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 …
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 can be mangled with a simple majority vote. In a bond exchange, Venezuela can ask participating creditors to vote to make the pari passu clause in their old bonds 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 vulnerable 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 15+% blocking positions in them. Anyone who holds these bonds could be in for a long ride: enforcement 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 weeds 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 are unappealing. 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 strongest contracts cannot break the impasse. Settlement takes 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 firm 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 would now try to seize the bonds on the theory that they were assets of the republic. A similar “liabilities are assets” argument was raised unsuccessfully by creditors who tried to block Argentina’s 2005 restructuring. Although it failed, it delayed the closing by a few months. Venezuela might be in a weaker position than Argentina: the target bonds are performing debt that Venezuela allegedly planned to sell for cash. Argentina had promised to cancel its old defaulted bonds as part of its 2005 restructuring. 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 decide whether the Argentina’s liabilities could also be attachable assets; they simply refused to derail a debt exchange that was clearly vital for Argentina’s recovery. Depending on how the Haitong episode plays out, it may solidify the view that the debtor’s own bonds are attachable assets. This in turn would call for extra care in executing debt exchanges, notably the proposed “cryonic” solution, which relies on parking the bonds tendered in an exchange with a trustee.
Last but not least, Venezuela has not had an IMF Article IV review since 2004, and has since progressively 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.
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 they spent more time on data reconciliation than on any other aspect of the debt settlement. Nonetheless, the Iraq debt episode is more famous for reviving the Odious Debt theory than for data reconciliation.
Odious Debt holds roughly that debt incurred by rulers without the consent of the governed and not for their benefit is not binding on the people; it is personal to the rulers. The practical effect could be to allow a successor government to repudiate with impunity. (This is one of several symposia on the subject published at the time along with books and countless articles on the topic.) The idea of Odious Debt has been powerful in 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 effectively odious (if by another name) has been floated more than once. Iraq’s experience suggests that with robust political support, Venezuela could press for substantial debt relief on economic and geostrategic grounds, and let the Odious Debt argument color the background of negotiations with creditors who firmly reject it as a formal doctrine.
The debt that comes closest to odium according to a former Iraqi finance minister remains unresolved more than a decade after it had settled with most other public and private creditors (see p. 7 of this). Debt to the Gulf states is poorly documented, complicated, and contested – there is even disagreement over its character as debt (but see here). This history of irresolution might caution against complicated financing arrangements with other governments, which dominate Venezuela’s borrowing strategy now.
Finally, Iraq like Venezuela relies on its 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 avoid throngs of creditors armed with attachment orders from multiple jurisdictions. By way of a preview, a Russian shipping firm trying to collect 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 …
Russia’s recent loans and investments in Venezuela are putting it on a path to overtake China one day. Its financial engagement is essential to keep the Maduro government afloat, but as the seized tanker episode suggests, it is not all about charity. Russia had bought $3 billion of bonds from Ukraine in December 2013, also to support a friendly government. When that government collapsed, Russia annexed Crimea, and Ukraine sought a debt restructuring, Russia held out and sued Ukraine in London; for now, it is winning. In Ukraine and in Venezuela, the Russian government appears to manage a portfolio of financial, economic, and security claims: each bit creates leverage for the others; all may settle one day in a grand compromise.
Until then, the nature, volume, and treatment of Venezuela’s government-to-government debt remain obscure. From the government’s perspective, the challenge is to ensure continued support at a manageable price and to avoid having official creditors hold out and disrupt restructuring, From private creditors’ perspective, the question is whether Russia and China would escape restructuring. Historically, official bilateral creditors have done worse than private creditors; however, sovereign restructuring institutions have changed to the point where exceptions look more likely, particularly when government actors use heterogeneous commercial contracts and are not deeply invested in the Paris Club. In light of Venezuela’s growing dependence on Russia and China and their growing exposure, it is reasonable to assume that they would be among the first to collect.
Extending the earlier assumption that any Venezuelan debt restructuring would come under the auspices of the IMF, it would test the Fund’s new policy on arrears to official creditors, which was partly prompted by the Russia-Ukraine standoff. The policy allows the IMF to lend to a country that is running arrears to other official creditors, but makes an exception when lending into arrears would jeopardize financing for the program. The bigger the creditor, the more essential to financing the program, and the more likely to escape default. Again, this suggests that Russia and China are not especially exposed in any debt restructuring.
I will leave debt sustainability analysis and program financing needs 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. If Venezuela gets exceptional access, then the only way in which it escapes any debt restructuring is if IMF staff judge its debt to be “sustainable with high probability.” If the probability is not high, the debt would have to be restructured or “reprofiled” (stretched out). In either case, this is when all the contract and bankruptcy stuff will finally take over, and Venezuela will be like … Venezuela.