Just how much power—or better yet, influence—does the American judicial system really have over sovereign nations? This is the underlying question that the Second Circuit must resolve before rendering its decision over how to handle a group of hedge funds’ dispute with the Republic of Argentina.
In 2001, amidst its worst economic turmoil in history, the Republic of Argentina defaulted on nearly $100 billion of its debt. While bondholders immediately felt an adverse effect, until recently, they were left with few options but to accept the government’s restructured—and heavily discounted—exchange bonds. This all changed, however, when Judge Thomas P. Griesa of the District Court for the Southern District of New York sided with the plaintiff hedge funds, and enjoined both the Republic of Argentina and third party banks from making payments on the exchange bonds unless the other bondholders were also paid.
As this decision comes under its review, the Second Circuit is presented with numerous considerations. Will its decision result in unrest in credit markets? If it affirms, will innocent exchange bondholders be negatively affected? Do third party U.S. banks stand to become the only victims? Rudimentary to all of these considerations, though, is what can the court threaten to do—or really do—to Argentina if it does not follow the court’s order?
In the present instance, traditional remedies are wanting. The issuer (Argentina) has left itself without a collective action clause in its bonds, which would have forced the plaintiff hedge funds group to accept both the exchange bonds and some losses upon a majority’s consent. The holders (owners of the Argentine bonds) are without creditor’s rights because a bankruptcy regime in the sovereign debt market does not exist. As such, the Second Circuit must carefully balance policy considerations in determining the proper course of action to ensure not only a just result, but a feasible one.
If the Second Circuit comes down too hard on the Republic of Argentina, the government is likely to exclusively use third party banks outside of the U.S. to continue to service the debt of the exchange bondholders. This result would not only frustrate the court’s orders, but also dare the court to use its lone power against Argentina—the threat of isolation, which might prove to be a questionable deterrent at best. On the other hand, if the Second Circuit does not give the hedge funds group some consolation, it might very well undermine the stability of the sovereign debt market and financial intermediaries both domestically and abroad.
*The basis for this post came from the February 26, 2013, New York Times article, “Banks Fear Court Ruling In Argentina Bond Debt,” by Peter Eavis.
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