The effectiveness of the coolest-named investment vehicle in finance, the “vulture fund,” may soon be limited, as New York lawmakers introduced a new bill to curb their legal maneuvering.
For context, vulture funds are hedge funds that seek to profit from buying up very cheap bonds that are close to, or already in, default (often sovereign debt issued by foreign countries), then suing for lucrative payouts. The most famous of these vulture fund litigations was a series of disputes between American hedge funds, led by Paul Singer’s Elliott Management, and the government of Argentina between 2001 and 2016.
In 2001, Argentina defaulted on $82 billion of sovereign bonds at the depth of its worst economic crisis in history. 93% of creditors accepted Argentina’s offer to issue them new bonds worth about 30% of the value defaulted bonds, but 7% of the bondholders, including Elliott Management, refused to take the reduced payout. One reason that these hedge funds refused Argentina’s discounted settlement was that the defaulted bonds had variable interest rates, and the interest rates spiked to 101% after the country defaulted. Basically, if they won in court, they would get a massive payout. 15 years after Argentina defaulted, these funds eventually scored a combined $4.65 billion payout, receiving around 75% of what they were owed.
This new bill would restore a full legal doctrine known as champerty, which would halt frivolous lawsuits taken by creditors who had only bought claims in order to sue, as opposed to traditional creditors who take part in restructuring negotiations. It would also cut the penalty rates applied to defaulted sovereign bond payments from 9% to the interest rates on one-year Treasury bills, which are currently 5%.
Basically, if this bill passes, “investors” could no longer buy foreign debt for pennies on the dollar with the sole intent of suing for a massive payout, holding foreign nations hostage until they met the creditors’ demands.
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