.jpg)
Avulture fund is ahedge fund orprivate-equity fund that invests indebt considered to be very weak or indefault, known asdistressed debt.[1] Investors in the fund profit by buying debt at a discounted price on a secondary market and then using numerous methods to sell the debt for more 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 involvingPeru andArgentina, such a seizure blocked payments to other creditors of the sovereign obligor.[2][3][4]
Sovereign debt collection was rare until the 1950s when sovereign immunity of government issuers started to become restricted by contract terms.[5] This trend developed from the long history ofsovereign defaulting on commercial creditors with impunity. Accordingly, sovereign debt collection actions began in the 1950s. One example was the freezing ofBrazil's gold reserves held by theFederal Reserve.[6]
Investment insovereign debt with the intent to recover was also restricted due to the laws ofchamperty and maintenance and by the fact that most sovereign debt was syndicated. Under the doctrine of champerty, it was illegal inEngland and the United States to purchase a debt with the sole intent of litigating it.[7] 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 thepetrodollarcrisis 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 inLatin America created many new and easily traded instruments such asBrady bonds that brought new players into the market, including banks andhedge 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 throughWorld 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.
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 obtaincommon 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) whenmortgage 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 intobankruptcy. Thus, when shareholders cannot repay bondholders, in principle, bondholders become the new shareholders. In practice, however, it is more complicated.[8][9]
In the financial markets, the bonds of troubled public companies trade in a manner similar to common stock of solvent companies.
The term "vulture fund" is ametaphor which is used to compare these particular hedge funds to the behaviour ofvultures (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.[10][11][12] 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."[13] A related term is "vulture investing", where certain stocks in near bankrupt companies are purchased upon anticipation of asset divestiture or successful reorganization.[14]
The term has gained wide acceptance from governments, newspapers, academics and international organizations such as theWorld Bank,Group of 77,Organisation of American States andCouncil on Foreign Relations, among others.[15][16][17][18][19]
In 2009, bipartisan legislation in theUS 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.[20] A non-profit financial reform organization,Jubilee USA Network, supported the legislation citing the impact that vulture funds have on poor countries.[21] Similar legislation was passed in the United Kingdom,[15] Belgium,[22][23] Jersey,[24] the Isle of Man,[25] Australia.[26][failed verification] The States of Guernsey debated legislation in 2012.[27]
TheInternational Monetary Fund andWorld Bank noted that vulture funds endanger the gains made bydebt 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 likeGhana 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."[17]
The conduct of the vulture funds blocking payments to other creditors to Argentina was denounced by theOrganisation of American States, with the exception of the United States and Canada.[18] TheG77+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".[16]
The US-basedCouncil 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 describedThomas Griesa's ruling against Argentina in favour of vulture funds as "punishing the innocent" and "turning the natural order of debt on its head".[19]
In 2002, the British Chancellor (and later Prime Minister)Gordon Brown told theUnited 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".[28] The Debt Relief (Developing Countries) Act passed in 2010 removed the ability of vulture funds to use UK courts to enforce contested debts.[29]
On 9 September 2014, theUnited Nations General Assembly voted to support a new bankruptcy process for sovereign nations, which would promotedebt 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.[30][31]
In October 2016, the Irish State closed taxloopholes that U.S.distressed debt funds (labeled "vulture funds" in the Irish media),[32][33] advised byIFSC tax-law firms (e.g.Matheson),[34] had exploited to avoid Irish taxes (capital gain, withholding tax and VAT/duty)[35][36][37][38] on over €80 billion of Irish distressed assets.[39] The affair caused a national scandal in Ireland,[40][41] and led to public backlash against the activities of USdistressed debt funds,[42][43] and particularly when it was discovered that they had used children's charities controlled by Irish tax-law firms to mask theirSection 110 SPV tax vehicles.[44][45]
The Irish State did not prosecute the "vulture funds" for tax avoidance, and in February 2018 theCentral Bank of Ireland created a new structure theL-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 2018GNI*).[46] On 28 December 2018, the IrishTaoiseach,Leo Varadkar, praised the activity of "vulture funds" in Ireland to theIrish Times newspaper.[47]
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.
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.
| Investment strategy |
|  | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Trading | ||||||||||
| Related terms |
| |||||||||
| Investors | ||||||||||
| Governance | ||||||||||
