Vulture funds inherently exploitative at expense of human rights
Vulture funds are raking in extravagant profits at the expense of human rights and development in poor indebted countries, the Advisory Committee to the UN Human Rights Council has said, underlining the need to curb the “predatory practices” of these creditors.
by Kanaga Raja
GENEVA: Vulture funds are inherently exploitative, since they seek to obtain disproportionate and exorbitant gains at the expense of the full realization of human rights, particularly economic, social and cultural rights, and the right to development, the UN Human Rights Council Advisory Committee has said.
In its latest report on the activities of vulture funds and their impact on human rights, the Advisory Committee said that seeking the repayment in full of a sovereign debt from a state that has defaulted or is close to default, is an illegitimate outcome.
“The duty to observe due diligence to prevent a negative impact on and potential violations of economic, social and cultural rights applies to all states and stakeholders, including the management of vulture funds. Therefore, assessments of the impact of their activities on the enjoyment of economic, social and cultural rights should be made systematically,” it said.
“Excessive claims awarded to vulture funds have allowed them to reap profits at the expense of the welfare and sustainable development of the poorest countries, without taking due account of the negative consequences of such actions on the state’s capacity to fulfil its human rights obligations,” it added.
The Advisory Committee comprises 18 independent experts and serves as a think-tank to the UN Human Rights Council.
In its report, the Advisory Committee recommended, amongst others, that the Human Rights Council maintain the issue of vulture funds and human rights on its agenda in order to assess the impact of their activities on economic, social and cultural rights and the right to development, and to support further initiatives aimed at identifying and curtailing illegitimate activities by vulture funds.
The Advisory Committee recommended that the Human Rights Council explore further ways of mainstreaming human rights in the context of debt restructuring workouts and operationali-zing processes aimed at assessing and monitoring the negative impact of the activities of vulture funds on the full enjoyment of economic, social and cultural rights and on the realization of the Sustainable Development Goals.
In addition, the Advisory Committee recommended that member states enact legislation aimed at curtailing the predatory activities of vulture funds within their jurisdiction.
“Domestic laws should not be limited to HIPCs [Heavily Indebted Poor Countries] but should cover a broader group of countries and apply to commercial creditors that refuse to negotiate any restructuring of the debt.”
Claims that are manifestly disproportionate to the amount initially paid (by these funds) to purchase the sovereign debt should not be considered, it underlined.
(When countries default, the value of their bonds and securities falls and the vulture funds purchase them on secondary markets at heavy discounts. When these debts are restructured by the creditors and the country recovers, these funds demand full repayment. – SUNS)
Making a killing
The Advisory Committee cited the African Development Bank as saying that 20 of the 36 poorest developing countries have been threatened or targeted by aggressive litigation by vulture funds since 1999.
The World Bank estimates that more than a third of the countries that qualified for its debt relief initiative have been targeted by lawsuits by at least 38 litigating creditors, with judgments totalling $1 billion in 26 of the cases.
Vulture funds have achieved, on average, recovery rates of some 3-20 times their investment, equivalent to returns of 300-2,000%. The International Monetary Fund (IMF) estimates that in some cases the claims by vulture funds constitute as much as 12-13% of a country’s gross domestic product (GDP).
The Advisory Committee noted that cases brought by vulture funds are particularly protracted: the average estimated time for recovery is six years, which would suggest annualized returns averaging 50-333%.
“Such long judicial proceedings are always burdensome and can complicate debtor states’ financial and reserve management,” it said.
Most vulture funds are incorporated in tax havens, where there is no obligation to disclose information on benefits or ownership and it is feasible to hide gains to avoid or evade taxation. Such jurisdictions facilitate the secretive manner in which vulture funds operate as well as the flight of much-needed capital, particularly from developing countries, said the Advisory Committee.
Vulture funds have a long history of predatory practices against developing countries, particularly HIPCs, it noted.
The most commonly targeted are countries, most of them in Africa and Latin America, with already unsustainable debt burdens and lacking the capacity and resources needed to face complex and protracted judicial processes.
