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Vulture fund

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Not to be confused with Venture fund.
Mural of a vulture across from Ulster Bank HQ in Dublin, Ireland, intended as critical of vulture funds[1]
Anti-vulture fund sign in Dublin

A vulture fund is a hedge fund, private-equity fund or distressed debt fund, that invests in debt considered to be very weak or in default, known as distressed securities.[2] Investors in the fund profit by buying debt at a discounted price on a secondary market and then using numerous methods to subsequently sell the debt for a larger amount than the purchasing price. Debtors include companies, countries, and individuals.

Vulture funds have had success in bringing attachment and recovery actions against sovereign debtor governments, usually settling with them before realizing the attachments in forced sales. Settlements typically are made at a discount in hard or local currency or in the form of new debt issuance. In some instances, such as those involving Peru and Argentina, such a seizure blocked payments to other creditors of the sovereign obligor.[3][4][5]

History

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Sovereign debt collection was rare until the 1950s when sovereign immunity of government issuers started to become restricted by contract terms.[6] This trend developed from the long history of sovereign defaulting on commercial creditors with impunity. Accordingly, sovereign debt collection actions began in the 1950s. One example was the freezing of Brazil's gold reserves held by the Federal Reserve.[7]

Investment in sovereign debt with the intent to recover was also restricted due to the laws of champerty and maintenance and by the fact that most sovereign debt was syndicated. Under the doctrine of champerty, it was illegal in England and the United States to purchase a debt with the sole intent of litigating it.[8] The distinction was made that if the debt was purchased to effect a recovery or facilitate investment, the doctrine was not a bar. Most jurisdictions have now eliminated the doctrine as archaic.

Similarly, sovereign debt owed to commercial creditors in the late 1980s was principally held by bank syndicates. This was the result of the petrodollar crisis of the 1970s when oil earnings were recycled into bank loans. The syndication of debt among banks made recovery impractical, as a fund intending to litigate had to buy out the entire syndicate of holders or risk having the proceeds of litigation attached pursuant to sharing clauses in the loan agreements.

As the 1980s progressed, debt rescheduling efforts in Latin America created many new and easily traded instruments such as Brady bonds that brought new players into the market, including banks and hedge funds. The original creditors then wrote down their positions and sold the debt into the secondary market, which is a market consisting of banks and investment funds focused on buying at discounts to achieve above market returns on their investment.

In this process, much debt was repurchased and converted into local currency by the sovereign country issuers in official debt conversion programs designed to attract investment, and in severely indebted countries through World Bank funded buy-backs. The result is that the old syndicates were broken up and many unreconstructed syndicate "tails" were available for purchase at discounts exceeding 80% of the principal face value. That pricing encouraged funds to invest in recovery actions, which would not otherwise make financial sense due to their length and cost.

Corporation law and theory of finance

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Businesses that need more capital than their founders can raise by personal contacts are enabled by this legal method of attracting investors to buy a portion of the business. Owners would invest capital and obtain common stock or equity in exchange for invested cash or other property like machines, factories, warehouses, patents or other interests. Then the owners would raise additional capital by borrowing from lenders in capital markets by selling bonds. In corporation law, the owners of these bonds come first in line for repayment so that if there is not sufficient funds to repay the bondholders, the stockholders get wiped out. The bondholders step into the shoes of the former shareholders. The shareholders own nothing because they, the owners, could not fully repay all the contractual promises, or loans. So like a bank (the mortgagee) that has lent money to a home buyer (the mortgagor) takes possession of the security (the home) when mortgage payments are not made (i.e. foreclosure), the bondholders of a corporation take possession of the business from the former owners (the shareholders) when the corporation falls into bankruptcy. Thus, when shareholders cannot repay bondholders, in principle, bondholders become the new shareholders. In practice, however, it is more complicated.[9][10]

In the financial markets, the bonds of troubled public companies trade in a manner similar to common stock of solvent companies.

