The Argentina Debt/Default Situation, Discharging Payment Obligations, and U.S. Treasury Securities

The Argentinian debt situation after the U.S. Supreme Court declined to hear an appeal, is the sleeper financial story of the summer. It has gotten some press coverage, but not a lot. This is the sort of story that could either become a front page story when and if Argentina defaults or it could fizzle if Argentina reaches a deal with its holdout creditors and the other creditors who previously accepted a restructuring of Argentinian debt do not object.

The situation is unusual, since the judge in this case, Thomas P. Griesa, is creating the possibility of default on the restructured debt through his orders, even though Argentina has the means and the desire to meet its obligations on these bonds. The last payment was due yesterday. There is now a 30-day grace period before default is declared.

While I am not an expert about the legal and practical fallout of this unfortunate situation, one aspect of this case I found interesting is the role of the trustee bank, BNY Mellon. The judge has said that, if BNY Mellon facilitates any payment on the bonds contrary to his prohibition of Argentina making any payments on the bonds without also paying the holdout creditors, then BNY Mellon would be in contempt. On this point, a Georgetown University law professor, Adam Levitan, writing for the blog Credit Slips, argues that if Argentina tenders payment to BNY Mellon, then it has not defaulted:

“… [I]f the Republic tenders payment to Bank of New York Mellon as the indenture trustee, then the Republic has fulfilled its obligation, and there's no event of default possible under the indenture (the EOD [event of default] only occurs 30 days after failure to pay anyhow). At this point, I think the problem becomes Bank of New York Mellon's. Because of Judge Griesa's injunction, Bank of New York Mellon might refuse to accept payment from Argentina. Or BNYM might accept payment, but refuse to distribute it (more likely the former). Either course of action raises potential liability for Bank of New York Mellon to the exchange bondholders.”

Argentina has in fact transferred the funds it owes to BNY Mellon, and I assume it is prepared to make an argument similar to the one Levitan makes concerning its obligations on these bonds. However, even if the argument is correct, which is by no means certain, the beneficial owners of the bonds will still be mighty unhappy, since they will not have received payment. (I do not think BNY Mellon will defy the judge.)

This discussion reminds me of a similar issue that came up when I was at Treasury. As a result of the Salomon bidding scandal in 1990, the Treasury Department decided it needed to consolidate the auction procedures and terms and conditions of its securities in the Code of Federal Regulations. This forced more precision than had heretofore been manifest for Treasury securities. One of the questions that we felt needed to be addressed was at what point has Treasury discharged its payment obligation on its securities.

By way of background, the bulk of marketable Treasury securities are held in what is called the commercial book-entry system, which is operated by the Federal Reserve Banks as Treasury’s fiscal agents. Depository institutions can have accounts at Federal Reserve Banks, through which they can hold Treasury securities for their customers, which may be other financial institutions, which in turn may be holding the securities for their customers. The question for Treasury in connection with the commercial book-entry system was whether Treasury is ultimately responsible to the beneficial owners of its securities or just to the depository institution with accounts at the Fed.

The current version of the Uniform Offering Circular, which has been rendered into “plain English,” which is supposedly easier to understand than the more legalistic version, says the following on this point:

“(c) Discharge of payment obligations—

“(1) The commercial book-entry system. We [the U.S. Treasury Department] discharge our payment obligations when we credit payment to the account maintained at a Federal Reserve Bank for a depository institution or other authorized entity, or when we make payment according to the instructions of the person or entity maintaining the account. Further, we do not have any obligations to any person or entity that does not have an account with a Federal Reserve Bank. We also will not recognize the claims of any person or entity:

“(i) That does not have an account at a Federal Reserve Bank, or

“(ii) With respect to any accounts not maintained at a Federal Reserve Bank.”

What happens as a practical matter is that the Treasury’s account at the Fed is deducted and the depository institutions’ accounts are simultaneously credited for the payment of interest or principal on Treasury securities on a payment date. The reason for the language limiting Treasury’s obligation to the depository institutions with Federal Reserve security accounts is that Treasury is not in a position to ensure that all the financial intermediaries which are holding Treasury securities for customers are maintaining accurate books and records and are passing on payments on Treasury securities in a timely manner. (Customers at most broker-dealers, though, do benefit from SIPC insurance of up to $500,000 if a broker-dealer uses customer securities improperly and cannot make customers whole.)

While the Treasury situation is not analogous to the Argentinian one, and the institutional arrangements and legal agreements are different, the question of what action a debt issuer needs to take to meet its payment obligation is the same. The U.S. Treasury’s answer is clear; the answer with respect to Argentinian bonds is currently murky.