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New York lawmakers are launching a new push to limit lawsuits by “vulture funds” against governments that default on their debts and cut the amount investors can recover through the courts on defaulted emerging market bonds.
A bill introduced Monday in Albany would aim to prevent certain investors from buying up cheap, defaulted Treasury bonds and then winning big payouts through the courts.
“These hedge funds have made billions in profits while leaving countries with insurmountable debt and a destabilized economy. . . By changing the law, New York can change the rules these hedge funds play by,” New York State Sen. Liz Krueger and Assemblymember Jessica González-Rojas, the bill’s sponsors, said in a statement.
About half of all bonds issued by emerging market governments are issued under New York state law. These borrowers include Latin American governments such as Argentina, a string of defaulters, as well as Mongolia and Sri Lanka.
The bill is the latest in a series of attempts to rewrite New York’s federal debt law. Three bills proposed last year ultimately failed to come to a vote, and an attempt to revive two of them in March was met with furious objections from Wall Street investors who said the proposed legislation would have a chilling effect on markets .
Investors hailed Monday’s bill as a more palatable and targeted approach to limiting “holdout” investors who reject restructuring talks, unlike the March bill that proposed sweeping changes to debt payments.
The new bill was inspired in part by Argentina’s long battle in 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 bankruptcy.
The new bill would expressly allow courts to look at the history and conduct of creditors who have bought up claims in order to file a lawsuit, eliminating a legal doctrine known as “champerty,” which traditionally halted frivolous lawsuits , would be fully restored.
The bill would also lower the penalty rates applied to post-default payments on Treasury bonds from 9 percent, which has led to huge payouts in the past, to the going rate on one-year U.S. Treasury bonds. Currently this is about 5 percent.
In April, Jay Shambaugh, the U.S. Treasury Department’s assistant secretary for international affairs, supported such a move as part of what he called “limited, targeted updates that prevent market disruptions.”
Other lawmakers have introduced a draft “law for the stability of public debt” that would allow the creation of an independent regulator to oversee the restructuring talks. Wall Street has received angry reactions for its perceived unworkability.
Advocates – and investors – say the Champerty bill has a much better chance of passage because it seeks to distinguish between holdouts and traditional creditors participating in restructuring negotiations.
“We have conducted a series of consultations with the formal sector and the investment community – this is aimed at professional holdouts and not conventional investors,” said Alicé Nascimento, campaign director of 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 says it is “not intended to apply to conventional and generally cooperative investors who may occasionally choose to make a to file a lawsuit.”
The revised bill “takes an elegant, precise approach, combining a champerty provision with limited scope and a reduction of interest to the federal statutory rate. The general market should remain unaffected, while this would significantly increase the risk of making a business out of suing states,” says Gregory Makoff, author of Default: the landmark lawsuit over the restructuring of Argentina’s $100 billion debt.