Presentation of my research on the holdout creditor problem (i.e. a situation where a minority of creditors blocks a sovereign debt restructuring deal) in the case of Argentina and Greece
Presentation the holdout creditor problem lessons from restructuring sovereign debt in argentina and greece
1. The Holdout Creditor
Problem: Lessons
from Restructuring
Sovereign Debt in
Greece and
Argentina
ECB-PUBLIC
Sebastian Grund*
DG/I/IRC (IFA-Team)
Presentation of PhD Research (University of Vienna, Faculty of Law)
Frankfurt, 24 October 2016
* The views expressed do not necessarily reflect those of the ECB or the European System of Central Banks
Welcome to presentation on holdout creditor problem
As a short explanation to avoid surprises, the holdout creditor problem refers to a situation in which individual creditors seek to achieve a better outcome in a debt restructuring by holding out and pressuring the sovereign into a favourable settlement
Presentation today is structured in the following way:
Context and Scope of Research
Legal Aspects of SD and SDR
Holdout Litigation and Argentina
We could witness an explosion of debt levels both in the private and public sector
Governments have never been more leveraged
Government debt makes up 58% of the global GDP and grew 9.3% per year between 2007-14
Threat to financial stability and lack of fiscal space
Government debt levels are high in both EMEs and AEs
EA government debt currently stands at around 100% of GDP
Portugal:~130%, Spain: 100%, Italy: ~132%
Question of what happens when sovereigns can no longer repay their debt has become pressing for policymakers around the globe – what mechanisms are there in place for debt restructuring?
Sovereign debt crises have always been a feature of the global economy
With increasing financialisation, the repercussions are however felt at a much broader level
Contagion risks are real – see examples of Latin America, Asia 1998 and EA in 2010-12
This study focuses on the two biggest sovereign defaults in history
Russian debt crises in 1998 affected approximately 30 bn $
Both cases predominantly concern defaults on privately-held debt where crisis resolution mechanisms are less advanced and resilient
Argentina and Greece were the first two sovereign debt crises where holdout problems actually impeded the crisis resolution
Holdout Problem arises when a minority of creditors decides to free-ride on a restructuring deal concluded by the majority of creditors and the sovereign
Due to secondary market trading, holdouts can buy bonds very cheaply and sue for the bond’s full face value
If successful, other creditors may too choose to hold out and attempt debt enforcement rather than agree to a haircut or a debt reprofiling
This thesis contributes to the literature by
Analysing instances of holdout litigation after Argentina and Greece
Comparative analysis of the main legal issues related to the holdout problem
Allows for a better understanding of how different jurisdictions deal with the holdout problem
Against the background of litigation in Greece and Argentina, the thesis seeks to expose potential flaws in the current framework and make proposals for better crisis resolution
Provides the analytical basis to devise better debt restructuring mechanism
Generally described as unique asset class
In contrast to corporate or private debt, creditors of sovereigns cannot simply enforce their debt in court
Doctrine of Sovereign immunity under international law makes attachment of assets difficult
Sovereign debt is an unsecured asset class which means that creditors have no recourse to other assets if sovereigns default
Sovereigns repay because
They suffer from reputational losses (exclusion from markets, higher refinancing costs)
Non-repayment leads to output losses and trade costs, hence making it unattractive for the sovereign
More recently, legal issues have been named as another incentive to repay debt since enforcement mechanisms are becoming stronger (also a result of increasing financialisation)
Results in sovereign debt equilibrium – sovereigns want to sustain access to credit markets and creditors have weak enforcement tools – negotiation is the only feasible alternative
Sovereign realises that it can no longer repay or decides to default strategically
IMF is typically involved to prepare lending program (DSA etc)
Official sector negotiations for bilateral debt (informal - Paris Club)
Private sector negotiations (very much dependent on the types of creditors and their share – bondholder coordination can be very difficult)
Implementation of restructuring
Holdout litigation – aim of holdouts is to block restructuring ex-post to force country into a settlement that is more favorable then the restructuring deal
Some (economic) facts
Argentine economy shrank by 28% (1998-2002)
Bond yields rose to ~45%
Default on $95bn in December 2001 (biggest sovereign default in history)
Default on 152 different series of bonds governed by 8 different jurisdictions
80% accumulated inflation in 2002 after pesos was floated
Due to the low bondholder participation rate in the first restructuring, Argentina offered another debt swap in 2010
First debt restructuring 2005
Affected 152 different series of bonds (6 currencies, 8 jurisdictions) and roughly 700.000 bondholders
Haircut was 70% (average is 37% in last 200 years – Greece 53.5%)
Creditor participation 76% - despite the unprecedentedly high haircut mainly due to Argentina’s aggressive negotiation
Second debt restructuring 2010
Creditor participation increased to 92%
After disappointing litigation experience (difficult hunt for assets) many (retail) investors gave in
Only very specialised hedge funds and some Italian bondholders continued to challenge the debt workout
Ultimately, 8 percent of creditors held out, challenging the restructuring in different courts (mainly New York though)
NML v Argentina
Dubbed by FT as sovereign debt trial of the century
Holdouts managed to block Argentina’s payments to international creditors – pushing country in default in 2014
NML in UK
UK courts more reluctant to follow US courts’ reasoning
US judgements were recognised but no attachable assets
Injunction to block payment streams through UK not applicable under English law
BVerfG
Argentina does not enjoy immunity for bond issuances on international capital markets
Argentina may not rely on state of emergency as a justification to stop payments to international bondholders
BGH
Creditor were granted money judgements but no credible enforcement (no Argentine assets in Germany)
Borri v Argentina
Italian courts granted sovereign immunity
Argentina found itself in a state of emergency that justified repudiation of debt obligations
Abaclat Arbitration
Sovereign bonds fall under definition of investment under the BIT and Art 25 of ICSID convention
Potential new forum for sovereign debt litigation – again similar debt enforcement problems
Successful italian bondholders were paid by Argentina in 2016
The different actors in the sovereign debt trial of the century
Trial broached questions of law but even more of morality, Western capitalism and defiant Latin American countries – deep resentment between litigants
NML purchased debt for extremely high discount and sued for full face value
Judge Griesa became a tragic figure – from first siding with Arg the 86 year old then granted a remedy that had never been used against sovereigns in US courts
Argentina’s broad pari passu clause
“[1] The Securities will constitute (…) direct, unconditional, unsecured and unsubordinated obligations of the Republic and shall at all times rank pari passu and without any preference among themselves.
