The current Zambian case not withstanding, most distressed debt traders form a valuable part of the financial system.

Distressed debt trading is increasingly a discipline that dare not speak its name. In The Banker’s story on the topic this month, few bankers could be persuaded to speak on the record (see page 42). The latest furore to hit the derogatively named vulture funds centres is the $55m claim for Zambian debt filed by Donegal International (DI).

The company, incorporated in the British Virgin Islands and part-owned and run by Debt Advisory International, a Washington-based company specialising in emerging markets, acquired debt at a massive discount (for only 12 cents on the dollar) that was supposed to be part of a government debt write-off.

Whatever one may think about the Zambian case – the rights and wrongs of the legal loopholes that enabled DI to buy the debt, and a decision on how much DI will be able to claim, were being debated in the British High Court as The Banker went to press – it is wrong to label all distressed debt businesses as a bad lot.

Distressed debt traders can play a crucial role in financial markets, providing liquidity when other providers do not want to take the risk and, in the process, enabling financial institutions to unwind positions they no longer want to hold, or are precluded from holding.

For example, when the credit environment is less benign (many believe we may not have to wait long before stress-testing that scenario) and the credit quality of investment grade companies’ debt slips below investment grade, after which they are referred to as ‘fallen angels’, many pension funds and other asset managers will be forced to sell the bonds because the terms of their mandate prevents them from owning sub-investment grade paper. It is often distressed debt funds that play a critical role in providing an exit route.

Asset managers will be far less willing to invest money, if they are not certain that they will be able to get it out again.

It is foolish to tar all distressed debt firms with the same brush, or to demonise by name-calling a sector of the markets. If one firm may be deemed to have behaved badly, or to have exploited a loophole that undid the good a gesture was intended to achieve, it does not mean that an entire sector should be punished. Better to close the loopholes and penalise those who exploit them.


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