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Why the vultures aren’t the big problem Joseph Cotterill | Jun 26 09:00

Why the vultures aren’t the big problem

Or, why the pari passu saga’s legacy won’t be to make holdouts all-powerful in sovereign debt, a worry expressed by Martin Wolf in his latest column.
Not quite. Rather, it will make holdouts just powerful enough so that the system becomes haphazard, interminable, and frustrating for everyone, we’d argue. And that would be the real problem.
This might seem unlikely. Last week Elliott collected two US Supreme Court victories over Argentina, one of the spikiest sovereign debtors ever, in one day. Martin calls it “extortion backed by the US judiciary” and compares the holdouts to a “moral hazard Taliban” in charge of a debtors’ prison.
Back-handed as it is, it still pays a compliment to holdouts’ supposed power. But what power?
Consider, if you will, three numbers to begin with.
Holdout Argentine bonds are trading above 70 cents in the dollar, true.
The restructured debt is also trading above 70 cents in the dollar. That can only be pricing in an eventual settlement between Argentina and Elliott (and the other holdouts). Elliott has the means to block payments otherwise, and swapping the bonds into Argentine law as a rerouting of payment just got riskier.
All that said, however: Paul Singer is 69.
Twenty-four hour pari passu people
Recall that it has taken a decade to get Argentina to the point of just talking to holdouts. That plus a complete overhaul of sovereign debt enforcement to target other bondholders. This was the dark genius of the pari passu strategy. Find a clause that gets courts to support ratable payment as an equitable remedy. That means you can press for it before you’ve actually gone to the trouble of getting a judgment on defaulted debt. Then let the intercreditor implications of ‘equal treatment’ crash into the complexity of modern payment systems for government bonds.
That strategy was chosen precisely because it’s still tough to take on a sovereign directly. Even now, Mr Singer could well still be doing this when he’s 79, if things just go a little wrong for him here and Argentina does find other ways to pay bondholders. This is what Matt Levine was pointing out the other day.
It would be why Elliott needs to stop Argentina from defaulting and leaving New York jurisdiction in a huff, and also needs to keep up the time pressure to negotiate. That last part includes telling Judge Griesa on Tuesday not to stay the order to pay holdouts. This is ‘litigotiation’. It’s risky business.
Elliott also has to be sure that no other holdouts will sizeably resist its own settlement, as ratable payment is now open to them too. We think it’s unlikely — but it also suggests that the real holdout danger is the haphazardness of enforcement, not that the likes of Elliott now run the system and debt restructuring will perforce collapse.
We’ll see how wrong it could go for Elliott here in a second post. But it is well worth noting that longevity issue. Remember the Mexican Black Eagle bonds of 1843, the first appearance of sovereign pari passu, according toBenjamin Chabot and Mitu Gulati? One distressed-debt investor involved in that history, the Martínez del Río family, also bought up debts from Mexico in 1856 which Gran Colombia (Venezuela’s predecessor state) had defaulted on back in 1826. In the Franco-Mexican war of the 1860s the del Ríos regrettably backed the side getting shot pictured right, so they had to endure bankruptcy before extracting full payment from Venezuela as part of a US treatyIn 1902. On the plus side, the del Río heirs received excellent Oxford educations on the money. JRR Tolkien tutored them.
Excusable defaults
In short, holding out has always been a minority pursuit because there’s a big risk it will take forever to no good end. Most normal creditors take pennies on the dollar from defaulting sovereigns for this reason. They wish for a quiet life, and they calculate (often correctly) that even reduced claims will rebound once unsustainable debts are cleared. We live in a world of “excusable defaults”, not sovereign debtors’ prisons. Sorry, Martin.
This is why Greece just borrowed again at 5 per cent, and Ecuador — Ecuador! — at 8 per cent. Both paid off holdouts quietly along the way, which you could also argue is morally queasy. But it was at their discretion (Greece paid foreign-law bond holdouts in full) and for reasons of policy, including to smooth restructuring.
Technically, US sovereign immunity law also permits a similarly acceptable level of violence, so to speak. Any holdout can collect judgment from a US court, and try to locate assets — but not have enforcement guaranteed. Holdouts can easily get their puppy back, just so long as they make it through a trip down Niagara Falls in a barrel.
Sovereign immunity isn’t working
Technically. This principle is now seriously under siege now that the US Supreme Court both declined to pick up Argentina’s pari passu case and allowed worldwidediscovery of assets in the other case that the country lost that day. The republic’s argument had been that ratable payment targeted at other bondholders (and payment systems) was roundabout attachment of assets. This objection is going to hang around like Banquo’s ghost now until some future sovereign holdout litigation brings it up again (which will depend on the rare event of a restructuring taking place in bad faith).
That’s really the problem here, then. Fragmentation.
We will now have lower US courts deciding whether sovereigns are ‘recalcitrant’ enough in their post-default behaviour to merit a ratable payment remedy: a behaviour test. (Pari passu language — and related boilerplate, like the negative pledge — is ubiquitous in sovereign debt.) The idea is that Argentina was uniquely bad, and therefore sovereigns elsewhere should relax. But this supposed boundary looks testable. At the very least it would involve time-consuming empirical inquiry by courts in order to be sure.
Also, the lower courts will become the primary place for judging the extraterritorial extent of enforcement, which thorny subject we’ll leave for the second post. But suffice to say that’s what the Supreme Court wants, notably including discovery of assets:
There is no [Foreign Sovereign Immunities Act] provision forbidding or limiting discovery in aid of execution of a foreign-sovereign judgment debt­or’s assets…
They ask for infor­mation about Argentina’s worldwide assets generally, so that NML can identify where Argentina may be holding property that is subject to execution. To be sure, that request is bound to turn up information about property that Argentina regards as immune. But NML may think the same property not immune. In which case, Argenti­na’s self-serving legal assertion will not automatically prevail; the District Court will have to settle the matter.
It isn’t so much a recipe for debtors’ prison or for extortion, as for confusion.
Also, if courts don’t or can’t give clear guidance, then we could see ever rising self-help from parts of the plumbing of international finance that may be blocked by intercreditor enforcement of sovereign debt. Any clearinghouse asked to process bonds might turn its nose up if they contain a dodgy pari passu clause, for instance, or custodian banks could think again about signing up to be bond trustees.
Will sovereigns adapt or even remove the pari passu clause, as Martin also suggests? Ah, well. As we’ve noted previously hereherehere, and here (the problem is also very well analysed here), issuers haven’t done very much to change their clauses so far. Some governments have made clear that they don’t believe the clause to allow ratable payment, but even such mild protestations are rare. Again, for now, fragmentation and contractual inertia hold sway, and it will take time to respond. This will further apply to fortifying other anti-holdout provisions in bond contracts, like removing individual rights to litigate, or firming up collective action clauses.
This still doesn’t mean the holdouts have won. As we’ve written previously: so much time and effort has been spent by Elliott, still without a payoff, that it could have done better just to stuff judgment debts in a drawer like the del Rios did, and wait for their moment. The abiding impression then is not of ‘vultures vs debtors’, but of a system in gradual breakdown.
And it isn’t clear what comes next.
Related links:
What will Argentina do with its vultures? – Matt Levine

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