When the US Supreme Court returns from summer recess in October it will announce which petitions, out of the many it receives, will earn their case the right to be heard. One of these, NML v. Argentina, pits a unit of New York hedge fund Elliott Management and other investors against Argentina. The plaintiffs, bondholders of debt that Argentina notoriously defaulted on in 2001, have been referred to as “vulture funds” for their distinctive strategy. A decision in favor of the plaintiffs would provide an incentive to other investors to emulate them in the future and only serve to increase the mistrust between the Argentine government and international creditors.
Elliott and other likeminded investors have been called “vulture funds” by critics because of their strategy of buying cheap bonds of nations that have defaulted or are expected to do so. The bonds are bought on the secondary market from investors who want to get rid of them. The funds use their financial resources and a lot of persistence, to sue for the full value of the bonds in countries where the nation has assets or where its assets pass through (banks, clearing houses, trading companies). The strategy has been used successfully by a small group of funds since the introduction of Brady Bonds in the 1980’s made it easier for original creditors to sell bonds on the secondary market. Elliott has been a key player from the beginning; arguably its greatest victory came with Peruvian bonds of which it made a 400% profit in 2000.
Elliott’s most creative tactic in its decade long battle against Argentina was its success in persuading a court in Ghana to seize a Navy ship belonging to the country last year; the decision was later overturned by a UN maritime court. When the ship returned to Argentina three months later President Kirchner greeted it with fireworks and a speech in which she celebrated a victory over “anarcho-capitalism.” This is one blatant example of how “vulture fund” tactics have not modified the behavior of Argentina’s government towards international creditors; they have only made it more combative.
In the case against Peru, Elliott successfully used an argument that other bondholders could not get paid back until it had received the full amount it was requesting. Unfortunately for Argentina, lower federal courts have already decided, with no chance of Supreme Court review, that the same rule applies in this case. Given Kirchner’s adamant refusal to pay back the $1.33 billion the bondholders want, an upholding of a lower court’s decision that Argentine assets must go to the plaintiffs and a refusal by the Supreme Court to hear the case will most likely result in a default on all current debt obligations. This would be a disaster for the nation, which has not been able to borrow money from international bond markets since its default. It would also be bad news for the 93% of bondholders that accepted earlier restructuring deals with lower repayments in 2005 and 2010.
To prevent another default, Argentina’s lawyers have asked the Supreme Court to consider whether existing US Sovereign Immunity legislation “limits the power of courts to issue injunctions [a court order] against [Argentina in this case]” and argue that this case is a situation of “credit risk and not legal matter” according to Henry Weisburg, a lawyer at Shearman and Sterling in New York. Either argument being accepted would be great news for Argentina. However, according to a publication by Shearman and Sterling, Argentina’s chances of being heard by the high court could be around 4%.
The fact that France, an important party in sovereign debt restructuring deals, filed a Supreme Court brief in support of Argentina last month could improve its chances. France’s brief stated that a “powerful incentive” for investors to continue these tactics was the reason for its backing for the nation. France, the IMF (which considered filing a brief) and other parties to debt restructuring deals would have less power at the bargaining table if investors believe they have a good chance of getting back the full value of bonds through the courts. This could hinder debt relief efforts under the Highly Indebted Poor Countries Initiative of the World Bank and IMF as well as bond restructurings linked to austerity in more developed countries.
France’s concerns are logical, but there are other factors, which could limit the success of the “vulture” strategy in the future. Belgium and the UK, whose courts were used by “vulture funds,” passed legislation in 2008 and 2010 respectively that prevent such cases being brought against poor countries as defined by the IMF. Similar legislation has been introduced in the US and Australia but has not yet passed. As things stand, national legislation targeting these funds is not enough of a deterrent to the strategy in question.
The best deterrent could come from debtor nations themselves. Since Argentina’s last default, sovereign bond contracts have begun to include a new clause. Known as a Collective Action Clause or CAC, it requires a bondholder to accept a restructuring deal if the majority approves. Unfortunately for debtor nations, it is not yet universally applied. Greece benefitted from this clause during its default last year with domestic bonds but not with those under foreign law; Dart Management, another so called “vulture fund,” was able to capitalize on this discrepancy by making about 30% profit on its bonds while domestic creditors lost around 75%.
A lot is riding on the outcome of this latest case; if the investors win, the Collective Action Clause would be a nation’s best tool to ensure it is not in Argentina’s position in the future. “Vulture funds” will be around to reap very high returns for their investors as long as there are bonds without it. A victory for the bondholders would also extend Argentina’s absence from international bond markets.