World Business and Economic Analysis
World Business and Economic Analysis
A ruling in the US judiciary system regarding Argentina’s debt restructuring has caused ructions in international markets. The country’s minister of economy and public finance presents Argentina’s position on this case.
The international community reacted with perplexity and alarm to the debt conundrum created by an unprecedented decision of the US judicial system. Amid overwhelming global support, Argentina is facing this extravagant ruling as every responsible nation would: defending its sovereignty and reaffirming its willingness and capacity to honour its debts with 100% of its creditors under fair, equitable, sustainable and legal conditions. In fact, it has a fair and reasonable offer on the table that would put an end to this litigation.
Due to this ruling, good faith bondholders unrelated to the litigation are being blocked from collecting regular payments duly made by Argentina – which are rightfully theirs. At the same time, the litigant vulture funds are holding the 92.4% of creditors hostage and demanding a profit we estimate at 1600%. This position is unreasonable and is a direct threat to the stability and predictability of the global financial system. It would also mark the definitive divorce between risk and yield, violating one of the basic pillars of modern capitalism.
Steps to normalisation
These are the facts. In 2001, after decades of over-indebtedness, Argentina defaulted on its sovereign debt. Since 2003, under a new government, the country has been taking the necessary steps toward normalising its financial obligations. Argentina paid its debt in full to the International Monetary Fund ahead of schedule; cancelled outstanding International Centre for Settlement of Investment Disputes awards; reached an agreement with the Spanish oil company Repsol; and, in a landmark deal, reached an agreement with the Paris Club creditor nations.
Without a doubt, the most complex challenge was to reach a deal with the bondholders of $81bn of defaulted debt. After extensive negotiations, Argentina successfully restructured 92.4% of its debt in 2005 and 2010, which it has faithfully serviced ever since. Argentina’s offer was determined based on its real payment capacity. By incorporating gross domestic product (GDP)-linked bonds, creditors became partners in the country’s prosperity. As Argentina grew, so did the returns for its bondholders.
For the past 10 years, Argentina has been honouring its debt commitments, having made payments for $190bn with no access to the international capital markets. A sustainable debt strategy allowed the country to grow steadily with social inclusion. While the economy expanded at an average rate of more than 6% per year, public debt as a percentage of GDP declined from 166% in 2002 to 40% today, with public debt in foreign currency with private creditors standing below 9%.
A small minority led by vulture funds chose not to join the debt exchange. Consistent with their modus operandi, these funds bought the defaulted debt for pennies on the dollar with the sole purpose of suing the country for the face value of the bonds plus interest. They have never lent money to Argentina. They have refused to negotiate and they have systematically rejected all offers. Argentina, in turn, gained credibility for its debt exchanges precisely by having pledged to its bondholders not to reward holdout behaviour.
US courts
On June 16, 2014, the US Supreme Court declined Argentina’s petition thus validating New York judge Thomas Griesa’s ruling. Based on an erroneous and unprecedented interpretation of a standard provision in most sovereign bonds (the pari passu clause), the ruling stated that Argentina could not pay its exchange bondholders unless the litigants were paid in full (face value plus interest), consecrating inequality among creditors.
But it went even further. In a bizarre move that violates sovereign immunity (by circumventing immunities granted by US law) as well as the rights of thousands of US and international creditors, the judgement involved an absurd 'equitable remedy' that brought about the most inequitable result. It empowered a minority of vulture funds (representing 1% of bondholders) with a weapon to sabotage sovereign debt restructurings by allowing them to block 92.4% of Argentina’s creditors from collecting payments deposited by Argentina. The vultures had hit the legal jackpot. They offered their ultimatum: pay us a 1600% ransom or we will hold thousands of other bondholders hostage, creating unworkable conditions for any sort of negotiation.
