The International Swaps and Derivatives Association (ISDA), the body that governs credit derivatives, recently declared a “failure to pay” credit event that triggers payment of credit default swaps (CDS) on Argentina’s debt. Bloomberg and others have raised the question of whether Paul Singer’s Elliott Associates or other hedge funds involved in the case against Argentina hold any of these CDS—and may be forcing a default and profiting from their CDS positions.

Elliott’s lawyers have denied that the firm owns CDS on Argentina’s debt, and a December, 2012 Reuters report cites an anonymous source saying the firm did have some, but no longer does. When asked by Judge Rosemary Pooler in a February 27th hearing in the Second Circuit Court of Appeals if Elliott’s NML owned any of the CDS, Elliott’s lawyer, Ted Olson, gave an evasive answer:

“I don’t know that that’s true,” Olson said. “I’m informed it isn’t true. But if it was true, it would be utterly irrelevant.”

Bloomberg pointed out that it was unclear if the denial applied to just NML Capital the Elliott subsidiary represented in the case, or to all of Paul Singer’s firms.

ISDA Decision

On June 20th, the law firm Schulte Roth & Zaber (SRZ) sent a memo on behalf of an anonymous holder of Argentine CDS to the ISDA Credit Derivatives Determination Committee (DC) asking them to decide whether Argentina had defaulted on its debt, and also arguing that Argentina’s public statements were tantamount to a repudiation of its restructured bond payments, urging them to rule that Argentina had triggered a “repudiation/moratorium” credit event.

SRZ wrote that their client’s CDS were set to expire on the 20th of June, and that if the ISDA DC ruled that “repudiation/moratorium” had occurred, this would extend the life of the CDS.

The ISDA DC did rule that Argentina had defaulted through a “failure to pay” credit event, which is different than a “repudiation/moratorium” credit event in that it apparently doesn’t extend the life of expired CDS, though it does trigger payment of non-expired CDS. ISDA DC later confirmed that Argentina’s public statements did not constitute a “repudiation” credit event. The ‘no’ vote was unanimous among the DC’s 15 members, including Elliott Management, which is a non-dealer voting member.

Does Elliott Own Argentine CDS? Circumstantial Evidence

First, we know that Elliott has a lot of CDS, including sovereign CDS. To be an ISDA non-dealer voting member of the Determining Committee, a firm must have over $1 billion in exposure to CDS. An ISDA spokesperson indicated that Elliott has no obligation to recuse itself because of its role in Argentina’s debt case, nor do any of the dealer institutions who sell the CDS of Argentine bonds, or the non-dealer buyers. So there is nothing stopping Elliott from purchasing these CDS, and it would make a lot of sense if they owned a lot of them. Elliott Management, by virtue of being on the committee, owns a significant amount of CDS, but they also have profited off of sovereign CDS in the past— as in the case of Ecuador, which in 2008 became ISDA’s first sovereign credit event. Elliott also held CDS [PDF] for Lehman Brothers.

SRZ, the firm that made the request on behalf of an anonymous holder, has Elliott as a client. This is a large firm that specializes in both derivatives and advising hedge funds, and especially in investor activism.  Elliott Associates is one of SRZ’s most important clients. On the other hand, SRZ represents a lot of hedge funds. Whoever the “anonymous holder” of the CDS was whom SRZ wrote on behalf of, may have been left holding the bag if their CDS expired and the DC ruled against extension. 

Owning CDS on Argentine bonds is the only way to call for a technical default. Under ISDA DC rules, an entity must be a holder of affected CDS in order to ask the Determining Committee to consider a credit event. This means that Elliott has a huge incentive to either own the CDS, or to coordinate with an ally who does.  Singer has two reasons to hold the CDS: First, to make money, and it would be an easy way to make money by collecting on a credit event that he has the power to influence; Second: to call for the default in order to increase pressure on Argentina. On the other hand, anybody who owns affected CDS would want to collect, not necessarily with the coordination of the interested hedge funds.

The “repudiation/moratorium” arguments in SRZ’s memo on behalf of an anonymous client closely mirror the arguments that the NML legal team and Elliott-run American Task Force Argentina (ATFA) have been making for a long time, including through an official campaign trying to argue that Argentina is repudiating its debt by intentionally ignoring court orders. It’s not inconceivable that SRZ’s memo was sent with the coordination of Elliott, particularly given that Elliott is a major client of SRZ, and given that SRZ markets itself as the “go-to” law firm for “investor activism” (though “hedge fund hardball” may be a more accurate term). A key point is that SRZ probably knew that their position had little chance of success. Argentina’s CDS have special rules with the ISDA, allowing the CDS to only apply to restructured bonds. To make their case, however, SRZ cited Argentine government statements referring to litigation with hedge funds which hold a completely different set of bonds, over which the ISDA Determining Committee has no jurisdiction. It is willfully misleading to argue, as SRZ did, that Argentina has repudiated or declared a moratorium on payments on its restructured bonds, particularly given that Argentina already made a coupon payment on these bonds. Argentina’s “default” was solely due to unprecedented injunctions on the intermediary banks that stopped the processing of this payment, and SRZ is arguing that Argentina’s public objection to these injunctions is somehow a repudiation of its restructured bond payment obligations.

Lastly, another major holder of the defaulted bonds with ties to the case, FH Asset Management International (which is still a member of the American Task Force Argentina) has bought CDS on Argentine bonds in the past. FH Asset Management and Montreux Partners, a party to the litigation against Argentina, are both run by Eric Hermann. Montreux filed these recent [PDF] amicus briefs in support of NML [PDF]. According to their newsletter [PDF], as of 2011 they were still litigating against Argentina along with Elliott. An investor newsletter [PDF] from May 31, 2005, shows that they purchased an index of sovereign emerging market bonds, the CDX EM; CDS on Argentine bonds were added to this index later that year [PDF]. Besides the question of whether FH still holds these CDS, this is an indication of something obvious—major dealers in distressed debt regularly deal in sovereign CDS, including the parties in the Argentina debt case—FH, Elliott, Bracebridge, and Aurelius. It would actually be surprising if these entities didn’t own CDS on Argentine debt, at least at some point over the last decade plus of litigation. Still, if these companies do own the CDS, it’s difficult to see how it would be “utterly irrelevant,” as Elliott’s legal team claims. Furthermore, Argentine Republic CDS prices have seen significant movement at different points, especially when compared to most other sovereign CDS—if these firms did own the CDS but no longer do, they may have also made considerable amounts of money buying and selling them before the credit event took place. For instance, if the anonymous source in the December, 2012 Reuters report is correct in claiming that Elliott had sold their Argentine CDS, they could have made a lot of money if they unloaded them during the dramatic CDS spread increase that happened just weeks prior (and that they played the central role in instigating), directly before and after the Second Circuit Court of New York ruled against Argentina in favor of the hedge funds.

Argentina’s government recently submitted a formal request to the SEC to find out if any of the holdout hedge funds that are parties to the case against Argentina hold CDS on Argentine debt. The CDS business rightly garners a lot of mistrust from people unfamiliar with the world of finance, who wonder how it’s possible to buy insurance for someone else's bonds. But even if these instruments served an important purpose, one thing is for certain: the CDS market does not have adequate regulation and disclosure—it’s pretty difficult to figure out what’s going on in this surprisingly self-regulated area of international finance. Given the prevalence of speculation in these markets and the potential damage this can cause, this is an extremely important question.