EMTA SPECIAL SEMINAR
VENEZUELA: THE PATH FORWARD (London)
Wednesday, April 11, 2018
10 Upper Bank Street
Canary Wharf, London E14 5JJ
2:30 p.m. Registration
2:45 p.m. Panel Discussion
Deborah Zandstra (Clifford Chance) - Moderator
Richard Cooper (Cleary, Gottlieb, Steen & Hamilton LLP)
Rodolfo Belloso Guzmán (LEC Abogados)
Rodrigo Olivares-Caminal (Queen Mary University of London)
4:00 p.m. Panel Discussion
Stuart Culverhouse (Exotix) - Moderator
Greg Saichin (Allianz Global Investors)
Hans Humes (Greylock Capital Management)
Pijus Virketis (HBK Europe Management LLP)
Siobhan Morden (Nomura)
5:00 p.m. Cocktail Reception
Additional Support Provided by MarketAxess & Nomura.
We regret that this event is not open to the press.
Registration fee for EMTA Members: US$95 / US$695 for Non-members.
This Special Seminar is part of a continuing series of panels and presentations that EMTA is pleased to sponsor on various topics of interest to Emerging Markets investors and other market participants, and is part of EMTA’s Legal & Compliance Seminars*.
*CLE credit will be available for NY attorneys. This Seminar is non-transitional and appropriate for experienced attorneys only. Please click here for details on EMTA’s Financial Hardship Policy.
Legal and Market Experts Discuss in London the Path Forward for Venezuela Following Default
EMTA’s Special Seminar “Venezuela: The Path Forward” was held on April 11, 2018 at Clifford Chance’s London offices. The Seminar was comprised of two panels – legal/academic and market. Deborah Zandstra (Clifford Chance) moderated the legal/academic panel, with Richard Cooper (Cleary, Gottlieb, Steen & Hamilton), Rodolfo Belloso (LEC Abogados) and Rodrigo Olivares-Caminal (Queen Mary University of London) as panelists. Exotix sponsored the panels, with additional support from MarketAxess and Nomura.
Ms. Zandstra’s introductory remarks included a summary of the current state of play in Venezuela – a deep economic and humanitarian crisis, social and political tensions, oil production and prices at lowest levels in years and hyperinflation. Access to funding is now increasingly uncertain and the U.S. has made Venezuela one of its top priorities by applying sanctions against it; as she explained, the context of debt resolution is probably one of the most complex we have seen, and it’s difficult to know what strategy to apply”. In addition, the following have all led to more tumult: late payments on sovereign and PDVSA bonds (which is challenging for both the country and its creditors), determination by ISDA’s Credit Determinations Committee that a Credit Event has occurred and an auction relating thereto, a Selective Default determination by rating agencies, EMTA Market Practice recommendations for flat trading of the Republic’s and PSDVA’s bonds and regional efforts to mediate between parties. She also discussed other challenges facing creditors – lack of data, need for a debt sustainability analysis, lack of credibility of engagement by authorities, the need for a “credible economic plan”, the inability to deliver a deal properly legally authorized and challenging inter-creditor issues. The panel also drew out the legal and political dimensions of the aforementioned and reviewed the possibilities and ramifications of the status quo vs. change.
Responding to Zandstra’s question of whether we are in a sustained hard default situation, Prof. Olivares-Caminal replied that it depended on the debt involved. He discussed the composition of the three-tiered total Venezuelan debt of $185 billion, of which $110 billion is Republic debt (60%) and $30 billion is PDVSA (and other state-owned enterprises) debt (16%), both under the commercial debt framework, and the remaining $45 billion (just under 25%) is bilateral debt. A point was raised as to whether the alter ego argument was sufficiently valid to distinguish between Republic and PDVSA debt and for right now it was deemed prudent to treat them as two separate entities (although Mr. Cooper thinks the veil can be pierced (ie, Crystallex/ICSID case and the fact that the Republic has substantial claims against PDVSA), although it does depend on the degree of extensive control and the principal/agent relationship). In addition, Olivares-Caminal explained that the Republic’s debt was mostly pursuant to a fiscal agency agreement with CACs (save for a couple of bonds), thus building in a restructuring mechanism (be it 85% or 75%, though not aggregating across bonds since this was a first generation CAC), where a dissenting minority must adhere to the majority’s wishes. PDVSA debt, on the other hand, was issued through promissory notes and trust indentures with no CACs, thus opening up different restructuring possibilities. PDVSA has many assets in the U.S. (ie, Citgo shares) and an anti-pledge clause, but assets can be pledged in favor of the Republic, so it has priority over PDVSA’s creditors. Whether the Republic or PDVSA debt will be easier to restructure is open to debate, and there’s no cross default between the two categories of debt. Whether there will be a critical mass to block either’s restructuring is also an open question. Cooper thinks that convergence of pricing demonstrates that the two entities should be restructured together.