In recent years, vulture funds have aimed their profit expectations at middle-income countries, particularly Argentina. With more than 40 lawsuits filed by commercial investors after the default of 2001, the country accounts for a third of the total number of lawsuits brought by vulture funds.
The Advisory Committee report cited three case studies highlighting the impact of vulture fund activities on human rights.
The first is Donegal International v. Zambia. By 1984, the Zambian government was unable to service a $30 million debt owed to Romania for the acquisition of agricultural equipment. In early 1997, the firm Debt Advisory International (which later incorporated as Donegal International) began to put forward proposals for acquiring the debt.
In 1999, just as Zambia was about to reach the decision point for comprehensive debt relief under the HIPC Initiative, Romania sold the debt to Donegal International for about $3 million, 11% of the face value.
In 2003, in controversial circumstances involving allegations of corruption and bribing of public officials, Zambia signed a settlement agreement with Donegal International to waive sovereign immunity from litigation and paid approximately $15 million of the then $44 million face value of the debt. The agreement also included penal rates of interest in the event of default and the application of United Kingdom law to any future dispute arising from it.
After paying off a total of $3.4 million, the Zambian government stopped fulfilling the terms of the agreement, arguing that it was tainted with corruption.
In 2006, only months before Zambia was due to receive debt cancellation under the HIPC Initiative, the company sued the country in the UK courts for a total amount of $55 million. Donegal obtained a favourable ruling, obtaining a 370% return, nearly 17 times the value of the original debt.
The government of Zambia reportedly recognized the judgment and allocated about 65% of the amount received, already earmarked for health programmes, to service the debt.
As a result of this litigation, vulture funds took away from the country almost 15% of its total social welfare expenditure, funds that could have been channelled instead towards education, healthcare and poverty alleviation.
The second case cited by the Advisory Committee is FG Hemisphere v. Democratic Republic of the Congo. In 1980, the Democratic Republic of the Congo entered into a credit agreement with Energoinvest, a company based in Sarajevo, for the construction of a high-voltage electric power transmission facility. The country soon defaulted on its repayment obligations.
In 2003, the International Chamber of Commerce made two arbitral awards in favour of the company, and in 2004 a District Court in the United States confirmed the amounts to be paid: $18,430,000 and $11,725,000, plus 9% interest and the costs of arbitration.
At that point, the company decided to transfer the right to recover the claim to FG Hemisphere, a company based in the state of Delaware, a tax haven in the US. The debt was reportedly purchased for $37 million.
FG Hemisphere then pursued its claim on the debt by attempting to seize the country’s assets in different parts of the world.
In 2005, a court ordered the government to provide detailed information about the location of those assets worth more than $10,000. Following the failure to provide that information, a US District Court imposed a fine of $5,000 per week, to increase periodically to a maximum of $80,000 per week, for failing to comply with the order.
To enforce the 2003 rulings, FG Capital Management has managed to freeze hundreds of millions of dollars owed to the Democratic Republic of the Congo and obtained enforcement judgments from several courts all around the world.
The Advisory Committee noted that the Democratic Republic of the Congo is rich in natural resources, but is recovering from more than four decades of dictatorship and war that have destroyed its infrastructure.
“In fact, it is difficult to see how a country with one of the lowest Human Development Index rankings (176) can service its external debt obligations without at the same time harming its poverty reduction and economic development prospects. The negative impact of vulture funds on the state’s capacity to create the conditions necessary to fulfil its human rights obligations is therefore evident,” it said.
Argentina and the “holdouts”
The third case cited by the Advisory Committee is NML Capital Limited v. Argentina.
It has been well documented how the deteriorating economic, financial and social situation led Argentina to a catastrophic collapse in 2001, said the Advisory Committee. Soon after defaulting, the government recognized the need to restructure roughly $81 billion of debt. In two successive exchanges of offers, in 2005 and 2010, Argentina succeeded in reaching an agreement with more than 92% of its creditors, which agreed to take an approximately 70% “haircut” on their bond holdings.
