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Wednesday, October 6, 2010

Argentina’s Defaulted Sovereign Debt: Dealing with the “Holdouts”

J. F. Hornbeck
Specialist in International Trade and Finance

In December 2001, following an extended period of economic and political instability, Argentina suffered a severe financial crisis, leading to the largest default on sovereign debt in history. It was widely recognized that Argentina faced an untenable debt situation that was in need of restructuring. In 2005, after prolonged, contentious, and unsuccessful attempts to find a mutually acceptable solution with its creditors, Argentina abandoned the negotiation process and made a one-time unilateral offer on terms highly unfavorable to the creditors. Although 76% of creditors accepted the offer, a diverse group of “holdouts” opted instead for litigation in hopes of achieving a better settlement in the future. Although Argentina succeeded in reducing much of its sovereign debt, its unorthodox methods left it ostracized from international credit markets for a decade and triggered legislative action and sanctions in the United States.

Argentina owed private creditors $20 billion in defaulted debt and $10 billion in past-due interest, as well as $6.2 billion to Paris Club countries. Of the disputed privately held debt, U.S. investors had approximately $3 billion. The more activist investor groups have lobbied Congress to pressure Argentina to reopen debt negotiations. Some Members of Congress have introduced punitive legislation in both the 110
th and 111th Congress, but to date it has not received any legislative action. Nearly five years after the original debt workout, however, a confluence of circumstances persuaded Argentina to restructure the holdout debt, particularly the need to secure long-term public financing.

On April 30, 2010, Argentina announced a new $18.3 billion offer to exchange new bonds and cash for defaulted bonds held by the “holdouts.” The exchange ran from May 3 to June 22, 2010. Two distinct offers were made, one for retail (small) investors, the other for institutional (large) investors. At settlement on August 2, 2010, retail investors received replacement bonds for the full face value of the defaulted bonds they held. Past due interest was paid in cash. Institutional investors received a discount bond equal to a 66.3% reduction in the face value of the defaulted debt they held. Past due interest was covered by a separate seven-year “Global” bond. Interest rates vary depending on the bond. Both groups of investors received a GDP-linked security called a warrant that provides for additional payments should the Argentine economy grow at rates higher that anticipated and stipulated in the prospectus.

The 2010 offer drew sufficient support to retire most of the remaining defaulted debt. Analysts estimate 66% of bondholders participated, leading to a total participation rate of 92% for the 2001 default, if the 76% tendered in the 2005 workout is included. Historically, a greater than 90% threshold of participation has allowed countries to eventually return to the international capital markets. So far, this has not been the case for Argentina. The $6.2 billion of bonds not exchanged are held largely by a group of Italian retail investors and various institutional “vulture” funds, which continue to litigate. Court reactions to these holdouts are not easy to predict, but technically any judgments against Argentina remain in place. It remains to be seen, and opinions vary, as to whether Argentina will be able to address these bondholders in some way that will allow for a return to the international capital markets in the near future.

If there is a legacy to the Argentine case, it may be in the changes to bond contracts that seek to improve outcomes for creditors. One option is the use of collective action clauses (CACs), now standard for sovereign debt, which require all creditors to bargain collectively, with a compulsory majority decision applicable to all bondholders. It is no coincidence that both the 2005 and 2010 Argentine exchanges are governed by CACs. 

Date of Report: September 24, 2010
Number of Pages: 19
Order Number: R41029
Price: $29.95

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Tuesday, October 5, 2010

Chile: Political and Economic Conditions and U.S. Relations

Peter J. Meyer
Analyst in Latin American Affairs

In the two decades since the country emerged from dictatorship, Chile has consistently maintained friendly relations with the United States. Serving as a reliable—if not always very public—ally, Chile has worked with the United States to advance democracy, human rights, and free trade in the Western Hemisphere. Chile and the United States also maintain strong commercial ties. Trade has more than doubled to over $15 billion since the implementation of a bilateral free trade agreement in 2004, and an income tax treaty designed to boost private sector investment was signed in February 2010 and is awaiting submission to the U.S. Senate for ratification. Additional areas of cooperation between the United States and Chile include renewable energy and regional security issues.

President Sebastián Piñera of the center-right “Coalition for Change” took office in Chile in March 2010, bringing an end to 20 years of governance by a center-left coalition of parties known as the Concertación. During its time in power, the Concertación enacted constitutional changes to strengthen civilian democracy, took steps to address human rights violations that had occurred during 17 years of military rule under General Augusto Pinochet, and supplemented free market economic policies—which had been implemented during the dictatorship—with moderate social welfare programs. Most analysts credit these policies for fostering the strong economic growth and considerable reductions in poverty that have put Chile on the verge of becoming a “developed country.”

Piñera’s first six months in office have been marked more by continuity than change, as he has largely maintained the Concertación’s economic and social welfare policies while shifting the emphasis from redistribution to economic growth. His primary focus has been dealing with the fallout from the massive earthquake that struck Chile just two weeks before his inauguration. In addition to coordinating humanitarian assistance, Piñera won legislative approval for a $8.4 billion reconstruction plan. Chile weathered the global financial crisis reasonably well as a result of a counter-cyclical stimulus program enacted by the Bachelet Administration; however, the country did suffer a slight economic contraction and increase in the poverty rate. Piñera has pledged to boost economic growth to 6% annually, eliminate extreme poverty, and create one million jobs by the end of his four-year term by attracting increased investment and running government more efficiently. Other issues requiring Piñera’s attention include militant activism by indigenous groups, Pinochet-era human rights abuses, and weaknesses in the education system. According to a September 2010 poll, 56% of Chileans approve of Piñera’s performance.

The 111
th Congress has expressed interest in several issues in U.S.-Chile relations. In March 2010, the U.S. Senate and House of Representatives passed resolutions (S.Res. 431 and H.Res. 1144) expressing sympathy for the victims of the country’s February 27 earthquake and solidarity with the people of Chile. The House also passed legislation (H.R. 4783, Levin) to accelerate income tax benefits for charitable cash contributions for earthquake relief in Chile. Other resolutions have been introduced to express support for the Energy and Climate Partnership of the Americas, including clean energy cooperation with Chile (H.Res. 1526), and to honor the bicentennial of the call for independence in Chile and several other Latin American nations (H.Res. 1619).This report provides a brief historical background of Chile, examines recent political and economic developments, and addresses issues in U.S.-Chilean relations.

Date of Report: September 22, 2010
Number of Pages: 24
Order Number: R40126
Price: $29.95

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