Key Takeaways
- • Governments in Senegal, Angola, Nigeria, and Colombia are deploying total return swaps (TRS)—derivative instruments traditionally used by hedge funds—to raise sovereign debt at significantly lower costs (7% for Senegal vs. 11–12% on open markets), creating creditor hierarchy concerns in future restructurings.
- • Senegal raised $1.24bn through TRS following discovery of $7bn in unreported borrowing and IMF programme suspension; the country now faces debt restructuring with bondholders worried that bank lenders (Africa Finance Corp., Société Générale, First Abu Dhabi Bank) will receive preferential treatment over traditional creditors.
- • Ecuador's 2020 experience—repaying $1bn to Goldman Sachs and Credit Suisse before restructuring its dollar bonds—demonstrates the risk: Fitch found bondholders suffered larger losses than they would have if bank creditors had participated in the restructuring.
- • TRS structures are classified as derivatives rather than conventional loans, reducing transparency around sovereign borrowing and collateral obligations and making it harder for investors to assess true leverage and contingent liabilities.
- • Nigeria has a $5bn TRS arrangement (involving First Abu Dhabi Bank), Angola borrowed $1.5bn via JPMorgan TRS, and Colombia raised $9.3bn through TRS before unwinding the transactions—signaling growing adoption but also potential reassessment of the strategy's risks.
Summary
Sovereign governments are increasingly using total return swaps—instruments more commonly associated with hedge fund derivative strategies—to access cheaper financing, but the structures are creating material risks for traditional bondholders by potentially elevating the seniority of bank lenders in future debt restructurings. TRS allow governments to pledge their own bonds as collateral for bank financing, providing faster and cheaper capital access (Senegal achieved 7% funding costs versus estimated 11–12% on international bond markets) but introducing opacity and creditor priority concerns absent in conventional loan structures.
Senegal has emerged as the key test case. The country raised approximately $1.24bn through TRS with lenders including Africa Finance Corp., Société Générale, and First Abu Dhabi Bank, following the 2024 discovery of $7bn in previously unreported borrowing and the suspension of its IMF programme. As Senegal now initiates debt restructuring, bondholders are concerned that the TRS lenders—classified as derivative counterparties rather than conventional creditors—may receive preferential repayment treatment. No established precedent exists for restructuring sovereign TRS, creating legal and financial uncertainty.
Ecuador's experience offers a cautionary precedent. In 2020, Ecuador repaid $1bn to Goldman Sachs and Credit Suisse before restructuring its dollar bonds; Fitch subsequently determined that traditional bondholders suffered larger losses than they would have had the bank lenders participated in the restructuring. This pattern reflects the seniority risk embedded in TRS structures: as derivative contracts rather than debt securities, they may be treated as financial obligations with higher priority than bond claims.
The practice is widening across emerging markets. Nigeria has deployed a $5bn TRS arrangement involving First Abu Dhabi Bank, Angola has borrowed $1.5bn via JPMorgan, and Colombia raised $9.3bn through TRS before subsequently unwinding its transactions—suggesting some sovereigns are reassessing the strategy. The classification of TRS as derivatives rather than conventional loans further obscures transparency, limiting investors' ability to assess true leverage and contingent collateral obligations during periods of sovereign financial stress. For traditional bondholders, the growing use of these instruments by sovereigns underscores a structural shift in financing hierarchies that could materially increase losses during restructuring events.
Senegal has emerged as the key test case. The country raised approximately $1.24bn through TRS with lenders including Africa Finance Corp., Société Générale, and First Abu Dhabi Bank, following the 2024 discovery of $7bn in previously unreported borrowing and the suspension of its IMF programme. As Senegal now initiates debt restructuring, bondholders are concerned that the TRS lenders—classified as derivative counterparties rather than conventional creditors—may receive preferential repayment treatment. No established precedent exists for restructuring sovereign TRS, creating legal and financial uncertainty.
Ecuador's experience offers a cautionary precedent. In 2020, Ecuador repaid $1bn to Goldman Sachs and Credit Suisse before restructuring its dollar bonds; Fitch subsequently determined that traditional bondholders suffered larger losses than they would have had the bank lenders participated in the restructuring. This pattern reflects the seniority risk embedded in TRS structures: as derivative contracts rather than debt securities, they may be treated as financial obligations with higher priority than bond claims.
The practice is widening across emerging markets. Nigeria has deployed a $5bn TRS arrangement involving First Abu Dhabi Bank, Angola has borrowed $1.5bn via JPMorgan, and Colombia raised $9.3bn through TRS before subsequently unwinding its transactions—suggesting some sovereigns are reassessing the strategy. The classification of TRS as derivatives rather than conventional loans further obscures transparency, limiting investors' ability to assess true leverage and contingent collateral obligations during periods of sovereign financial stress. For traditional bondholders, the growing use of these instruments by sovereigns underscores a structural shift in financing hierarchies that could materially increase losses during restructuring events.
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