Report: Rise of "odious debt" draws scrutiny on development finance regulations

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A series of investigations have revealed that governance failures and probable corruption led to the collapse of a US$2 billion infrastructure project in Mozambique.

A swathe of missing money and allegations that loans were illegally signed-off by politicians have stirred up complaints that the debt is contrary to international democratic standards.

The controversy has called into question the level of due diligence carried out by the lending banks. These suspicions, coupled with the fees the banks received and further allegations over the banks’ conduct have raised questions over whether the international system of development finance is fit for purpose.

Best laid plans

In 2013, the Mozambique government finalised a plan to exploit the abundant natural resources of its territorial waters through an initial US$850 million loan from international banks.

The plan was to diversify Mozambique’s economy. Firstly, a fishing fleet would be built to create a tuna-exporting industry. Second, a security fleet would be built so that foreign gas companies could be invited to drill underwater, and pay for the privilege.

The project was predicted to lead to revenue of US$2.3 billion by December 2016. Instead, its collapse has contributed to Mozambique’s debt rising to 112% of its GDP.

According to the International Monetary Fund (IMF), in April 2016 the Mozambique government revealed hidden debts of over $1 billion that had been accrued as part of the project, bringing the total debt to around $2 billion.

IMF head Christine Lagarde told the BBC in June 2016 that a lack of transparency in Mozambique was “clearly hiding corruption”. In January this year, the IMF and other international donors told Mozambique that aid would be suspended until this was investigated. A team from risk consultancy Kroll was then retained to audit the loans.

Kroll’s report, which was released in June, says that the enterprise has generated “negligible” revenue with accounts that reveal an unexplained shortfall of $713 million.

The report found that the money which can be accounted for was mainly spent on security boats and weapons. A team of journalists in the UK, Switzerland and Mozambique is investigating whether these purchases and the missing money have contributed to human rights abuses linked to the government’s clashes with rebel group Resistência Nacional Moçambicana (RENAMO).

Beyond that, Kroll’s investigation raised more questions than it answered. 

The loans

Kroll divided the loans between the three Mozambique companies, ProIndicus, EMATUM and MAM. They relied on loans arranged by the London branches of Credit Suisse and Russian bank VTB.

  • ProIndicus borrowed $622 million arranged by Credit Suisse. The loan bore an interest rate of LIBOR plus 3.2% and included a bank fee of $10.1 million and a further $64.4 million fee that went to the contractor in charge of the projects, Lebanon-based PrivInvest.
  • EMATUM borrowed $850 million arranged by Credit Suisse at a rate of LIBOR plus 3.7%. Credit Suisse took a fee of $13.7 million and PrivInvest fees of $76.5 million.
  • MAM (Mozambique Asset Management, a financing entity) borrowed $535 million arranged by VTB at a rate of LIBOR plus 7%, with a bank fee of $35 million, but no contractor fee, according to Kroll.

Overall, Credit Suisse loaned $1.47 billion, taking $23.8 million in fees (1.6%) plus interest. Contractor fees on these loans totalled $141 million, or 9.6% (figures confirmed to WikiTribune by the banks).

According to the Jubilee Debt Campaign, the fees appear to have been arranged to lower the interest rate so that it was not as high as market rates. Due to the risk of investing in Mozambique, credit ratings agencies would have recommended a high interest rate. Such a high rate might have been politically unpalatable for either the government or the bank, so the interest rate was kept relatively low but a fee was charged to account for this and protect the lender, the campaign group suggests.

This is in line with what PrivInvest told Kroll, explaining that the fees were due to Mozambique’s high risk profile.

In a statement sent to WikiTribune, Credit Suisse said that the fees were “in line with comparable emerging market financing transactions”.

VTB told WikiTribune that the information regarding the fees being widely reported is “misleading”, and also said that the transaction fees “were in line with market pricing”.

Joseph Hanlon, an expert on Mozambique at the Open University, told WikiTribune that the fuss over the banks’ arrangement fees is a “smokescreen” for the real issues underlying the loans.

A cloud of accusations

The audit says that Credit Suisse initially said that the loans required the approval of the Bank of Mozambique and the Mozambique Administrative Court, as well as being reported to the IMF. This is in-keeping with historic statements given by the IMF regarding the hidden debt. These conditions appear to have been dropped.

