Monday, December 10, 2012

Argentina's Last Tango With Bondholders?

Last week, I hooked up with Nathan Schipper, a Montreal businessman who invested in Argentinian wineries. We talked about Greece's debt deal and then discussed Argentina's latest tango with bondholders and its impact on global sovereign debt deals. Nathan was kind enough to provide the comment below:
You may have read one of Leo’s previous posts about my company in Argentina. We are in the wine business; one of our businesses is selling vineyards to private owners that produce magnificent wines in the shadow of the majestic Andes. I’ll describe it more below.

As I have business in Argentina, Leo asked me for a summary of the ongoing Argentina bondholder saga. I think it’s an incredibly interesting situation that could have serious ramifications on future sovereign restructurings and debt issuance. For some reason, only the Financial Times seems to be reporting on the story, so most are pretty unaware of what’s happening. The Economist had a decent article on it last week.

Now I will caveat that I’m no expert and I may have some of this wrong. But here’s how I understand it.

In 2001, as we all know, Argentine suffered a major crisis and devaluation. Over the next few years, they were unable to meet their debt obligations and defaulted on some bonds. At the time, it was the largest debt default in history: $93B. They tried to restructure the debt and negotiated firmly. Ultimately, they came to an agreement for about 75% of the defaulted debt, where the holders received about 30% of the par value. The new debt was to be paid over time and included warrant kickers based on Argentine GDP performance. In 2010, they reopened the exchange and ultimately they were able to get 94% of the old debt restructured. Since there were no collective action clauses in the debt instruments, Argentina couldn’t force the holdouts into the deal.

So that left 6% - and that’s where the story gets interesting.

The Holdouts claim that Argentine is in default and Elliott Management is leading the attack. Elliott argues that since the bonds were under New York law, the Argentine government couldn’t just unilaterally rewrite the bonds. The bonds are subject to the law of another jurisdiction. Argentine can’t really dispute that but they argue that Elliott can’t force them to pay.

The recent legal battle had to do with a clause in the bonds called the Pari Passu clause. Basically, the clause says that Argentina’s payment obligation under the bonds can’t be subordinated to any other unsecured debt of the country. Elliott argues that they are as entitled to payment as the ones who exchanged their bonds (the Exchange Bondholders). They’ve been fighting for years. Except last week, Elliott finally won a big battle.

A trial judge, perhaps angered by some of the rhetoric coming out of Buenos Aires, agreed with Elliott. He issued an order stating that Argentina had to pay the Holdouts along with the Exchange Bondholders. He also said that Bank of New York, who manages disbursements to Exchange Bondholders on behalf of Argentina must comply with the order, as must the Exchange Bondholders.

The Exchange Bondholders are angry because the order jeopardizes their chances of receiving payment. Argentina says they won’t pay the Holdouts – and if they can’t pay the Exchange Bondholders without paying the Holdouts, they may default on the Exchange bonds. BNY is angry because they just want to do their job – pay the Exchange Bondholders. So that's one of the key questions here - is the money paid to BNY (to be paid to Exchange Bondholders) the property of Argentina (which can be subject to seizure) or is it the property of the Exchange Bondholders (and perhaps should be immune from seizure, as the claim is against Argentina)?

An added factor is the Credit Default Swaps. There are many rumors that Elliott is betting on an Argentine default to the Exchange Bondholders using CDS instruments. If Argentine defaults on the Exchange Bondholders to avoid paying the Holdouts, Elliott wins big through its CDS bets. Smart.

Argentina may try to pay the Exchange Bondholders via Argentina or another, non-US jurisdiction. But that would probably constitute a default according to the bond rules – and Elliott wins on the CDS bets. Argentine doesn’t want to see Elliott making any money and while that’s really irrelevant to everything, it seems that some in Argentina are concerned with that.

A few days after the trial court’s ruling, the appeal circuit issued a stay, with a hearing to be held in late February. Now the Holdouts are asking for the court to ask Argentina for an escrow payment and the Exchange Bondholders are protesting (they are arguing that the Holdouts are trying to create a situation where Argentina will default). Holdouts should lose on this, but you never know.

Elliott realized that a sovereign default is different than a corporate default. In a corporate bankruptcy, the issuer can disappear and there is a finite amount of money that needs to be a spread around. In a sovereign default, the company will never ‘go bankrupt’. It will always be around (barring exceptional circumstances) – so there will always be a chance to collect.

This is a big deal because Elliott is proving that a country can’t force a restructuring if the bonds are in a foreign jurisdiction. And now they may be able to force Argentina to pay them. This could have severe repercussions in sovereign debt restructurings (Greece, Spain, Italy….). Issuers (and creditors) will be paying more attention to pari passu clauses and collective action clauses.

In the end, I think the final result will be that while Argentina owes the money, and Elliott can try and seize Argentina's assets (see the Ghana boat story), the money paid to BNY will be seen as property of the Exchange Bondholders (as it's due to them) and not subject to seizure. May not happen that way, but I'm not afraid of being wrong.

Argentina is a wonderful place. It’s a beautiful country with incredible scenery, great food, great wine and wonderful people. Unfortunately, it has a history of populism and a very screwed up government. But – that makes life interesting.