Argentina cannot accept this extortion. First, because while paying the litigants would amount to $1.5bn, in addition Argentina would have to face payments for more than $15bn in the immediate future to the rest of the holdouts. Second, because offering the vulture funds a privileged treatment over the overwhelming majority of its creditors would be against Argentina’s own legislation and would trigger the Rights Upon Future Offers, or RUFO, clause, in force until the end of 2014. The exchange bondholders would have the right to demand the same conditions as the vultures. This would derail Argentina’s entire debt restructuring and prompt claims for more than $120bn (or up to $500bn according to some experts). Simply put, Argentina cannot pay all bondholders what the vulture funds are demanding for themselves.
Pandora's box
As predicted, the ruling has opened a Pandora’s box of cross litigation, even across jurisdictions. This is because, in overstepping his jurisdiction, Mr Griesa’s orders are also obstructing the collection of payments of bonds denominated in euro and yen issued under European and Japanese laws. Even some Argentine bonds unrelated to the debt exchanges have fallen into further scrutiny. Not surprisingly, bondholders are taking action to defend their rights, for example in the UK courts.
Through expensive media campaigns, the vulture funds have tried to demonise Argentina by manipulating the facts. They have created misleading slogans to frame Argentina as a unique and isolated case. They have insisted that this would never happen to other countries. But their empty arguments have fooled no one.
Multilateral and regional organisations, heads of state and members of congress across the globe, non-governmental organisations, hundreds of world-renowned experts and even the US government, in different briefs filed in the US courts, have rallied to warn about the grave consequences of this ruling for the global financial system and for the rights of sovereign nations. By dramatically tilting the incentives and trampling the rights of the vast majority of creditors, this ruling renders future sovereign debt restructurings impossible. As a consequence, states are granted even fewer rights than corporations: while there is a way out for a company that has gone bankrupt, sovereign nations would have no way out.
Some have also insisted that collective action clauses (CACs) would solve the holdout problem. But experts were fast to call them out. First, there are billions of dollars of existing sovereign debt without CACs. Second, CACs in most international bonds do not prevent holdout creditors from buying up blocking positions in single series of bonds, effectively preventing any debt restructuring of that series.
A new plan
The financial community agreed. In late August, and after lengthy discussions, a group of 400 of the world’s largest banks, investors and debt issuers gathered under the International Capital Market Association (ICMA) released an agreement on a new plan to prevent chaos in global financial markets created by this ruling. The plan would ground holdouts by limiting the ability of a small group of speculators to sabotage sovereign debt restructurings and undermine the interests of the majority of bondholders.
Sovereigns spoke up and took action. In a historical initiative the UN adopted a resolution toward the establishment of a multilateral legal framework for sovereign debt restructuring processes. This much-needed resolution approved by the vast majority of nations in September is proof of the will to move forward in a multilateral effort to ensure an orderly and predictable regulatory approach to sovereign debt restructurings.
Argentina wants to pay to 100% of its bondholders. It has a fair and reasonable offer already on the table that would end this litigation: holdouts can join the debt exchange under the conditions accepted by 92.4% of the bondholders. By accepting Argentina’s offer, the vulture funds can bank an immediate profit with a return of more than 300%.
Argentina will continue to pursue every available course of action to resolve this dispute. It has not and will not repudiate its debt; however, it will not surrender to the extortions of a minuscule group of voracious speculators that seek to endanger the future of the Argentine people and put at risk the stability of the international financial system.
Axel Kicillof is Argentina’s minister of economy and public finance.
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Peru's stellar economic performance over the past decade hit a bump in 2013 as a result of the US quantitative easing programme. However, the country's central bank governor sees this as a temporary setback, and reports that the Peruvian economy is back on the track towards long-term growth.
After a decade of hectic growth, the Peruvian economy was hit hard by 2013’s “tapering tantrum” – as Julio Verlarde, the country's central bank governor, describes the impact of the US Federal Reserve tapering its quantitative easing programme – but it is now back on course and predicted to grow by 6% in 2015.
