March 2013

DISTRESSED DEBT: The noose tightens

GavelThe Isle of Man recently moved to deter distressed-debt investors from pursuing claims against poor nations in its courts. These so-called ‘vulture funds’ are a small but growing business. Stefanie Eschenbacher reports. Towards the end of last year the Isle of Man, Jersey and Guernsey started to significantly limit the activity of distressed-debt investors that buy poor-country debt. Pejoratively called “vulture funds”, they buy debt issued by heavily indebted poor countries at a substantial discount on the open market and then take private legal action to recover the full sum, plus interest payments and penalties. Despite pursuing an expensive and risky strategy, they can sometimes generate large profits. Some of these funds made it onto the news pages of both trade publications and broadsheets last year.
FG Hemisphere Associates, a Delaware corporation, sued the Democratic Republic of Congo (DRC) in Jersey’s courts. The debt originated from supply and financing contracts entered into by the DRC during the Mobutu era with the then Yugoslavian hydroelectric company, Ergoinvest. FG Hemisphere was seeking assets held in Jersey, which are owed to the DRC’s state mining company, La Générale des Carrières et des Mines. It argued that the mining company was an organ of the state and so responsible for debts owed by the DRC, the judgement, entitled La Générale des Carrières et des Mines (Appellant) v FG Hemisphere Associates LLC (Respondent) claims. FG Hemisphere was reportedly seeking $100 million (€75.9 million) of debt obligations that had been bought for $3 million.   When Funds Europe contacted FG Hemisphere, the asset manager declined to comment on how much it was seeking and how much it had paid for the debt. In a lengthy and strongly worded statement, dated December 11, 2011, FG Hemisphere Associates says that the debt had been purchased “at a discount” and at a market price for non-performing loans in emerging markets. After a decade-long court battle and several attempts to settle these claims, FG Hemisphere says it has incurred hundreds of thousands of dollars of legal fees. It also says it would have settled at a discount.
“So the idea that we have invested $3 million and we are trying to get $100 million, is a completely [sic] mischaracterization of the situation,” the statement says. “So, yes, we are claiming 100% of what we are owed – in the lawsuit.” In what the Jubilee Debt Campaign, which supports debt relief for certain poor nations, described as a “surprise ruling”, the Privy Council found on July 18, 2012, that while state-owned, the mining company is not responsible for the Congolese government’s debts. OPAQUE
“We do not know where these funds are domiciled and who their investors are,” says Nick Dearden, director at the Jubilee Debt Campaign. The case raises larger questions about offshore finance. Dearden says: “Why is the Democratic Republic of Congo’s [DRC’s] mining wealth being fought over in faraway Jersey?” Most of these funds will pursue one claim, Dearden says, to avoid having other assets tied up in decade-long court battles. They will typically be located in offshore financial centres, such as the British Virgin Islands, Delaware and the Cayman Islands. The new law in the Isle of Man, and existing laws in the UK, should prevent “vulture funds” from using their courts to recover certain types of debt. However, the law does not address other issues on how such funds operate. On December 12, 2012, the Isle of Man introduced the Heavily Indebted Poor Countries Limitation on Debt Recovery Act 2012. The law is equivalent to the UK Debt Relief Developing Countries Act 2010, which limits the amount a “vulture fund” can claim from the 40 poorest and most indebted countries in UK courts. But because the law passed by UK parliament does not apply to its crown dependencies and overseas territories, some have started to act on their own. Eddie Teare, treasury minister at the Isle of Man, says the law will ensure that the Isle of Man will not be used for “the disreputable business of exploiting heavily indebted poor countries”. This officially outlaws practices that undermine international debt efforts. “We recognise that we have a part to play in the international community and have to be responsible,” Teare says. “It is unlikely that any of these companies could use the Isle of Man court to enforce a judgement.” Citing numbers from the International Monetary Fund and the World Bank, Teare says “vulture funds” are seeking total claims of $1.47 billion (€1.1 billion) from countries such as Cameroon, Ethiopia, Sudan, Uganda and the DRC. In the Isle of Man, not all funds need to be authorised. Private funds with less than 50 investors are exempt, as are unregulated funds. Only authorised funds in the Isle of Man are regulated and available for retail distribution.   “It is highly unlikely that any such funds would include investments made to enforce debts against the countries mentioned, and we are not aware that any have such investments,” he says. ‘ACT AS A BAN’
The purpose of the Isle of Man’s legislation is to prevent the courts from being used to enforce in full the debts of countries subject to official relief but, Teare says. In theory, such funds could, however, still be domiciled in the Isle of Man. “Depending on a fund’s status, the Financial Supervision Commission has powers to ask for details of a fund’s investments,” he says, adding that he is unaware of such cases. “It can also petition the court to have a fund wound up in the public interest.” When asked whether such funds will be banned altogether, Teare says the legislation in this area is relatively new and “we plan to see how it works before making any further changes”. Guernsey is also implementing legislation that would prevent vulture funds using its courts to pursue debts of heavily indebted poor countries. Jo Reeve, principal external affairs officer at the States of Guernsey, says Guernsey’s legislation on vulture funds will come forward later this year, and like the UK act it will be retrospective in its scope. Parliament has agreed to this and Reeve adds that it makes Guernsey “an unattractive location for vulture funds following this decision”. He says: “Any vulture fund trying to enforce such debt through Guernsey would be pretty daft.” Reeve says the FG Hemisphere case did not affect Guernsey’s stance on the law itself, but the states were interested in the outcome of the case because it might have led to the law being phrased differently. “It can take a long time to amend a law so we wanted to make sure we get it right the first time,” Reeve says. Reeve adds that all collective investment funds in Guernsey are regulated by the Guernsey Financial Service Commission (GFSC) under the Protection of Investors Bailiwick of Guernsey Law, 1987.  “Under this law a fund must obtain authorisation from the GFSC to establish in Guernsey,” he says. “The GFSC will take into account reputation, conduct and nature of business when considering these applications.” Reeve says that the Guernsey government has resolved to support the debt relief initiative and this decision would, therefore, be taken into account when considering any such application. On October 1, 2012, the chief minister of Jersey, senator Ian Gorst, also proposed new legislation designed to stop creditors, including vulture funds, from pursuing what he called “inequitable payments” through Jersey courts. Aiming to limit the practices that could undermine international debt relief efforts, Gorst says the law “will send a clear and positive message that Jersey is committed to supporting international debt relief efforts”. Although there are no policies to ban such products, a spokesperson for the States of Jersey says that it is envisaged that the new policies should prevent such funds from being domiciled in Jersey and “should act as a ban on such products”. UNDER THE RADAR
The Jersey Financial Services Commission and the registrar of companies have licensing and sensitive activities policies that are applied when deciding whether to issue a product licence. The regulator can force a fund to leave the jurisdiction or sell particular assets if it were to discover the fund is acting as a vulture fund. “It is unlikely that a fund will be distributed within Jersey, but if the distributor is distributing in or from within Jersey, they will generally require authorisation,” the spokesperson says. “Accordingly, if a vulture fund wishes to set up in Jersey or market to investors from Jersey, it will be regulated if it falls within these parameters. “Therefore, as a matter of policy, Jersey would not authorise a Jersey-based vulture fund nor authorise a non-Jersey vulture fund to be distributed in Jersey.” Data on these funds, however one defines them, is difficult to obtain. Funds Europe provided Lipper with a list of the nine most prominent funds in this sector, none of which showed up in its data base.
Lipper says the data base does include funds that are unregulated in offshore centres, but it relies on those companies wishing to provide such data. ©2013 funds europe

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