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Keeping Cosy by the Dumpster Fire: Argentina Reads Its Contracts ... Twice ... Quel Scandale!

posted by Anna Gelpern

Argentina's capacity to trigger outrage in sovereign debt circles is to behold. After nine defaults, thousands of lawsuits, and enough intrigue and screaming matches to break Big Data, wouldn't you think that someone somewhere would learn to yawn at another Argentina debt drama. And yet ... on the eve of tomorrow's debtapalooza, the internet is hopping mad again about a restructuring proposal from Bueons Aires--not the money (that's regular old mad), but the red-hot-appalling abuse of the shiny new Collective Action Clauses (CACs) in the 2016 bond indenture. The government again managed to tick off both its private creditors, who discovered that their contracts let the debtor gerrymander bond voting pools after the vote, and the well-wishing policy wonks watching their baby--decades of international bond contract reform--swirl down the drain with this one deal's bathwater. Because much of the technical ground was ably covered by my colleagues earlier this evening (don't miss the link to Rodrigo Olivares-Caminal), I have the luxury of using the rest of this post to speculate about the implications of the brouhaha for sovereign debt policy and sovereign debt markets.

For the Umpteenth Time, CACs. CACs allow a majority of bondholders to override a dissenting minority that could disrupt a sovereign debt restructuring and with it, the country's economic recovery. Policy makers have worked to convince countries and their creditors to adopt CACs for more than two decades. Within the past decade, industry groups have helped refine and diffuse CACs throughout the market. The most recent and most robust version, ICMA CACs, gives the debtor three voting options to change payment and other key terms: (1) single limb (requires supermajority of multiple series voting together as a pool, akin to popular vote), (2) two-limb (requires supermajority of a pool plus clearing a lower threshold for each bond series, akin to popular vote plus electoral college), or (3) series-by series (requires supermajority of each bond series, akin to electoral college only). Single limb was the big innovation in ICMA CACs. A supermajority "popular vote" can override a minority even if any given series is overwhelmingly opposed, provided the outcome is "uniformly applicable" for everyone in the voting pool. The debtor gets to choose how to pool and subpool, but does so once ahead of the vote ("Any selection of a modification method or designation of series to be included will be final for the purpose of that vote or consent solicitation.") Argentina has both single-limb and two-limb CACs. If you are up for more suffering, I wrote about them here in excruciating detail.

Argentina's Two Sins. The government's restructuring offer includes not one, but two distinct sins against CACs.

  • The first sin is "redesignation" --  reserving the right to expel a bond series from a voting pool and change the applicable voting mechanism after the votes had been cast.  But wait, you say, isn't the selection of modification method "final"? Yes, but that particular promise of finality is not a "reserved matter" that requires supermajority amendment (see p. 15 here). Even if Argentina does not get a supermajority of its bondholders to support the restructuring, chances are, it can get a simple majority to do away with the final selection business, and gerrymander to its heart's content after the fact. Strictly speaking, this is not quite like the president changing voting procedures after losing the election, but more like discovering that your state constitution (which you did not bother to read) lets the secretary of state (for whom you did not bother to vote) fiddle with the voting procedures as they please. INFURIATING, but that's not all.
  • The second sin is the "PacMan" strategy, which would let the government use the single-limb procedure multiple times in succession on all bonds issued under its ICMA CAC indenture, to sweep up dissenting holders. Mitu and Mark illustrated the mechanics very nicely earlier this evening.  The relevant language is here:

After completion of the Invitation, the Republic may in its sole discretion, subject to applicable regulations, propose one or more Subsequent Modifications that are “uniformly applicable” (as defined in the accompanying prospectus) and that would affect one or more series of New Bonds and one or more series of 2016 Indenture Eligible Bonds that are not successfully modified and substituted pursuant to the Invitation. Under the terms of the 2016 Indenture, if the Republic proposes modifications on that basis, the holders of more than 75% of the aggregate principal amount of any series of New Bonds and any series of Eligible Bonds affected by the proposed modifications, taken in the aggregate, may approve the Subsequent Modifications.

So What? Toss the Water! Save the Baby! As just about everyone has already said, this strategy is just too clever, particularly in a relationship already rife with mistrust. Should sophisticated market actors live with the consequences of their investment decisions? Sure. And yet ... I have been amazed over and over again at the emotional intensity of these negotiations. So much of the outrage you heard in 2003-2016 and hear today is cast entirely in moral-emotional tones -- manly money managers feel ill-used and lied to, and I would too (but I am not a money manager).

The risk is that Argentina, which needs money more than it needs any contract clause today, would agree to ditch or pay a premium for ICMA CACs in the new bonds this Friday. This would signal to the world that these CACs were damaged goods, even though they might have helped save the day with or without the too-clever maneuvers. Countries would start diluting or dropping robust CACs, setting up for a big mess in the next round of restructurings -- and, dare I say, the triumphant return of treaty-based sovereign bankruptcy.

No one should underestimate the extent of Argentina's restructuring challenge. As Brad Setser at CFR has pointed out (and will point out in writing, no doubt), the government has a large and variegated debt stock -- no ABCD for BA! -- including a big chunk of bondholders with near-term maturities, plus discount bond holders with big buttery coupons, all angling for a much better deal than the rest of the lot. Crafting a sleek uniformly applicable menu would be a tall order here, even if the contracts allowed it, and even if everyone trusted everyone else.

And yet. Why not use this opportunity to fix what is wrong with Argentina's ICMA CACs, reducing or eliminating the scope for opportunistic moves of the sort fueling today's outrage? Citizenship, leadership, rising to the occasion, etc.  For anyone who might recoil at the idea of sovereign bankruptcy ---whose prospects are looking brighter by the day-- why not insist on real contract standardization and more robust private ordering, including contract interpretation and standard form revision on the derivatives industry model, where ISDA is charged with filling gaps and fixing messes of the sort people are complaining about?

Contracts are incomplete. Things happen. Especially in Argentina. Toss the bathwater.  Save the baby before it vanishes down the drain.

And if you read this far, register for the webinar tomorrow, where I will NOT talk about Argentina or CACs. Because I have said my peace.

Disclosure: I was part of the working group that worked on ICMA CACs and am a fan on balance. But I have also said lots of ambivalent things about CACs, most recently here.

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