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Taming the Vulture: Turning Distressed-Debt Investors into Agents of Social Change

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By Brian Finlay – At a time when we are told that terrorist interest in acquiring nuclear, biological, and chemical weapons of mass destruction is at an all time high–and competitive budgetary pressures to address a multitude of national security threats are straining resources–the search for innovative approaches to finance critical nonproliferation activities could not be more imperative. Such thinking has been ongoing in the global development world for decades thanks to celebrities like Bono, committed nongovernmental organizations, and big money individuals and endowments like the Rockefeller and Bill and Melinda Gates Foundations. As a result, the international community is today not only acutely aware of the need, but is actively pursuing innovative strategies to address poverty reduction and capacity building that expand upon, but ultimately transcend, the traditional and limited government aid approaches to development. By contrast, perhaps content with its larger portion of the budgetary pie, the national security community has rested on its innovation laurels and has failed to generate new approaches whose implementation is not dependant upon bigger government appropriations to existing national security agencies.

Meanwhile, the solutions to the proliferation threat itself have necessarily grown more complex. It is increasingly clear that preventing the spread of weapons of mass destruction must go beyond immediate security preoccupations of the Western world to address the root causes of the problem in weak and failing states. As with Afghanistan and Sudan, it is often in nations with a vacuum of legitimate authority that would-be WMD terrorists can freely operate. It is time to connect the dots between the creative approaches to economic development and the enduring problem of proliferation. It is time to implement new “whole-of-government approaches” to address the threat of weapons of mass destruction.

Debt as an Instrument of Security

Over the past decade, the “Hollywoodization” of global politics has turned debt forgiveness and economic development into an international cause célèbre. Invariably, these movements are driven by the development constituencies both in government and beyond, and seek to target the poorest of the world’s poor. But in a globalized world where developing world debt is increasingly found in states of proliferation concern, the nexus of these scourges should be leveraged for mutual benefit. The AQ Khan affair illustrated the ease with which bad actors can access sensitive WMD knowledge and hardware from sources beyond the presumably well fire-walled developed world.

In April of 2004, the UN Security Council unanimously passed Resolution 1540 mandating all states to “adopt and enforce appropriate effective laws which prohibit any non-State actor to manufacture, acquire, possess, develop, transport, transfer or use nuclear, chemical or biological weapons and their means of delivery.” But while mandating complex and expensive new standards, the Resolution did little to provide new financial support to the developing world to realize these obligations. Without adequate assistance, there is little chance that 1540 will become any more than a hollow gesture. And with rising budgetary pressures across the Western world, such assistance is increasingly less likely. A solution to this quandary may however, be achievable.

On September 30, 2002, President Bush signed the Russian Federation Debt for Nonproliferation Act as part of the Foreign Relations Authorization Act of 2003. In the context of fiscal belt tightening on Capitol Hill, the motivation behind the new scheme was to provide innovative new sources of funding for critical nonproliferation activities in a country still considered the greatest threat for the proliferation of weapons, materials, and expertise of mass destruction. The law outlined a mechanism for applying forgiven debt toward the funding of nonproliferation projects and operate similar to the successful “debt for ecology” swaps of the 1980s and nineties. At its signing, the plan was heartily embraced by the Russian Government.

Economic recovery and rising oil and gas prices by 2005 meant that Russia was more likely to be able to service its foreign debt, and its increasing value vitiated interest in nonproliferation swaps among all parties. Though debt forgiveness no longer makes economic sense in Russia, its applicability elsewhere may make room for innovative new approaches to achieve similar objectives. The threat of proliferation is global, and creditor governments around the world-and all other governments for that matter-have a common interest in ensuring that weapons of mass destruction do not fall into the hands of terrorists and terrorist states. As noted, globalized trade and commerce has made many of the same governments challenged by an overwhelming debt burden, also hubs of proliferation concern.

The continuing challenge of course, is that even as debt is forgiven, Western governments must forgo the would-be revenue from repayment. Many governments have been hard-pressed or unwilling to do so. Thus, any mechanism that capitalizes upon debt forgiveness to achieve a social benefit-be it global development or nonproliferation-must be self-financing. Simple debt swaps may no longer cut it.

Enter the Vultures

Recent high-profile financial settlements obtained by distressed-debt investors-so-called “vulture funds”-have brought renewed public scrutiny on what is widely perceived as an egregious predatory practice targeting the world’s poorest nations. But the financial principles that underlie vulture funds could have a positive, if counterintuitive, impact in holding corrupt governments accountable for their fiscal policies, or by providing incentives to agreeable governments to achieve common global development, or even security, objectives.

The International Monetary Fund (IMF) defines vulture funds as arbitrage-seeking investors who specialize in obtaining debt in the secondary market at prices far below face value. Their goal is to recover the debt, through negotiation or even litigation, at a value greater than the purchase price. At present, it is estimated that these hedge funds collectively hold more than $1 billion in claims against the developing world.

At their worst, these investors have stimulated infrequent but high-profile cases involving onerous repayment schemes from some of the most impoverished countries in the world. Perhaps the most famous of these cases involves an American firm and a substantial Cold War-era debt from Zambia. In 1999, a US investment firm, Donegal International, acquired $40 million- worth of Zambian debt owed to the Government of Romania for the discounted purchase price of $3.2 million. In 2007, a British high court granted Donegal permission to enforce a claim for tens of millions of dollars against the Government of Zambia, handing the US firm a multimillion dollar profit on its eight -year investment, and the beleaguered Zambian people a crushing financial burden.