A group representing 1.6% of bondholders, led by NML Capital Ltd. (a hedge fund based in the Cayman Islands), refused to restructure and decided to sue the country in the New York state courts for the full amount.
Some of the defaulted bonds had been bought on the secondary market just before the country’s default in 2001, but most were purchased after, at bargain prices. The vulture funds allegedly paid about $48.7 million for more than $220 million in defaulted bonds soon after the default; others were purchased even after the bond exchanges of 2005 and 2010.
In November 2012, a New York District Court judge ordered Argentina to pay NML Capital and other “holdouts” in full (about $1.3 billion), an amount that may represent a profit of about 1,600%.
The court ruling was first confirmed by a decision of the US Court of Appeals for the Second Circuit and subsequently endorsed by the Supreme Court, which stated that the country could not pay the creditors that had accepted the exchange offers until the “holdout” creditors had been paid in full.
The Advisory Committee noted that these rulings represent a major departure from the traditional market/legal understanding of the pari passu clause, a common component of bond contracts. NML contended that the country was not granting the same treatment to the creditors that did not participate in the exchange because it had agreed only to pay its debt to the exchange bondholders.
In February 2016, with a newly elected government in office in Argentina, the US court set a number of conditions to effectively lift the injunction and allow Argentina to service the restructured debts.
Events accelerated from then on and in April, ceding to massive financial pressure, Argentina abruptly reversed its previous policy regarding these claims and agreed in an out-of-court settlement to pay $6.5 billion to the “holdouts”.
“The settlement represents a further setback in the process aimed at setting up an international sovereign debt restructuring mechanism based on the equal treatment of creditors, and human rights experts have expressed profound regret,” said the Advisory Committee.
Paying vulture funds much more than what was paid to cooperative creditors in previous debt restructuring is a disturbing outcome. Rewarding those who refuse to participate in debt restructuring efforts sends the wrong message, it underlined.
It said that this long judicial dispute highlights the pressing need to regulate speculative investment practices in order to bring them into line with human rights approaches and requirements.
Furthermore, it has prompted a process aimed at establishing a multilateral mechanism with a mandate to resolve sovereign debt litigation in an independent and impartial manner.
The case of Argentina is not an exception but forms part of a more general trend, said the Advisory Committee. Increasingly, non-cooperative creditors are reaping extraordinary profits owing to settlements reached or judgments obtained after disruptive litigation.
Not only do investors’ expectations of obtaining high returns by suing countries asphyxiated by onerous financial terms benefit from the lack of a global mechanism on debt restructuring, but they may also be at the origin of this state of affairs.
In fact, statistics show that lawsuits and attempted attachments are increasingly becoming a common way of solving sovereign debt disputes, entailing costly and protracted judicial processes for the state that has defaulted.
The trend has grown since the 1990s, from 10% to almost 50% of such disputes. In the period 1976-2010 there were about 120 lawsuits against 26 defaulting countries in the US and the UK alone.
The high rate of success (72%) certainly encourages this worrying tendency, said the Advisory Committee.
Accounting for 79 and 27 creditor lawsuits respectively, Latin American and African countries are among the most affected.
Over the past few years, litigation against HIPCs has reached a plateau. Although most lawsuits are now filed against middle-income countries, nearly 30% of all lawsuits have been launched against HIPCs. In March 2016, at least 13 cases were still outstanding against eight such countries.
With an average of eight cases being filed per year, Africa has been by far the most harassed region. According to IMF reports, claims by vulture funds constitute between 12% and 13% of African countries’ GDP.
African countries have the lowest rate of winning cases and have disbursed more than 70% of the nearly $1 billion awarded to vulture funds as a result of lawsuits.
The Advisory Committee noted that at present, only two countries, Belgium and the UK, have enacted some sort of legal framework to discourage disruptive litigation initiated by vulture funds. In 2013, UK legislation was replicated in the Overseas Territories and the dependencies of Jersey, Guernsey and the Isle of Man. Attempts to enact similar initiatives in France and the US have so far failed.
