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US 'vultures' shake up the world of sovereign debt

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(Globalpost/GlobalPost)

A US court's decision to back two hedge funds demanding Argentina pay them for defaulted bonds has jolted the mult-trillion dollar market for sovereign debt.

On Friday the New York appeals court rejected Buenos Aires' arguments that the funds -- the country brands them "vultures" -- deserve nothing because they refused to take part in a restructuring of the debt, which the country defaulted on in 2001.

Instead, it ordered the Argentine government to shell out $1.47 billion to the funds, a decision that critics say could unravel the restructuring deal and send the country back into virtual bankruptcy.

Moreover, critics say the decision could upend other sovereign debt restructuring deals and make it harder for some countries to get back on their feet after falling into default.

Buenos Aires defaulted 12 years ago on nearly $100 billion worth of bonds. In two restructurings, in 2005 and 2010, most of the bond holders took a steep 70 percent "haircut" on the face value.

But New York hedge funds NML Capital and Aurelius Capital, which bought some of the defaulted debt at a steep discount, declined to join the restructuring. They sued to recover 100 percent of the bonds' face value, plus accrued interest.

Argentina still refuses to repay them, and has petitioned the US Supreme Court to review the case.

A Supreme Court endorsement of the lower court would "have serious effect on the ability to negotiate necessary debt restructuring in the future," said Mark Weisbrot of the Center for Economic and Policy Research in Washington.

When countries cannot pay their debt, they can negotiate with creditors as a group -- aiming to reduce some of the value and lengthen the time for repayment, in a way that makes the government solvent and allows the creditors to recover at least some of their investment.

Such deals depend on the large majority of bondholders to agree, while holdouts are meant to get nothing.

That was the case with the largest restructuring ever, the 2012 deal between Greece and holders of some 200 billion euros ($267 billion) worth of its bonds that wrote off about half of their value.

That makes it troubling if holdouts can lay claim to full payback, according to Jacob Kirkegaard, of the Peterson Institute for International Economics

"If it turns out that a holdout creditor could end up being paid out in full, this would have very detrimental effects on the prospect for future debt restructuring," he told AFP.

"Because it means that the funds that can afford to wait and to hire enough lawyers, they will have zero incentive to agree to any debt restructuring."

"In many cases, you would not get enough participants to join in a such an operation," he added.

The Argentine case has sparked concern in the International Monetary Fund, often a crucial player in arranging restructurings for countries mired in unpayable debt.

The debt deals are vulnerable to holdouts because the restructurings are negotiated as contracts, rather than being decided by a specialized court with authority over all parties, as in a corporate bankruptcy case.

Weisbrot says the Argentine case demonstrates the need for a formal restructuring mechanism for the global financial system. One was proposed by the IMF in 2003, but ultimately rejected.

The New York court however argued that the Argentine case was "exceptional" and hinged on the country's "extraordinary behavior" as a "uniquely recalcitrant debtor."

The judges insisted their ruling would have "little apparent bearing" on other cases, because of the way Argentina's debt contracts were written, giving holdouts the right to make full repayment claims.

More recent bond restructurings make use of collective action clauses by which a majority can impose restructuring conditions on minorities, and deny holdouts any payment, the court pointed out.

Adam Lerrick, researcher at the American Enterprise Institute, agreed that the Argentine bond contract was the source of the problem.

"Argentinian bonds have a specific sentence saying basically that they cannot pay any other bond holder without paying the holdout investors."

"This issue is important for Argentina. But from the point of view of the capital markets, this is just a non-event, just a blip," said Lerrick.

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http://www.globalpost.com/dispatch/news/afp/130827/us-vultures-shake-the-world-sovereign-debt