The utility of vulture funds

At a conference on sovereign debt in Washington last week, Daniel Osorio, the chief executive of Andean Capital Management, delivered a warning: if Venezuela’s opposition government seeks an Iraqi-style debt restructuring — meaning investors end up with a 90 per cent haircut — all bondholders will sell their Venezuelan debt once the sanctions are lifted, and prices will fall to the high teens.

The bonds, he added, would then be bought by “the people you don’t want buying them if you want to avoid 15 years of litigation”.

The 15 years-of-litigation event that Osorio referred to involves Argentina and its high-profile stand-off with Paul Singer’s hedge fund, Elliott Management. After the country defaulted on $80bn of debt in 2001, Elliott and a group of hedge funds rejected the government’s debt restructuring offer and sued for full repayment. The gambit, which involved the attempted seizure of an Argentine frigate and two SpaceX contracts, proved successful. More than a decade later, Elliott collected some $2.4bn from the country after striking a deal with reformist president Mauricio Macri.

The move helped to earn Elliott the title of “vulture fund,” implying that the firm was “preying” on Argentina at a time when the country was under economic pressure. Other creditors decried Elliott’s tactics, claiming that their holdout strategy forever changed the way sovereign debt restructurings would proceed going forward.

In the case of Venezuela, some hedge funds have taken heed. A new guard of creditors have started to sue the government and its state-owned oil company over unpaid debts, despite the country suffering an unprecedented economic and humanitarian crisis. The thinking is that a judgment could give litigious creditors a leg up when it comes to repayment later down the line.

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Between the creditors and sovereign debt lawyers that Alphaville sat down with on the sidelines of the IMF and World Bank meetings last week, there’s a roughly 50-50 split between those that concede this point and those that vehemently disagree, with one creditor previously telling the FT that the hedge funds suing have no legal leverage and just look like “assholes“. Regardless of where people fall on this point, most say the timing is off. Bread and penicillin need to come first, says Osorio.

Arturo Porzecanski, a Wall Streeter-turned-academic at American University, agrees that no one is expecting Venezuela to repay right away, but says there is a case to be made that lawsuits and the vulture funds behind them can actually do good. He told Alphaville in Washington that hedge funds played a “constructive role” in Argentina:

It was thanks to Elliott that 50,000 pensioners in Italy got paid. If it wasn’t for Elliott they were not going to get a dime. Lawsuits and vultures have played in the past a very constructive role, and I hope that they will play a very constructive role in the forthcoming [Venezuela] restructuring. That starts with standing up for your rights.

In 2016, Argentina paid a group of Italian bondholders $1.35bn in cash in order to settle a suit over the country’s unpaid debts. The deal came just before president Macri agreed to a settlement with Elliott.

Porzecanski’s conclusion is perhaps unsurprising considering he sees himself as a “proponent, protector and defender of creditor rights”. What is more surprising, however, is that his argument for the overarching utility of vulture funds has an unlikely supporter.

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For the most recent episode of Alphachat, Alphaville sat down with Odette Lienau, a professor of law at Cornell University and Yale. The author of Rethinking Sovereign Debt, Lienau has previously argued that under certain circumstances, nations don’t necessarily have to repay their debts. The practice, she writes, is “not essential” even if countries want to return to international capital markets in the future.

While Lienau does not agree with the exact benefits Porzencanksi attributes to vulture funds, she does make the case that they can sometimes do good. More specifically, she says that vulture funds are pretty good at identifying sovereign assets that have been “sequestered and illegitimately privatised” by government officials:

They are trying to take this money back for themselves. They’re still trying to enrich themselves, but they have this positive externality or benefit of exposing corruption that otherwise is hidden.

Vulture funds are well-positioned for success because other global actors like the World Bank have their own constraints (emphasis ours):

They require the co-operation of the state that is recovering the assets and frankly, the ruling elites are all interconnected. So even if you’ve had a change in administration, they’re still a little wary of ‘maybe we don’t want to go down that route.’ The vulture funds don’t have that conflict of interest so to speak. They have a pure interest in finding the money and therefore uncover corruption.

As debtor countries know all too well, that “pure interest” has its downsides. And too often, it is the vulture funds themselves that hobble the ability of a country to get back on its two feet.

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Worryingly for Venezuela, vulture funds are set to be a feature of its forthcoming debt restructuring. As Lienau pointed out in a separate panel organised by the IMF last week, given the wide range of creditors with money at stake in the country:

The ongoing risk of holdout creditor litigation is significant. It is rare, but rarity does not necessarily speak to import . . . When that risk does actually emerge, it does have a substantial impact on the likelihood of restructuring and the economic growth that comes after restructuring.

Related Links:
The most complicated debt restructuring in history — FT AlphavilleVenezuela workout pits hot-headed newcomers against veterans — FT
Venezuela’s long and winding road to debt restructuring
— FT Alphaville
A bad situation in Venezuela is getting worse — FT Alphaville

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