After the ‘battle of the century’: what next for debt crisis management?

13 May 2016 by Bodo Ellmers

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In late April, the ‘battle of the century’ between the government of Argentina and a group of vulture funds reached an inglorious end. The government of Argentina finally surrendered and paid the vulture funds in full, at a price tag of more than US $10 billion. The consequences are severe: Argentina started a new cycle of indebtedness; the vulture funds’ predatory business model has been further strengthened and threatens to affect more and more nations; and future debt crisis management in general is in a mess. Now this battle has been lost, the question remains: what next for debt crisis management?

Argentina: back to markets or back to debt crisis?

Argentina had to borrow the money it needed to pay the vultures, thus it returned to financial markets after more than a decade of absence. To the surprise of many financial market Financial market The market for long-term capital. It comprises a primary market, where new issues are sold, and a secondary market, where existing securities are traded. Aside from the regulated markets, there are over-the-counter markets which are not required to meet minimum conditions. observers, the bond Bond A bond is a stake in a debt issued by a company or governmental body. The holder of the bond, the creditor, is entitled to interest and reimbursement of the principal. If the company is listed, the holder can also sell the bond on a stock-exchange. issue of the former pariah state was hugely oversubscribed. In the largest emerging market issuance ever, Argentina managed to raise US $16.5 billion in three different bond series that yielded on average 7.2%. This successful return has the caveat that it starts a new cycle of indebtedness. While the government of Argentina hopes that the ‘normalisation’ of financial relations will attract foreign investment, none of these borrowed dollars will be invested productively. The lion’s share Share A unit of ownership interest in a corporation or financial asset, representing one part of the total capital stock. Its owner (a shareholder) is entitled to receive an equal distribution of any profits distributed (a dividend) and to attend shareholder meetings. of more than US $10 billion went to pay the vulture funds Vulture funds
Vulture fund
Investment funds who buy, on the secondary markets and at a significant discount, bonds once emitted by countries that are having repayment difficulties, from investors who prefer to cut their losses and take what price they can get in order to unload the risk from their books. The Vulture Funds then pursue the issuing country for the full amount of the debt they have purchased, not hesitating to seek decisions before, usually, British or US courts where the law is favourable to creditors.
; the smaller share replenished Argentina’s depleted currency reserves, i.e. mainly to refinance capital flight.

The issuance was a perfect deal for investors. It soon turned out that Argentina had sold the bonds too cheaply. Prices surged in the first few days, allowing the banks that were the bookrunners to make quick profits. JP Morgan celebrated:“These yields don’t exist anywhere else in the world in countries with such low levels of debt.”

Argentina’s citizens are paying the price for their government’s strategy of pleasing foreign investors. The recent removal of exchange restrictions has resulted in a 40% currency devaluation Devaluation A lowering of the exchange rate of one currency as regards others. and a spike in inflation Inflation The cumulated rise of prices as a whole (e.g. a rise in the price of petroleum, eventually leading to a rise in salaries, then to the rise of other prices, etc.). Inflation implies a fall in the value of money since, as time goes by, larger sums are required to purchase particular items. This is the reason why corporate-driven policies seek to keep inflation down. . Subsidies on essential services have been removed and, by March 2016, 32,000 public service workers had been laid off.

Vulture funds: a menace to debt restructurings and to democracy

Argentina’s payments to the vulture funds have repercussions far beyond this case. They have replenished the funds’ war chests by an additional US $10 billion, enabling them to attack more nations. Puerto Rico and Belgium have become the first countries to fall prey to their new aggressions.

Vulture funds, in particular Aurelius capital, have purchased Puerto Rican bonds, which have junk bond status and are traded far below nominal value on secondary markets. The vultures’ financial firepower not only allows them to prepare for litigation. They have also started a public relations campaign to influence public opinion in their favour. For instance, they hired some retired International Monetary Fund (IMF) officials to draft a ‘research’ paper, which argues that Puerto Rico would be able to fully service its huge debt burden if the government just imposed ever harsher austerity measures on the population. Quite obviously, their campaign targets not only the Puerto Rico case, but also relevant bankruptcy legislation processes going on at the US Congress and US opinion in general. Even the comedian John Oliver felt challenged to comment on the case.

Belgium is another example where vulture funds are attacking democratic legislation processes. The small European country passed the world’s most comprehensive vulture fund legislation in 2015. Belgian law determines that a vulture fund can never make more money through litigation than it paid for the concerned debt instruments in the first place, if there is a large discrepancy between the nominal value at issuance and the price it paid for it. This law renders the vultures’ business model unattractive. Investors can still recover their money, but they can no longer use the litigation strategy to make exorbitant profits. Not surprisingly, the Belgian law that has inspired the United Nations (UN) to call for similar legislation in other countries has disgusted vulture funds. So they filed a lawsuit at the Belgium Constitutional Court, hoping that it would make clear that the vulture fund law infringed the Belgian constitution.

Creditor participation: fair burden sharing and good faith?

Another consequence of the vulture funds’ victory is that thousands of responsible investors have been fooled. Until recently, Argentina has been a country with low levels of debt, as JP Morgan correctly analysed. But this was because, after the Argentine debt crisis of 2001/02, the vast majority of investors holding Argentine debt participated in debt restructurings and agreed to write off a substantial share of their investment. Now the vulture funds have proved that, if you hold out and manage to procure the help of New York judges, profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. rates of more than 1,000% on your investments are possible. That means those who cooperated in good faith are the fools who helped to restore Argentina’s solvency, but who also enabled Argentina to borrow again and pay the vultures. Following this experience, debt crisis management can no longer count on voluntary creditor participation.

What next for debt crisis management?

