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Policy Proposal: A White Knight Distressed Debt Buyer

In emerging markets with weak borrowing capacity and low market faith, a class of private equity funds deploys large sums of capital to buy sovereign, sub/quasi-sovereign and corporate bonds when trading at distressed levels (pennies on the dollar). By buying these bonds when other investors, like pensions, are fleeing they buy the bonds up cheaply. Then these Vulture Funds will pursue legal, intermediation, or asset stripping activities to force the bond issuer into full repayment. The most common method is delaying restructuring that would allow the issuer to return to capital markets for additional borrowing. This has three serious consequences in EMs 1. By holding up these debt restructurings for years to decades, lenders face enormous legal costs, and overall reduction of operational preparedness as the money necessary to fight these funds takes away from critical operational expenditures 2. Many times, corporate and quasi-sovereign borrowers face the risk of asset-stripping and forced sales which accept below market rates, further leaving lenders less capacity and 3. The delayed reaccessing of capital markets weakens borrowing capacity in the long run, makes final restructuring agreements more difficult and less lender friendly, thus raising the probably of re-defaulting in the end.

To prevent the asset stripping, holdups, and costly litigation that pulls capital out of EMs and away from more productive uses, a 'White Knight" distressed debt fund would behave as the opposite of a vulture fund. By investing in key levels of specific tranches of bonds, the fund could take advance of collective action clauses (CACs) in many bonds which force acceptance of a restructuring proposal if (often) a supermajority of creditors agree to the terms. Buy acting quickly when a country or critical company was facing default, the pro-sovereign fund could assess the bondholder landscape and purchase a level of distressed debt that makes faster restructuring possible, therefore nullifying the tactics Vulture Funds Use (buying up majorities of specific tranches to gain a degree of influence and delay deals). While the fund would likely focus only on capital preservation, a deal where bonds are purchased in primary and secondary markets alike for pennies on the dollar and then able to be resold closer to par after a speedy restructuring(Uruguay is a good example of this) could still potentially turn a large profit.

See the full proposal here:

Greyrise Fund I
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