July was not a good month for Argentina. On the 13th, with just minutes left in overtime at the FIFA World Cup final in Rio de Janeiro, national soccer hero Lionel Messi lifted a free kick over the crossbar of Germany’s goal, spoiling his country’s last chance at winning the coveted trophy.
Seventeen days later Argentina lost another hard-fought battle: Ratings agency Standard & Poor’s declared it in default of its debt for the second time in 12 years, throwing the South American nation, its creditors and custodian Bank of New York Mellon Corp. into a complex web of litigation. This time around, Argentinean President Cristina Fernández de Kirchner has denied S&P’s charge. The fallout could change the relationship between custody banks and sovereign debt issuers.
At roughly $100 billion, Argentina’s 2001 sovereign default remains the biggest ever, and creditors have borne the brunt. Investors holding about 92 percent of the country’s bonds voluntarily accepted a 70 percent haircut following restructurings in 2005 and 2010. The remaining holdouts didn’t exchange their paper and demanded full repayment.
On June 26 the Argentinean government deposited $539 million, intended to pay interest on the most recently restructured debt, into a BNY Mellon account. Come June 30 the New York–based bank, which became trustee to Argentina in 2005, refused to distribute the funds to the holders of restructured debt, in accordance with a controversial U.S. court ruling.
Several hedge funds bought defaulted Argentinean bonds from the holdout investors in 2001 at a steep discount. In a move deemed predatory by many, the hedge funds, led by Paul Singer’s NML Capital, the Cayman Islands–based offshore unit of his New York firm Elliott Management Corp., sued Argentina for the bonds’ original face value plus interest. In 2012 Thomas Griesa, U.S. district judge for the Southern District of New York, ruled in NML’s favor: Argentina must pay the holdouts in full, roughly $1.5 billion, before servicing interest on the restructured bonds.
Griesa’s ruling sets a dangerous legal precedent for future sovereign debt restructurings that could crucially impact the international financial system, according to some observers. In late June the United Nations Conference on Trade and Development published an essay arguing that it “represents a significant setback for international sovereign debt restructuring” and “remove[s] financial incentives for creditors to participate in orderly debt workouts.” In other words, bondholders may be more reluctant to accept haircuts on restructured sovereign debt; if so, countries might suffer harsh political, economic and social consequences.
“In my view, this is a suggestion that we need to have a more coordinated international debt-restructuring mechanism that would provide a degree of certainty to the market,” says Odette Lienau, an associate professor at Cornell University Law School who specializes in international economic law, bankruptcy and debtor-creditor relations. Custodian banks, investors and others associated with sovereign debt should press for rules and mechanisms to help limit the fragmentation among the parties involved in restructuring, Lienau adds.
Big international players seem to agree. In early September the U.N. General Assembly approved a multilateral legal framework for sovereign debt restructuring to improve coordination and efficiency. Also, the International Capital Market Association trade group recently proposed collective action clauses that bind all sovereign bondholders to a restructuring if at least 75 percent of them agree. But these proposals are guidelines, Lienau notes, so compliance by members isn’t guaranteed.
If BNY Mellon’s experience is any indication, the threat of losing business after a sovereign debt restructuring could leave custodians reluctant to act as trustees. In August and September, respectively, the Argentinean government revoked the bank’s operating license for the country and voted to remove its trusteeship.
The country plans to replace BNY Mellon, the world’s largest custodian of assets for central banks, sovereign wealth funds and national pensions, with state-run Banco de la Nación Argentina and allow creditors to swap bonds for newly issued ones governed by Argentinean and French legislation through another restructuring. This change would skirt BNY Mellon and the U.S. financial system.
BNY Mellon had no comment on the developments. Although a source close to the bank asserts that most of the services offered through its Argentinean representative office haven’t been affected, it will surely feel the pinch by year-end. In the second quarter of 2014, non-U.S. clients accounted for 38 percent of BNY Mellon’s total revenue.
Requiring that the custodian be based in the same jurisdiction as the law controlling the sovereign debt from the start of the restructuring might help avoid future calamities, Cornell’s Lienau suggests. “Of course, that’s difficult and lowers the potential economies of scale” because there might have to be separate custodians for debt issuances in multiple countries, she adds. Also, a single bank would prefer to have all of the business because it would earn more from fees.
Custodians may grow wary of accepting trusteeship of sovereign debt that is subject to multiple jurisdictions. Back in 2005, Argentina appointed BNY Mellon trustee of debt issued under U.S., U.K. and Japanese laws, among others, and in different currencies; governments often make such moves to appeal to diverse creditors.
Unlike other sovereign debt debacles, however, Argentina’s case involves a patchwork of jurisdictions with widely varying views on custodial obligations. BNY Mellon is caught in a catch-22. In abiding by Griesa’s ruling, the bank violates its fiduciary duty to dish out interest payments to Argentinean bondholders.
But if BNY Mellon forwarded the payments, it would be in contempt of U.S. law. In August several holders of Argentina’s restructured debt, including George Soros’ Quantum Partners and Kyle Bass’s Hayman Capital Management, filed a lawsuit against the bank in London for refusing to surrender €226 million ($291 million) in interest. President Fernández and Soros met on September 22, though details of their discussions have not yet been released.
The plaintiffs claim they’re entitled to their interest payments because Judge Griesa doesn’t have jurisdiction to bind their euro-denominated bonds, which are held under English law. Griesa’s argument: The payments are routed through New York, so they fall under his jurisdiction.
A complicated administrative process follows Argentina’s vote to issue new debt locally, and time is running out: The next interest payment is due at the end of September. The country is making a concerted effort to repay its restructured debt and resolve the hedge fund situation, it appears, and creditors have yet to call for accelerated repayment in response to the default. This holding pattern may persist. “I don’t think the world is going to end September 30,” Lienau concludes. Let’s hope she’s right.
Follow Georgie Hurst on Twitter at @Ghurst_iimag.
