De­beaking the vul­tures

Financial Mirror (Cyprus) - - FRONT PAGE -

In the midst of the on­go­ing dis­pute be­tween Ar­gentina and the “vul­ture funds” that hold its bonds, a broad con­sen­sus has emerged con­cern­ing the need for sovereign­debt re­struc­tur­ing mech­a­nisms (SDRMs). Oth­er­wise, US Fed­eral Judge Thomas P. Griesa’s rul­ing that Ar­gentina must pay the vul­tures in full (after 93% of other bond­hold­ers agreed to a re­struc­tur­ing) will give free rein to op­por­tunis­tic be­hav­iors that sab­o­tage fu­ture re­struc­tur­ings.

Most re­cently, the In­ter­na­tional Cap­i­tal Mar­ket As­so­ci­a­tion (ICMA) rec­om­mended new terms for gov­ern­ment bonds. Though the ICMA’s pro­posal leaves un­re­solved the hun­dreds of bil­lions of bonds writ­ten un­der the old terms, the new frame­work says in ef­fect that Griesa’s in­ter­pre­ta­tion was wrong, and recog­nises that leav­ing it in place would make re­struc­tur­ing im­pos­si­ble.

The ICMA’s pro­posed con­trac­tual terms clar­ify the pari passu clause that was at the heart of Griesa’s mud­dle-headed rul­ing. The in­tent of the clause – a stan­dard com­po­nent of sov­er­eign-bond con­tracts – was al­ways to en­sure that the is­su­ing coun­try treated iden­ti­cal bond­hold­ers iden­ti­cally. But it has al­ways been recog­nised that se­nior cred­i­tors – for ex­am­ple, the In­ter­na­tional Mon­e­tary Fund – are treated dif­fer­ently.

Griesa did not seem to grasp the common un­der­stand­ing of the clause. After Ar­gentina de­faulted on its sov­er­eign debt in 2001, vul­ture funds bought de­faulted bonds in the sec­ondary mar­ket at a frac­tion of their face value, and then sued for full pay­ment. Ac­cord­ing to Griesa’s in­ter­pre­ta­tion of pari passu, if Ar­gentina paid the in­ter­est that it owed to cred­i­tors that ac­cepted the re­struc­tur­ing, it had to pay the vul­tures in full – in­clud­ing all past in­ter­est and the prin­ci­pal.

The vul­tures’ business was en­abled in part by lit­i­ga­tion over the so-called cham­perty de­fense – based on a long­stand­ing English common-law doc­trine, later adopted by US state leg­is­la­tures, pro­hibit­ing the pur­chase of debt with the in­tent of bring­ing a law­suit. Ar­gentina is sim­ply the lat­est vic­tim in the vul­tures’ long le­gal bat­tle to change the rules of the game to per­mit them to prey on poor coun­tries seek­ing to re­struc­ture their debts.

In 1999, in El­liot As­so­ciates, LP v. Banco de la Na­cion and the Repub­lic of Peru, the Sec­ond Cir­cuit Court of Ap­peals de­ter­mined that the plain­tiff’s in­tent in pur­chas­ing the dis­counted debt was to be paid in full or oth­er­wise to sue. The court then ruled that El­liot’s in­tent, be­cause it was con­tin­gent, did not meet the cham­perty re­quire­ment.

Though some other courts ac­cepted the Sec­ond Cir­cuit’s nar­row read­ing of the cham­perty de­fense, the vul­tures were not sat­is­fied and went to the New York state leg­is­la­ture, which in 2004 ef­fec­tively elim­i­nated the de­fense of cham­perty con­cern­ing any debt pur­chase above $500,000. That decision con­tra­dicted un­der­stand­ings ac­cord­ing to which hun­dreds of bil­lions of dol­lars of debt had al­ready been is­sued.

In­vestors who ac­quire de­faulted sov­er­eign debt at huge dis­counts should not ex­pect re­pay­ment in full; the dis­count is an in­di­ca­tion that the mar­ket does not ex­pect that, and it is only through lit­i­ga­tion that one could hope to re­ceive any­thing close to it.