Viewpoints

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Anti-vulture fund sign on North Circular Road, Dublin

Term "vulture fund"

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The term "vulture fund" is a metaphor which is used to compare these particular hedge funds to the behaviour of vultures (scavengers) “scavenging” on debtors in financial distress by purchasing the now-cheap credit on a secondary market to make a large monetary gain, in many cases leaving the debtor in a worse state. The term is often used to criticize the fund for strategically profiting from debtors that are in financial distress, and thus is frequently considered derogatory.[11][12][13] However financiers dealing with vulture funds argue that "their lawsuits force accountability for national borrowing, without which credit markets would shrivel, and that their pursuit of unpaid commercial debt uncovers public corruption."[14] A related term is "vulture investing", where certain stocks in near bankrupt companies are purchased upon anticipation of asset divestiture or successful reorganization.[15]

The term has gained wide acceptance from governments, newspapers, academics and international organizations such as the World Bank, Group of 77, Organisation of American States and Council on Foreign Relations, among others.[16][17][18][19][20]

Legislation

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In 2009, bipartisan legislation in the US Congress was introduced aimed to prevent vulture funds from profiting on defaulted sovereign debt by capping the amount of profit that a secondary creditor can win through litigation based on those debts. The Stop VULTURE Funds Act was introduced, but not passed, in the United States.[21] A non-profit financial reform organization, Jubilee USA Network, supported the legislation citing the impact that vulture funds have on poor countries.[22] Similar legislation was passed in the United Kingdom,[16] Belgium,[23][24] Jersey,[25] the Isle of Man,[26] Australia.[27][failed verification] The States of Guernsey debated legislation in 2012.[28]

Financial institutions

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See also: Argentine debt restructuring

The International Monetary Fund and World Bank noted that vulture funds endanger the gains made by debt relief to poorest countries. "The Bank has already delivered more than $40 billion in debt relief to 30 of these countries...thanks to this, countries like Ghana can provide micro-credit to farmers, build classrooms for their children, and fund water and sanitation projects for the poor," wrote World Bank Vice President Danny Leipziger in 2007. "Yet the activities of vulture funds threaten to undermine such efforts... the strategies adopted by vulture funds divert much needed debt relief away from the poorest countries on earth and into the bank accounts of the wealthy."[18]

Governmental and non-governmental organisations

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The conduct of the vulture funds blocking payments to other creditors to Argentina was denounced by the Organisation of American States, with the exception of the United States and Canada.[19] The G77+China also criticised the funds and stated: "Some recent examples of the actions by vulture funds before international courts show their highly speculative nature. These funds pose a danger for all the future process of debt swaps, for developing countries and for developed nations as well".[17]

The US-based Council on Foreign Relations questioned the US Supreme Court for rejecting Argentina's appeal in its legal dispute with the so-called vulture funds. The organization claimed that such actions make it "more difficult for countries to free themselves from the burden of over-indebtedness" and are " very bad for international capital markets", as well as being a huge blow to national sovereignty. The organization described Thomas Griesa's ruling against Argentina in favour of vulture funds as "punishing the innocent" and "turning the natural order of debt on its head".[20]

United Kingdom

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In 2002, the British Chancellor (and later Prime Minister) Gordon Brown told the United Nations that when vulture funds purchase debt at a reduced price, and make a profit from suing the debtor country to recover the full amount owed, the outcome is "morally outrageous".[29] The Debt Relief (Developing Countries) Act passed in 2010 removed the ability of vulture funds to use UK courts to enforce contested debts.[30]

United Nations

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On 9 September 2014, the United Nations General Assembly voted to support a new bankruptcy process for sovereign nations, which would promote debt restructuring by excluding so-called "vulture funds" from the process. The vote was 124–11 in favor, with 41 abstentions. The United States voted against the measure.[31][32]

Ireland

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In October 2016, the Irish State closed tax loopholes that U.S. distressed debt funds (labeled "vulture funds" in the Irish media),[33][34] advised by IFSC tax-law firms (e.g. Matheson),[35] had exploited to avoid Irish taxes (capital gain, withholding tax and VAT/duty)[36][37][38][39] on over €80 billion of Irish distressed assets.[40] The affair caused a national scandal in Ireland,[41][42] and led to public backlash against the activities of US distressed debt funds,[43][44] and particularly when it was discovered that they had used children's charities controlled by Irish tax-law firms to mask their Section 110 SPV tax vehicles.[45][46]

The Irish State did not prosecute the "vulture funds" for tax avoidance, and in February 2018 the Central Bank of Ireland created a new structure the L-QIAIF, which does not file public accounts, which was how the scandal was uncovered, into which the "vulture funds" transferred over €55 billion of assets (one-quarter of Irish 2018 GNI*).[47] On 28 December 2018, the Irish Taoiseach, Leo Varadkar, praised the activity of "vulture funds" in Ireland to the Irish Times newspaper.[48]

