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Republic and PDVSA Bonds: No Trades With Friends and Family

posted by Mark Weidemaier

Mark Weidemaier and Mitu Gulati

A few days ago, we wondered why the U.S. government had constrained U.S. holders of PDVSA debt instruments to sell only to non-U.S. parties. The constraint would likely kill liquidity for these bonds and impose losses on bondholders. But why? And why impose the constraint on PDVSA bonds but not the Republic’s bonds?

On Friday, the Treasury apparently amended the sanctions order to impose the same constraint on the Republic’s bonds. Now these too can only be sold to non-U.S. persons.

But again, why?  Venezuela hasn’t issued new bonds for a while, so why kill the secondary market for existing bonds? 

Here are four possible explanations; we’d be grateful to hear others from readers:

1.    Cut Off Oxygen: Venezuela has made a habit of issuing bonds and then parking them in domestic financial institutions, for later sale when the government is low on cash. Counterparties have been willing to accept these bonds in the hope that a future government will pay, even if the current one won’t. Perhaps the U.S. government believes Venezuela still has a stockpile of these parked bonds and is trying to eliminate this last source of oxygen for the Maduro government.

2.    What’s Coming is Brutal: Perhaps the U.S. government expects a brutal restructuring and wants to give U.S. holders an opportunity to escape by selling to non-U.S. parties. But query: If this is the story, why would anyone want to buy? (Ans: They wouldn’t, thereby reducing liquidity even further).

3.    Don’t Want Irate Bondholders Calling and Yelling at US Treasury Officials: This explanation is a version of the first one (Oxygen denial) and says that the U.S. wants to dramatically reduce the value of Venezuelan bonds in the short run, but not to zero, so that U.S. holders who really need to exit will still have a small escape window.

4.    Cut Venezuela Out of the Index: Nearly two years ago, Harvard economist Ricardo Hausmann urged JP Morgan to remove Venezuelan bonds from its index (see here, for Hausmann’s now-famous “Hunger Bonds” article). Venezuela needed to solve a humanitarian crisis, not pay coupons to foreign bondholders. Hausmann understood that many investors would view Venezuelan bonds less favorably if the bonds were removed from JP Morgan’s index. Indirectly, the U.S. government might be trying to bring about this result. To stay in the index, a bond must be traded to some minimal degree. If the sanctions prevent this, Venezuelan bonds may be removed from index. But why would this matter to the U.S. government? Hausmann was worried about coupon payments being made to foreign creditors in lieu of assistance to the people of Venezuela. But Venezuela is not paying any coupons these days (except on the one collateralized PDVSA bond).

Explanations one and three seem most plausible to us. Perhaps the U.S. government is hoping for regime change in the near future. If so, the pain bondholders feel will be temporary and offset by gains once a reasonable government is in place. But if Maduro retains power, then the pain for U.S. holders of these instruments will be significant.

Comments

Could the purpose be to prevent bonds from further changing hands from EM investors (who mostly want to participate in a restructuring) to litigation inclined investors, who are mostly US hedge funds? They might be preparing to protect assets from potential attachment. This could have been designed in coordination with the opposition.

It seems that #1 is the most likely answer, perhaps with an additional expressive motivation. The U.S. government may be sending a message to the world and Venezuela that "there is no miracle coming" for Maduro and his government. Markets may have short memories and investors may be amoral, but there's no coming back from this. To the extent that Venezuela isn't currently offering bonds, that seems like a moot point, but it goes to demonstrate the intent from the U.S. government that it will not allow even an incredibly unlikely turnaround. As far as the USG is concerned, regime change is coming and this is a strong signal that regime change is the only way to return to markets: "I mean, look, we even disregarded the desires of our own bondholders!"

Hello,

I believe #1 is the most likely answer. Until very recently Venezuela was using bonds to settle with ICSID award holders.

Which begs another question - would be really interesting to hear your views on the future settlements/restructuring of ICSID awards against Venezuela. There are now, I believe, at least five $1+ billion awards (including $8.8 billion awarded to ConocoPhillips last week). Settlements for three of them were agreed.

I am admittedly not a lawyer, but it seems to me that these guys are "holdouts on steroids" - recognizing the awards is straightforward, and once they have the judgment there is zero incentive for them to budge on anything.

Also, if my reading of Treasury's FAQ is correct, ICSID awards are not "debt" and hence can be restructured and settled.

Many thanks

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