This spring, Argentina is casting a shadow over global markets. That is partly because of widespread investor fascination with the colourful persona of Javier Milei, the libertarian economist now running the country.
However, the other factor is Albany, the chilly New York state capital. Yes, really. Last week, state legislators submitted a bill that seeks to change how the state’s law courts handle sovereign debt restructurings. This matters since half of all emerging market bonds, worth an estimated $870bn, have been issued under New York law.
The details are complex but the essential aim is to prevent any repeat of the 2016 saga when the hedge fund Elliott used New York courts to recoup the full value of some 2001 defaulted bonds it owned, scoring a $2bn profit — even as public sector lenders swallowed haircuts.
It is unclear whether the bill will pass. Last year, a similar initiative was mooted, but ran into the sand. No doubt Wall Street will now use its formidable lobbying muscle — and money — to fight the measure. But it seems to have such strong support in the Albany legislature that law firms such as Clifford Chance are rushing to issue client briefings on it.
So investors should take note. After all, the reason for Albany’s move is that the current framework for tackling sovereign defaults is “completely flawed, completely rotten”, to cite the recent words of none other than Jay Newman, the financier behind Elliott’s 2016 coup.
And whatever happens to the bill, it will raise pressure for reform. That is good news, albeit belated.
To understand why, it pays to read a memo sent to the New York legislature by Martín Guzmán, José Antonio Ocampo and Joseph Stiglitz, respectively the former Argentine and Colombian finance ministers, and a Nobel Prize-winning economist. This notes that “within virtually all countries, mechanisms to restructure debts exist in the form of bankruptcy laws, which are now seen as a vital part of market economies”. Chapter 11 of the US bankruptcy code is a case in point.
“Yet there is no comparable mechanism for the debts of sovereigns,” they continue. Thus outcomes are sometimes ad hoc, with uneven payouts, and it is hard to enforce any resolution.
In the 20th century, institutions such as the Paris Club or the IMF made up for this gap by co-ordinating creditors. More recently, collective action clauses that enable a majority of creditors to impose a deal have been added to issuance documents. And in 2020 the G20 nations created a Common Framework for Debt Treatments, which offers another path to collective action.
But the common framework lacks legal teeth, and the Paris Club and IMF structures are increasingly ineffective. One reason is that China has quietly become the biggest lender to low-income countries, even exceeding western multilateral development banks, and its role in restructuring is unpredictable.
The second issue is hedge funds such as Elliott: their footprint is growing and it is so expensive for poor nations to fight private creditors in western courts that they often cave in to their demands. “In 2010 the share of developing country debt held by private creditors was 46 per cent,” the Guzmán memo notes. “By the end of 2021 it had shot up to 61 per cent.” Yikes.
Meanwhile, the external debt-servicing costs for poor countries, relative to revenue, have almost tripled in the past decade, leaving 48 nations at or near debt distress. Indeed, since 2020 there have already been around a dozen defaults. In every case, this produced a debilitating mess. Just look at Ethiopia, Sri Lanka and Zambia.
The solution offered in the Albany bill is to give emerging market governments two options for handling default: either a New York-appointed administrator will step in to organise and impose a deal, or the G20 common framework mechanism will be triggered. Either way, the key point is that private and public creditors are supposed to suffer the same level of haircut. The idea, then, is that taxpayers won’t suffer while groups such as Elliott make fat gains.
Unsurprisingly, this horrifies some financiers, who argue that making retrospective changes to the issuance frameworks would undermine market trust in the rule of law, and create an even more fragmented system at odds with federal law. Asset managers such as Pimco and Fidelity warn that the measures will raise the cost of debt issuance, since investors will need to be compensated for future legal uncertainty. There is also a possibility that bond issuance flees to places such as London or Texas.
However, supporters of the bill retort that these measures would actually create lower funding costs since a more equitable and predictable framework raises the chance of debts being repaid. They also note that British parliamentarians are considering copying the Albany approach.
In reality, it is impossible to judge the price impacts right now. But what is crystal clear, to cite Newman once again, is that the status quo is “rotten” and needs to change.
So while the Albany measures are imperfect, if they finally accelerate action around the common framework, we should all cheer. Not least because 2024 could soon produce more debt stress — including from Argentina, which is facing $5.5bn in payments to private creditors next year that Milei will struggle to repay.