OXFAM, the World Bank, and other aid and development organizations have spoken out against the predatory practices of these funds, which at times have targeted heavily indebted poor countries (HIPCs) whose debts are destined for forgiveness. In these isolated cases when aggressive profiteering occurs and prevents the benefits of debt forgiveness from reaching its intended targets, distressed-debt investors are justifiably viewed as rapacious vultures preying upon the misfortunes of the developing world. Such egregious practices should be prevented. But more often than not, these cases are the exception rather than the rule.

The underlying principle of distressed-debt investing rests on sound financial ground: when you borrow money, you should repay it. And as you build a reputation for being a reliable client, lenders will continue to provide capital and developing world governments can continue to finance needed services and infrastructure. This is good for the lender and the borrower.

Of course, it is not just the poorest countries that hold debt. All countries owe money, and sometimes, governments are simply unwilling to pay. Last year, Bolivian President Evo Morales launched an aggressive campaign to nationalize his country’s oil and gas industry. Foreign companies which had invested almost $4 billion since Bolivia opened up its energy sector in the late 1990s stood to lose millions. Just weeks later, the Government of Ecuador seized and nationalized oil fields owned by Occidental Petroleum Corporation. In this instance, a dispute settlement tribunal ordered Ecuador to pay Occidental more than $75 million-a sum Ecuador has been unwilling to pay.

In cases such as these where the “distressed-debt” is a result of an infraction of international law or a treaty, it is not uncommon to find vulture funds providing a critical service. Oftentimes, big institutional investors-national governments and large multinationals like Occidental-are unwilling to exert the necessary energy to sue and then collect settlements from sovereign countries-an expensive and time consuming process whose result, even with a legal ruling, may not yield payment. Witness Romania’s enthusiasm to reap the immediate gain from Donegal of $3.2 million rather than negotiate or litigate repayment of the full $40 million debt from Zambia. This unwillingness to pursue payment reduces the penalties associated with defaulting on sovereign debt-and even litigation settlements-and makes private sector investment in that country problematic as investors are unwilling to advance more loans to countries with a history of defaulting. Back to the nationalization initiative of President Morales: economists maintain that Bolivia needs these foreign investors which account for roughly 20 percent of the country’s gross domestic product and one quarter of its overall tax revenue. In these cases, by forcing payment on the acquired debt or on settlements resulting from illegal seizures of foreign property, mendacious or recalcitrant governments are forced to play by globally accepted rules.

Some have even argued that vulture funds help create the conditions under which countries like Zambia and Bolivia can raise private resources for investments in health, education and infrastructure. While it may be a stretch to say that these funds are the guarantors of public welfare for the developing world, it is certainly critical for any government to maintain sound financial practices as it seeks foreign loans and investment. Though they themselves have the capacity to do harm, if used appropriately, vulture funds can help keep developing nations honest.

The Distressed-Debt Nonproliferation Fund

The potential benefits of “vulturesque” funds can go beyond the enforcement of rules in a capitalist economy. If on one hand, debt is a burden to developing countries that must service their loans and divert resources from other national objectives, and on the other, a commodity that can be bought or sold (or forgiven) by wealthier nations, then it is not difficult to imagine using this market mechanism to promote common interests in non-HIPC countries where debt/settlement sales and forgiveness could be “swapped” for mutually beneficial ends.

Joining the debt for nonproliferation concept with distressed-debt investing, concerned governments should capitalize a new Distressed-Debt Nonproliferation Fund. The Fund would begin purchasing non-HIPC distressed debt in countries of proliferation concern at reduced value. Innovative deals could then be struck where, for example, one-third of the outstanding value of the debt could be immediately forgiven, with another third refinanced to recapitalize the Fund over time. The remaining third could then be converted in national currency and used for predetermined nonproliferation activities-or any other common objective-in the target country. These newfound resources could be used, for instance, to fund security enhancements mandated by UN Security Council Resolution 1540, secure biological and chemical materials, purchase border detection equipment, invest in rule of law infrastructure, engage scientific personnel of proliferation concern, and so on.

Albania, the Dominican Republic, Georgia, Guatemala, Pakistan, the Philippines, Ukraine, and others have called for assistance in one form or another to prevent the diffusion of nuclear, biological and chemical weapons either within or from their territory. Each of these countries also owes some portion of the existing $509 billion of Paris Club debt. Each also owes a significant bilateral debt to the United States. All of these countries could become ideal candidates for participation in the Distressed-Debt Fund.

All governments utter platitudes on the threats associated with the proliferation of weapons of mass destruction, but most have proven unwilling to invest the necessary resources to address the mutually reinforcing threats of poverty and proliferation. Until all countries around the globe are willing and capable of meeting their legally binding obligations to prevent the proliferation of nuclear, biological and chemical weapons on or from their shores, the world will remain under constant threat. A private, self-financing plan for distressed-debt forgiveness and national security investment could be a combined solution to these enduring challenges.

Photo Credit: Wing-Chi/Wikimedia Commons


 Brian Finlay co-directs the Cooperative Nonproliferation Program, a multifaceted project designed to accelerate existing efforts and design innovative new initiatives aimed at more rapidly and sustainably securing nuclear, biological, and chemical weapons, materials, and expertise.

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