“While these national laws have played an important deterrent role, it is evident that more national laws are needed to tackle this problem effectively. The enactment of national legislation is particularly needed in those jurisdictions preferred by vulture funds for starting litigation or enforcing attachments,” said the Advisory Committee.
In that regard, useful guidelines for states can be derived from existing domestic laws and experience on their implementation, including the following: (a) protection should be extended to any debt-distressed country and not only to HIPCs; (b) where possible, procedures should allow for the identification of debts that are protected from the claims of vulture funds, on the basis of objective criteria; (c) concerns about the socioeconomic situation of the debtor state and the well-being of its population should be adequately incorporated and addressed by the legislator; and (d) issues regarding the lack of transparency in the secondary debt market and the operation of vulture funds in tax havens should also be tackled.
“A growing consensus has emerged in recent years on the need to curb the activities of vulture funds. A number of states have expressed support for international action to protect HIPCs in particular from the activities of vulture funds as well as broad support for the establishment of an international mechanism for orderly debt restructuring,” the Advisory Committee noted.
The Advisory Committee emphasized that litigation by vulture funds represents a substantial burden on the budgets of already poor countries. Harmful conditions of loans or high and abusive interest rates may make repayment extremely difficult.
The state having to repay far more than the amount originally borrowed may be obliged to redirect into debt service resources previously allocated for essential public services, also triggering cuts in public spending.
“Such a course of action hinders the state’s capacity to fulfil economic, social and cultural rights (i.e., to adopt appropriate measures towards their full realization) and, ultimately, has an impact on the economic growth and development of the country.”
According to the Advisory Committee, it has been demonstrated that in many countries debt repayment is often carried out at the expense of basic human rights, including the rights to food, health, education, adequate housing and work.
In the case of Ecuador, for example, the UN Committee on Economic, Social and Cultural Rights noted that the high percentage of the annual national budget (around about 40%) allocated for foreign debt servicing seriously limited the resources available for the achievement of effective enjoyment of economic, social and cultural rights.
The case of Malawi may be extreme, but it shows how debt repayment affected the country’s capacity to create the necessary conditions for the realization of economic and social rights. In 2002, the government decided to sell the maize from its national food reserve agency with the aim of raising funds to repay loans. Following a poor harvest that year, 7 million people, of a population of 11 million, were left facing a serious food shortage.
“The ability of vulture funds to jeopardize the objectives of the International Monetary Fund and the World Bank HIPC Initiative is striking, particularly bearing in mind that it aims at ensuring the debt sustainability of poor countries. In a number of cases, it has been clearly demonstrated that resources freed up for development and poverty reduction programmes were used to service debt owed to vulture funds.”
The Advisory Committee said that a good example is the case of the Democratic Republic of the Congo. A US District Court ruled in 2014 that it had to pay nearly $70 million to a vulture fund for an $18 million debt acquired in 2008, dating back to the regime of former dictator Mobutu Sese Seko in the 1980s. On the basis of the improved fiscal situation resulting from international debt reduction programmes, the country was ordered to pay the claims of the hedge funds. “This example shows how domestic rulings can clearly undermine the intent of the HIPC Initiative, which is often not taken into account by national courts.”
However, this is not an isolated case. In 2013, the World Bank and IMF reported that commercial litigation was ongoing against eight HIPC countries, said the Advisory Committee.
Vulture funds take advantage of the lack of adequate regulation of a financial system that has traditionally been based on purely commercial interests and foreign to human rights-based approaches and concerns.
“Though relevant actions have been undertaken in previous years, and though human rights monitoring bodies have provided some valuable guidance in striking a better balance between the different interests at stake, human rights should be further mainstreamed in this context,” said the Advisory Committee.
“The international community should work to provide the basis for shaping a more coherent framework where both commercial interests and human rights concerns are accommodated. In this context, the inter-linkages between an enhanced capacity of states to fulfil economic, social and cultural rights and sustainable development should be strengthened,” it added. (SUNS8299)
Third World Economics, Issue No. 623, 16-31 August 2016, pp9-11, 14