See also

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References

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  1. ^ "Painting of vulture appears opposite Ulster Bank HQ". independent.
  2. ^ Blackman, Jonathan I.; Mukhi, Rahul (2010). "The Evolution of Modern Sovereign Debt Litigation: Vultures, Alter Egos, and Other Legal Fauna". Law and Contemporary Problems. 73: 47–61. Retrieved 19 July 2014.
  3. ^ Ebrahimi, Helia; Blackden, Richard (24 April 2011). "Paul Singer's Elliott Management takes the fight to National Express". The Daily Telegraph. Retrieved 21 July 2014.
  4. ^ "A victory by default?". The Economist. 3 March 2005. Retrieved 4 March 2013.
  5. ^ Bronstein, Hugh (26 June 2016). "Argentina deposits debt payment, but U.S. court blocks payout". Reuters. Archived from the original on 19 December 2023. Retrieved 19 December 2023.
  6. ^ Choi, Stephen; Mitu Gulati; Eric Posner (31 May 2012). "The Evolution of Contractual Terms in Sovereign Bonds". Journal of Legal Analysis. 4 (1): 131–179. doi:10.1093/jla/las004. Retrieved 4 March 2013.
  7. ^ Szulu, Tad (15 July 1957). "HARD CURRENCIES SHORT IN BRAZIL; Nation Is Nearly Out of Such Reserves--Coffee Crop May Replenish Funds Debt Payments Due Reserves Were Low". The New York Times. Retrieved 4 March 2013.
  8. ^ Ng, Jern-Fei (2010). "The Role of the Doctrines of Champerty and Maintenance in Arbitration". Arbitration: The International Journal of Arbitration, Mediation and Dispute Management. 76 (2). Chartered Institute of Arbitors: 208–213. Retrieved 4 March 2013.
  9. ^ Huang, Peter; Knoll, Michael (2000). "Corporate Finance, Corporate Law and Finance Theory". Retrieved 3 August 2014.
  10. ^ Tirole, Jean (2006). "The Theory of Corporate Finance" (PDF). Retrieved 3 August 2014.
  11. ^ Pesendorfer, Dieter. (2012). "Good-Bye Neoliberalism? Contested Policy Responses to Uncertain Consequences of the 2007-2009 Financial Crisis". In Alexander, Kern; Dhumale, Rahul (eds.). Research Handbook on International Financial Regulation. Cheltenham: Edward Elgar. p. 426. ISBN 9780857930453. Retrieved 19 July 2014.
  12. ^ Moles, Peter; Terry, Nicholas (10 June 1999). The Handbook of International Financial Terms. Oxford University Press. ISBN 9780191727245. Retrieved 21 July 2014.
  13. ^ Cone, Sydney (Fall 2010). "The International Review" (PDF). New York Law School. 13 (1): 17. Archived from the original (PDF) on 3 March 2016. Retrieved 22 July 2014.
  14. ^ Moore, Jina (22 March 2014). "The end of vulture funds?". AlJazeera. Retrieved 19 July 2014.
  15. ^ "Vulture Investing: Why a Hedge Fund Chased an Argentine Frigate". Archived from the original on 25 April 2016. Retrieved 26 May 2015. The most benign version of vulture investing involves buying liabilities of struggling companies, such as American Airlines or the Motors Liquidation Co. spun off from General Motors, sometimes for a few cents on the dollar, with the hope that the investments will regain some of their lost value as the companies restructure or sell assets to repay creditors.
  16. ^ a b Wray, Richard (8 April 2010). "Bill to stop vulture funds using UK courts gets royal assent". The Guardian. London.
  17. ^ a b "Unified support of G77+China Summit to Argentina on Malvinas and vulture funds". Telam. 15 June 2014. Archived from the original on 8 August 2014. Retrieved 31 July 2014.
  18. ^ a b "Fonds vautours contre pays pauvres : 26 June 2007" (PDF). Dannyleipziger.com. Retrieved 15 October 2013.
  19. ^ a b Alexander Main (9 July 2014). "U.S. on Its Own, Once Again, at OAS Meeting on Argentine Sovereign Debt". CEPR. Archived from the original on 14 July 2014. Retrieved 10 July 2014.
  20. ^ a b "US Council of Foreign Affairs supports Argentina, blasts Judge Griesa". MercoPress. 26 June 2014.
  21. ^ "The Stop VULTURE Funds Act". Govtrack.us. 1 August 2008. Retrieved 28 July 2014.
  22. ^ "Vulture Funds: A Threat to the Poorest Countries and U.S. Foreign Assistance" (PDF). Jubilee USA. June 2009. Archived from the original (PDF) on 31 May 2013. Retrieved 23 July 2014.
