A Lone Hedge Fund Seeks Allies in $5.1 Billion Peru Bond Dispute

February 4, 2016

  • Gramercy claims Peru witheld key details in recent bond sales
  • Distressed-debt fund disputes value of bonds from ’80s default

The South American nation’s notes are outperforming rival emerging-market debt since a lawyer hired by Gramercy Funds Management LLC accused Peru of withholding information about disputes over decades-old defaulted debt when it sold new bonds. The Greenwich, Connecticut-based fund, which bought and holds an undisclosed amount of the defaulted debt, wants the U.S. Securities and Exchange Commission to either insist that investors be informed about the dispute or halt trading of Peruvian notes.

By making the allegation, Gramercy may be seeking to stir up a revolt among current investors that could add pressure on the government to renegotiate payment on its defaulted debt, according to Narghis Torres, who teaches securities law at Lima’s Esan business school and Universidad de San Marcos and has never advised the government.

So far, holders of Peru’s overseas debt aren’t biting.

“If bondholders thought this was a negative development, it would be reflected in risk levels — it’s not,” said Sean Newman, a senior money manager in Atlanta at Invesco Advisers Inc., which bought Peru’s dollar-denominated bonds last year. “You look at public debt management, and they’re a benchmark that other emerging-market countries should strive to reach.”

Holders of Peru’s international bonds should be concerned that the default on the land debt isn’t being properly disclosed, said Steve Bruce, an outside spokesman for Gramercy.

“Many institutional investors are not permitted to purchase securities issued by a sovereign in default,”  Bruce said via e-mail. “If Peru had properly disclosed its ongoing default, it likely would have precluded a number of investors from purchasing their bonds and, therefore, may have affected the pricing of such bonds.”

The SEC declined to comment.

Peru’s foreign debt has returned 0.9 percent since Jan. 11, when John Coffee, the lawyer hired by Gramercy, issued his opinion. That’s compared with a 0.9 percent drop for notes from the rest of Latin America, data compiled by JPMorgan Chase & Co. show. Emerging-market debt overall has returned 0.2 percent in the period.

The dispute between Gramercy and Peru relates to bonds issued under the military dictatorship in the 1960s and 1970s as compensation to farmers whose lands were seized. Peru defaulted on the debt after the economy collapsed in the 1980s. APJBA, a creditors’ association in Peru, says a 2013 court ruling ordering the government to calculate the debt using U.S. Treasury rates rather than Peruvian inflation reduces its value to just 5 cents on the dollar. Local creditors have put the true value owed to them at about $5 billion.

Coffee, a professor of securities law at Columbia University, said Peru failed again and again to disclose pending litigation in the prospectuses for new bond issues, including a sale as recently as August. Coffee says there are hundreds of unsettled legal claims against the government related to the defaulted land bonds that haven’t been resolved.

“Investors should have all the material information to make a decision,” Coffee said in an interview from New York. “Some bond investors may take a risk but that doesn’t mean that Peru shouldn’t disclose.”

He also pointed to statements made by former constitutional court judge Carlos Mesia, who said in a September criminal complaint that his signature was falsified on the 2013 ruling.

But in an Aug. 18 filing to the SEC, Peru said it is isn’t “involved in disputes with its internal or external creditors” and is “unaware of any claims filed against it for overdue debt payments.”

The land bonds “are completely different” from contemporary sovereign bonds and were issued in local currency and subject to Peruvian law and jurisdiction, the Finance Ministry said in an e-mailed response to questions.

“The markets know about this historic context,” the ministry said, adding that it provided information on the land debt situation when issuing bonds. The ministry didn’t respond to a question on why it didn’t mention the unsettled legal claims in the filings.

Finance Minister Alonso Segura said in an interview in Davos on Jan. 22 that Peru is following the constitutional court’s ruling on how to evaluate and repay the land debt.

“Peru is a country that honors its commitments,” Segura said. “All of them.”

The price on Peru’s $1.25 billion of 2027 notes has climbed 0.8 cent since Jan. 11 to 98.41 cents on the dollar. Peru is the highest-rated country in South America after Chile.

It’s unlikely the SEC will get involved given that the bonds are performing well and there appears to be no material risk to investors, said Adam Pritchard, a law professor at the University of Michigan.

“If those bonds are still trading at par or close to par, that significantly dampens the SEC’s interest in bringing an enforcement proceeding,’’ Pritchard said.