After Argentina

It's done!  As Mark has chronicled, the U.S. Supreme Court has drawn the curtain on the pari passu drama, and separately has rejected Argentina's appeal to limit the scope of discovery by creditors with judgments against it. I am still undecided about how much I will miss it all. Meanwhile, here are two lists -- so-what and what-next.

So What:

• Governments trying to restructure New York-law debt contracts have less scope to threaten default. For now, a government with a pari passu clause in its distressed debt should expect  creditors who refuse its debt exchange offer to try blocking payments to the participating creditors.  Participating creditors will plan accordingly. Pending litigation against Grenada may limit this risk to a subset of debtors, but not yet--stay tuned.
• Financial market service providers--clearinghouses, banks, trustees, fiscal agents around the world--are now sovereign debt enforcement agents. Any service provider or intermediary dealing with a government in default should expect orders and subpoenas targeting the sovereign's assets and activities anywhere and everywhere.
• Creditors now have a promising tool to sanction a defaulting sovereign, though not to collect what they are owed.  If dealing with a sovereign in default is a headache for everyone in the market, many will avoid it, or will charge more for it. The result is an effective boycott. It becomes so costly for a sovereign to live a normal financial life outside its borders, that it just pays up. As with any boycott, the pain threshold is in large part a function of domestic politics.
• The sovereign debt management regime, such as it is, has over-relied on sovereign immunity in lieu of sovereign bankruptcy. Argentina and NML have tested the limits of this regime, and have shaken it quite a bit. It will be interesting to see how the regime adapts.  And so ...

What Next:

• Argentina and NML will keep at it before Judge Griesa--who has been fed up with Argentina for years, and wants to get it over with. But the implications for everyone else are only moderately interesting. Argentina might default on all its debt to avoid paying NML, as threatened. It might also try to fashion a workaround, though the risks for its bankers and lawyers are considerable. The outcome is ultimately a function of domestic politics, which I leave to the Argentinian press. In light of the government's recent settlements with direct investors and the Paris Club, I suspect they are more likely to settle. However, I doubt they can settle with NML and its co-plaintiffs alone. Any deal would have to reassure all involved that all the holdout litigation is put to bed--which means a settlement that is closer to $15 billion than $1.5 billion. This would take time, and Argentina is just about out of time--it has weeks, not quarters--not enough time for a face-saving political transition. This in turn might raise the risk of inadvertent default.
• Financial market service providers will adapt their contracts and policies to limit the risk of getting caught up in another Argentina-style mess. They could demand more indemnities from governments and their creditors, but these would not be too useful when the government is in default. The better way is to refuse to handle contracts that expose them to litigation risk, and to have clear exit procedures for when the risk materializes.
• The IMF, the G-7 governments, and others in the official sector will have to rethink their reliance on sovereign immunity for getting restructurings done. My hunch is that the bulk of the activity will be on the contract reform front--pari passu and Collective Action Clauses--not sovereign bankruptcy. The IMF is slated to come out with a paper on contract reform shortly; a major trade group has floated a contract reform proposal within the past year; more may come. Whatever happens, transition looms large and long. It is implausible that all sovereigns will swap all their bonds for ones with new, less vulnerable terms. This means that the fallout from Second Circuit decisions is with us until the existing debt stock runs off.
• Courts in the United Kingdom, Belgium and elsewhere are in a pickle. They are not bound by the U.S. decisions, but cannot very well ignore the fact that the highest court in the United States has blessed a contract interpretation and a remedy that might either conflict with their own jurisprudence, or, in the case of Belgium, with national legislation shielding Euroclear. It will be interesting to see how they resolve the conflicts.

At long last, the full ramifications of Argentina's crisis and default are coming into focus. There will still be noise surrounding the lifting of the stay, and the scope of the injunction--but we now have a glimpse of the sovereign debt world after Argentina. This world is fraught with uncertainty, perhaps more so than it has been since the early 1990s--but also opportunity for market participants and the policy establishment to build a more functional sovereign debt management regime, one that does not rely so much on unenforceable contracts. Meanwhile, those looking for good news from Argentina will have hold their breath through the World Cup.

Comments

[Rahul]

Naive question: Doesn't the pari passu clause just mean that the holdout bondholders get equity with the bondholders who agreed to restructuring?

Why is this such a big deal for Argentina? It isn't as if the holdouts get a deal any better than the others, right?

And when the original restructuring happened the holdouts could have joined & gotten the exact same deal?

[Longterm view]

@Rahul, it means that every borrower gets the same percentage, related to what is owed. So: If the borrowers who agreed to a 50% haircut receive 10% of the outstanding 50 (ie 5), then, under pari passu, the holdouts, who are owed 100, need to be paid 10% of 100 (ie 10). These are just examples, not real numbers, but I hope the principle is clear.

[Mark E. Herlihy]

Another naive question: Can't Argentina, with the consent of the holders of the restructured bonds, simple reverse the restructuring swap, credit payments already made under the restructuring to the original bonds, make their eatable payments up to (or somewhere short of) the haircut level, and then start the restructuring process again? They might still have problems in the long run, but they should have gotten around the NY court's injunction.

[Mark E. Herlihy]

.errrr... That should be "ratable" not "eatable". Damn autocorrect.

[Mark E. Herlihy]

Errr... That should be "ratable" above, not "eatable." it's not Freud, it's autocorrect..