EMERGING-MARKET FINANCE has more than its fair share
of polarizing personalities. Some people, such as former
Mexican finance minister Angel Gurria, are universally
admired. Others, including Carnegie Mellon economics
professor and former CSFB banker Adam Lerrick, are seen as
highly divisive.
So eyebrows were raised last month when Lerrick and Gurria
announced that they had gone into business together, setting up a
for-profit negotiating team designed to represent European holders
of defaulted Argentine debt.
The two are not natural bedfellows: Gurria admits that "when we
first met to discuss these problems, we were looking at them from
relatively different points of view". Lerrick is famous as a
right-winger who believes that the public sector should drastically
reduce its role in emerging markets; he was the prime mover of the
Meltzer Commission report, which advocated sweeping changes at the
IMF. Gurria, on the other hand, has had a very close relationship
with the highest levels of the official sector for more than 20
years.
Both, however, are convinced that one of the foremost challenges
facing the asset class today is the restructuring of Argentina's
foreign debt.
"Argentina's exports have not risen in volume terms because they
have no access to trade credit," says Lerrick. He argues that a
restructuring of the foreign debt would mean a reopening of trade
lines and a much stronger growth path for the country.
Such a restructuring won't be easy, though, largely because the
country's creditors are much more diverse than has ever been seen
before. Argentina has about $50 billion of foreign debt
outstanding, about half of which is held in Europe. Some 350,000
Italians own roughly $13 billion-worth of bonds; 50,000 Mrs
Watanabes in Japan account for another $2 billion; and 200,000 of
what have traditionally been labelled as Belgian dentists are owed
$9 billion or so. It's this last group of retail investors that
Lerrick is concentrating on.
In fact there are few Belgians among these retail investors. The
vast majority of what Lerrick prefers to call the central European
investors come from Austria, Germany, Luxembourg, the Netherlands
and Switzerland.
None of them, individually, is remotely big or important enough
to be able to sit down with the Argentine government and attempt to
negotiate a debt exchange. On the contrary, says Lerrick, retail
investors are at the bottom of the food chain of Argentina's
creditors when it comes to how much money they're likely to
receive. The problem is that such investors have nothing to
offer.
The IMF, World Bank and Inter-American Development Bank will
continue to provide new money to Argentina at very low interest
rates. They will, of course, insist on being repaid in full.
Domestic institutions, such as local Argentine banks, simply have
no ability to take any further hits on their Argentine sovereign
debt: insofar as they do, they'll simply have to be recapitalized
by the government later anyway. International institutional
investors, primarily in the US, have the ability to take a
significant haircut, but will also be the prime source of future
funding once Argentina regains access to the capital
markets.
Keeping institutions sweet
In fact, there is a case to be made that, at least at the
margin, it's actually in Argentina's best interest to be more
generous to institutional investors than to retail investors.
Argentina hopes that the institutions will start lending to the
country again, while European individuals - at least the ones left
holding defaulted debt - almost certainly won't.
What's more, institutional investors, since they're more
sophisticated than their retail counterparts, are likely to
appreciate any favours done for them. Belgian dentists, on the
other hand, are unlikely to be able to tell the difference between
a reasonably good deal that pays them back their principal in full
and a reasonably bad deal that does the same thing.
What's more, unless the retail investors can somehow unite,
they're far too small to be able to block a deal: they therefore
have almost no leverage over Argentina.
At the same time, notes Gurria, individuals' holdings of
Argentine debt generally constitute a much larger proportion of
their total portfolios than is the case with any other group of
foreign investors, including the multinational development banks.
Stories abound of individuals sinking their entire life savings
into Argentine bonds.
"It's almost impossible for anyone who has not met with retail
investors to understand how violent they are about this," says
Lerrick. "They lost their savings. They're taking this very
personally. These people are very angry."
Argentina, understandably, does not particularly relish
attempting to negotiate a restructuring with hundreds of thousands
of angry - and therefore highly unpredictable - retail investors.
There's a good chance that they would rather talk to a professional
and experienced negotiating team, even if that means having to pay
the European creditors a little bit more, in aggregate, than they
would otherwise have done.
Enter Lerrick and Gurria. They have teamed up with the Deutsche
Schutzvereinigung für Wertpapierbesitz (DSW) - the largest
investor-rights protection organization in Germany - to persuade a
list of 19 banks (and growing) to ask their clients if they would
like to join a group called ABRA: the Argentine Bond Restructuring
Agency.
In return for handing over their bonds to ABRA, investors will
receive tradeable certificates representing, in effect, the bonds
with which Argentina will replace its defaulted debt.
There's a very good chance that ABRA will become Argentina's
single-largest bondholder: as such, it would have a lot of leverage
in being able to negotiate terms of any restructuring. Although
neither Lerrick nor Gurria will say how many bonds they expect to
receive, the intention is clearly for ABRA to assemble sufficient
to give it veto power over any proposed deal.
Retail priorities
ABRA has two main goals. The first is to make sure that its
bonds get repaid in full, with any debt relief provided by
extension of maturities and/or reduction in coupons. This is much
more important to retail investors, who want to get their money
back, than it is to institutional investors, who mark to market and
want to maximize the present value of their paper.