This year growth is likely to be about 4%, says Mr Verlarde, who argues that Peru's past decade has been about much more than a typical Latin American commodities boom. While Peru's economy was certainly boosted by high gold and copper prices over this period – and has been impacted by recent price reversals – it has an investment rate of 28% of gross domestic product (GDP), which is translating into both expanded commodity production but also increased exports in other sectors such as agriculture.
Latam star
The IMF reports that Peru has posted the fastest growth and slowest inflation in Latin America over the past decade, with GDP growth averaging 6.6% and inflation 2.93%.
But last year’s announcement by then chairman of the Federal Reserve Ben Bernanke that the US would start pulling back on its bond buying programme caused panic in global markets, and Peru was badly affected with its currency falling by 10% as foreign investors sold Peruvian assets. On top of this, Peru which is the world’s third biggest copper producer and fifth largest gold producer, had to contend with falling commodity prices.
Mr Verlarde says that this “tapering tantrum” was not really based on fundamentals, and he has managed the situation through a combination of interest rate movements and changes to reserve requirements, as well as selling of foreign exchange reserves to strengthen the country's currency, the sol.
“We don’t want the exchange rate to be too far from fundamentals; we only intervene when we believe it is going beyond fundamentals,” he says. “In this case we are talking [about] a tapering tantrum. It overshot [the sol depreciated too much against the dollar], it was unsustainable and it was going to be reversed.”
More than half of Peruvian government local currency debt is held by foreigners, but Mr Verlarde says: “The market is currently underestimating the prospects of a US rate rise and it may come sooner than expected. But the fickle investors have already left so those remaining are more professional long-term investors and I don’t expect the same kind of sell off as last time.”
The market reaction in Peru to a falling dollar was also greater because 40% of loans are in dollars. Mr Verlarde would like to see this proportion reduced, but says that historically low US interest rates since the 2009 financial crisis have made dollar borrowing superficially attractive.
Overall bank loans to GDP in Peru are a low 40% and government debt to GDP is just 18%, meaning that the country has plenty of room to expand without becoming overburdened.
Heading upstream
When it comes to the current position of the Peruvian economy, Mr Verlarde says: “We had a good decade, helped by high commodity prices, but there is more to the story than that.
Indeed, the commodity prices boom has brought with it upstream improvements to Peru, and a sizeable chunk of the mining profits has been invested in other sectors, producing a big jump in agricultural exports and high-end textiles and clothing.
A huge fillip to the attractiveness of the domestic market has come with the advent of the Pacific Alliance trade agreement linking Peru, Chile Colombia and Mexico, as well as the Mercado Integrado Latinoamericano (MILA), which integrates the stock exchanges of Chile, Colombia and Peru.
Christian Laub is both president of the Lima Stock Exchange and CEO of the Peruvian investment banking franchise of Creditcorp Capital, which was formed through the integration of three banks: BCP Capital in Peru, Correval in Colombia and IM Trust in Chile. Mr Laub says that Peruvian companies and investors are now thinking on a regional rather than national scale, and that both the development of MILA and the creation of Creditcorp were designed to respond to this. Creditcorp also has an inter-dealer broker in the US.
Mr Laub admits that the trading volumes on MILA are still small, but says they do not take account of all the regional business, such as that carried out by family offices. He is also arguing for lower trading costs to make Peru competitive with both the Chile and Colombia exchanges, as well as those in the US, where the majority of the liquidity in Peruvian stocks is held.
“Last year we reduced [trading] costs by 50% but they are still high and we are not competitive with Chile and Colombia. We need to aim higher. The liquidity exists but it is traded in other markets. We need to get that liquidity back to Peru," says Mr Laub.
He says that by the Peruvian, Colombian and Chilean exchanges, companies in these countries can serve an $800bn economy with 90 million people. Adding Mexico to this bloc would create an economy the same size as Brazil. “The growth rate is not what we are used to [in Peru], but we are not in a downward spiral and there will be a pick-up next year,” concludes Mr Laub.
