Venezuela Is Like ... (Part I)

Market and civil society observers have taken Venezuelan debt restructuring as a certainty for more than two years, putting it in contention for the world’s slowest train wreck and quite possibly the messiest. Designs abound, but even after last weekend’s vote followed by new U.S. sanctions, too many variables remain too far up in the air to start laying the yellow brick pavers quite yet.

Depending on where you sit and how long you stare, Venezuela can present as some, none, or all of many past sovereign debt crises. The tour that starts below with broad-brush analogies is not exhaustive, but still plenty depressing.

Romania

Contrary to the stereotype of leftist repudiationism and its own anti-Yankee rhetoric, the Maduro government has scrupulously paid “Wall Street bond lords” while Venezuelan babies starve. Forward oil sales to China and joint ventures with Russia have brought periodic cash infusions, but the state is running out of stuff to sell, and oil prices are not recovering quickly enough. Which brings to mind one Nicolae Ceausescu.

In the 1980s, the Romanian leader baffled observers with his insistence on repaying the country’s foreign creditors ahead of schedule. While people went hungry, Ceausescu cut essential imports, save for barter-style deals with other governments. Romania swapped tractors for oil with Iran, Iraq, and Libya on increasingly unfavorable terms. Shifting geopolitical winds made these arrangements unstable and costly: Romania kept getting the short end of the bargain, and never got all it was owed.

For fear of losing policy autonomy, Ceausescu walked away from the IMF and the World Bank, and shunned debt restructuring throughout the decade famous for everyone doing it. Home-grown austerity policies undermined the government’s promise of progress for the working people, and fueled unrest that culminated in Ceausescu’s execution, along with his wife. As the grim ending nears, rulers go to grossly destructive lengths to buy another day, week, or month.

Puerto Rico

Venezuela’s debt stock is insanely complex. The simple part—foreign-currency, foreign-law bonds—is approximately $70 billion, roughly split between the sovereign itself and the state oil company PDVSA. PDVSA also reportedly owes more than $10 billion in loans and promissory notes to banks and suppliers. On the asset side, PDVSA holds oil concessions and stakes in a messy mille-feuille of subsidiaries and joint ventures, including U.S.-based CITGO. The subsidiaries have borrowed up a storm in their own name, and are tied up in a tangle of cross-guarantees (for a flavor, see pp. 70-83 of this).

PDVSA’s Corporate Structure

(Source: PDVSA Offering Circular dated September 16, 2016)

PDVSA pledged just over half of CITGO equity to bondholders in a $3 billion debt swap last year, and just under half to the Russian state-owned oil company Rosneft, as collateral for a $1.5 billion loan. If the subsidiaries’ creditors do not get hold of the U.S. assets first, these could also get caught up in sanctions against Russia, Venezuela, or both. Venezuela’s and its state entities’ obligations to Russia and China top $30 billion by some estimates, but no one quite knows for sure; here too, contract and corporate complexity thoroughly obscure the economics. Tens of billions of dollars in domestic claims and investor-state arbitration awards round out the picture.

The question of legal and structural priority among the various claimants looms large in trading strategies and policy designs, but remains largely unresolved. And I have not even touched on differences in contract language, which get their own rubric in the next post.

Puerto Rico sheds some light on the consequences of structural complexity for public debt restructuring. The island commonwealth borrowed through more than a dozen entities and a variety of secured, unsecured, and quasi-secured debt contracts. Each creditor group seems to have gotten its own special package of legal and structural safeguards, which must have convinced them that their bonds alone would escape the inevitable carnage.

 

(Source: The Financial Times)

Variegated debt stocks are pretty common for corporate borrowers, which can have it all sorted out in bankruptcy; they are unusual for sovereigns, which cannot. Puerto Rico fits somewhere in between: it cannot file for bankruptcy, but it can seek federal legislation to cut through the complexity, at least in theory. In fact, the federal law that frames Puerto Rico’s ongoing restructuring does little to simplify its debt structure, partly because it reflects intense lobbying by different creditor groups. A year into default and despite fairly comprehensive judicial oversight, the claim hierarchy is still not fully clear.

