By Sujata Rao
LONDON, Dec 10 (Reuters) - A legal clause as the key to
smoothing future debt restructurings could be undermined by a
U.S. court ruling that Argentina must pay creditors holding its
The case has implications for emerging markets, source of
protracted and painful past defaults, and for Europe, where the
rules setting up the euro zone's bailout fund state that
government bonds must carry Collective Action Clauses from 2013.
Known as CACs, the clauses make a restructuring binding for
all creditors if agreed by a specified majority -- usually 75
percent. They are intended to eliminate the risk that some
investors will shun offers and take legal action to squeeze cash
from the debtor, often dragging the process out for years.
But 'Argentina vs NML Capital' revives the threat that such
holdouts will stall future debt restructurings. The U.S. court
ruling upheld the principle of pari passu, meaning debtors
cannot pick and choose between creditors.
In Argentina's case, that means the hedge funds which
brought the litigation, and which refused to participate in two
debt restructurings accepted by 93 percent of bondholders, must
be paid what they are owed alongside those who did take part.
That has galled investors who took a 70 percent writedown on
Argentine debt during the 2005 and 2010 swaps. The Argentine
debt did not have a CAC, but the ruling could make it harder to
secure the majority needed to trigger CACs in future.
"Such a ruling creates a big incentive to be a holdout going
forward," said Bart van der Made, lead portfolio manager at ING
Investment Management, which swapped its Argentine bonds.
"If you think there's a judge waiting around the corner who
says you will be paid in full and with past due interest --
well, in that case, everyone will hold back and you won't hit
the 75 percent approval rate required to (trigger) the CAC."
As the process drags on, more interest accrues, pushing the
debt up further and impelling the borrower to concede more to
creditors - some of whom may have bought their debt at vastly
discounted prices - to secure a deal.
"In a new-type restructuring people may get extreme in their
demands," van der Made added. "If a country comes with a
proposal, bondholders will have a strong hand and could make it
very hard for a country to get the resolution it needs."
Perhaps emboldened by the Argentine case, hedge funds last
week proved reluctant to participate in a Greek bond buyback,
the timetable for which had to be extended after Greece
initially fell short of its target despite generous pricing.
Greece retroactively inserted CACs into its domestic bonds
to enable a successful swap in March, but still has 6.4 billion
euros of foreign law bonds, the terms of which can't be altered.
Some of these will have been tendered in the new buyback,
but many hedge funds say they plan to hold on to their Greek
debt in expectation they will be repaid at par later.
Analysts at JP Morgan advised Greece prior to the buyback to
enforce its CACs, estimating that by doing so debt relief would
be double what it would get if it allowed some creditors to hold
If the swap is voluntary, "the burden of achieving the 30
billion euro participation will likely fall mostly on Greek
banks, and expectations will rise that the remaining bond
holders will eventually be paid in full," JPM said in a note.
That happened last May when Greece, spooked by the prospect
of lengthy legal battles, paid 435 million euros to bondholders
who had refused to exchange during an earlier swap.
CACs have been included for nearly a decade on sovereign
bonds issued on international markets -- a 2008 Duke University
study found them in over 90 percent of bonds under U.S. law.
Emerging market countries, some of which have bought back
billions of dollars of older debt and replaced it with CAC
bonds, have expressed concern about the ruling's impact.
Alexandre Tombini, the central bank governor of Brazil,
itself a past debt defaulter, has said the rulings against
Argentina set a bad precedent.
Hedge funds, however, are excited at the prospect.
"I think you'll look back in two or three years' time on
this crisis and the Argentine U.S. court decision ... will prove
to be a very, very interesting juncture - a very strong
strengthening of a creditor's hand and a weakening of
governments," said Lee Robinson of hedge fund Altana Wealth.
Funds that specialise in buying up defaulted debt at a
fraction of face value and then pursuing the issuer for
repayment at face value are sometimes known as vulture funds,
although they argue they are upholding creditors' rights. They
can be aggressive in trying to secure payment: the two hedge
funds suing Argentina recently seized a naval ship off Ghana.
Recalcitrance has been profitable in the past, with
countries from Peru in 2000 to Greece in 2012 having paid
holdouts rather than do battle in court.
Argentina says its own law prevents it from paying holdouts,
however, making compliance with the U.S. ruling illegal.
One creditor group does still enjoy preferential treatment
during restructurings, however: the official sector, including
the International Monetary Fund, although rating agency Moody's
notes this status is conferred by practice rather than law.
"The court ruling, which strengthens the pari passu clause
in bond contracts and stipulates equal treatment of creditors,
could potentially raise questions about the "senior" status of
official sector lenders," Moody's said.
(Additional reporting by Laurence Fletcher)
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