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New York lawmakers are launching a new push to restrict “vulture fund” litigation against governments that default on their debts and limit the amount investors can recover in defaulted emerging market bonds.
A bill introduced Monday in Albany would prevent certain investors from buying up cheap, defaulting government bonds and then seeking large compensation in court.
“These hedge funds have made billions in profits while leaving countries with insurmountable debts and destabilized economies… By changing the law, New York can change the rules of the game for these hedge funds,” said the bill’s sponsors, New York State Senator Liz Krueger and Jessica González -Rojas, Representative in the House of Representatives, in a statement.
Approximately half of all bonds issued by emerging market governments are issued under the laws of New York State. These borrowers include Latin American governments such as Argentina, a serial debtor, as well as Mongolia and Sri Lanka.
The bill is the latest in a series of efforts to rewrite New York’s law regulating the national debt. Three bills introduced last year ultimately failed to get a vote, and an attempt to reintroduce two of them in March faced stiff opposition from Wall Street investors who said the bill would have a chilling effect on markets have.
Investors hailed Monday’s bill as a more palatable and targeted approach to reining in “holdout” investors who reject restructuring talks, in contrast to March’s bill, which made sweeping changes to debt resolution.
The new bill was inspired in part by Argentina’s long battle in the New York courts against Paul Singer’s Elliott management, which resulted in a large payout for the hedge fund many years after the country defaulted in 2001.
The new bill would explicitly allow courts to investigate the history and conduct of creditors who have bought up claims in order to sue them, thereby fully restoring a legal doctrine known as “champerty” that traditionally stopped frivolous lawsuits.
The bill would also reduce the penalty interest rate that applies to payments after Treasury defaults, from 9 percent, which has resulted in huge payouts in the past, to the usual rate on one-year U.S. Treasury bonds. This is currently around 5 percent.
In April, Jay Shambaugh, the U.S. Treasury’s undersecretary for international affairs, supported such a move as part of what he described as “narrow, targeted updates to avoid market disruption.”
Other lawmakers have introduced a draft “sovereign debt stability law” that would authorize the creation of an independent observer to oversee restructuring talks. Wall Street sparked anger over its perceived impracticality.
Proponents – and investors – say the Champerty bill has a much better chance of passage because it aims to distinguish between holdouts and traditional creditors participating in restructuring negotiations.
“We have conducted a series of consultations with the official sector and the investment community – this is aimed at professional objectors, not conventional investors,” said Alice Nascimento, campaign director for New York Communities for Change, which supports the new bill.
Institutional investors said the most promising development in the revised bill was a line in the draft that said it “shall not apply to conventional and generally cooperative investors who occasionally choose to sue.”
The revised bill “takes an elegant, targeted approach, combining a narrow Champerty provision with a reduction in interest rates to the statutory federal rate. The general market should remain unaffected, although it would significantly increase the risk of making a business out of suing states,” said Gregory Makoff, author of Default: The Landmark Court Battle Over Argentina’s $100 Billion Debt Restructuring.