  23. ^ Wray, Richard (11 April 2010). "Parliament's last virtuous act: to stop vulture funds picking off the poor". The Guardian. London.
  24. ^ Antonio Gambin (5 March 2018). "Vulture fund takes the Belgian government to court - and Belgian NGOs join the defence team". Archived from the original on 14 March 2018. Retrieved 14 March 2018.
  25. ^ "Jersey law to stop 'vulture funds' comes into force". BBC News. 1 March 2013.
  26. ^ Chief Secretary's Office (12 December 2012). "Isle of Man introduces legislation to outlaw vulture funds (press release)". Government of the Isle of Man. Archived from the original on 3 March 2013. Retrieved 6 August 2015. LEGISLATION ... has this week received Royal Assent. The Heavily Indebted Poor Countries (Limitation on Debt Recovery) Act 2012 outlaws a practice that undermines international debt relief efforts. The legislation prevents vulture funds from buying up poor nations' debts for a fraction of their original amount and then using the courts to sue for the full value, plus interest and penalty charges.
  27. ^ "ParlInfo - Federation Chamber : PRIVATE MEMBERS' BUSINESS : Heavily Indebted Poor Countries Initiative". Parlinfo.aph.gov.au. 25 June 2012. Retrieved 28 July 2014.
  28. ^ "Guernsey government targets 'vulture funds'". BBC News. 20 October 2012.
  29. ^ "[ARCHIVED CONTENT] Speech by the Chancellor of the Exchequer, Gordon Brown, at the United Nations General Assembly Special Session on children, New York - HM Treasury". Webarchive.nationalarchives.gov.uk. Archived from the original on 7 April 2010. Retrieved 15 October 2013.
  30. ^ Wray, Richard (8 April 2010). "Bill to stop vulture funds using UK courts gets royal assent". The Guardian. Retrieved 11 September 2014.
  31. ^ IndyBay International, UN Votes for Process to Enact Bankruptcy Treaty and Stop Vulture Funds, 9 September 2014
  32. ^ IndiaBlooms, UN rights expert welcomes new Assembly resolution on debt structuring, 11 September 2014
  33. ^ "Loophole allowing Vulture Funds to pay almost no Irish profit tax shut". Irish Independent. 16 September 2016.
  34. ^ "Government moves to amend Section 110 to close tax loophole used by vulture funds". RTE News. 6 September 2016.
  35. ^ "How do vulture funds exploit tax loopholes?". Irish Times. 17 October 2016.
  36. ^ "Loophole lets firms earning millions pay €250 tax, Dáil told". Irish Times. 6 July 2016.
  37. ^ "Vulture funds pay just €8,000 in tax on €10 billion of assets". TheJournal.ie. 8 January 2017.
  38. ^ "Revealed: How vulture funds paid €20k in tax on assets of €20bn". The Sunday Business Post. 8 January 2017.
  39. ^ "Cerberus paid €1,900 tax on €77m Project Eagle profits". Irish Times. 29 November 2016.
  40. ^ "WHY LETTING SECTION 110 SPVS OPERATE IN THE IRISH DOMESTIC ECONOMY WILL DAMAGE OUR TAX BASE AND OUR REPUTATION AS A 'LOW-TAX' ECONOMY" (PDF). Stephen Donnelly (Dail Submission). September 2016.
  41. ^ "Forget Apple: Ireland's other taxing issue". BBC News. 6 September 2016.
  42. ^ Boland, Vincent (11 September 2016). "Ireland confronts another tax scandal closer to home". Financial Times.
  43. ^ "'Vultures' minimise their tax bills - as State now appears to have delivered the sale of the century". Irish Independent. 21 August 2016.
  44. ^ David McWilliams (1 August 2016). "Vulture funds rub salt into the carcass of this country". The Sunday Business Post.
  45. ^ "Vulture funds using charities to avoid paying tax, says Donnelly". Irish Times. 14 July 2016.
  46. ^ "Why would a Vulture Fund own a Children's Charity". Dáil Éireann. 24 November 2016. Archived from the original on 11 June 2018. Retrieved 27 April 2018.
  47. ^ "Tax-free funds once favoured by 'vultures' fall €55bn: Regulator attributes decline to the decision of funds to exit their so-called 'section 110 status'". Irish Times. 28 June 2018.
  48. ^ Jennifer Bray (28 December 2018). "Leo Varadkar defends 'vulture funds' and criticises practices of Irish banks". Irish Times.
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