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Personal Finance

Borrowing from vulture funds has many risks. PHOTO | FOTOSEARCH 

African countries, especially those which are rich in natural resources, are attracting a lot of global investors.

One of the entities is global funds known as sovereign wealth funds (SWFs). These are investment funds various governments own for investments. One such fund is the Beijing-owned China Investment Corporation.

Kenya has plans to set up an SWF too. The fund is of great benefit to an economy and its people because returns from diversified investments benefit citizens. I really look forward to a well-managed Kenyan SWF as this would give Kenya an additional source of income in addition to the traditional sources of income.

Since SWFs are state-owned equity funds, many times they have political goals when investing.

A few countries, especially in Africa, have borrowed from SWFs for various projects and such loans are secured by agreements. Sometimes the borrowing country is unable to honour its debt obligations leading to a sovereign debt.

A sovereign debt is unlike any other debt because the debtor is a state while the creditor may be a private or a public entity.

Therefore, international law applies to a situation where a sovereign debt arises, the chief being the principle of sovereignty of nations.

This principle assumes that all nations are free and independent. Consequently, a creditor has limited options in debt recovery. For example, one cannot for invade the country or sell off its assets.

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Agreements with SWFs are complex and unique. One of the provisions of such agreements, which is often resorted to, is the provision to restructure the debt should the borrowing nation fail to honour its obligations.

In such a situation, the parties may mutually agree to renegotiate the debt or may refer the dispute to arbitration to reach a mutual agreement.

The agreements, allow the SWF to sell the debt owed to third parties. The debt owed is traded in the secondary debt market and a third party known as a vulture fund purchases it and assumes the initial position of the SWF. A vulture fund, as the name suggests, buys the debt when a country is unable to service it and make a large margin later on. They usually leave such countries even worse off than they were.

In the event a country is not able to honour its obligations to the vulture fund, it can sue the country in international courts.

In 2001, Argentina had a debt of about $100 billion. Pursuant to the agreement between Argentina and the SWF the debt was restructured and sold off to a vulture fund.

Argentina defaulted and the fund sued it in New York (as per the choice of law contract) and won the case. While the issue was a minor one where the vulture fund wanted its right to be paid recognised as equal to the initial creditor, this case goes to show that sovereign debt can be litigated.

Fortunately, there are a lot of treaties to protect the vulnerable countries. Some provide that public debt should not exceed a certain percentage of the gross domestic product. Further, the restructuring agreements, give borrowing countries a reprieve as they allow renegotiations.

It is, therefore, far-fetched that a creditor can privatise a country’s assets to settle the debt.



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