The Holdout Saga: Season Finale

The Holdout Saga: Season Finale

Argentina Bonds Corporate & Sovereign Strategy

Despite the complexity of the case, there are not many options open to the different parties involved in the Argentine holdout saga. Should Argentina fail to secure a stay, the country is prepared to face a selective default on the bonds affected by Judge Thomas Griesa’s injunction, in order to avoid payments to holdouts triggering the Right Upon Future Offers (RUFO) clause included in the original bonds, leading to the failure of the 2005 and 2010 exchanges.

The holdouts know this and have become ostensibly more flexible, indicating that they will accept a payment in bonds, as was the case with Repsol’s deal in February. Indeed, it is the holdouts who may eventually request a new stay to give Argentina time to elude RUFO and avert a lose-lose selective default scenario.

The unexpected setback at the Supreme Court frustrated the Argentine government’s original plan to negotiate a settlement with the holdouts in January 2015 (upon expiration of the RUFO clause). The Argentine government’s current priority is to avoid the failure of the 2005 and 2010 exchanges, which would happen if the RUFO clause were successfully invoked, even at the risk of a selective default.

A selective default would probably trigger the acceleration of the exchange bonds governed by New York law, should BONY continue to be enjoined from distributing payments (bonds under English law are likely to be serviced on time, although Judge Griesa has not yet been explicit on that). In the case of a selective default, the most likely scenario would be an exchange of the defaulted bonds in January 2015 (after expiration of the RUFO clause) for new bonds under a non-US jurisdiction.

The effectiveness of this selective default option as a bargaining tool depends on its costs for each of the parties involved. I believe these costs are large enough to catalyze a settlement.

What is the cost for Argentina? One should not underestimate the immediate implications of a new default. True, the default will be partial and probably temporary. But, unlike 2001, when the debt crisis preceded the default itself, in this instance the Argentine economy has not yet suffered any consequences. And, unlike 2009, when Argentina had ample reserves and fiscal flexibility to counter the global crisis, now the twin deficits and meager reserves severely reduce the policy space to mitigate the pain. From today´s fragile starting point, a selective default would lead to a deepening of Argentina’s recession, with an associated political cost that would be hard for the government to blame on third parties.

What is the cost to the holdouts? Since there is no pari passu ruling covering the bonds governed by non-US law, a default leading to a jurisdictional change would indefinitely postpone the payment to the holdouts. And, more generally, once Argentina has incurred the cost of a selective default, the country´s incentives for a quick settlement would weaken considerably. In any event, it does appear that a rapid settlement (including a mix of cash and bonds) is in the holdouts’ interest.

What is the cost to the Court? Judge Griesa would not want to be remembered as the one who discredited New York as a financial center and led an emerging economy to default and financial crisis. The same is true for Special Master Daniel Pollack, the Court’s facilitator, whose prestige and compensation are contingent upon a successful settlement.

What is the cost for emerging markets in general? In principle, the prevalence of collective action clauses (CACs) in later vintage sovereign issues should open a door to cram down creditors in an exchange, leaving no space for holdouts – that is, if the majorities required to activate CACs are reached.

But holdouts may be encouraged by the promise of a full payment Griesa-style, rendering those majorities harder to get – which would call for lower majorities in future CACs. At any rate, the die is cast: whether the epilogue is a settlement or a selective default, the exposure of US-law sovereign bonds to holdout litigation has increased. While emerging economies now issue global bonds only marginally, frontier economies making their first appearances in global markets may want to reconsider where and how to borrow.

In sum, the costs of default look more evenly distributed among the parties than would appear at first sight: every actor has a strong incentive to settle, which is why I think that, barring an accident, a settlement is more likely than a default. The season finale may be long and complex and uncertainty may well extend beyond July 30th; but, besides the press campaigns and the public speeches and posturing fuelling the headline risk, the true negotiation carries on behind closed doors. LF

Eduardo Levy Yeyati is chief economic advisor at ACGM, and was previously chief economist at the Argentine central bank.