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After failing to reach an agreement with the bondholders who declined the restructuring offers it proposed in 2005 and 2010, Argentina again defaulted on its sovereign debt on 31 July 2014. Noiana Paula Marigo, a partner in the New York office of Freshfields Bruckhaus Deringer, considers Argentina’s dispute with the holdout creditors and the potential consequences of this new default for Argentina, its bondholders and foreign investors.
Press Release: ISDA Americas Credit Derivatives Determinations Committee—Argentine Republic failure to pay credit event
The International Swaps and Derivatives Association’s (ISDA) Americas Derivatives Determinations Committee has ruled that Argentina has failed to defaulted on its credit liabilities. The committee has resolved to hold an auction in respect of outstanding credit default swaps and the ISDA will publish further information regarding the auction online.
In 2001, Argentina defaulted on approximately $90bn of sovereign bonds (defaulted bonds). Argentina managed to restructure most of its debt in 2005 and 2010, by offering creditors new bonds (restructured bonds) in exchange for defaulted bonds. 93% of the holders of defaulted bonds accepted this restructuring.
Some of Argentina’s holdout creditors, predominantly hedge funds, claimed full payment of the sums they were owed, mainly in New York courts (in respect of bonds issued under New York law). Holdout creditors also sought relief before the domestic courts of France, Germany, Belgium and the UK, but with limited success. Finally, a group of Italian holdout creditors brought a claim pursuant to a bilateral investment treaty between Argentina and Italy. This claim is being heard by an international arbitral tribunal constituted under the auspices of the International Centre for the Settlement of Investment Disputes (ICSID), which is part of the World Bank.
In December 2011, Judge Thomas Griesa of the Southern District Court of New York ordered Argentina to pay the holdout creditors the full amount due under their defaulted bonds. In February 2012, Judge Griesa, interpreting the pari passu clause in the defaulted bonds, further ordered that:
This order was confirmed by the Second Circuit Court in October 2012 and by the US Court of Appeals in August 2013. In June 2014, the US Supreme Court refused Argentina’s petition for appeal. Argentina’s applications for a stay on Judge Griesa’s orders were equally unsuccessful.
As a result of these decisions, Argentina was left with two options—either negotiate an immediate settlement with the holdout creditors or default on its payments to holders of restructured bonds.
On 31 July 2014, Argentina failed to make a $539m interest payment due to holders of restructured bonds. Argentina had deposited the necessary funds with its payment agents, Bank of New York Mellon (BNY Mellon). However, in compliance with Judge Griesa’s order, BNY Mellon had not transferred the funds to holders of restructured bonds.
On 1 August 2014, ISDA’s Americas Credit Derivatives Determinations Committee (the Determinations Committee) resolved that:
On 13 August 2014, the Determinations Committee set 21 August 2014 as the date of the settlement auction and announced its terms.
Standard & Poor’s has placed Argentina in ‘selective default’. The Argentine Government has argued that the non-payment of interest cannot be treated as a default, on the basis that Argentina did deposit the necessary funds with BNY Mellon and, but for Judge Griesa’s order, the holders of restructured bonds would have received payment in full.
The main obstacle to Argentina’s negotiation of a settlement with the holdout creditors is the ‘Rights upon Future Offers’ (RUFO) clause in the contracts governing the terms of the restructured bonds. Under the RUFO clause, Argentina cannot voluntarily offer any of its bondholders terms that are more favourable than the terms of the restructured bonds, without also extending those terms to the holders of the restructured bonds. While it is unclear whether a settlement offer arising out of a court-ordered payment would trigger the RUFO clause, the Argentine Government has approached this issue cautiously. So far, it has not made a settlement offer to the holdout creditors (although a group of Argentine banks reportedly attempted to resolve the dispute by offering to purchase the holdout creditors’ bond on the eve of Argentina’s entry into default).
Argentina’s default occurred only a few months after its Government had adopted a number of measures in a bid to facilitate access to international finance and encourage foreign direct investment into the country. These measures included:
It is expected that Argentina’s default may not last long because, once the RUFO clause expires at the end of 2014, Argentina should have more freedom to negotiate a settlement with holdout creditors. However, the possible short-term consequences of the default may be as follows:
According to recent data from the Depository Trust & Clearing Corp, there are $20.7bn of credit default swaps outstanding on Argentine Government debt. When offsetting trades are accounted for, the maximum that can be paid out on these derivatives is estimated to be $1bn.
ISDA’s determination that a credit event has occurred triggers the reference obligations under these derivatives. The Determinations Committee is in the course of arranging a settlement auction or auctions which will calculate the payments due under these transactions.
Restructured bondholders could request repayment of their debts in full (including interest), which would force Argentina to either implement into a new phase of debt restructuring or to enter a state of general default.
The Government may be forced to tighten existing exchange controls measures, in order to tackle further exit of capital.
Argentina may fail to attract foreign direct investment in the short term (some investors had started to consider investing in Argentina in light of a possible change of government after next year’s elections).
Argentina may delay negotiations with holders of international arbitral awards.
Sovereign states may resist choosing New York law and jurisdiction in respect of future bond issues, resulting in an increase in the cost of capital for some emerging market nations. In fact, Argentina has already chosen Argentine law to govern some of its more recent bond issues.
The immediate next step will be the ISDA credit derivatives settlement auction on 21 August 2014.
In the short term, it is expected that, in anticipation of Argentina achieving a settlement with its holdout creditors, the holders of restructured bonds will not seek acceleration and enforcement as a result of the default. As mentioned above, a settlement should be facilitated by the expiry of the RUFO clause at the end of this year.
Interviewed by Emma Millington.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
First published on LexisPSL Banking & Finance. Click here for a free trial.
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Emma is head of the Banking and Finance team and the Finance Group at LexisNexis®UK.
Emma has wide-ranging experience in derivatives and capital markets with a particular emphasis on credit derivatives and structured products. Emma qualified as a solicitor with Allen & Overy LLP, working in the derivatives and structured finance teams in both their London and Paris offices before gaining experience with Deutsche Bank AG (advising the foreign exchange prime brokerage desk) and Crédit Agricole CIB (advising the fixed income and derivatives desk) before joining LexisNexis®.
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