Sovereigns’ hedge-fund swaps raise bondholder risks

Governments in West and southern Africa have used total return swaps to borrow from banks, pledging their sovereign bonds as collateral while keeping ownership of the bonds.

Senegal raised about $1.24 billion through swaps after audits uncovered roughly $7 billion of previously unreported borrowing in 2024 and its IMF programme was suspended. The government reported the financing cost about 7%, compared with an estimated 11%–12% on international markets. Lenders involved included Africa Finance Corp., Société Générale and First Abu Dhabi Bank.

Nigeria used a $5 billion swap facility arranged with First Abu Dhabi Bank. Angola obtained about $1.5 billion through a swap arranged by JPMorgan. Colombia raised about $9.3 billion through similar structures last year and has since unwound those transactions.

A total return swap transfers the economic returns of an asset without moving title. In these deals, a government posts its own bonds as collateral and receives cash from a bank, creating liquidity without selling the bonds. Governments report the contracts can be faster and cheaper than issuing new bonds or arranging syndicated loans.

Because swaps are treated as derivatives rather than conventional loans, they can be harder for outside investors and some agencies to track. The classification can limit transparency about a country’s full borrowing and collateral commitments.

Bond investors and restructuring advisers say the arrangements could affect creditor priority in a sovereign restructuring. If banks that financed governments under swap agreements are treated as secured or preferred creditors because of pledged collateral or collateral calls, bondholders could face larger losses. There is no settled legal precedent for how sovereign total return swaps should be treated in restructurings.

A prior episode in Ecuador is referenced in restructuring discussions. Ecuador repaid roughly $1 billion to banks before restructuring its dollar bonds in 2020; subsequent analysis indicated bondholders experienced greater losses than they might have if those bank creditors had been part of the restructuring.

Swaps carry operational risks for borrowers. Falling bond prices can trigger margin or collateral calls under swap contracts, requiring governments to post additional collateral at times of market stress. That dynamic can force sales of assets into weak markets or the rapid gathering of liquidity. The derivative classification can also obscure these contingent obligations in public fiscal accounts.

Legal advisers and restructuring experts note the lack of clear precedent could complicate negotiations if multiple creditor classes claim priority based on collateral or contract terms. Market participants are watching whether future restructurings will establish rules for how swap-based bank claims are treated relative to bondholder claims.