Sometimes I worry that you don't even know what this boat is. Photographer: Ricardo Figueredo/Getty Images
Sometimes I worry that you don't even know what this boat is. Photographer: Ricardo Figueredo/Getty Images

(Updates fifth and seventh paragraphs for ISDA's receipt of the Japanese yen bond prospectus.)

Here's a strange little quirk about the fallout from Argentina's continuing debt troubles. After Argentina defaulted at the end of last month, the International Swaps and Derivatives Association declared a credit event, triggering the credit default swaps on those bonds. And the ISDA determinations committee (DC) announced an auction to settle those swaps.

The idea of the auction is roughly that, if you own CDS, you can either deliver bonds in exchange for 100 cents on the dollar, or you can cash settle by delivering no bonds and just getting X cents on the dollar, where X = 100 minus the price of the bonds set by ISDA's auction. You'd want to deliver the cheapest possible bonds into the auction, to maximize your CDS recovery.

The auction is scheduled for Aug. 21; there are currently 11 exchange bonds on the list of deliverable bonds. There are also, amusingly, four bonds not on the list because, "the members of the DC have been unable to obtain documentation for those bonds." Nobody was keeping an eye on them and they just vanished. Oops.

Those bonds are Japanese yen exchange bonds, and their prospectus is easily available on Bloomberg. Here it is. It does have the disadvantage, from a certain perspective, of being in Japanese. The indenture seems to be less easily available, but still. It is 2014. We're talking about hundreds of millions of dollars worth of a G-20 sovereign's bonds. It's sort of weird that they just went missing.

[Update: They found the bonds! "ISDA has received a copy of the Prospectus for Japanese Yen denominated bonds of the Republic of Argentina dated as of January 2005." That would be the prospectus I linked in the previous paragraph.]

Theses bonds are of interest because some of them, the 0.45 percents of 2038, seem to be by far the lowest-priced exchange bonds:1

Source: Bloomberg
Source: Bloomberg

The missing yen bonds are the green line at the bottom, and I guess the line's flatness does support the theory that they've vanished from the earth. But as Reuters puts it, "their exclusion from the list could result in a higher final auction price," and so a lower CDS recovery. On the other hand, if someone finds and/or translates those documents, then there'll presumably be a lower auction price, and a higher CDS recovery. If you take the prices in that chart literally -- and you probably shouldn't, not all of those bonds trade that much -- then the cheapest to deliver non-yen bond implies a CDS recovery of around 55 cents on the dollar. The 4.33 percent yen bond -- which they can find documents for for some reason? -- implies about 60 cents on the dollar. The missing bonds imply more like 80 cents on the dollar. That's a difference of around $190 million on the nearly $1 billion of net CDS outstanding. [Update: After finding the bonds, "ISDA has received a request to add" the 0.45 percent bonds to the auction.]

I mostly mention this because it's another creepy illustration of how sovereign CDS works, or doesn't. It's not, like, a hedge against default on your bonds; it's a weird game of figuring out what is deliverable and where the documents are and what language they're in and stuff like that.

But there's one possible way in which the CDS auction might actually matter for Argentina's situation. That situation has settled into a pretty boring rut these days. Basically, Argentina and its holdout bondholders take out vicious advertisements in newspapers (and on Bloomberg View) about each other and Judge Griesa, and get yelled at by Judge Griesa, but otherwise not much happens.2 Bloomberg News explains the current state of negotiations:

While Argentina isn’t opposed to a settlement that compensates the holdouts and enables the nation to resume payments to current bondholders, Economy Minister Axel Kicillof said last week the government can’t get involved in those negotiations.

So Argentina isn't opposed to negotiations, as long as those negotiations don't involve it negotiating. If the holdouts can manage to convince themselves to take the 30-cents-on-the-dollar offer that Argentina made in 2005, then, great. But they'll have to negotiate that with themselves.3

One thing you might ask is: What is the catalyst for Argentina to get involved in its own debt negotiations? Or more generally, for anything to happen? That Bloomberg News article mentions one theory, that falling prices on the exchange bonds "may be just what prods the government into pursuing a solution."

Argentines themselves will look to bond prices as an indication of confidence in a resolution, and they “may start losing faith in the official narrative emphasizing prospects of domestic stability” if prices fall below 70 cents, JPMorgan wrote in a note on July 31.

