Argentina's Last Bond Exchange Went So Well It's Doing Another
Oh man, big day for Argentina. Let's start with the smaller and sillier news, which is that the International Swaps & Derivatives Association is delaying the auction to settle credit default swaps on Argentine debt until it figures out which bonds are eligible for the auction. Remember when the ISDA's determinations committee couldn't find some of Argentina's bonds, the ones denominated in yen? And then it found them? Well, now some people want it to lose them again. "Some people" presumably meaning "protection sellers"; here is Peter Eavis:
The challengers may be motivated by a desire to sway the swaps payout more in their favor. By removing the yen-denominated bonds from the auction, the swaps may pay out a lower amount.
Those yen bonds trade at much lower prices than Argentina's dollar and euro bonds, so excluding them will make for higher auction prices and so lower CDS recovery. Good if you've sold CDS, bad if you've bought it. So what's the argument for excluding them? Eavis again:
An I.S.D.A. committee is now considering the objections. One issue it may focus on is when the disputed bonds were issued. Swaps on Argentine sovereign debt are said to apply only to bonds issued after 2005. The committee may need to determine that the bonds were issued after the cutoff date.
Well but those yen bonds were issued at the same time as the other eligible bonds, sometime in 2005. 1 It's actually much weirder than that. Here's my best effort to reconstruct what's happening:
- After defaulting on its old bonds, Argentina issued new bonds in a 30-ish-cents-on-the-dollar exchange offer in 2005 (and another in 2010).
- The new bonds denominated in dollars, euros and pesos were issued under a U.S. prospectus supplementdated Jan. 10, 2005.
- The new bonds denominated in yen got their own prospectus (in Japanese).
- The exchange offers in dollars, euros, pesos and yen were all more or less simultaneous, and all were scheduled to close with the issuance of new bonds in April 2005.
- Later that year, people started trading CDS on Argentina again.
- The whole point of trading that CDS would be to bet on or against new defaults by Argentina. After all, the old bonds had already defaulted, remained in default and, in 2005, it seemed very unlikely that they'd ever be worth anything.
- So in December 2005, ISDA pronounced that new CDS on Argentina would only reference new bonds, those issued in 2005 and later. 2
- But what it actually said was, "Any obligation that is a Bond that was issued on or prior to June 1, 2005 (other than any Bond constituting a New Security (as defined in the 'Prospectus Supplement of the Republic of Argentina dated January 10, 2005', as the same may be amended or supplemented)) shall be 'Excluded Deliverable Obligations'." (Emphasis added.)
- Why June? I haven't the foggiest idea. [Update: I do now! In 2006 Argentina said that the 2005 exchange settled on June 2, 2005, instead of in April when it was supposed to. Thus the June 1 cutoff. You can probably ignore the rest of this paragraph.] One theory that I've heard is that it was "scrivener's error" -- just a typo for "January," or at least "April." The first batch of new bonds were issued in April, not June. June doesn't, from the perspective of 2014, make much sense. Maybe it made more sense in 2005.
- In any case, anything that's a "New Security," as defined in the January prospectus supplement, is still eligible for CDS, even if it was issued before June 2005.
- You can go read that prospectus supplement if you want. I would not say that it does a super-wonderful job of defining the term "New Security," exactly, but I think the better reading is that the term refers only to the (dollar, euro, peso) bonds covered by that prospectus -- and not the contemporaneous yen bonds (though those are referred to in the prospectus).
- So there's a decent case, based on the words of the document [and the scheduled closing date of the 2005 exchange], that the yen bonds are not eligible for the CDS auction. 3
- On the other hand, there's a decent case that they are eligible, just because the "June 1, 2005" thing doesn't make much sense.
I will not advise you one way or the other on your Argentina CDS bets. I'm telling you this only because I think it's funny. There's no moral to the story, except the moral I've mentioned before, which is "that sovereign CDS is weird, and functions much more as a way to bet on the workings of CDS technology than as a hedge for sovereign debt holdings." 4 Like, people will now argue about how big their recovery should be not based on whether Argentina defaulted or what will happen in default, but rather on whether yen bonds issued in April 2005 should, like dollar bonds issued in April 2005, be treated as though they were issued in June 2005.
