Why One US Hedge Fund Wants a Piece of the Action

The Cuban flag flying in Park Central in Havana.
Buena Vista Images | Getty Images
The Cuban flag flying in Park Central in Havana.

Nathan Sandler, founder of Ice Canyon, a $2 billion hedge fund based in Los Angeles, is leading a lonely crusade against one of the toughest departments in the U.S. government — the Office of Foreign Asset Controls, which enforces the U.S. embargo against Cuba.

He's petitioned for an exemption to the embargo, asking OFAC to give him clearance to buy defaulted Cuban sovereign debt.

Yes, he says he thinks it will be profitable, but he also thinks it would serve the interest of U.S. foreign policy.

"Allowing U.S. investors to acquire Cuban debt insures U.S. interests will have a seat at the table, an inevitable part of the normalization process, " Sandler told CNBC.

Sandler revealed his desire to buy Cuban debt at CNBC's Delivering Alpha conference in July. On a panel discussion about frontier market investing, Sandler said he was most excited about "transformational stories."

"There are three repressive, repugnant, rogue countries that, I think, over the next one to three years will experience massive political change—Cuba, North Korea and Sudan, " he said.

All three have defaulted government debt "that will have to be the predicate to normalizing relations with the international community and ultimately gaining access to the international capital markets."

Sandler is quite active in the debt of North Korea, but said at the conference: "Unfortunately, as U.S. investors, we're still prevented from investing in Cuba and Sudan."

While other U.S. hedge fund managers are desirous of owning Cuban debt, no one has gone as far as Sandler in their attempts to achieve it. (Read More: Inside Cuba: Market Economy Takes Hold in Socialist State .)

He's reached out to some of the best-known legal minds on sovereign debt to help him, petitioned OFAC, and then appealed when he was denied.

His petition rests on two key ideas. First, that buying and owning debt defaulted on for more than 30 years does not fund the current Cuban government in any way.

Second, in his letter to government regulators, Sandler makes the point that Cuban debt issued in the 1970s requires unanimity of debt holders to amend payment terms, a clause that is nearly non-existent in sovereign debt deals done today. Once the debt was in the hands of a U.S. investor, OFAC would actually have legal control of them, and thus could block any debt forgiveness deal if they so choose.

"OFAC would have no such ability to block debt forgiveness if the Debt Instruments remain in the hands of foreign bond holders, " the legal document states.

His biggest hurdle may be Cuban American members of Congress. When asked to discuss defaulted Cuban debt, Representative Ileana Ros-Lehtinen, R-Fla., declined to speak with CNBC but sent a written response:

"Financial institutions in the United States should think twice before considering doing business with the Castro dictatorship. Many businesses have already been sanctioned and fined for violating current U.S. law, as Cuba is designated by the United States as a State Sponsor of Terrorism. The Cuban regime regularly defaults on their loans and trade credits it receives from international entities and owes billions in hard currency debt. Doing business with a totalitarian state with no separation of powers, while attempting to make money off the backs of the Cuban people, is despicable and immoral."

Mauricio Claver-Carone, Executive Director of Cuba Democracy Advocates and the U.S. Cuba Democracy PAC, said Cuban American members of Congress do not want to allow hedge funds to buy defaulted Cuban debt, because they fear it will give ammunition to the US agricultural community which wants to extend credit to Cuba.

Currently under U.S. law, the agricultural community is exempt from the embargo when selling foodstuff to Cuba, however, the Cuban government must pay cash up front. The agricultural community has long lobbied for that to change. (Read More: Doing Business With Cuba, Despite Embargo .)

"It would send a horrible policy message, " Claver-Carone said.

Additionally, Claver-Carone said, Cuban-American legislators' first priority, in the event of normalized relations, will be compensation for the seized property of Cuban exiles now living in the United States.

Supporting hedge funds' purchases of the defaulted debt might risk their standing with constituents who see the funds as competing with the future funds available for compensation.

—By CNBC's Michelle Caruso-Cabrera