As to our company: We have a wine business in Mendoza, the wine capital of the country. It’s called The Vines of Mendoza (www.vinesofmendoza.com). While we are involved in many parts of the wine industry, our most interesting product is our Private Vineyard Estates. We sell small private vineyards to wine lovers all over the world. Our clients own their vineyards and choose what varietals to plant (of course, many choose Malbec). After a few years, when the vines are mature, they can make wine from their own grapes – or can sell the grapes on the market. We farm the vineyards for our clients and help them make wine in our unique state-of-the-art winery.

We started this business in 2007 and now have over 120 clients. We have clients who are interested in starting a small wine business and we also have clients who are only interested in making a barrel or two each year for their personal use. Our oldest clients are already making wine from their grapes and the wine is turning out to be truly magnificent. We also make wine for clients who don't own vienyards - these clients buy a barrel of wine (about 300 bottles) and get to choose the grapes and decide on the blend themselves. Our consulting winemaker, who works with each of our clients, is Santiago Achaval, arguably Argentina’s top wine-maker.

We are also building a resort on the property – when it’s completed in 2013, it will be the top boutique hotel in the country. Our restaurant will be run by Francis Mallman, one of the top chefs (if not the top chef) in Argentina. We are really looking forward to the opening.

If anyone would like to learn more about our vineyards, please give me a call at (848) 628-4261 and I’ll be happy to tell you more about the company.
I thank Nathan for providing this insightful comment on Argentinia's debt woes and explaining to me why hedge fund holdouts, including Elliott Management's NML Capital Ltd and the Aurelius Capital Management funds, are hell bent on fighting for full repayment in US courts (always thought this was foolish and a long-shot). 

Last week, Argentina got a second reprieve from US court on debt payment:
Barring another attempt by holdout investors to win an order requiring a payment, Argentina looks to be in the clear to continue servicing its restructured debt without fear of court intervention.

Argentine Economy Minister Hernan Lorenzino welcomed the decision.

"It's a positive ruling," he told reporters in Buenos Aires. "It's (also) positive that the participation of interested third-parties -- not only (exchange) bondholders but also the payment intermediaries -- has been ratified."

Argentina has called the holdout creditors "vultures" and vowed never to pay them.

The latest battle stemming from Argentina's $100 billion sovereign default nearly 11 years ago centers on a 2nd Circuit decision in October that the country violated a bond provision requiring it treat all creditors equally when it paid the exchange bondholders without paying the holdouts.

December 15 is a critical day because Argentina is scheduled to pay $3 billion on warrants issued as part of the debt swaps.

This had raised fears of another default because if Argentina had refused to pay the holdouts, as was expected, U.S. courts could have disrupted payments to holders of restructured bonds handled by intermediaries such as banks and clearing houses.

Argentina next owes money on its restructured debt in March 2013.

The case is NML Capital Ltd et al v. Argentina, 2nd U.S. Circuit Court of Appeals, No. 12-105.
But pressure is mounting on Argentina to pay all its bondholders. In an op-ed published in the FT, Time to ratchet up the pressure on Argentina, James K. Glassman, former US Under Secretary of State for Public Diplomacy and Public Affairs, writes the following:
In May, an article in the Guardian newspaper in Britain carried the headline: “Greece should follow Argentina’s lead: As Argentina’s experience after 2002 shows, when an economic crisis hits, it is often best to go it alone.” Greece, or other nations, may consider the Argentine strategy of flouting international standards a profitable or desirable course. This would be a disaster for global economic stability.

Some governments are now recognizing the danger. In September 2011, the Obama Administration stated that it would henceforth oppose loans to Argentina (except in humanitarian cases) from the World Bank and IADB. Then in August, Spain and Germany also voted “no” to a $60m IADB loan. The following month, other European countries, including France and Denmark, did the same.

This, however, continues to look like what it is: a piecemeal, ad hoc approach. The way to apply pressure to Argentina would be through coordinated, clear, public statements from European governments that they will join together to vote “no” until Argentina starts acting responsibly.

Another antidote would be ending Argentina’s membership of the G-20. In June, with economist Alex Brill, I produced a study that advocated transparent, objective criteria for G-20 admission in three categories. Argentina fell far short of qualifying. The cutoff for G-20 membership was an index of 40; Germany scored 83, France 76, Argentina 18.

Incentives count. The government of an indebted nation watching Argentina’s misbehavior will undoubtedly be encouraged to follow its example. And in a world in which economies are so systemically linked, the actions of one country, even a relatively small one, can affect finances globally.

It is past time for responsible nations to ratchet up the pressure. Raising the future of Argentina’s membership in the G-20 would help, as would clear declarations, especially from European nations, that they will no longer devote their taxpayers’ money to further loans until Argentina settles its debt, stops fudging its statistics, and ends the seizure of property owned by others.
Of course, it's somewhat hypocritical of the US and Europe to "ratchet up the pressure on Argentina" given they can't get their own fiscal houses in order. I wonder who paid Glassman to write this commentary.

Below, Roque Fernandez, former Argentinian Economy Minister talks to CNN's Richard Quest about the US appeals court putting a repayment order on hold.