But the rest of us might want to think about what will happen in Argentina's default. And now there's sort of an answer: Since its earlier exchange offers were so clear and effective, Argentina's going to do another one!
The government will submit a bill to Congress that lets overseas debt holders swap into new dollar-denominated bonds governed by domestic law, President Cristina Fernandez de Kirchner said in a nationwide address yesterday. Payments will be made into accounts at the central bank instead of through Bank of New York Mellon Corp., the current trustee.
Here is the proposed bill(in Spanish), which is long on rhetoric but short on detailed mechanics; basically it authorizes the government to remove BoNY Mellon as trustee, set up a repayment account at the central bank of Argentina, and do some sort of exchange. How that exchange would work is still a murk. For instance:
A swap may be challenging to execute because any intermediaries assisting Argentina in the process could be sued for contempt of court, while investors who aren’t able to hold local bonds would have to sell their holdings.
It's pretty clear that the New York federal judge in charge of the case, Thomas Griesa, would hold intermediaries in contempt for helping Argentina do the exchange offer in New York. In fact, some people worry that even bondholders could be held in contempt for exchanging. 5
So I for one would be very interested to hear how the exchange would work. Say you own some U.S. dollar bonds. You don't though: The Depository Trust Company owns all the dollar bonds 6 ; you just have an account at (a broker who has an account at) DTC reflecting your beneficial ownership of the bonds that DTC technically owns. And even DTC doesn't own the bonds in the form of, like, fancy pieces of embossed paper: It owns them "in fully registered form," i.e. as a book entry at BoNY Mellon, the trustee.
So if you want to exchange your New York-law dollar-denominated bonds for Buenos Aires bonds, DTC and/or BoNY Mellon probably need to be involved. Otherwise, what, you go to Argentina's government and say, "Hey, I have like $100 million of N.Y.-law bonds, trust me"? And they're like, "OK, here you go, $100 million of B.A. bonds, enjoy"? You'd think they'd want proof that you own the bonds. I guess you could give them an account statement without involving DTC or BoNY Mellon. But once you get the new bonds, surely Argentina would want to make sure that the old bonds are canceled, right? It would not want a situation in which you "exchange" $100 million of New York bonds for $100 million of Buenos Aires bonds, and then sell the New York bonds to someone else. I think the only way to do that would be to have DTC or BoNY Mellon cancel the New York bonds once they're exchanged. 7 That's why regular exchange offers tend to involve the trustees and depositories of the old bonds. But here, that would seem to run contempt risks for them.
On the other hand, if you want to exchange your English-law euro-denominated bonds for Buenos Aires bonds ... you wouldn't, right? There's still at least a chance that the U.S. courts will allow payment on Argentina's euro-denominated bonds, or that European courts will force that payment even without U.S. approval. 8 If that happens, then Argentina can just keep paying those bonds in Europe and won't have to bother with an exchange. But its exchange proposal seems to contemplate exchanging those bonds too. Which makes sense for Argentina: If it has to go through this, it might as well consolidate all its foreign debt under Argentinean law, and never have to worry about annoying foreign courts again, whether in New York or Luxembourg. But obviously if you have euro-denominated bonds now, and if they can keep getting paid, leaving them where they are seems a lot more attractive than moving them to Argentina.
What is the result of this? For bondholders, a mess. If this goes forward -- and you wouldn't bet against it, would you? -- then there will be three categories of bonds outstanding:
- the old old bonds, the ones held by Elliott Management and other holdouts;
- the old exchange bonds, the ones that were issued in New York and Europe and Japan in 2005 and 2010 and kept by holders afraid of contempt of court, etc; and
- the new exchange bonds, the ones issued in Argentina in exchange for the old exchange bonds (and for the old old bonds
The new exchange bonds will be getting paid as normal in Argentina. (Unless Argentina changes its mind! In which case it will have home-court advantage in changing the terms of the bonds.) The old exchange bonds, and the old old bonds, won't get paid, exactly, but Argentina will deposit money at the central bank for them, which they can get any time they want to swap into new exchange bonds. Presumably many people will hold on to the old exchange bonds, hoping for some improvement in their lot in life, and eventually that hope will turn into lawsuits, as hope does. So there will be two classes of bondholders suing Argentina, and each other, and not getting paid, and being sad.
