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.
Those who are sceptical about Lerrick’s plan note that bondholders hardly need Lerrick and Gurria to achieve this goal: offering retail investors a deal where the principal is untouched is hardly rocket science. The Argentines are well aware of European investors’ preferences in this regard, and will surely come up with a plan that respects them.
The second goal, however, is to ensure that holders of euro-denominated paper do not come off second best to the institutional holders of dollar-denominated bonds. Debt restructurings are a zero-sum game, says Lerrick, and “institutional investors will be just as happy to take money away from retail investors as they will from Argentina.”
But there are others who still need to be convinced. “The jury’s still out, since Argentina’s case is a more complex one,” says Anna Gelpern, international affairs fellow at the Council on Foreign Relations in Washington DC. “But based on the experience of sovereign restructurings to date, particularly Ukraine and Uruguay, it is by no means clear that retail investors are at a disadvantage to institutional investors. It is not clear that this plan is filling a gaping need, and filling it efficiently.”
ABRA’s fees are certainly non-negligible, although they will only be charged on completion of any restructuring. There’s a 1.3% fixed fee, plus another 0.3% if the negotiations stretch on through a second year. Bondholders also have to pay ABRA a performance fee of 20% of the amount that the gap between euro-denominated bonds and dollar-denominated bonds shrinks – a gap that Lerrick says has already shrunk from between four and five points to zero.
In the case of a four-point shrinkage, the fee would be 0.8%, assuming that Argentina, as is relatively standard practice, pays the 1.3% fixed fee. If it doesn’t, the performance fee would drop to 0.54%, or 20% of 2.7% (the four-point gain in marginal value less the 1.3% fixed fee). Total fees would then be 1.84%, which is roughly half the bid-offer spread on e1 million lots for most Argentine euro-denominated bonds today.
The question of the fees seems to be causing a fair amount of confusion among retail investors, some of whom don’t understand how much they are going to have to pay.
Nobody knows. ABRA might be able to persuade Argentina to pay all its fees, in which case bondholders would have to pay nothing, or Argentina might refuse to pay any fees, in which case bondholders could end up paying as much as 2% if the negotiations dragged on into a second year.
Private-sector profits Either way, Lerrick, Gurria and the other two members of ABRA’s negotiating team stand to make a lot of money. Although they will see very little of the 1.3% fixed fee – most of it will be spent on paying the member banks to sign up bondholders – their company, Sovereign Debt Solutions, will get all of the performance fee.
If they get one-third of the universe of bonds they’re looking for, that’s $3 billion in face value, 0.8% of which comes to $24 million. “This is a private-sector institution,” says Lerrick, a former investment banker at CSFB. “The private sector is profit-oriented.”
Many European retail investors, of course, will not sign up for ABRA. Maybe they blame their banks for putting them into Argentine debt in the first place, and are mistrustful of the banks’ proposals for getting them out. Maybe they don’t want to risk the chance that they, and not Argentina, will pay ABRA its fees: after all, the chances are that all bondholders will get offered the same deal.
Lerrick, however, is clear that he will not hesitate to try to get a better deal on his bonds than on those that are not members of ABRA. “Sovereign borrowers buy back bonds at different prices in privately negotiated transactions or at auctions all the time,” he says. “Even if there’s one final debt exchange, that doesn’t mean that different values are not paid to different creditors. There’s no legal requirement – and there are many precedents to the contrary – that Argentina pay each creditor the same amount.”
