In many important ways, this ruling takes away the incentive to restructure sovereign debts usually done on the basis of debt reductions. Worse, it places legal creditors who underwent the restructuring procedure on the same basis as highly speculative investors who operate on bad faith buying the debt after the swaps are finalised.

This sordid episode has brought to the fore the nature and presence of US law and rulings in international finance. Much of US dollar-denominated debt is issued under US law and therefore is subject to the US courts. It implies that if Botswana borrows from Uganda in US dollars, it is most likely that such contracts will be written under the US laws.

In 2002, the IMF took the initiative to design a Sovereign Debt Resolution Mechanism but the US Treasury knocked it down in favour of a market solution in 2003.

One of the key lessons of NML Capital v Argentina case is that non-OECD countries should avoid issuing debt instruments in US dollars and should seek a new international clearing house. The creation of an international financial law mechanism within the UN system – similar to the United Nations Commission on International Trade Law (UNCITRAL) – is also vital.

Oscar Ugarteche works at Instituto de Investigaciones Económicas (IIEc), UNAM, México. He is the coordinator of Observatorio Económico de América Latina (OBELA). Ariel Noyola Rodríguez is associated with IIEc-UNAM and OBELA. 

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