[2] The payment obligation of the Republic under the Securities shall at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness (…)”.
The payment interpretation by U.S. Courts
“The first sentence of the clause prohibits Argentina, as bond issuer, from formally subordinating the bonds by issuing superior debt. The second sentence prohibits Argentina, as bond payor, from paying on other bonds without paying on the FAA Bonds.” (NML Capital v. Argentina, 12-105(L) (2d. Cir. 2013)
The pari passu injunction and its reach
“if Argentina attempts to make payments . . . contrary to law, then third parties should properly be held responsible for making sure that their actions are not steps to carry out a law violation” (NML Capital v. Argentina, 12-105(L) (2d. Cir. 2013)
What is the correct interpretation of pari passu – that it allows for rateable payment or just protects from subordination of creditors by law – payment interpretation has flaws since it makes debt restructurings ex-ante unworkable, defying the intentions of the parties at the time
Repercussions of US court decision were unprecedented
First time a country defaults on its debt as a consequence of litigation
Scholars and policymakers strongly condemn the US courts’ stance (IMF was concerned about broader systemic implications)
Newly elected Macri government gave in and paid holdouts much of what they were owed
NML’s return on investment was north of 1100 percent
At the peak of the Greek debt crisis, roughly 50% of privately-held debt was cut
Private sector losses of 107bn € (face value)
Biggest and most complex restructuring in history
130 bonds
Governed by 5 laws
Affecting investors in 40 countries
Four years later, it becomes apparent that debt cut might not have been sufficient to achieve debt sustainability
Legal technique ingenious
Big advantage in comparison to Argentina and other EMEs – 97% of Greek bonds governed by domestic law
Parliament could legislate inclusion of CACs
30-40% of creditors were big financial with implicit bailout guarantee - EU policymakers pushed debt restructuring even though banks were extremely critical (see Commerzbank Chief – “As voluntary as ta confession during he Spanish inquisition”)
No blocking of the deal but post-restructuring litigation in several jurisdictions
Litigation in general unsuccessful
Austrian and German courts did not grant immunity to Greece BUT jurisdiction for such creditor-debtor disputes lies in Greece under the applicable European Regulation
ICSID arbitration unsuccessful due to the specific drafting under the Slovak-Greece BIT and a return to a more restrictive interpretation of the term “investement” under international law
European Court of Rights acknowledged that Greek debt swap interfered with property rights but that it pursued public interest aim and was adequate
Here we can see a comparison of the restructuring of Greek bonds governed by domestic and English law
Debt restructuring for Greek bonds successful
CACs failed however under English law – holdouts purchased blocking majorities in smaller series of bonds (votes were not counted on the aggregate but for each individual series)
Greece paid holdouts under English law in full (6bn – more than the annual Greek health budget) while all other creditors were forced to accept a 50% haircut
Raises pressing questions of intercreditor equity & shows that old G10 CAC model insufficiently protects from speculative bondholder behaviour
Powerful contractual tool to avoid holdouts
Reduce necessity for official sector bailout (CACs allow for bail-in of private creditors – especially since governments can influence big financials, see LAm debt crises and Eurozone crisis)
Allow majority of investors to bind minority to restructuring deal
Increase legal certainty in a debt restructuring (CACs reduce instances of litigation)
Different types of CACs (English, NY, ICMA, etc.)
Transitional problems (most outstanding debt does not include CACs)
Holdouts may still buy blocking majority (in single series or small debt stock still possible)
Only applicable to bonds (guarantees etc. not protected)
Standard in English-law sovereign bonds since 1930s
Standard NY-law sovereign bonds since 2003
All euro area government bonds include two-limb CACs since 2013
- Very gradual implementation (only new bonds can include CACs – changing old bond terms is difficult and costly) – transitional problems are pronounced
This slide shows the different voting thresholds for CACs
Generally, it should be noted that the old English and NY law CACs provide for series-by-series voting while the newer CAC models have aggegation features
The euro area CAC has both voting styles
Individual countries have sometimes used other CACs (e.g. Uruguay in 2003 used a two limb voting structure with 85% majority)
Moreover, it should be noted that the lower the voting threshold the easier it is to cram down holdouts
This slide will not be discussed in detail but circulated after the presentation