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This year’s Top 200 Latin American banks ranking sees Brazil’s behemoth banks reducing in size, while Argentine and Venezuelan lenders continue to show jaw-dropping profitability ratios.
Latin American economies are expected to grow on average by only 1.3% this year, the second lowest growth rate of the past 12 years, according to the International Monetary Fund’s (IMF’s) most recent forecast. This includes data for the Caribbean region, but the worst-affected countries are in the south: Argentina, Brazil, Chile, Peru and Venezuela, where the IMF’s downward revision since an earlier prediction has been even more severe. Other analyses confirm the unappealing picture of the region, as weakening commodity prices and uncertainty around domestic policies in certain countries depress investor outlook.
Bank results across the board are likely to reflect this. Brazil’s stagnant economy, for example, has already affected the strength and performance of local lenders, as highlighted in The Banker’s list of Top 200 Latin American banks, which ranks lenders according to the size of their Tier 1 capital from their most recent annual financial statements.
Brazil downsizes
All top four Brazilian banks that dominate the regional list have reduced their asset size – Caixa Econômica Federal, in fifth place, changed accounting standards last year, so a comparison with previous data would not be meaningful. Two of these lenders, Bradesco and Santander Brasil, also downsized their Tier 1 capital from the previous year. Smaller banks in the country, however, seem to have followed a different path and have grown. These tend to be either local banks with a specific territorial focus or foreign-owned lenders that tend to serve large corporate clients.
Banco Sumitomo Mitsui Brasileiro and Goldman Sachs Brasil, for example, raised their assets by more than 85% and 60%, respectively, making them the second and third most improved banks in the country by asset growth. Meanwhile the Brazilian unit of Morgan Stanley displayed the largest percentage growth in Tier 1 capital in the country, with a jump of almost 56% – the fifth largest in the Latin America region. Banco Cooperativo Sicredi, the mutual lender that operates in a number of Brazilian states, also grew its Tier 1 capital significantly by just over 45%.
Brazil and Mexico remain the largest banking markets in Latin America, although Brazil is still by far the region’s heavyweight. Total assets of Brazilian banks are $2231bn, more than four times the aggregate figure of their Mexican peers.
Mexican heavyweights
Mexican banks occupy four of the remaining top 10 places in the Top 200 Latin American banks ranking by Tier 1 capital. The highest scoring is Grupo Financiero BBVA Bancomer, with Tier 1 capital of just under $1bn in sixth place; immediately followed by Citi’s Banamex and Santander’s operations in the country. Banorte, the largest locally owned lender, sits in 10th place.
Banco Inbursa, which occupies 13th place in the Top 200 ranking, is the highest scoring bank by profit growth. The Mexico City-based lender closed 2013 with a $1.26bn pre-tax profit, a jump of just under 190% from the previous annual results.
When it comes to profitability, rather than size, the much smaller and distinctive markets of Argentina and Venezuela stand out. Citibank Argentina displays the highest return on capital (ROC), at 70%, followed by BBVA’s Venezuelan operations, with a 65% ratio. In fact, the whole top 10 banks by ROC ranking is occupied by banks from either country. Another Argentine bank, Banco de San Juan, shows the highest return on assets at 8.77%, followed by Citibank Argentina and Banco Patagonia. High inflation, and therefore higher interest rate margins, in both markets helps to explain such returns.
Looking at the growth in strength and size, the picture seems more diverse, with a variety of countries being represented in the list, from Chile to Colombia to Panama. Chile’s Banco Ripley leads the rankings for growth in both Tier 1 capital and assets. Part of a retail conglomerate best known for its department stores, the bank’s Tier 1 capital jumped by 381%, while its assets rose 153% to $1.39bn. Ripley has expanded from a relatively low position, as have most of the other lenders in these tables.
The largest bank, however, to have improved both figures is from Venezuela. Mercantil Servicios Financieros has assets of $38.1bn, which it expanded by more than 56%, and a Tier 1 capital of $3.51bn, 68% larger than the previous year.
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