Argentina Debt Dilemma Spotlighting Tangled Swaps Web

Whenever the knotted world of credit-default swaps is pushed to the forefront in a financial crisis, conspiracy theories abound. Argentina is no exception.

Argentine Economy Minister Axel Kicillof described a group of so-called holdout creditors this week as “vulture funds” after failing to reach a restructuring agreement with them. Kicillof specifically directed his ire at credit swaps, a market, he said, that clouds the motives of creditors while leading to “the most wretched speculative capitalism that exists.”

“When they present a solution you don’t know if it’s something you can believe at the negotiating table or if there’s something else that you’ll never know about happening outside that gives them greater benefits,” Kicillof told reporters at a July 30 news conference.

Many bond buyers also own credit swaps as protection against losses or as a way to double down on a company’s creditworthiness. The dual roles can skew incentives because creditors will sometimes stand to profit more from a swaps payout than an issuer actually meeting its debt obligations.

One of Argentina’s holdout creditors is New York-based hedge fund Elliott Management Corp., which also sits on an industry committee that will determine whether investors who bought credit-swaps protection on the nation’s bonds are paid out.

Elliott Denial

The $24.8 billion fund manager, run by billionaire Paul Singer, last year denied in a U.S. court that it owned credit swaps that would allow it to profit if the government halted payments. Stephen Spruiell, a spokesman for Elliott, declined to comment yesterday.

Citigroup Inc. and JPMorgan Chase & Co. are also among the 15 dealers and investors on the swaps committee. Both Wall Street titans are said to be negotiating to buy the defaulted bonds that Elliott and other creditors own. Citigroup is in talks to buy the securities, according to Buenos Aires-based newspaper Ambito, and discussions with JPMorgan are also ongoing, according to a bank official with knowledge of the situation.

A deal would allow Argentina to resume paying interest on restructured notes. The nation missed a deadline to pay $539 million in bond interest after failing to reach an agreement with Elliott, Aurelius Capital Management LP and other creditors from its last default in 2001.

Argentina’s Claims

Argentine Economy Minister Kicillof says the funds are like vultures since they prey on countries in distress and seek massive profits by squeezing governments through embargo attempts and lengthy litigation.

Kicillof says Elliott is seeking a profit of 1,600 percent on its investment of defaulted bonds and would still make 300 percent if it accepted the restructuring terms.

Argentina claims it can’t offer holdout creditors a better deal without violating a “rights upon future offers” clause in the restructured bonds that may trigger additional claims. The clause requires Argentina to extend to the restructured bondholders any improved terms it “voluntarily” offers holders of the defaulted bonds.

If the International Swaps & Derivatives Association committee decides that a default has occurred, that would result in payouts on 2,652 contracts that insured a net $1 billion of Argentina’s debt as of July 25, according to the Depository Trust & Clearing Corp. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent when borrowers fail to adhere to their agreements.

Committee Meeting

ISDA’s determinations committee is meeting at 11 a.m. in New York today to decide whether the missed payment constitutes a failure-to-pay credit event. Swiss bank UBS AG posed the question to ISDA asking whether Argentina had triggered a credit event.

“In every determination committee decision there is a potential that there’s a group skewed to one side or another,” said Jochen Felsenheimer, the Munich-based founder of XAIA Investment GmbH, which manages credit funds. “I’m pretty happy with how they come to the decision. It’s a very transparent process and not like the Mafia sitting around doing funny things. The credibility of ISDA is crucial.”

Despite confidence in the integrity of the committee, the decision may not be straightforward, he said. Bondholders haven’t been paid because a U.S. court prevented the trustee from distributing funds that Argentina deposited on time.

“I wouldn’t be surprised if the ISDA committee will decide it’s not a credit event,” Felsenheimer said. “Investors didn’t get the money, but on the other hand Argentina already paid. We do not see a failure to pay, rather it’s a failure to deliver.”

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