After the “Battle of the Century”

What next for debt crisis management?

Bodo Ellmers

Bodo Ellmers is Policy and Advocacy Manager at the European Network on Debt and Development (Eurodad).

In late April, the ‘battle of the century’ between the government of Argentina and a group of vulture funds reached an inglorious end. The government of Argentina finally surrendered and paid the vulture funds in full, at a price tag of more than US $10 billion. The consequences are severe: Argentina started a new cycle of indebtedness; the vulture funds’ predatory business model has been further strengthened and threatens to affect more and more nations; and future debt crisis management in general is in a mess. Now this battle has been lost, the question remains: what next for debt crisis management?

Argentina: back to markets or back to debt crisis?

Argentina had to borrow the money it needed to pay the vultures, thus it returned to financial markets after more than a decade of absence. To the surprise of many financial market observers, the bond issue of the former pariah state was hugely oversubscribed. In the largest emerging market issuance ever, Argentina managed to raise US $16.5 billion in three different bond series that yielded on average 7.2%. This successful return has the caveat that it starts a new cycle of indebtedness. While the government of Argentina hopes that the ‘normalisation’ of financial relations will attract foreign investment, none of these borrowed dollars will be invested productively. The lion’s share of more than US $10 billion went to pay the vulture funds; the smaller share replenished Argentina’s depleted currency reserves, i.e. mainly to refinance capital flight.

The issuance was a perfect deal for investors. It soon turned out that Argentina had sold the bonds too cheaply. Prices surged in the first few days, allowing the banks that were the bookrunners to make quick profits. JP Morgan celebrated: “These yields don’t exist anywhere else in the world in countries with such low levels of debt.”

Argentina’s citizens are paying the price for their government’s strategy of pleasing foreign investors. The recent removal of exchange restrictions has resulted in a 40% currency devaluation and a spike in inflation. Subsidies on essential services have been removed and, by March 2016, 32,000 public service workers had been laid off.

Vulture funds: a menace to debt restructurings and to democracy

Argentina’s payments to the vulture funds have repercussions far beyond this case. They have replenished the funds’ war chests by an additional US $10 billion, enabling them to attack more nations. Puerto Rico and Belgium have become the first countries to fall prey to their new aggressions.

Vulture funds, in particular Aurelius capital, have purchased Puerto Rican bonds, which have junk bond status and are traded far below nominal value on secondary markets. The vultures’ financial firepower not only allows them to prepare for litigation. They have also started a public relations campaign to influence public opinion in their favour. For instance, they hired some retired International Monetary Fund (IMF) officials to draft a ‘research’ paper, which argues that Puerto Rico would be able to fully service its huge debt burden if the government just imposed ever harsher austerity measures on the population. Quite obviously, their campaign targets not only the Puerto Rico case, but also relevant bankruptcy legislation processes going on at the US Congress and US opinion in general. Even the comedian John Oliver felt challenged to comment on the case.

Belgium is another example where vulture funds are attacking democratic legislation processes. The small European country passed the world’s most comprehensive vulture fund legislation in 2015. Belgian law determines that a vulture fund can never make more money through litigation than it paid for the concerned debt instruments in the first place, if there is a large discrepancy between the nominal value at issuance and the price it paid for it. This law renders the vultures’ business model unattractive. Investors can still recover their money, but they can no longer use the litigation strategy to make exorbitant profits. Not surprisingly, the Belgian law that has inspired the United Nations (UN) to call for similar legislation in other countries has disgusted vulture funds. So they filed a lawsuit at the Belgium Constitutional Court, hoping that it would make clear that the vulture fund law infringed the Belgian constitution.

Creditor participation: fair burden sharing and good faith?

Another consequence of the vulture funds’ victory is that thousands of responsible investors have been fooled. Until recently, Argentina has been a country with low levels of debt, as JP Morgan correctly analysed. But this was because, after the Argentine debt crisis of 2001/02, the vast majority of investors holding Argentine debt participated in debt restructurings and agreed to write off a substantial share of their investment. Now the vulture funds have proved that, if you hold out and manage to procure the help of New York judges, profit rates of more than 1,000% on your investments are possible. That means those who cooperated in good faith are the fools who helped to restore Argentina’s solvency, but who also enabled Argentina to borrow again and pay the vultures. Following this experience, debt crisis management can no longer count on voluntary creditor participation.

What next for debt crisis management

So the question remains: what can indebted countries in particular – and the international community in general – do to counter the surging vulture plague? The answer is: there are a number of options:

• 1) An international insolvency regime for sovereign debtors

A vulture fund lawsuit against sovereign debtors is possible because there is no bankruptcy protection for this kind of debt. This is in contrast to corporate debt, where specialised insolvency courts are mandated to make binding decisions, and codified insolvency law guides their decision making. That this governance gap exists is not news – lots of conceptual work has been done at the IMF as well as at the UN to fill it.

The multilateral solution is certainly the best and most effective one. The dilemma is, however, that it depends on multilateral consensus, including by those nations that host financial centres and in which vulture funds fuel the political system with party donations. The IMF and UN attempts have been stopped by US and UK resistance primarily. The processes at both institutions must be kept alive however, as windows of opportunity can pop up at anytime. For instance, many decision makers in Washington have learnt through the Puerto Rico case (a US territory/colony) that better bankruptcy protection for sovereigns is not so bad after all, even if it is just to avoid creditor bailouts funded by taxpayers’ money. Both institutions, the UN and the IMF, have mandates to pursue further reforms.

• 2) National vulture fund legislation

The Belgian law has been a remarkable innovation. It complemented a British law that was passed when it became clear that vulture funds’ lawsuits against Heavily Indebted Poor Countries (HIPC) imply that UK aid funds are de facto used to feed vultures, instead of their stated purpose of fighting poverty. Thus, two countries have vulture fund legislation in place. However, the UK law covers only a small group of HIPC countries. The UN, in paragraph 100 of its recent Addis Ababa Action Agenda on Financing for Development, encourages all governments to take similar action. Moving towards national vulture fund legislation could be a way forward for countries that host important financial centres but have a certain aversion to multilateral solutions – such as the UK or particularly the US.

• 3) Sidelining uncooperative financial centres

There also actions that can be taken by the issuers of foreign bonds. It is mostly the governments of emerging and developing countries that are issuing bonds in foreign currency and under foreign legislation. These are the ones that vulture funds are particularly targeting. Many were surprised how badly New York’s court treated Argentina; how it bent the pari passu clause to please the vulture funds.

Argentina is traditionally one of the largest emerging market bond issuers, an important client for Wall Street banks. But it made (as it eventually turned out) the terrible mistake of issuing bonds under New York law. Of course, in globalised financial markets there are lots of alternatives to the financial centre of New York. Even countries that strive to issue US-dollar denominated bonds can easily do so in European or Asian financial centres. Or in some cases even under domestic legislation, which should be the preferred option. Thus they can avoid a location, which, from the perspective of effective debt crisis management, must nowadays be called an uncooperative financial centre.

Moving forward  

Debt sustainability indicators in many countries are currently deteriorating rapidly. The latest Global Sovereign Indebtedness Monitor by Jubilee Germany found debt problems in 108 emerging and developing countries. The IMF also warned at its recent Spring Meetings that financial stability risks are growing. More debt crises will come and more debt restructurings will be needed. Urgent action by policymakers is therefore indispensable in order to create a regime that makes fair, speedy and effective debt crisis management possible, and options to move forward do exist.

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