Re­struc­tur­ing of loans that in­volves third par­ties could be costly for an econ­omy

Business Daily (Kenya) - - LIFE - CATHY MPUTHIA Founder of C Mputhia Ad­vo­cates

Why coun­tries should be wary of vul­ture fund deals

African coun­tries, es­pe­cially those which are rich in nat­u­ral re­sources, are at­tract­ing a lot of global in­vestors. One of the en­ti­ties is global funds known as sovereign wealth funds (SWFS). These are in­vest­ment funds var­i­ous gov­ern­ments own for in­vest­ments. One such fund is the Bei­jing-owned China In­vest­ment Cor­po­ra­tion. Kenya has plans to set up an SWF too. The fund is of great ben­e­fit to an econ­omy and its peo­ple be­cause re­turns from di­ver­si­fied in­vest­ments ben­e­fit cit­i­zens. I re­ally look for­ward to a well-man­aged Kenyan SWF as this would give Kenya an ad­di­tional source of in­come in ad­di­tion to the tra­di­tional sources of in­come. Since SWFS are state-owned


eq­uity funds, many times they have po­lit­i­cal goals when in­vest­ing. A few coun­tries, es­pe­cially in Africa, have bor­rowed from SWFS for var­i­ous projects and such loans are se­cured by agree­ments. Some­times the bor­row­ing coun­try is un­able to hon­our its debt obli­ga­tions lead­ing to a sovereign debt. A sovereign debt is un­like any other debt be­cause the debtor is a state while the cred­i­tor may be a pri­vate or a pub­lic en­tity. There­fore, in­ter­na­tional law ap­plies to a sit­u­a­tion where a sovereign debt arises, the chief be­ing the prin­ci­ple of sovereignty of na­tions. This prin­ci­ple as­sumes that all na­tions are free and in­de­pen­dent. Con­se­quently, a cred­i­tor has limited op­tions in debt re­cov­ery. For ex­am­ple, one can­not for in­vade the coun­try or sell off its as­sets. Agree­ments with SWFS are com­plex and unique. One of the pro­vi­sions of such agree­ments, which is of­ten re­sorted to, is the pro­vi­sion to re­struc­ture the debt should the bor­row­ing na­tion fail to hon­our its obli­ga­tions. In such a sit­u­a­tion, the par­ties may mu­tu­ally agree to rene­go­ti­ate the debt or may re­fer the dis­pute to ar­bi­tra­tion to reach a mu­tual agree­ment. The agree­ments, al­low the SWF to sell the debt owed to third par­ties. The debt owed is traded in the sec­ondary debt mar­ket and a third party known as a vul­ture fund pur­chases it and as­sumes the ini­tial po­si­tion of the SWF. A vul- ture fund, as the name sug­gests, buys the debt when a coun­try is un­able to ser­vice it and make a large mar­gin later on. They usu­ally leave such coun­tries even worse off than they were. In the event a coun­try is not able to hon­our its obli­ga­tions to the vul­ture fund, it can sue the coun­try in in­ter­na­tional courts. In 2001, Ar­gentina had a debt of about $100 bil­lion. Pur­suant to the agree­ment be­tween Ar­gentina and the SWF the debt was re­struc­tured and sold off to a vul­ture fund. Ar­gentina de­faulted and the fund sued it in New York (as per the choice of law con­tract) and won the case. While the is­sue was a mi­nor one where the vul­ture fund wanted its right to be paid recog­nised as equal to the ini­tial cred­i­tor, this case goes to show that sovereign debt can be lit­i­gated. For­tu­nately, there are a lot of treaties to pro­tect the vul­ner­a­ble coun­tries. Some pro­vide that pub­lic debt should not ex­ceed a cer­tain per­cent­age of the gross do­mes­tic prod­uct. Fur­ther, the re­struc­tur­ing agree­ments, give bor­row­ing coun­tries a re­prieve as they al­low rene­go­ti­a­tions. It is, there­fore, far-fetched that a cred­i­tor can pri­va­tise a coun­try’s as­sets to set­tle the debt.


Bor­row­ing from vul­ture funds has many risks.

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