New York lawmakers push to block funds’ sovereign bond litigation

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New York lawmakers are launching a fresh push to limit “vulture fund” litigation against governments defaulting on their debts, and cut how much investors can recover through the courts on defaulted emerging-market bonds.

A bill introduced in Albany on Monday would seek to block certain investors from buying up cheap defaulted sovereign bonds and then winning high payouts through courts.

“These hedge funds have made billions in profits while leaving nations with insurmountable debts and a destabilised economy . . . by changing the law, New York can change the rules by which these hedge funds play,” New York state senator Liz Krueger and Assembly member Jessica González-Rojas, the bill’s sponsors, said in a statement.

Roughly half of all bonds issued by emerging market governments are issued under New York state law. Those borrowers include Latin American governments such as Argentina, a serial defaulter, as well as Mongolia and Sri Lanka.

The draft legislation is the latest in a series of efforts to rewrite New York law governing sovereign debt. Three bills proposed last year were ultimately not voted on, and an attempt to revive two of them in March was met by furious objections from Wall Street investors who said the proposed legislation would have a chilling effect on markets.

Investors greeted Monday’s bill as a more palatable and targeted approach to limiting “holdout” investors who reject restructuring talks, as opposed to the March bill, which proposed sweeping changes to debt workouts.

The new bill has been 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’s 2001 default.

The new bill would expressly allow courts to look at the history and behaviour of creditors who have bought up claims in order to sue, restoring in full a legal doctrine known as “champerty” that traditionally halted frivolous lawsuits.

The bill would also cut the penalty rates applied to post-default sovereign bond payments from 9 per cent, which have driven huge payouts in the past, to the going rate on one-year US Treasury bills. This is currently about 5 per cent.

In April, Jay Shambaugh, the US Treasury’s under-secretary for international affairs, backed such a switch as part of what he called “narrow, targeted updates that avoid market disruptions”.

Other lawmakers have brought forward a draft “sovereign debt stability act” that would authorise setting up an independent monitor to oversee restructuring talks. It has drawn angry response from Wall Street over its perceived unworkability.

Supporters — and investors — say the champerty bill has a much better chance of passing because it seeks to distinguish between holdouts and traditional creditors who take part in restructuring negotiations. 

“We’ve gone through a series of consultations with the official sector and investment community — this is targeting professional holdouts and not conventional investors,” said Alicé Nascimento, director of campaigns for New York Communities for Change, which is backing the new bill. 

Institutional investors said the most promising development in the revised bill was a line in the draft saying it “is not intended to apply to conventional and generally co-operative investors who may occasionally choose to sue”. 

The revised bill “takes an elegant, pinpoint approach, combining a narrowly scoped champerty provision with a reduction of interest to the federal statutory rate. The general market should be unaffected while it would substantially raise the risk of making a business of suing sovereigns,” said Gregory Makoff, author of Default: The Landmark Court Battle over Argentina’s $100 Billion Debt Restructuring.