The lesson of Puerto Rico so far seems to be that structural complexity fuels inter-creditor fights, detracts from debtor-creditor negotiations, and prolongs the workout … and maybe also that government promises of priority through complexity should be taken with a big lump of pink Himalayan salt. Because Russia, China, or Uncle Sam will most likely eat your lunch.

Russia and Turkmenbashi

The subject of PDVSA’s corporate separateness from the sovereign and the risk of PDVSA’s bondholders being left with an empty shell of a debtor has dominated analysis for some time, and sensibly so. I have nothing profound to add, just this general sentiment.

Sovereign borrowing through corporate entities always makes me think of post-Soviet Russia, even when there are other, closer analogies, because it seems so straightforward. The Soviet Union had borrowed abroad through Vneshekonombank (VEB). In 1997, Russia got foreign banks to exchange their loans to VEB for tradable notes, also issued by VEB, which promptly defaulted in 1999. The government then swapped $32 billion in VEB notes for $21 billion in pure sovereign bonds, cutting the net present value of the debt by more than half, but adding contract protections elevating the new bonds on par with other Russian-era bonds, which reflected a stronger political commitment to pay. Bondholders’ fear of being left with a bag of hot air played an important part in securing near-total participation. (The story is concisely told in Chapter 4 of this book.) Although VEB is alive and kicking today, the episode reinforced my hunch that there were two sure ways for state-owned entity bonds to get ahead of pure sovereign bonds in a general crisis: assets in hand and political favor.

The intermittently popular bet that PDVSA’s foreign bondholders come out ahead of the sovereign’s is either a bet on purely political preference, or a view that PDVSA bondholders would have first dibs on its assets. The political preference theory is for experts on Venezuelan politics. As for the assets, color me skeptical. I pointed out earlier (as did PDVSA) that subsidiaries’ debts come ahead of the parent company’s. Oil and gas belong to the state, not to PDVSA. Assuming there is anything left after subsidiaries’ creditors get paid, what would prevent PDVSA from transferring contracts and ownership stakes to the state (as it did with Pequiven in 2005), an offshore special purpose vehicle or a foreign partner (as seems to be happening a lot lately)? If all else fails, the government can simply ramp up the payments PDVSA remits to various public causes. If PDVSA or some part of it tries to file for bankruptcy and have the proceedings recognized in the United States, flagrant asset stripping might smell like a fraudulent transfer … in which case marginally more modest and indirect asset stripping  tracking the letter of PDVSA’s bond contracts might do better. It all ends in the same bag of hot air.

Rather than speculate about what might happen if and when PDVSA tries to restructure, I would worry that its foreign subsidiaries could be stripped of all attachable value in the desperate but still-ordinary course of business long before a judge gets a go at its debt contracts. Note this May 2017 Delaware opinion, rejecting a plea by Canada’s Crystallex to stop PDVSA from "monetizing" CITGO and shipping the money out of the United States. Crystallex, which holds a confirmed $1.2 billion arbitration award against Venezuela, argued that the government, via PDVSA, made CITGO borrow $2.8 billion and upstream the money as dividends. The court concluded that it had no subject matter jurisdiction over the transfers because they presumptively took place in Venezuela, and were directed by a corporate entity distinct from the government. Citing earlier enforcement cases against Cuba and Argentina, the court held that “[m]ere ownership and control of Delaware subsidiaries, and ‘overlapping management’” would not create enough of a link between PDVSA, the state, and commercial activity in the United States.

At the other extreme is this case involving Argentina’s Bridas, cheated out of its interest in an oil and gas joint venture with a Turkmen state company “whose identity was designated and re-designated at will by the President of Turkmenistan …,” and which was “manipulated … legally and economically to repudiate the contract with Bridas and then render it impossible for Bridas to collect damages.” Yes, but Turkmenistan is in a wacky dictatorial league by itself. … which leads me back to the simple old VEB episode. Sovereign bonds still seem like a safer bet unless you have oil in hand or make a compelling political argument for escaping haircuts (in which case even local law would not do you in).

Next Up/Spoiler Alert: Comparisons to Ukraine, Iraq, Liberia, and Argentina are not comforting either.