Stopping the circling vultures: restructuring a solution to sovereign debt profiteering.

• Author: Beneze, Elisa

Abstract

When a sovereign state becomes unable to repay its debts and enters into default, an ideal outcome involves a quick and mutually agreeable resolution with creditors, allowing the country to reenter the international markets and continue its recovery with limited impediments. However, the situation in Argentina, unfolding since 2001, has provided a stark example of why change is needed at the domestic and international level to address the growing problem of vulture funds' presence in the sovereign debt markets. These aggressive hedge funds have demonstrated an uncanny ability to hijack the sovereign debt restructuring process. Vulture funds purchase discounted debt on the secondary market and pursue private litigation against sovereign states in an attempt to recover large profits off the sovereign default. The vulture funds' actions pose significant threats to the sovereign debt restructuring process. These threats are poised to continue if steps are not taken to limit the funds' power.

Table of Contents I. Introduction.. II. Vulture Funds: Feeding Off of the Carcass of Argentina's Sovereign Debt Crisis III. Argentina's Fifteen Year (and Counting) Debt Crisis A. The $100 Billion Catch-22 B. Ramifications Beyond Argentina C. Ruling Bad for Both Creditors and Debtors IV. A Cure for the Vulture Problem: A Call for A Solution at Both the National and International Level . A. A Changing Landscape Makes Settlement More Likely B. A Chance to Revive Congressional Action C. A Pressing Need for a Better International Framework V. Conclusion I. Introduction

Sovereign defaults are inevitable occurrences, especially for developing and emerging economies. (1) Defaults are rarely sudden events but rather are many years in the making--generally resulting from a series of ill-conceived economic policy decisions and larger global economic instability. (2) Argentina alone has defaulted eight times throughout its history, most recently in 2001. (3) It went through a related technical default in 2014--triggered by U.S. District Court for the Southern District of New York Judge Thomas Griesa's decision to prohibit Argentina's repayment to restructured bondholders until the creditors who had refused to participate in restructuring (holdouts) were also paid. (4) The Great Recession, which played a role in the Argentine crisis, has also caused a marked increase in the frequency with which countries are forced into default.

However undesirable and unfortunate it may be, a sovereign state may at some point be unable to repay its obligations to its creditors. (5) The best hope in such a situation is that the sovereign state will be able to reach a compromise with its creditors and restructure its debt, offering a reduced return on the creditors' original investment (or a "haircut"). Restructuring the debt allows the state to recover from the default and reenter the international capital market. In the past, this process has been a fairly reliable cycle that balances the interests of the creditors in maximizing repayment with the interests of the sovereign state in being able to continue to provide essential services to its citizens and return to the international capital market as soon as possible. (6)

However, in recent years, the prevalence of "vulture funds"--hedge funds that purchase distressed debt at a deep discount only to demand full repayment after the country has defaulted and restructured most of its debt--has been steadily increasing. (7) Vulture funds often use litigation and aggressive pursuit of sovereign assets to accomplish their goals. (8) The entrance of these types of vulture funds onto the sovereign debt scene has unsettled what was previously a fairly stable and predictable process of default followed by restructuring and recovery. (9) In the past, funds that refused to participate in restructuring and demanded full repayment were merely an annoyance to the sovereign state and had limited leverage to force full repayment if they refused to take part in the restructuring process. (10) This all changed drastically, however, following Judge Griesa's recent ruling that the pari passu clause (11) of the sovereign bond agreement should be interpreted to mean that Argentina cannot make any payments to bondholders who had previously restructured their debt as part of the 2005 and 2010 bond exchanges unless the country also repaid the holdout funds in full at the same time. (12)

This ruling has threatened to seriously disrupt the sovereign debt restructuring process, especially considering that many, if not most, sovereign bond agreements include a clause giving jurisdiction to New York courts, regardless of the nationality of the parties. (13) The ruling caused immediate problems for Argentina--forcing the country into technical default in August of 2014, despite Argentina's continued ability and willingness to repay the vast majority of its bondholders. (14) However, the ramifications of the ruling extend far beyond the borders of Argentina.

