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Do Sanctions Prevent Venezuela From Restructuring CAC Bonds?

posted by Mark Weidemaier

This is a joint post by Mitu Gulati and Mark Weidemaier.

At the end of last week, press reports noted that Mr. Maduro has given the green light for restructuring talks to begin with holders of Venezuelan debt. Curiously, the Russians may lead the talks. One question is whether bondholders subject to US jurisdiction can participate in a restructuring given recent sanctions levied by the Trump administration. Press accounts suggest that the sanctions were intended to prevent this. Bloomberg reports the sanctions were "designed to prevent investors from engaging in liability management, and, if Venezuela can't pay its debt, a restructuring." The Financial Times reports likewise, quoting a senior analyst who thinks the sanctions will work: "If these sanctions stay in place, then Venezuela cannot restructure."

We accept that the sanctions were intended to block a restructuring. But they don't seem to actually do this. There is a rather large loophole that would allow Venezuela to employ a common restructuring technique.

The Executive Order imposing the sanctions includes a number of prohibitions. Those contained in Section 1(a) are most important here. Subsections 1(a)(i) and (ii) forbid transactions in new debt: PDVSA debt with a maturity over 90 days, or debt issued by the Republic or its other instrumentalities with a maturity over 30 days. Next, subsection 1(a)(iii) bars transactions in old debt issued by any government entity before the Executive Order's effective date. It's the old debt, of course, that Venezuela needs to restructure. Subsection 1(a)(iii) seems to forbid that.

However, the Treasury Department has issued a number of General Licenses qualifying the executive order. Here's what License 3 has to say:

all transactions related to, the provision of financing for, and other dealings in bonds specified in the Annex to this general license that would be prohibited by Subsection 1(i)(iii) of [the] Executive Order ... are authorized.

What's in the Annex? Only most Venezuela and PDVSA bonds.

The text of License 3 is pretty clear. It's okay to engage in transactions related to most old debt. True, the Executive Order still forbids transactions in most new debt, but the Republic does not have to issue new debt to restructure many of its bonds. That's because most bonds issued by the Republic have CACs. The payment terms of these bonds can be modified with a vote of 75% of the holders (in principal amount). There is no need for new debt.

Bonds without CACs (including PDVSA bonds) are a different story. Absent the sanctions, these bonds would likely be restructured through a technique called the Exit Amendment or Exit Consent, in which bondholders exchange old bonds for new ones and, in the process, vote to strip the old bonds of important contractual protections. This requires the issuance of new debt, so the sanctions likely forbid participation by anyone subject to US jurisdiction. Note, however, that there may be ways to work around the prohibition. For example, US investors might try selling non-CAC bonds to foreign parties. But it would be a risky move; the sanctions also forbid efforts to "evade or avoid" their effect. All in all, we suspect few investors will try.

Others have probably noticed the loophole for CAC bonds, perhaps including officials at the US Treasury. If those officials really want to bar a restructuring, they might want to plug the hole sooner rather than later.

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