Yves here. Martin Khor focuses on the alarm created by the ruling against Argentina that allowed a Paul Singer’s NML, a vulture fund with a small position in Argentina’s bonds, to vitiate a hard-fought bond restructuring. The particularly ugly part that don’t get the attention warranted is that it is widely believed that Singer took a much larger position in credit default swaps, meaning he was seeking to create and betting on an Argentine default. And another ugly wrinkle is the role of private law in these processes. ISDA, a private organization, determines what is an event of default for credit default swaps.
Singer was on the committee that voted whether Argentina was in default (recall it had made payment under the restructuring to the trustee, Bank of New York, but BONY was barred by the court from remitting payment to the bondholders). This gave him a direct say in an event in which he had a large economic interest. And that was no lucky accident.
Lisa Pollack of FT Alphaville described in 2011 how ISDA is set up to make sure CDS payouts take place, regardless of the merits of the case. Who will have CDS positions? Parties either buying insurance or betting on failure. Who gets to vote on whether an event of default has occurred? From her post (emphasis hers):
Imagine playing a game where you bet on the outcome of a certain event. Most of the time the final outcome is unambiguous: you play, and afterwards, it’s clear whether you won or you lost. But every now and then, the result is hazy. Did the ball go into the goal? Was there a handball? Did he reach base?
This is usually where a referee steps in to decide.
So, it’s worth asking, how should referees be chosen?
Knowledge of the game is a sensible prerequisite. Also, the referee shouldn’t be conflicted. For example, anyone who has bet on the outcome of a match probably shouldn’t be the one who awards penalties.
And there’s no reason why what’s true of sports referees shouldn’t also be true of market referees, such as the International Swaps and Derivatives Association (Isda).
However, Isda picks the members of a committee that determines who has won and lost in the game of credit derivatives by selecting those who have the greatest potential to be conflicted. (And then it indemnifies them.)
And her conclusion (emphasis ours):
In summary, 10 out of the 15 members of the committee are picked because they are likely to have the biggest positions in any CDS contract under examination.
In other words, aside from how inefficient this looting is (as in the very high economic costs to the economies involved relative to the returns the vulture funds make on their sovereign adventurism), there are separately serious issues about the legitimacy of the process by which they make their outsized returns.
This post describes how experts are very concerned about the precedent set by Judge Griesa’s ruling against Argentina. Bear in mind that some legal experts contend that it does not have broad implications, that Griesa’s ruling keyed off specific terms in Argentina’s bonds that are absent from most sovereign issues. Nevertheless, there is a troubling tendency in jurisprudence for ruling creep.
By Martin Khor, Executive Director of the South Centre, Geneva. Originally published at
External debt is rearing its ugly head again. Many developing countries are facing reduced export earnings and foreign reserves.
No country would like to have to seek the help of the International Monetary Fund to avoid default.
That could lead to years of austerity and high unemployment, and at the end of it, the debt stock might even get worse.
Low growth, recession, social and political turmoil are probable. This has been experienced by many African and Latin American countries in the past, and by several European countries presently.
When no solution is found, some countries then restructure their debts. Since there is no international system for an orderly debt workout, the country would have to take its own initiative.
The results are usually messy, as it faces a loss of market reputation and the creditors’ anger. But the country swallows the pill, rather than have more turmoil at home.
Such was the experience of Argentina, whose public debt reached 166% of GDP in 2002. After many years of decline and political instability, Argentina defaulted in 2001.
Argentina then arranged for two debt swaps in 2005 and 2010, thus restructuring its debt with 93% of its creditors, who agreed to receive about a third of the original debt value. But 7% of creditors, known as “holdouts”, did not agree to the restructuring.
A few influential hedge funds (comprising only 1% of creditors) which had bought some of the debt very cheaply on the secondary market, sought a court order in New York (where the original loans had been contracted) to be paid in full.
There are several such funds, now popularly termed “vulture funds”, that specialise in buying distressed debt at low prices (say, 10% of the original loan value) and then insist through the courts on being paid in full with interest.
Like vultures, they circle overhead and swoop to make a meal of the dead or dying bodies. Only in this case the bodies are countries and they are asked to squeeze their shrivelled economies further to pay the vulture funds, like drawing blood from a stone.
The United States judiciary, after a long process that went to the Supreme Court, decided a few months ago that the holdout hedge funds that took up the case should indeed be paid in full, and with interest.
Further, it decreed that the 93% of creditors who had already agreed to be paid at a big discount, are now not allowed to be paid, unless the vulture funds are paid in full at the same time.
The New York judge used the principle of pari passu (that all creditors should be treated the same) in reaching the decision.
Argentina had already arranged with a bank in New York to pay out interest to the 93% a few weeks ago, but the bank refused to do so, due to the court order.
The vulture funds want their pound of flesh. The main fund, NML Capital, would make an estimated 1,600% profit.
Argentina’s President Cristina Kirchner refused to bow to these funds. If she did, the country might have to also repay all the creditors the full value, which is US$120bil (RM384bil), and that is impossible to do.
This incredible turn of events has caused outrage among many public interest groups and anger among developing countries’ governments.
The South Summit of the G77 in May in Bolivia criticised the vulture funds and called for a proper global debt restructuring mechanism.
Finance ministries of developed countries have been concerned as well as they are also affected.
Greece also went through debt restructuring, in which private creditors agreed to take a loss, a few years ago.
Accepting the court decision as the new template would make it quite impossible for any country to restructure their debts, since the now emboldened vulture funds would pounce and block it.
Influential Financial Times commentator Martin Wolf has supported Argentina in its battle with the vulture funds. Wolf even went so far as saying that it is unfair to the real vultures [i.e., the birds] to name the holdouts as such, since at least the real vultures perform a valuable task!
At the end of August, the Swiss-based International Capital Market Association, a group of bankers and investors, issued new standards aimed at reducing the ability of holdout investors to undermine debt restructuring.
Last week, the Group of 77, representing developing countries, succeeded in promoting a resolution at the United Nations General Assembly which recognised that a state’s efforts to restructure debt should not be impeded by hedge funds that seek to profit from distressed debt.
The General Assembly, by a vote of 124 in favour, 11 against and 41 abstentions, also decided to set up a multilateral legal framework for sovereign debt restructuring by the end of 2014, to increase the stability of the international financial system.
An international debt restructuring mechanism will be a systemic solution, since countries with debt crises can have recourse to an international court or system and need not do a messy debt restructuring on its own.
There will now be an uphill battle to get the resolution implemented, since the US, Germany and Britain (all key countries in global finance), were among those which objected.
Another resolution, initiated by Argentina, is now being considered by the UN Human Rights Council, aimed at setting up legal frameworks to curtail vulture funds’ activities and for sovereign debt restructuring.
One good thing is that the UN, which is a universal body in which developing countries have a greater say in decision-making, is now at the centre of the debt discussion.
The negotiations ahead will be tough but well worth it since preventing and managing a debt crisis is now a priority for a growing number of countries.