Sovereign State VS Hedge Fund

It has been dubbed as the financial case of the decade, involving a Latin American sovereign state, the Republic of Argentina versus NML Capital LTD hedge fund, led by billionaire hedge fund manager Paul Singer.

The story goes something like this; you have a group of bond holders who reckoned that there was a killing to be made by purchased Argentinean sovereign debt just after it had collapsed in 2001.  This relatively risky investment strategy may sound wolf like but if it played out in your favor it could also be extremely lucrative for those cashed up and well connected.  The idea is to hunt for distressed debt and buy it (in this case sovereign Argentinean debt) on the secondary market at or near the point when the debtor is very weak or in imminent danger of default, at a huge discount, then sue the debtor for a larger amount than the purchase price.

So that is precisely what Mr. Singer and his pack of wolves did and they are now arguing that Argentina should cough up and pay back in full the 1.5 billion USD debt. But that isn’t the way the South American state sees it. On the other side of the fence Argentina is contending that NML Capital LTD, is immorally profiteering from a debtor in financial distress.  The country is arguing that NML Capital should have restructured the debt in 2005-2010 just like the other bond holders had done. Argentine President Cristina Fernandez, known for not mincing her words and always ready to tap into populace opinions is calling the hedge fund managers “vultures,” and flat right refusing to pay as a matter of principle.  But perhaps this could be partly due to the fact that if Argentina where to agree to pay NML it may also open the floodgates for the country to pay their other bond holders to the tune of 15 billion USD. This would certainly be an unwelcomed scenario for Argentina’s fragile economy, which it cannot afford.

Nevertheless, the US Supreme court has recently ruled in favor of NML Capital. Argentina’s final appeal has been refused by the Court, which has ordered Argentina to pay back the 1.5 billion USD within 14 days. Moreover, the US Supreme Court ruled 7-1 that bondholders could now force Argentina to reveal where it owns property around the world, making it easier to collect on the unpaid debts. This could even expose its embassies and military ships to seizure if the government doesn't pay, according to Justice Ruth Bader Ginsburg. Drumming the sound beats in favor of the US Supreme Court’s ruling a NML spokesman said: “America’s highest court has spoken. Now it is time for Argentina to honor its commitments to its creditors, which would benefit both Argentina’s economy and its international standing.”

Nevertheless, responding to the US’s highest court in the land ruling Argentine president Kirchner appeared on national TV stating, 'What I cannot do as president is submit the country to such extortion.' The financial consequence of such a stern posture by the head of the Argentine state was both immediate and predictable.  The cost of insuring Argentine bonds against default rocketed, and the value of Argentina's currency plunged to 12 pesos to the dollar on the black market and shares on Buenos Aires Merval stock exchange index fell by a whopping 6 percent and they were down again 4.92 percent on Friday, June 20.

There are now a number of options available for Argentina; it could obviously honor its commitment and pay the bond holders. But this is unlikely to happen since it would be keen to avoid a floodgate scenario with it’s other bond holders.

Alternatively, Argentina could try and renegotiate the debt. A likely obstacle here could be a piece of legislation called “the lock law”, which prohibits offering a better rate to the debt holders who did not accept the restructured rates.  Alternatively, Argentina could try and reroute payment to exchange holders outside the US, thereby circumventing US ruling, but as cited in the FT this would be logistically difficult to do.  The final option is that Argentina could default on its debt. This would not be a feeble matter, since the last time Argentina defaulted was in 2001 on 82 billion USD sovereign bonds, which happened to be the largest in history. The following events occurred; the Argentina President resigned; the peso was devalued, unemployment rocketed and riots broke out with more than 53 percent of Argentines falling below the poverty line. It took four years for the economy to recover. 

It’s worth noting that Argentina remains today cut off from the global financial markets. So an Argentina debt default may not be so damaging to the global financial markets this time around.  Furthermore, the likely amount of debt default of approximately a few USD billion is significantly less than last times non-payment of its 82 USD billion debt.

Bearing this in mind, the consequence of another Argentina default, while it may rattle Mr Singer and his pack, it is unlikely to result in a major global financial disruption. However, the US Supreme Court’s ruling could be a floodgate case for next time a country runs into financial difficulties and is unable to pay back its debts. Investors may have little or no incentive, or even be under a fiduciary obligation not to participate in any future debt restructuring scheme. While the court’s ruling is a boon for holdouts it has also made striking a debt restructuring deal a lot harder for debtors. Argentina’s next payment is due on June 30.