Don’t cry for Argentina

In accordance with the Right Upon Future Offers or RUFO clause (similar to a conventional clause requiring creditors to be treated pari passu) contained in the 2005 agreement on the restructuring of the debt of the exchange bondholders (preventing Argentina from making more favourable repayments to holdouts unless the conditions are the same as for exchange bondholders), the funds paid by Argentina were not handed over to the creditors.

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There finally was no last minute agreement, meaning that Argentina has defaulted once again. The previous default was back in 2001.

On 16 June, the Southern District Court of New York, in the person of Judge Thomas Griesa, ruled that Argentina could not pay USD 539m of interest on its restructured debt (held by exchange bondholders) without paying USD 1.5bn to bondholders having refused previous bond holdouts, led by NML Capital.

In accordance with the Right Upon Future Offers or RUFO clause (similar to a conventional clause requiring creditors to be treated pari passu) contained in the 2005 agreement on the restructuring of the debt of the exchange bondholders (preventing Argentina from making more favourable repayments to holdouts unless the conditions are the same as for exchange bondholders), the funds paid by Argentina were not handed over to the creditors.

Had Argentina agreed to pay USD 1.5bn, it was at risk of activating the RUFO clause and hence of having to compensate the holders of the bonds restructured in 2005 and 2010 (who, at the time, agreed to a 70% haircut on the bonds’ nominal value), which total nearly USD 56bn (all bonds, including those not governed by US law).

Since the country’s foreign exchange reserves reached USD 29bn on 31 May 2014, one understands why Argentina opted to default, as this does not interrupt negotiations with creditors, on the contrary.

Consequences:

  • The country’s economy is not in fine shape, but the situation is markedly better than in 2001 when the country experienced an altogether much more serious economic and social crisis (15% fall in GDP in Q2 2002 compared with a 0.2% decrease in Q1 2014). Public finances are not in the dire straits they were in back in 2001. There remains that the default can but increase the refinancing costs of the central and provincial governments and drive down the peso (hence lead to higher imported inflation, etc.).
  • An agreement remains likely. In the worst case, the RUFO clause expires on 31 December 2014, after which it will be easier to reach an agreement with the holdouts. It is not really in anyone’s interest to accelerate debt repayment at this point in time (in the event of default, it requires only 25% of the holders of an Argentine bond series to vote for an acceleration to obtain the payment in full of the principal and interest for this series). Argentina has 60 days to make a payment before an acceleration becomes possible. The country could also seek to suspend the application of the RUFO clause, but this would require a vote by 85% of exchange bondholders and of 66.7% of bondholders for each bond series, which is not impossible to secure but looks daunting.
  • As interest payments were not honoured on Wednesday (payments were due 30 June, but the 1-month grace period pushed back the deadline to 30 July), S&P logically determined Argentina to be in Selective Defaut (CCC-previously). CDS should be activated by the ISDA Determinations Committee (failure to pay) when it meets today [1]. Note that the 15 members of this committee include Elliott Management, the owner of NML Capital, which is the plaintiff in the case. As for Argentina, it will argue that the funds were transferred to BNY Mellon acting as central depository and that the blocking of the funds was not of its doing. The notional value of the CDS is quite limited at USD 20.6bn, with a net of USD 1.04bn compared with USD 3bn for Greece in 2012. Again, this does not point to the existence of a systemic risk.
  • The Argentine peso and CDS are likely to remain under pressure, although so far the reaction has been quite limited, the default risk having been priced in to a large extent before its occurrence. Argentine CDS were already amongst the most expensive in the world (although they never reached the heights scaled by Greek CDS in March 2012).There remains that Argentina’s 2014 default is a very different credit event to the Greek default in 2012 or the earlier Argentine default in 2001.

  • As regards the exposure of certain corporate to the Argentine risk, our Telecom analysts estimate that Telefonica (4.5% of EBITDA) and Telecom Italia (EUR 650m investment in Telecom Argentina) could come under a little pressure. Other corporate concerned by all this also include Spanish banks Santander and BBVA, also certain car makers.
  • As always, a default has a reputational cost (nullifying recent efforts within the Paris Club and the payment made to Repsol, etc.) and obviously Argentina’s return to the international markets will not be any easier.
  • The ruling by Judge Griesa set a precedent for debt restructurings. It reduces incentives to participate in bond exchanges, notably when governed by US law. Disputes in other jurisdictions could become more chaotic, while sovereign issuers could resort increasingly to Collection Action Clauses (CAC) to avoid wrangles of this type.

Cyril Regnat , Jean François Robin , Juan Carlos Rodado , August 2014

Article also available in : English EN | français FR

Footnotes

[1] Friday, the 1st august

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