Argentina is facing the potential of a new financial crisis after it defied legal attempts to force it to repay US$1.33 billion in debt owed to the so-called “vulture” funds that have pursued the country for more than a decade.
Over the weekend the Argentine government proceeded with a $US539 million payment to creditors that had agreed to restructured debt terms following the country’s 2002 default.
But it has ignored a US Supreme Court order to pay out a group of mainly New York-based “hold out” hedge funds. These had refused the country’s restructured terms and are demanding a payment of $1.33 billion.
US Supreme Court Judge Thomas Griesa described Argentina’s payment to the restructured debt holders as illegal and “explosive”, ordering the Bank of New York Mellon to return the money to Argentina. The judge has pleaded with Argentine authorities to negotiate with the hedge funds to avoid a technical default. Argentina argues that paying both classes of creditor would also cause it to default.
A brief history of debt
The dramatic events have been brought about by the court’s decision on June 16 to quash an appeal by the Argentine government against an earlier decision forcing it to repay the hedge funds.
As I have written before, the dispute dates back to the country’s US$100 billion debt default, the world’s largest.
Vulture funds are private financial institutions that speculate by investing in debt such as high-yield bonds and other financial securities that are close to defaulting. According to the African Development Bank Group, these financial institutions buy “… distressed debt on the secondary market, where it trades significantly below its face value, and then seek to recover the full amount, often through litigation”. They operate in a legal space that is highly favourable to them, often in the US or European courts.
On February 23 2012, US District Judge Griesa ruled that Argentina had infringed upon the notion of “pari passu” or equal treatment provisions for all creditors when it paid bondholders who accepted debt restructure swaps in 2005 and 2010, while refusing to pay vulture funds.
At times, the saga has taken startling turns. In October 2012 the Argentine sailing ship ARA Libertad was detained by the Ghanaian government and prevented from leaving the Port of Tema, due to an injunction by US hedge fund NML Capital. However, the Argentine vessel managed to sail back to Argentina while court proceedings continued in US jurisdictions.
In November 2013, the US Second District Court, the jurisdiction where the original loans were contracted, ruled in favour of the holdout funds. Argentina responded by filing an appeal to the US Supreme Court in February 2014, which was finally rejected on June 16.
The ramifications of this crisis are staggering. According to the USA Jubilee Network, an organisation that calls for debt relief for poor countries:
The decision will impact debt restructurings, poor country access to credit and propel predatory behaviour. The Court also ruled against Argentina in a related case involving the ability of hold-out creditors to locate the foreign assets of the sovereign nations they are suing.
The vultures’ legal victory virtually means that they have been given free rein to target poor countries’ funds which are badly needed for financial recovery and economic and social development. The Jubilee Network again:
The orders here give a preference to a minority of holdout creditors like Elliott at the expense of the majority of creditors who agreed to give relief to a sovereign facing economic difficulties … If this type of relief becomes the law, bondholders who restructure their debt - a group that consists of numerous individuals and pension funds - could be deprived of payments on their bonds, thus resulting in economic hardship to many people.
The Union of South American Nations (UNASUR) has criticised the effects of the decision on the international financial system. UNASAR warned that the “legalisation” of such behaviour threatens the stability of the system.
Uruguay’s President Mujica expressed his deep concern and suggested the real intentions of the vulture funds “ … are related to the Vaca Muerta oilfields in the Province of Neuquen”.
The court ruling is quite unprecedented given that it went against a decision on a similar claim made in Europe by another vulture fund on Argentine assets. On July 11 2013, German courts rejected hedge fund claims on Argentine assets in Germany.
The $1.33 billion Argentina is being forced to pay back to the New York-based hedge funds represents a staggering 1,000% profit margin. Of further concern is the fact that the vulture funds represented 1.6% of bondholders, hence jeopardising 92.4% of bondholders who voluntarily accepted a restructure.
Meanwhile, the high-level stakes played by Judge Griesa and the Argentine government continue to spring surprises. Argentina’s financial daily Ambito Financiero reported that if the Bank of New York Mellon does not make its payments to bondholders according to the instructions directed by Casa Rosada the bank would be in breach of its obligations as a financial representative of the Argentine government.
This would mean that payments to creditors could then be shifted to a new geographical jurisdiction outside the US. This could well be Buenos Aires, as earlier requested by the Argentine government of its bondholders. It is no surprise, therefore, that Judge Griesa asked both Argentina and the vulture funds to negotiate.
The chess game of financial brinkmanship continues with numerous twists and turns. In the meantime, the international financial community and many indebted third world nations await its outcome.