An im­por­tant change in the le­gal frame­work, such as the elim­i­na­tion of the cham­perty de­fense, is de facto a change in “prop­erty rights,” with the debtors los­ing, and cred­i­tors who pur­chase the bonds in­tend­ing to sue if they are not paid what they want – the vul­tures – gain­ing. The vul­tures were thus un­justly en­riched, dou­bly so with the novel and un­jus­ti­fied in­ter­pre­ta­tion of the pari passu clause.

Will so-called col­lec­tive-ac­tion clauses (CACs) – another as­pect of the ICMA “re­form” aimed at de­beaking the vul­tures – save the day? In many coun­tries, CACs stip­u­late that if, say, two-thirds of the in­vestors ac­cept a company’s (or a coun­try’s) re­struc­tur­ing pro­posal, the other in­vestors are bound to go along. This mech­a­nism pre­vents spec­u­la­tive hold­outs from hold­ing up the re­struc­tur­ing process and de­mand­ing ran­som. But CACs do not ex­ist for sov­er­eign debt writ­ten in many ju­ris­dic­tions, leav­ing the field open for the vul­tures.

More­over, CACs are no panacea. If they were, there would be no need for do­mes­tic bank­ruptcy law, which spells out is­sues like prece­dence and fair treat­ment. But no gov­ern­ment has found CACs ad­e­quate for re­solv­ing do­mes­tic re­struc­tur­ing. So why should we think that they would suf­fice in the much more com­plex world of sov­er­eign-debt re­struc­tur­ings?

In par­tic­u­lar, CACs suf­fer from the prob­lem of “ag­gre­ga­tion.” If a CAC re­quired, say, 75% of the hold­ers of each bond class, vul­tures could buy 26% of only one bond class and block the en­tire re­struc­tur­ing. The re­cent Greek debt re­struc­tur­ing had to con­front this is­sue.

The ICMA’s new frame­work seems to pro­vide a way out: The su­per­ma­jor­ity would be de­fined by the ac­cep­tance of the ag­gre­gate prin­ci­pal amount of out­stand­ing debt se­cu­ri­ties of all of the af­fected se­ries. The su­per­ma­jor­ity’s de­ci­sions would be bind­ing on all other in­vestors.

But this, too, poses a prob­lem: The more ju­nior cred­i­tors could vote to have them­selves treated in the same way as more se­nior cred­i­tors. What re­course would the se­nior cred­i­tors then have? In bank­ruptcy court, they would have grounds for ob­ject­ing, and the judge would have to weigh the eq­ui­ties.

Th­ese is­sues are es­pe­cially im­por­tant in the con­text of sov­er­eign-debt re­struc­tur­ings, be­cause the claimants to a coun­try’s re­sources in­clude not only for­mal cred­i­tors; oth­ers, too – for ex­am­ple, pen­sion­ers – might not be paid if bond­hold­ers are paid in full. Chap­ter 9 of the US Bank­ruptcy Code (which ap­plies to pub­lic en­ti­ties) recog­nises th­ese rights – un­like Griesa and the vul­tures.

To­day, the in­ter­na­tional com­mu­nity faces two chal­lenges. One is to deal with the hun­dreds of bil­lions of dol­lars of debt writ­ten un­der the old terms, which can­not be re­struc­tured un­der Griesa’s rul­ing. The sec­ond is to de­cide on the terms that should be im­posed in the fu­ture.

The in­vest­ing com­mu­nity has made a se­ri­ous pro­posal. But changes of this mag­ni­tude must be based on dis­cus­sions among cred­i­tors and debtor gov­ern­ments – and more is needed than tweak­ing the terms of the agree­ments.

An ini­tia­tive at the United Na­tions to en­cour­age the es­tab­lish­ment of SDRMs is re­ceiv­ing the support of prom­i­nent aca­demic econ­o­mists and prac­ti­tion­ers. Global ef­forts are good first steps to rem­edy the dam­age to in­ter­na­tional fi­nan­cial mar­kets that the US courts have in­flicted. For the sake of a healthy global econ­omy, the vul­tures must be grounded.

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