Around the world in Argentine bond payments?

Beyond all the interesting ( maybe precedent-setting ) stuff about pari passu …

Since last week’s US Appeals Court ruling went against Argentina, there’s been a lot of comment about how the country could try changing the trustee or payments structure of the bonds which came out of its 2005-2010 restructuring.

The basic idea would be for the government to make sure it can still service these bonds — including pars, discounts, and those famous GDP warrants — without simultaneously having to make payments on the holdouts’ debt as ordered by US courts. In a word, to Griesa-proof them. In a concept, to somehow offshore payments to a place outside US jurisdiction.

Sounds a bit dry… until you look at the inverted CDS curve for Argentina this week:

(Charts via Markit, click to enlarge.)

There are a few ways in which “offshoring” or “rerouting” payments — or just stopping them outright and defaulting: this is President Cristina Fernández de Kirchner ultimately pulling the levers, folks — could trigger CDS. As if the Argentine government particularly cares about credit events. In one sense, the interesting part of this story is really just the unfathomable depths of the Kirchner government’s hatred for holdouts. But also, we think, there’s kind of a lesson here for the widening difference between treatment of foreign-law and local-law sovereign debt.

First, though, a casual observer might be confused by what the Appeals Court decision says about foreign-law (here, New York law) debt. On the face of it, the case gave us a simple demonstration of why bondholders might want their debt governed by NY or English law — the holdouts got the creditor protection this is supposed to give them and other bondholders (pending possible further appeal by Argentina).

NY-law bonds become harder for a sovereign to just plain walk away from at this point. And yet, the talk now is about the restructured foreign-law debt potentially not getting paid, because of what the court said about having to pay the holdouts as well.

The reality is that there is no real contradiction, because the latter problem really only comes from the Argentine government hating the holdouts with such passion that the whole superstructure of its debt exchange is now seen in danger of being defaulted upon.

And so we turn to this idea of tinkering with the restructured bonds’ trustee or payments agent. Judge Griesa already told Argentina not to do this:

…altering or amending the processes or specific transfer mechanisms by which it makes payments on the Exchange Bonds without approval of the Court.

The fact that everyone thinks Argentina will try it anyway just goes to show how determined they’d be to avoid the ultimate order of Griesa and now the appeals court: paying up Elliott. And also how Argentina has habitually ignored US court judgements on the restructuring.

So, how to go about altering payments?

Just for some context, it’s worth going back to read through the original debt exchange prospectus documents. Even on a quick skim you can get a sense of the importance – and careful wording – of the trust indenture which sets up Bank of New York as trustee for bondholders. (Trustee structures in general remain fairly new innovations in sovereign debt.)

There are also details that set out how Argentina sends payments on the bonds to the clearing intermediaries which then distribute them on to actual bondholders, and also complex procedures for further modification of the bonds’ terms. The latter involve collective action clauses with varying degrees of voter threshold.

In short, it’s complicated.

But here’s Barclays’ analysts’ take on what the terms allow, in an excellent note published on Monday (it’s also worth reading Sid Verma’s great post over at Euromoney on these points). Their first scenario starts out fairly simple, for example:

The possibility of using another paying agent does not require bondholders to vote. The change in the paying agent can be done unilaterally by the Republic without this constituting a default event under the “Trust Indenture”. This means that the administration can buy some time changing the domicile of the payment agent. However, eventually, holdouts would likely file a similar “pari passu” case in other jurisdictions around the globe, forcing the administration to retreat to Argentine jurisdiction. And this takes us to the next question: can the administration actually pay external law bonds inside Argentina? It is possible that investors could be asked voluntarily to open an account locally in Caja de Valores. But if a small number of bondholders did not agree with this, they would have the ability to push the Republic into default, which would also trigger CDS. And it does not take much to assume that the current plaintiffs could be that “small number of bondholders”. This implies that the strategy of changing the location of the payment agent, while technically viable, would likely force the Republic inside its own jurisdiction at the end of the road. And paying inside its jurisdiction would likely mean a higher probability of default and the triggering of CDS contracts at some point in the future.

Another possible alternative would be a voluntary swap into local law bonds. Such a swap could be set up rather fast locally, but could potentially imply default as some bondholders might become holdouts. And given the impossibility of paying in the United States, it would imply default on those holdouts. Alternatively, using CACs, by the petition of the Republic, with a “special majority” (because it would be a “Modification of a Reserved Matter”) of 85% of the bondholder support, bondholders could change the governing law of the 2005 and 2010 restructured securities. In such an event, as in Greece, the use of CACs would imply that CDS would trigger according to ISDA, but the Republic could remain current on new local debt.

We think the main problem with the first idea — “rerouting” payments through Europe or elsewhere, in fact everywhere short of the US or Buenos Aires — is creating exactly the situation Argentina doesn’t want: further legal victories for holdouts. Elliott’s claim against Argentina is fairly small relative to the other potential holdouts out there. The outstanding principal on holdout bonds is $6bn, with interest past due possibly amounting to $12bn. Letting these holdouts smell blood during a lengthy chain of litigation related to payment agents might be a bit silly. Then again, we wouldn’t put any bloody-mindedness past President Fernández de Kirchner.

Also, another obstacle pointed out to us this week is simply that Argentina may well require the cooperation of US lawyers or banks to carry out either of these options. With Judge Griesa yet to clarify how third parties should be affected by his ruling, those actors may tread carefully.

But the second option outlined by Barclays — a local-law exchange, a fairly blunt instrument for solving foreign-law issues — is particularly problematic for the government. (It’s not just that an exchange could also manufacture even more holdouts, though there’s also that.)

There’s the small matter that Argentina’s best hope of access to borrowing — when foreign-law issuance is more in doubt than ever — would be in local-law bonds.

Every now and again (but with increasing force lately) USD local-law bonds in Argentina undergo a period of anxiety about forced redenomination into the Argentine peso. The recent odd incident with the Chacos provincial government moving to pay dollar debt in pesos is a case in point. Well, in general, domestic law is inherently sketchier, and the Greek restructuring-through-retroactive-legislation of March 2012 is a fresh enough memory. The point is, falling back on the mutability of local-law debt to solve this foreign-law dispute – primarily in order to snub holdouts to the bitter end – just might cast some doubts in the minds of holders of the local-law paper.

Related link: Argentina debt: turbulent times – FT beyond brics