In Part II, using the Argentine default and subsequent U.S. District Court ruling as a framework, this Note will discuss the role of holdout funds in the Argentine default and sovereign defaults in general. Part III will analyze the implications of the vulture funds' litigation tactics and the U.S. district court ruling in their favor, both within Argentina and beyond. Part IV will discuss three solutions, none of which are mutually exclusive. First, the Argentine presidential election in fall 2015 opened the door for the country to finally reach a resolution to this saga. The newly elected president, Mauricio Macri, has reopened talks with the vulture funds through a mediator. Second, the U.S. Congress has the opportunity to provide better protection against vulture funds for developing and emerging economies like Argentina that act in good faith to repay bondholders but are held hostage by a small number of creditors. Third and most importantly, the Note will address how the Argentine situation has reemphasized the need for a better international framework to deal with sovereign debt defaults and suggests an increased use of international arbitration under the United Nations.

A growing number of sovereign states are facing default following the Great Recession. With the novel legal interpretation of the pari passu clause by the District Court of the Southern District of New York and the increased prevalence of vulture hedge funds, sovereign debt has reached a turning point. The international community faces a stark need for a new approach to sovereign defaults and restructuring.

2. Vulture Funds: Feeding Off of the Carcass of Argentina's Sovereign Debt Crisis

   Due to an unfortunate combination of years of questionable domestic economic policies, a growing global recession, and perverse incentives for high-risk lending, Argentina suffered rampant inflation quickly followed by a devastating default on the country's sovereign debt in the late 1990s and early 2000s. (15) Argentina's stunning default on $82 billion of debt in December 2001 was the single largest sovereign debt default in history up to that point. (16) However, that dubious distinction was later taken over by Greece, when it defaulted on $138 billion in 2012. (17) Among others, Jamaica and Ecuador also saw large defaults in the 2000s, though both were thoroughly overshadowed by the massive scale of the Argentine and Greek defaults. (18)

   Seeing an opportunity for profit in the midst of the Argentine crisis, vulture funds began purchasing the deeply devalued Argentine debt, even after it became clear that the country would be forced to default. (19) The term vulture fund is generally used to describe hedge funds whose strategy involves purchasing debt on the secondary market at deeply discounted rates, refusing restructuring deals, and then pursuing litigation to demand full repayment on the original value of the bond, with the possibility of massive profits. (20) On average, these types of funds see returns of between three and twenty times the amount they originally invested on the discounted bonds. (21) Vulture funds, as the name implies, tend to target financially distressed countries--particularly countries likely to default in the near future. (22) Vulture funds also tend to be extremely tenacious and aggressive, as well as patient, in pursuing repayment, making resolution of conflicts more protracted--and thus more costly and difficult. (23)

   Argentina first began the debt restructuring process in 2002 with the help of the International Monetary Fund (IMF) but was unable to reach a viable solution to repay its creditors. (24) Abandoning its previous attempts, Argentina decided to act independently--without the IMF's help and thus without requiring the IMF's approval--and opened a bond exchange. (25) The exchange was ultimately very successful in restructuring over 75 percent of the old bonds. (26) The exchange involved a fairly large haircut, resulting in a 66 percent reduction on the bond repayments to creditors. (27) After the first bond exchange, $18.6 billion in debt remained un-exchanged, along with $6.3 billion owed to Paris Club countries and $9.5 billion owed to the IMF. (28) Argentina was eventually successful in repaying the debt to the IMF in full and made plans to repay the Paris Club countries as well. (29) The majority of the debt left in flux was that owed to the holdouts that had turned down the opportunity to participate in the bond exchange in hopes of forcing Argentina to repay on terms more favorable to creditors. (30)

   In 2006, a group of Italian debt holders requested arbitration to settle their dispute over the restructuring with the International Centre for Settlement of Investment Disputes (ICSID). (31) Since 2006, two more groups have filed similar requests, and, in all three cases, the tribunal found that the claims were admissible under the Italy-Argentina bilateral...