So the question remains: what can indebted countries in particular – and the international community in general – do to counter the surging vulture plague? The answer is: there are a number of options:

1) An international insolvency regime for sovereign debtors
A vulture fund lawsuit against sovereign debtors is possible because there is no bankruptcy protection for this kind of debt. This is in contrast to corporate debt, where specialised insolvency courts are mandated to make binding decisions, and codified insolvency law guides their decision making. That this governance gap exists is not news – lots of conceptual work has been done at the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.
as well as at the UN to fill it.
The multilateral solution is certainly the best and most effective one. The dilemma is, however, that it depends on multilateral consensus, including by those nations that host financial centres and in which vulture funds fuel the political system with party donations. The IMF and UN attempts have been stopped by US and UK resistance primarily. The processes at both institutions must be kept alive however, as windows of opportunity can pop up at anytime. For instance, many decision makers in Washington have learnt through the Puerto Rico case (a US territory/colony) that better bankruptcy protection for sovereigns is not so bad after all, even if it is just to avoid creditor bailouts funded by taxpayers’ money. Both institutions, the UN and the IMF, have mandates to pursue further reforms.

2) National vulture fund legislation
The Belgian law has been a remarkable innovation. It complemented a British law that was passed when it became clear that vulture funds’ lawsuits against Heavily Indebted Poor Countries Heavily Indebted Poor Countries
In 1996 the IMF and the World Bank launched an initiative aimed at reducing the debt burden for some 41 heavily indebted poor countries (HIPC), whose total debts amount to about 10% of the Third World Debt. The list includes 33 countries in Sub-Saharan Africa.

The idea at the back of the initiative is as follows: a country on the HIPC list can start an SAP programme of twice three years. At the end of the first stage (first three years) IMF experts assess the ’sustainability’ of the country’s debt (from medium term projections of the country’s balance of payments and of the net present value (NPV) of debt to exports ratio.
If the country’s debt is considered “unsustainable”, it is eligible for a second stage of reforms at the end of which its debt is made ’sustainable’ (that it it is given the financial means necessary to pay back the amounts due). Three years after the beginning of the initiative, only four countries had been deemed eligible for a very slight debt relief (Uganda, Bolivia, Burkina Faso, and Mozambique). Confronted with such poor results and with the Jubilee 2000 campaign (which brought in a petition with over 17 million signatures to the G7 meeting in Cologne in June 1999), the G7 (group of 7 most industrialised countries) and international financial institutions launched an enhanced initiative: “sustainability” criteria have been revised (for instance the value of the debt must only amount to 150% of export revenues instead of 200-250% as was the case before), the second stage in the reforms is not fixed any more: an assiduous pupil can anticipate and be granted debt relief earlier, and thirdly some interim relief can be granted after the first three years of reform.

Simultaneously the IMF and the World Bank change their vocabulary : their loans, which so far had been called, “enhanced structural adjustment facilities” (ESAF), are now called “Growth and Poverty Reduction Facilities” (GPRF) while “Structural Adjustment Policies” are now called “Poverty Reduction Strategy Paper”. This paper is drafted by the country requesting assistance with the help of the IMF and the World Bank and the participation of representatives from the civil society.
This enhanced initiative has been largely publicised: the international media announced a 90%, even a 100% cancellation after the Euro-African summit in Cairo (April 2000). Yet on closer examination the HIPC initiative turns out to be yet another delusive manoeuvre which suggests but in no way implements a cancellation of the debt.

List of the 42 Heavily Indebted Poor Countries: Angola, Benin, Bolivia, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Comoro Islands, Congo, Ivory Coast, Democratic Republic of Congo, Ethiopia, Gambia, Ghana, Guinea, Guinea-Bissau, Guyana, Honduras, Kenya, Laos, Liberia, Madagascar, Malawi, Mali, Mauritania, Mozambique, Myanmar, Nicaragua, Niger, Rwanda, Sao Tome and Principe, Senegal, Sierra Leone, Somalia, Sudan, Tanzania, Togo, Uganda, Vietnam, Zambia.
(HIPC) imply that UK aid funds are de facto used to feed vultures, instead of their stated purpose of fighting poverty. Thus, two countries have vulture fund legislation in place. However, the UK law covers only a small group of HIPC countries. The UN, in paragraph 100 of its recent Addis Ababa Action Agenda on Financing for Development, encourages all governments to take similar action. Moving towards national vulture fund legislation could be a way forward for countries that host important financial centres but have a certain aversion to multilateral solutions – such as the UK or particularly the US.

3) Sidelining uncooperative financial centres
There also actions that can be taken by the issuers of foreign bonds. It is mostly the governments of emerging and developing countries that are issuing bonds in foreign currency and under foreign legislation. These are the ones that vulture funds are particularly targeting. Many were surprised how badly New York’s court treated Argentina; how it bent the pari passu clause to please the vulture funds.
Argentina is traditionally one of the largest emerging market bond issuers, an important client for Wall Street banks. But it made (as it eventually turned out) the terrible mistake of issuing bonds under New York law. Of course, in globalised financial markets there are lots of alternatives to the financial centre of New York. Even countries that strive to issue US-dollar denominated bonds can easily do so in European or Asian financial centres. Or in some cases even under domestic legislation, which should be the preferred option. Thus they can avoid a location, which, from the perspective of effective debt crisis management, must nowadays be called an uncooperative financial centre.

Moving forward

Debt sustainability indicators in many countries are currently deteriorating rapidly. The latest Global Sovereign Indebtedness Monitor by Jubilee Germany found debt problems in 108 emerging and developing countries. The IMF also warned at its recent Spring Meetings that financial stability risks are growing. More debt crises will come and more debt restructurings will be needed. Urgent action by policymakers is therefore indispensable in order to create a regime that makes fair, speedy and effective debt crisis management possible, and options to move forward do exist.




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