Vultures, a Ship, and RUFO: The Weird Tale of Argentina’s Latest Default

Last week, Argentina fell in default…again. Argentina last failed to make payments on its sovereign debt obligations in 2001, to the tune of $80 billion.

Market reaction outside of Argentina to the most recent stumble was generally muted.  The U.S. stock market was down last week, but mostly because of a combination of troubles associated with European stocks, geopolitical woes, and uncertainty surrounding Fed policy. Yields were up last week on broad emerging market debt indices, but nowhere near this year’s highs. Argentina’s default wasn’t much of a surprise, after the country lost an appeal at the end of June to a holdout bondholder. Add to that, Argentina has been locked out of international markets for the last 13 years as a consequence of its last default. Lastly, Argentina has a fairly large economy; though, it’s not large enough to likely have a significant impact on the rest of globe. According to 2013 purchasing power parity GDP data from the CIA World Fact book, Argentina’s economy makes up less than 1% of world GDP. That’s compared to the Brazil’s 2% and the U.S.’s 16%.

To understand the consequences of Argentina’s latest default, let’s first look at what triggered it.  After its 2001 default, Argentina made a deal with most of its debt holders between 2005 and 2010.  About 93% of its creditors agreed to receive about 30 cents of the dollar for Argentina’s initial obligations; these bonds are referred to exchange bonds. In fact, up until last week, Argentina had never missed a payment on the exchange bonds.

The problem, though, for Argentina is that 7% of its debt holders, or ‘vultures’ as President Cristina Kirchner dubbed them, never agreed to the restructuring deal.  Hedge fund Elliott Management has been battling Argentina to get their share of $15 billion of holdout money. Elliott Management even went so far as getting Ghana to confiscate an Argentinean navy ship as partial payment. Even though Argentina only owes Elliot Management a couple billion dollars, Argentina won’t pay Elliott Management. This isn’t Argentina is being a jerk; it’s practicality – if they paid out Elliott, then, they’d have to pay all $15 billion owed those pesky holdouts.

The rub is that and Argentina could also be forced to repay everybody that took the restructuring deal (that other 93% of bond holders) the same amount as the holdouts. This is because of a clause in the original bonds, RUFO (Right Upon Future Offers). Felix Salmon, a senior editor of Fusion, estimated that Argentina would ultimately be forced to pay not just a couple billion to Elliott Management, but hundreds of billions of dollars. So, when a U.S. court ruled in Elliott Management’s favor, Argentina did the only rational thing – default. The choice was between pay one/pay ‘em all and pay nobody.

A lot of bond investors ultimately expect that Argentina will reach some sort of deal with its creditors. Think of this as sovereign debt brinksmanship. Argentina may either pay out more money to owners of exchange bonds or pay interest, an attractive 8%, on coupon payments currently in default.

That said, there are consequences from Argentina’s default, but the ramifications are likely more legal than market-oriented. Elliott Management’s win against Argentina adds more legal uncertainty to debt restructuring deals. In the future, bondholders may be less willing to accept restructuring deals, especially if it’s possible to hold out for more money later. That’s of course bad for the troubled economy doing the paying – they’d be much better off with the restructuring deal (think Portugal, Greece, and Ireland most recently).  Countries are rewriting bond provisions and removing bondholder-friendly provisions. For example, the Wall Street Journal cited that Cote d’Ivoire removed a “creditor engagement clause” from its most recent bond auction. Also, according to the Wall Street Journal, over the last year and half, the majority LatAm countries removed any clauses allowing holdouts’ leverage.  It’s unclear what the lasting impacts on the sovereign debt market will be.  But, the incentive structures of bond holders and countries have definitely changed.

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