On August 1, the International Swaps and Derivative Association (ISDA) “resolved that a failure to pay credit event occurred in respect of the Argentine Republic”. What does that mean? It means that any institution holding a credit default swap (CDS) insuring against a default by Argentina can collect.
CDS are written by private parties. Banks and insurance companies (remember AIG?) developed a lucrative fee-generating business line by writing CDS. The notional value of the CDS written can -- and often does -- far exceed the nominal value of the debt being covered by the CDS. Estimates of the value of the CDS written on the defaulted bond issue are not widely known, if they are known with any exactitude.
By triggering the right to collect, the ISDA resolution opens up a can of worms. Over the coming days, we'll see how much exposure to the Argentine default there really is in the international financial system and which financial institutions are most heavily exposed. The issue isn't really who holds the actual bonds. It's which institutions bet that Argentina wouldn't default and they value of the CDS they wrote based on that belief.
Argentina entered into a technical default when it failed to make a debt payment to foreign creditors on June 30. The technical default became a real one a month later. It’s not that the country didn’t have the money to make the payment or even that it didn’t want to pay. The funds are sitting in a US bank awaiting transfer.
The situation is the consequence of a June 16 US Supreme Court’ decision that it would not accept an appeal of lower court rulings requiring Argentina to pay bondholders who refused to participate when the country restructured its debt earlier this decade as well as the holders of the restructured bonds. The US Supreme Court ruling also upholds lower court decisions that permit bondholders to issue subpoenas to banks to trace assets held abroad by Argentina.
The rulings are a major victory for those “vulture investors” who often bought the bonds at discounted rates in the secondary market and turned to the courts to enforce their right to payment in full. Be that as it may, the rulings will greatly complicate any future debt restructurings since the rewards for holding out have just soared.