UK Treasury goes to war on vulture funds

August 5, 2009
vulture funds has gone from silly to serious, thanks to Her Majesty's Treasury, which has just put out a "consultation on legislation" which could be hugely damaging to international sovereign debt capital markets.

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The war on vulture funds has gone from silly to serious, thanks to Her Majesty’s Treasury, which has just put out a “consultation on legislation” which could be hugely damaging to international sovereign debt capital markets.

The Foreword is written by Ian Pearson, the economic secretary to the Treasury, who singles out the Jubilee Debt Campaign by name as a particularly useful contributor to the paper. That comes as no surprise when you see what is being proposed:

Under UK laws, holders of existing debts of Heavily Indebted Poor Countries will only be able to reclaim these debts up to a set level, unless the courts consider it just and equitable to order otherwise.

The “set level” is clearly intended to be the level at which the Paris Club of rich nations has decided to give debt relief to the country in question. And it’s worth noting that this legislation would apply equally to vulture funds and to original creditors. A construction company, for instance, might have built a hospital in a particular country, and be owed a few million for its work — but under this law, if the country then got debt relief, the construction company could expect just pennies on the dollar.

Clearly, this would have a chilling effect on any foreign companies doing business in poor countries; it would also increase borrowing costs for all such countries. The paper puts the expected gross benefit to poor countries at no more than £33.2 million per year; my guess is that it would be much lower than that, given how spectacularly unsuccessful most attempts at suing HIPC nations turn out to be. (Generally, it’s easy to get a judgment against the country in question, and all but impossible to actually get paid.)

The net benefit, by contrast, would clearly be negative for HIPC countries in aggregate. Most of them don’t suffer at all from the vulture fund “problem” — in fact, they benefit from the existence of vulture funds because such funds provide a floor for the value of their debt. If legislation along these lines were to be enacted, the cost of funds in HIPC countries would rise — and even if it only rose by a few basis points, HIPC countries would still lose, every year, much more money than they stand to gain.

The way that the legislation seeks to minimize this effect is weak indeed:

The Government proposes that legislation is tightly targeted at the existing stock of HIPC debt and allows the court some discretion over the level of payment to award. The Government’s view is that designing the legislation in this way is necessary to minimise the risks to smoothly functioning financial markets whose importance was outlined in paragraphs 2.12- 2.14. For example, legislation should not impose unnecessary costs on lending beyond the appropriate risk pricing, as this would lead commercial lenders to provide less new financing to the countries affected, or to demand higher rates of interest. If it did, the benefit to developing countries may be more than counterbalanced by the cost.

Certainly, it helps that the legislation applies only to existing HIPC debt and not to future debt issuance. It also helps that there’s judicial discretion involved. But once legislation like this is passed, it will almost certainly be renewed on a semi-regular basis to keep it up to date: after all, in 2015 it’s going to look a bit weird that debts issued before 2009 are subject to this law but debts issued in 2010 are not. What’s more, the judicial discretion will only be valued by creditors once there have been a few precedent-setting cases, and it’ll take a long time for that to happen. In the meantime, businesses and lenders will assume that judges will simply comply with the spirit of the law.

The good news is that this is only a consultation document; I’m sure that both borrowers and lenders are putting together good arguments for Treasury as to why it’s a bad idea. What’s more, the current Labour government won’t be in power much longer, and I can’t see the Conservatives trying to push through something along these lines. But it’s depressing indeed that this idea has moved from the fringe (think Maxine Waters) to something approaching the mainstream. And I hope that Treasury backs down sharpish once the consultation period is over.

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