Venezuela Is Like ... (Part II)

Last time on Super-Sad Updates, I speculated (i) that the Venezuelan people could be in for more suffering and bondholders for more coupon payments (see Romania), (ii) that Venezuela’s complex debt stock was prone to shell games and inter-creditor conflicts, which could delay a workout (see Puerto Rico), and (iii) that a bet on PDVSA bonds over sovereign bonds today required too many assumptions to hold my shrinking attention span (but see Turkmenistan … or not). Now I try to imagine what might happen if the government did decide to restructure. It brings back memories of …

Argentina

Those who never want to hear the words “pari passu” again should skip the next three paragraphs.  Gluttons for punishment, please read on.

Some Venezuelan bonds have pari passu clauses like those that let a few of Argentina’s creditors block payments to the rest. These bonds have no Collective Action Clauses (CACs), so that changing key terms requires unanimous creditor consent. Pari passu did not rate as key back when the bond contracts were drafted, which must be why it only takes a simple majority vote to eviscerate it. In a bond exchange, Venezuela can ask participating creditors to approve amendments to the pari passu clause in their old bonds. If the participation rate clears 50% (a low bar), the clause would become worthless to holdouts. Such “exit consents” targeting pari passu would benefit participating creditors directly, by shielding the new payment streams from Argentina-style ambush. They are a small ask compared to, say, exit consents to switch the obligor on the old bonds.

In addition to its CAC-less old bonds, Venezuela has two flavors of CAC bonds, with 75% and 85% voting thresholds. These have less enforcement-friendly pari passu clauses, but also less scope for exit consents. All else equal, the 85% bonds are harder to amend, but word is that would-be free-riders already have the 15+% blocking position in them. Anyone who holds these bonds could be in for a long ride: lawsuits took fifteen years to bear fruit in Argentina, and left behind a trail of regret and defensive learning.

Rounding out the tour, PDVSA’s bonds are too hard and too loose at the same time. They require unanimous consent to amend most key terms outside bankruptcy, but seem to allow the debtor to substitute another obligor, even a near-empty shell, with a simple majority vote. The courts would have a lot to chew on here, and might take their time chewing.

From a free-rider’s perspective, contract details are most valuable when they help you escape default altogether (see Greece) or get a quick side payment. Especially as money gets dear, protracted court battles lose appeal. A quick deal is likely when holdouts are a small part of total debt, and when the debtor really wants to move on from the crisis (see Peru). At the other extreme, when the government has no political room to settle—when foreign court rulings take center stage in domestic politics and domestic political rhetoric becomes foreign court bait—even the most creditor-friendly contracts cannot break the impasse. Settlement must wait for a new government, which is so eager to move on that it risks giving away the store. In Argentina and elsewhere, contract terms seem to do more work to implement a sovereign’s political choices than to constrain them.

Two other aspects of the Venezuela story bear watching in light of Argentina. On July 14, Canadian miner Crystallex got a federal court in New York to block China’s Haitong Securities from selling $5 billion in  weird Venezuelan bonds initially issued in December. Crystallex is now poised to claim the bonds on the theory that they are assets of the republic. A similar “liabilities are assets” argument was raised unsuccessfully by holdouts who tried to derail Argentina’s 2005 bond exchange. They failed, but still delayed the closing by a few months. Venezuela would have a harder time arguing that its debt was not an asset: the bonds were supposedly being marketed for cash, while Argentina’s were to be canceled in the exchange. The fact that the Crystallex injunction would not have major collateral consequences also seems to cut against Venezuela. Back in 2005, U.S. courts did not resolve the liabilities=?=assets question; they simply refused to sabotage a debt exchange that was clearly vital for Argentina’s recovery. If the Haitong episode ultimately confirms that sovereign bonds are attachable assets of the sovereign, future debt exchanges would require extra care in execution. This goes especially for the proposed “cryonic” solution, which tries to dilute holdout claims by parking the old bonds tendered in an exchange with a trustee.

Last but not least, Venezuela has not had an Article IV review with the International Monetary Fund (IMF) since 2004, and has since shut down economic data releases, most recently those bearing on inflation. If it decides to return to the IMF fold before tackling the debt problem, it would have to produce decent statistics in short order or face the wrath of the board, recently visited on Argentina.

Iraq

The data challenge was also extreme in post-Saddam Iraq, which (like Venezuela) had a heap of obscure and poorly documented supplier credits and inter-governmental arrangements that were hard to classify and vulnerable to manipulation. Officials and advisers said that data reconciliation took up more of their time than on any other aspect of the debt settlement. Nonetheless, the Iraqi debt restructuring is far more famous for reviving the Odious Debt theory than for its feats of data reconciliation.

