Sometimes truth is stranger than fiction, and my many years involved in the hedge fund industry vouch for this. Indeed some of my university students think I am inventing the stories I tell them in class, but I promise them I am not that creative. Here is one of my favourites.
This story details the battle between an activist hedge fund, Elliott Associates, and the Argentinean government, regarding some sovereign debt it defaulted on in 2002.
Purchase of distressed debt
Elliott Associates is a large and well-known hedge fund which has been operating since 1977. Today it manages over US$20 billion in assets. The fund runs a multi-strategy approach where money is allocated to many different investment strategies, including an emerging market distressed sovereign debt strategy. The strategy purchases the sovereign debt of nations in financial distress at a low (distressed) price in anticipation of some sort of recovery. A restructure could take the form of a refinancing of the debt into a new arrangement (for instance longer maturity or reduced coupons), an offer of payout, or indeed a full financial recovery.
Argentina experienced a painful recession in the late 1990s which pushed the government towards running increasingly unsustainable fiscal deficits. By 2001, investor confidence evaporated and yields on Argentinean bonds blew out to 50% above US Treasury yields! No offshore counterparties would lend to the Argentinean government and at the start of 2002 they defaulted on nearly US$100 billion of sovereign debt. At this point Elliott Associates stepped in as a purchaser of bonds trading at distressed prices (rumoured to be 6 cents in the dollar).
Argentina attempted to restructure its sovereign debt by offering defaulted creditors a new bond that included a 70% haircut (effectively investors would receive $30 principal at maturity instead of $100). In two offers made in 2005 and 2010, the government managed to get at least 92% of bondholders on board. Elliott Associates resisted and ran a campaign along multiple avenues to seek a higher payout.
The paths of action have included court challenges, offers to negotiate, possession of security, and emotive use of media. The case is still ongoing – yes that is correct: Elliott Associates and Argentina have been at legal loggerheads now for 12 years.
From a legal perspective Elliott Associates, through its subsidiary NML Capital Ltd (I will continue with Elliott Associates so as not to confuse) have won court decisions in their favour. Argentina appealed through all levels of the US system but lost. However while rulings have been in favour of Elliott Associates, a key issue is enforceability – there appears limited mechanisms to enforce a foreign sovereign to adhere to a US court ruling.
Argentina’s tactics have been two-fold. First they have attempted to take the case beyond the US courts and into international jurisdiction. This represents unchartered waters as the US is the foreign currency in which the majority of emerging sovereign nations issue their debt (beyond issuing local bonds in their own currency). Second, Argentina argues that it is prevented from offering better terms to a single creditor without opening itself up to similar claims from other creditors who refused the two previous restructuring offers. This could also lead to flow on claims from those that did accept the two restructuring offers. If this were to occur then Argentina argues that they would be forced to default on all their debt and be plunged back into economic recession.
Seize the day!
Events took an amazing turn when in early October 2012 Elliott Associates took the unprecedented step of seizing ARA Libertad, a training ship owned by the Argentine navy. It was docked in Ghana and apparently the ship was accompanied by 200 naval officers. You can imagine the online banter about how a group of ‘nerdy’ hedge fund managers could seize such a vessel.
ARA Libertad (Photo: Wikimedia Commons)
Elliott Associates is apparently prepared to ‘bail’ the ship back to Argentina at a high price to offset any entitlements. The Argentinean government has made claims of bully tactics, and describes Elliott Associates as ‘vultures’.
There are more questions than lessons to be learnt from this case study. Important market questions include whether this case sows the seeds for foreign issuers to look beyond the US as the currency of sovereign debt denomination, and the possible weakening of the US’s stronghold on financial markets. And structural questions such as, when stretched to its limits by highly intelligent people, can the operations of the world’s financial system handle all the challenges thrown at it? And finally social questions such as is a 12 year battle really an efficient allocation of resources and talent?
David Bell is Chief Investment Officer at AUSCOAL Super. He runs the Hedge Funds elective for Macquarie University’s Master of Applied Finance Program.