For Argentina, on the other hand, the result is quite clean: one set of bonds (the new exchange bonds), all under local law, all being paid through intermediaries located in Argentina and subject to Argentina's control. If you just ignore everything that happens in the outside world -- like U.S. court contempt decrees, or more substantively like the (continuing) inability to sell new debt abroad -- then the old old bonds and the old exchange bonds vanish from your vision, and Argentina's debt situation is very neat and manageable.
This is not something that Argentina could have accomplished on its own, at least not without creating even more bad blood than it has now. If two years ago Argentina had said, "You know what, we'd rather have all of our dollar and euro bonds governed by Argentine law and paid in Argentina, would you mind doing an exchange?" no one would have agreed to it. Not that too many people will agree to it now, but at least now Argentina has a plausible excuse: It wants to pay, but a U.S. judge won't let it send payments to holders abroad, so those holders will have to come to Argentina to get paid. If this exchange succeeds -- though you probably would bet against that, right? -- then Judge Griesa is actually doing Argentina something of a favor. Not that anyone, anywhere, will be all that happy about it.
Here's the March 2005 press release announcing the results of Argentina's exchange offer. "Settlement of the Offer is scheduled to begin on April 1, 2005 and may last up to seven business days." Table A of the press release lists the exchange bonds being issued in April 2005, including the yen bonds, ISINs ARARGE03E667 and ARARGE03E659, that are currently on ISDA's list but are being challenged. (Here are the determinations committee rules governing the challenge, if you're interested.)
[Update: Donato Guarino of Barclays Capital points me to Argentina's 2006 Annual Report on Form 18-K. If you look at pages 134-135, it seems that the bonds that were scheduled to settle in April 2005 actually settled on June 2, 2005. This seems to be true of the yen bonds as well as the other ones -- they're all on the same list -- so they should be eligible for delivery.]
And that only those bonds would be eligible for delivery. Reference and eligibility are different concepts, but both seem included here.
And also that they're not a reference obligation. So, for instance, when Argentina missed payment on the yen bonds, that may not have triggered CDS until a few hours later when it also missed payment on the euro bonds. [Update: But if they were actually issued in June, then that case evaporates. See the update in footnote 1, above.]
As Peter Eavis puts it:
The complication to the payout process may provide ammunition to critics of credit default swaps. While the swaps often pay out without a hitch, there have been situations when the swaps did not activate for certain investors. This has raised questions about their usefulness as hedges against defaults.
Seems unlikely to me, but why take that chance? From a Credit Suisse research note today:
This swap faces important execution risks, in our view. It would likely violate Judge Thomas Griesa’s orders against evading his pari passu ruling, which could result in Argentina being held in contempt of court. U.S. based financial intermediaries and investors could be wary of risking contempt themselves if they were to participate.
Technically Cede & Co. as nominee for DTC but come on. More in "Scheme 3" and "Scheme 4" here.
One alternative is to say, "After October 1" -- or whenever -- "all New York law bonds are canceled as far as we're concerned, and we never want to hear about them again." (They can still sue in New York, of course, but let's assume Argentina will never care about being sued.) But you still need to make sure that each bond can only be submitted for exchange once: You don't want someone submitting a bond on Sept. 15 and then selling it to someone else to submit on Sept. 20. I think the only way to do that is to have some sort of global record date, some sort of definitive list of holders -- which I think requires some cooperation from intermediaries in the U.S.
Another alternative is: I mean, this is a double-spending problem, why not solve it with bitcoin? Here I'm being techno-utopian and terrible, but maybe there is some sort of distributed mechanism for making sure that each bond is only submitted once. Bitcoiners, get to work!
See "Scheme 4" here for some more on that, and the euro bondholders' motion citing European law requiring the payments to be made. If, as these holders contend, Argentina's payments to them never touch the U.S. -- I think they're right though it's not an easy question -- then the U.S. shouldn't be able to hold them up.
You wouldn't expect Elliott to take Argentina up on this offer, but the proposal is to deposit money at the central bank of Argentina not only in respect of the old exchange bonds but also in respect of the old old bonds -- i.e. to treat the holdouts as though they had accepted the 2005 exchange offer (at 30 cents on the dollar). This is of course what Argentina has been offering, and what Elliott has been refusing, for a decade. (Only worse because now the offer is for Argentine-law bonds.)
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