This would appear counter-intuitive, as such high standards of due diligence exist to protect the bank’s investments. Relaxing standards would work in favour of the banks if their investments were protected in another way.

In December 2016, a report on the loans by the Mozambican Parliamentary Inquiry Commission (CPI) was leaked to the press. WikiTribune has been unable to verify the authenticity of this report, but certain elements of these reports have been confirmed by the IMF. 

Mozambique’s finance minister signed a contract to ensure that the debt was guaranteed by the government. This would be in breach of Mozambique’s constitution, which requires such deals to be approved by parliament. The amount borrowed also breached Mozambique’s budget constraints.

Local reports have gone further, alleging that Credit Suisse created feasibility prospectuses for the project that vastly overestimated the viability of the tuna fishing businesses. WikiTribune has not been able to verify these reports, but Hanlon says that the banks misled investors and the Mozambican government.

In March 2016, the government sought to restructure the debt. With the help of Credit Suisse and VTB, both of whom took further fees, and two London-based law firms as well as advisory services, the government issued $727 million of Eurobonds to replace the original loans with debt that had a longer repayment timescale. Mozambique has since defaulted  on this debt.

Next steps

From this confusion emerges the suggestion that the banks created business plans which overestimated the prospective revenue of Mozambique’s offshore projects and ignored local laws to secure the investment and take the arrangement fees and interest.

WikiTribune put this to the two banks. Credit Suisse declined to comment. VTB said it had “followed strict internal policies in issuing the loans and hired the best international legal advisors to consult the bank on these transactions”.

“We have properly executed these deals and are absolutely sure of our legal position,” said a bank spokesperson.

Switzerland’s regulatory body Finma confirmed to WikiTribune that it is “in contact” with Credit Suisse in regard to the loans, but would not go further.

Hanlon says that, apart from alleged exaggerated business plans and corruption, all of the debt is illegitimate as it required an unauthorised state guarantee, which breached Mozambique’s constitution and budget laws.

The difficulty with this argument is that the debt was contracted using English, not Mozambique, law.

If Mozambique continues to default on the debt, its creditors are likely to seek reparation in London, disregarding the sovereignty of the African state.

Tim Jones, policy officer at the London-based Jubilee Debt Campaign, tells WikiTribune, “this odious debt comes from loans which were given in secret, without approval from Mozambique’s parliament, and with an apparent complete lack of adequate due diligence”.

“Campaigners in Mozambique want the officials involved held to account, but Credit Suisse and VTB Capital also have to be as well,” said Jones.

“Odious debt” or everyday business?

The term “odious debt” is usually associated with countries emerging from the shackles of oppressive governments. Newly-fledged democracies in Argentina, South Africa and Chile, for example, found themselves weighed down by the burden of debts amassed by their former governments. Campaigners lobbied, with varying success, to have the debt forgiven, arguing that the people of those countries should not be burdened with debt built up undemocratically, the funds from which were often spent repressing their democratic rights.

Calls to drop Mozambique’s debt have a hard road ahead. The money lent was not owned by the banks, and only some of it was entrusted directly to them to invest – with the rest coming from syndicates of lenders whose investment in Mozambique the banks facilitated. The banks arranged the debt, took fees and in some cases interest, but they are protected.

According to the Wall Street Journal, Credit Suisse’s revenue from loans and bonds jumped 18 percent in 2013, the year the loans were made. The bank attributed the rise in its annual report to “higher revenues in emerging markets, particularly in structured lending.”

“Going forward we need enforceable rules on disclosure and due diligence around loans to governments,” said Jones. “In the UK, a law should be introduced that all loans to government by UK financial institutions, or made under UK law, have to be publicly disclosed when they are given, and abide by the law of the country concerned.”

For now, Mozambique and other developing economies are at the mercy of banks based in wealthy financial centres if they want to play in the international markets, attract investment and leverage their growth potential. And it is the rules of the lenders that govern the game.

Jack Barton is a WikiTribune journalist. He has an LLM in Human Rights and a background reporting on law and international development. Follow @jackbarton91

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