The term “Odious Debt” stands for the proposition that debt incurred by rulers without the consent of the governed and not for their benefit is personal to the rulers; it is not binding on the people. The practical effect would be to allow a successor government to repudiate with impunity. (This is one of several symposia, books and articles on the subject published in the wake of Iraq.) The idea of Odious Debt has inspired civil society campaigns and academic writing; it has influenced restructuring outcomes, but has not quite coalesced as a doctrine of international law.

The question of treating some or all of the Maduro government borrowing as odious (if by another name) has been floated more than once. Iraq’s experience suggests that with robust political backing, Venezuela could press for deep debt relief on economic and geostrategic grounds, and let the Odious Debt argument color the moral and public context of its negotiations with creditors.

Political backing from the United States, China, and other government creditors may even hinge on keeping Odious Debt at a distance, since official bilateral claims are especially likely to fall under that rubric. In Iraq, debt to Gulf states comes closest to “odium” according to the former finance minister; it also remains unresolved more than a decade after all other creditors had settled (see p. 7 of this). The Gulf debt is poorly documented, complicated, and contested (is it even debt?). This history of irresolution would caution against complicated financing arrangements with other governments, which dominate Venezuela’s borrowing strategy now.

Finally, Venezuela like Iraq depends on oil exports. Tankers filled with state-owned oil are fat targets for creditors trying to collect (seizing tall ships is more of a nuisance move). Iraq got bankruptcy-style breathing space under a May 2003 U.N. Security Council Resolution shielding its hydrocarbons from attachment. National governments in major financial jurisdictions, including the United States and the UK, adopted domestic measures to give effect to the shield. Nonetheless, the shield was temporary and hardly generalizable against the background of the invasion and occupation of Iraq; the extraordinary measure testifies to the seriousness of the attachment problem in the eyes of coalition governments.

Assuming Venezuela does not secure an Iraq-style shield in time for its debt talks, it would have to structure the legal and logistical aspects of its oil sales to dodge hordes of creditors armed with attachment orders from around the world. By way of a preview, a Russian shipping firm collecting unpaid bills from Venezuela got a St. Maarten court to bless its seizure of one tanker in October 2016. The oil was released five months later, but the enforcement proceedings continue in the United Kingdom. … Which brings to mind …

Ukraine

Russia’s recent loans and investments are putting it on a path to eclipse China’s influence in Venezuela. Its financial engagement is essential to keep the Maduro government afloat, but as the Caribbean tanker episode suggests, it is not all about charity. Ukraine’s experience is instructive. Russia had bought $3 billion of Ukrainian eurobonds in December 2013 to prop up a friendly government that collapsed less than two months later. Russia then annexed Crimea and supported separatist insurgents in the east; Ukraine sought an IMF program and eventually a debt restructuring. Russia held out and sued Ukraine in London, with some success for now. In Ukraine and in Venezuela alike, the Russian government appears to manage a portfolio of financial, economic, and strategic claims. These seem to reinforce one another, and could be settled piecemeal or become part of one grand compromise.

Until then, the nature, volume, and status of Venezuela’s government-to-government debt remain obscure. From the government’s perspective today, the challenge is to find cash to fight another day; later on, it will be to prevent official holdouts from disrupting a debt workout. The question for private creditors is whether Russia and China would end up with claims senior to theirs or escape default altogether. Historically, private creditors have come out ahead; however, sovereign debt restructuring practice has changed to the point where exceptions look more likely, particularly when official creditors use commercial contracts and are not deeply invested in the old institutions. In light of Venezuela’s growing dependence on Russia and China and their growing exposure, it is safe to suppose that they would not accept subordination without a fight.

Enter the IMF. Assuming that any Venezuelan debt talks would happen under its auspices, they would test the Fund’s new policy on arrears to official creditors (partly prompted by the Russia-Ukraine standoff). Until December 2015, the IMF was severely constrained in lending to members in arrears to other governments. The new policy permits such lending when the member engages with its creditors in good faith, except when it would jeopardize financing for the program. Translation: a big, essential government creditor (Russia? China?) can insist on getting paid in full and on time.

I leave debt sustainability analysis and policy conditionality to the economists, except to note that Venezuela’s IMF quota is around $5 billion, annual access limit is 145% of the quota; and cumulative limit is 435%. This seems unlikely to cover any plausible program financing needs, especially if the economy keeps deteriorating. It is therefore reasonable to expect funding from multiple sources, not just the IMF, even if the IMF proceeds under its exceptional access policy framework. The only way for Venezuela to escape any debt restructuring under these circumstances is to have its debt judged “sustainable with high probability” by IMF staff. If the probability is not high, the debt would have to be restructured or “reprofiled” (stretched out). This is when all the contract and bankruptcy stuff would finally take over, and Venezuela would be like … Venezuela.

This post has been lightly edited since the original posting.