Ha sure. Argentina's bonds are now trading at around 87 cents on the dollar.4 They last traded below 70 in February. Also for most of 2013. One thing that did not happen in February, or in 2013, was Argentina pursuing a settlement with its holdout bondholders. But maybe now it will?

Why? Perhaps because, as exchange bondholders lose hope, and money, they will accelerate their bonds and drag Argentina into court for a restructuring?

“Some acceleration might be desirable for Elliott, since it would increase the pressure on the country to get out of default,” Alejo Czerwonko, a strategist at UBS Wealth Management’s chief investment office, said in an e-mail. “Even acceleration ‘talk’ or acceleration that winds up being decelerated could help Elliott.”

Mmmaybe. But it seems to me that the threat of being sued by bondholders for full repayment in U.S. courts is the one thing, of all the things in the world, that is least likely to make Argentina settle.5 I mean! That's the thing that Elliott has been doing for the last decade. "Ooh, maybe if someone else tries a lawsuit, that'll work." Mostly I'm with this guy:

“What do the holdouts stand to gain if they inadvertently cause a group to come and accelerate and essentially get Argentina to a point where they have to give a seat to everybody else?”

Though I guess Argentina could give the accelerating bondholders Argentina's seat at the negotiating table, which it doesn't seem to be using.

On the other hand: There is a popular though I think unconvincing theory that the holdout bondholders, particularly Elliott, own a lot of CDS on Argentina. (Elliott has denied this, and the total net CDS notional outstanding is much less than the size of the holdouts' position.6 ) If that's true, then the lower Argentina's bonds trade in the next week, the higher the CDS recovery will be. If you own CDS on Argentina, you want the news in the next week to be terrible, because that increases the value of your investment.

But after the auction next week, incentives become normal again, and badness is pretty much bad for everyone. And I suppose there's some chance that that normalization would be the catalyst for more fruitful negotiations.

I'm not holding my breath though. Even if the holdouts do make a big CDS profit next week, and I have my doubts, that will just improve their incentives to negotiate with Argentina. But that won't help much if Argentina won't show up to negotiate.

1 That chart just takes the ISDA list and cleans up similar/duplicate bonds (i.e. two bonds with different identifiers but same currency, maturity and coupon). The data is from Bloomberg and you shouldn't take it absolutely literally; those 0.45 percent yen bonds, in particular, don't really trade much.

2 I mean, there's that International Court of Justice lawsuit, but that's pretty much a nothing too.

3 I kid, of course; there are frequent rumors that banks -- first Argentine banks but more recently global/U.S. banks -- are negotiating to bridge the gap. The idea is something like:

  • Banks pay holdouts $X for their old bonds.
  • Banks step into the holdouts' shoes in court and are much nicer, agreeing to let Argentina un-default on its exchange bonds.
  • Banks hold the bonds until 2015, when the terms of the exchange bonds allow Argentina to offer them a settlement at above 30-ish cents on the dollar.
  • In early 2015, Argentina pays banks $Y for their bonds.

X and Y might be roughly identical (adjusted for interest, etc.), or Y might be less than X since the banks also get some benefits from Argentina's return to global capital markets. For one thing, if the banks hold exchange bonds, those bonds will go up in value with a settlement. For another, if Argentina returns to global capital markets, it'll need, you know, capital markets bankers. And guess who'd go to the front of the list for that?

Anyway this all seems to be off now but who knows.

4 That's the U.S. dollar 8.28 percent "discount" bonds of 2033, ISIN US040114GL81, which I assume is the relevant comparison here.

5 Or, that and the trading below 70 thing. Actually there are a lot of things that you'd have to say, based on empirical evidence, are unlikely to make Argentina settle. Really just about anything you can think of probably goes straight on that list.

Anyway here is Joseph Cotterill on acceleration:

Then again, we suspect there are also tourists who have come to the bonds from outside the asset class (from high yield, say). They may not have been around the block with the extent of Argentina’s wackiness before. They thus may well believe they have something to gain by accelerating and then litigating for full payment. Which given how Argentina likes to litigate, is a bad idea.

6 Another data point: Elliott is on the ISDA determinations committee running the CDS auction. That committee unanimously agreed to the statement about not being able to find the documents for those cheap yen bonds. Presumably if Elliott held a lot of CDS -- CDS whose value would increase dramatically by including the yen bonds in the auction -- it would have worked harder to find those documents. I mean surely someone has them, right? And Elliott is nothing if not dogged.

To contact the writer of this article: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this article: Tobin Harshaw at tharshaw@bloomberg.net.