Financial Times; Apr 25, 2002
By ALAN BEATTIE

MIDDLE EAST & INTERNATIONAL ECONOMY: Investors voice concern over banks' emerging market role: Tensions emerged at the Institute for International Finance's conference this week over a new deal for bankrupt governments. Alan Beattie reports.

Since the elixir of life for many emerging market countries appears to be their ability to attract foreign capital, the opinions of international investors - the alchemists of finance - is of paramount importance. Hence, during the debate on a new deal for bankrupt governments in which the Group of Seven rich countries are currently engaged, a single question is constantly raised: what does the private sector think?

But at this week's Institute for International Finance conference in New York, bubbling tensions between those who do the investing and those who merely take a cut along the way rose to the surface. Mohamed El-Erian, managing director of Pimco - one of the world's largest emerging market bond investors - made his fears plain: "Investment banks are not the right institution for leading this debate," he said. "When the size of the fees are related to the size of the deal, the outcome will not be optimal." Discussions should involve the borrower governments themselves and the bondholders, not intermediaries, he said. He cited a mega-swap of Argentine debt last June, in which the country bought itself only a little more time at the cost of pushing up its borrowing costs and paying an estimated Dollars 150m (Pounds 104m) in fees to 10 investment banks including J.P. Morgan Chase and Citigroup.

Investors are concerned that the IIF's conversion to the wisdom of "collective action clauses" - new bond provisions suggested by the US Treasury as a means of easing debt restructuring negotiations - is motivated merely by its chance to take a cut during many more such deals as old bonds are swapped for new. The investors themselves may be less keen on provisions which make it easier for countries to default and lead to minority views being overridden. This tension echoes events in another industry grouping, the Emerging Market Traders' Association, when a group of disgruntled buy-side investors formed the rival Emerging Market Creditors' Association.

The IIF represents more than 300 of the world's largest financial institutions and seeks to portray itself as the legitimate representative of the private financial sector. When Horst Kohler, managing director of the International Monetary Fund, set up a capital markets consultative group, IMF officials reported heated discussions when the IIF tried to interpose itself between the fund and the individuals involved. But as the domination of commercial bank lending to emerging markets has given way to bond, equity and foreign direct investment, the IIF has appeared increasingly unrepresentative. It is dominated by commercial and investment banks: it is chaired by HSBC chairman Sir John Bond and its vice-chairmen include Josef Ackermann, the new head of Deutsche Bank, and William Rhodes, Citigroup's vice-chairman and legendary sovereign debt negotiator.

One of the problems in discerning what investors think is simply that "buy-side" managers do not have time or inclination to fly around the world to conferences. "Mohamed sits in a small office in California and manages billions of dollars almost single-handed," says one IMF official. "He is great when you get hold of him, but he generally has better things to do." Nor is there a unified investor view. Many of the smaller hedge funds - particularly those who make a living out of buying up distressed debt, such as the so-called "vulture fund" Elliott Associates - predictably see no need to change the current system.

There is little love lost between them and the IIF, which advocates a legal strategy to prevent them suing bankrupt governments as Elliott famously did with Peru. Moreover, there are now huge numbers of smaller players - thousands of Italian retail investors hold Argentine debt, for example - whose views, including their willingness to accept debt reschedulings, are simply unknowable. Some managers at larger funds, such as Jerome Booth, research head at Ashmore Investment Management in London, also see no need for change. Although sharing the distrust of the IIF, he also resists the idea that the bond market should even try to come up with a collective alternative view. "It is the G7's sovereign right to come up with stupid ideas," he said. "I will just find a way of making money nevertheless."
Mr El-Erian himself, a former senior IMF official, is more open to discussing all possible solutions, including the IMF's preferred solution of a new judicial procedure. This week, the investment banks defended their role against Mr El-Erian's accusations. "If he would like to tell me how my investment bank can make money out of giving advice to governments in trouble, I would like to know how," said Sir David Walker, senior adviser at Morgan Stanley. Charles Dallara, managing director of the IIF, said he was sure that differences of incentive within the IIF's membership could be overcome. But if the debt debate moves towards implementation and real money becomes involved, the tensions within the private sector could prove a serious stumbling block to a peaceful consensus. 

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