Mr. Belloso reported that Maduro has not mentioned restructuring in his campaign, and Falcon (through Francisco Rodriguez) may be interested in dollarization and some restructuring with some small payments in the short term and extension of maturities, but those strong rumors have not yet been confirmed, no definitive documentation has been suggested and a “transitional government” may be a possible hypothesis of what is currently in play.
Cooper stated that the U.S sanctions applied to U.S. persons and very broadly to those subject to U.S. jurisdiction. With a prohibition on trading new securities, it was “hard to imagine” a restructuring or exchange offer. Prices may be driven downward and Russia and/or China may finance Venezuela through a cash tender (which is not a restructuring per se), while “plenty of other factors” would prevent a restructuring. He posits that the U.S. probably won’t prevent oil exports into the U.S. (because of the big impact on the U.S. economy in doing so), but this may have an impact on preventing imports. In response to Zandstra questions relating to acceleration, Cooper suggested that the 25% threshold may not yet have been reached, but a possible race to the courthouse may ensue as judgments are obtained before any cram-down (although post-judgment interest rates are at a very low rate so it would be disadvantageous to litigate). This is a “difficult call” and even harder in the PDVSA case.
Olivares-Caminal discussed the pari passu litigation and how there was a shift in sovereign cases, as creditors were pitted against each other vs. old debtor-creditor battles. The recovery strategies were also complex, especially when one views the composition of debt involved and, as Zandstra raises, potential arbitration and bilateral claims.
In response to Zandstra’s question regarding alter ego arguments, and in view of the pledge of security of the Citgo shares, whether there was any value in building litigation around this legal doctrine, Cooper replied that it depended on the degree of extensive control and the principal/agent question, but that there were other PDVSA assets and also substantial claims that the Republic has against PDVSA.
Responding to Zandstra’s question as to, aside from sanctions, whether it were feasible for bond creditors to agree to giving a breathing space or providing some debt relief without good data, without a plan to turn the economy and PDVSA around, without Venezuelan political support across the spectrum, Olivares-Caminal’s view was that without a credible economic plan there won’t be a restructuring, or if there was one it would be short-lived. He also stated that he thought the IMF was doing its own analyses and projections (and thus the lack of credible data and an ability to do a debt sustainability analysis was very problematic for bondholders), and that a two-step restructuring may be possible.
Belloso explained that, in general, in order to amend the Constitution a national referendum approving said amendment would be required. The Constitutional Assembly has sustained that it is vested with supra-constitutional powers; however, existing legislation indicates that, in general, the National Assembly is the entity empowered to approve a debt restructuring, especially in the case of the Republic. He thought the process was very badly managed, that it was a matter of liquidity and not insolvency, and that adding sweeteners would be a good incentive for creditors (Cooper agreed). He also informed the audience that PDVSA is an SOE created in 1976, wholly owned by the Republic to develop activities legally reserved to the State.
Cooper spoke to the complexities of creditors trying to attach assets (especially if PDVSA claims the Trust Indenture was not properly authorized) and the need to obtain a large percentage of creditor consent to so attach. The balance of the country’s large oil reserves against its humanitarian concerns also loomed.
Belloso didn’t think the country’s cryptocurrency appears viable, its regulation is contradictory and “sketchy”, and in addition there are serious questions as to the legality of the issuance (the program appears to be an attempt to raise capital outside of sanctions). The Government has argued that the Petro is backed by oil. However, said backing is dubious and, under existing legislation, difficult to implement due to constitutional and legal limitations. The backing proposed as currently drafted doesn’t seem to “amount to a security”. He also didn’t think that the Central Bank was involved and he was not sure what the issuing entity was. Dollarization could be implemented if there was a Constitutional amendment to replace the Bolivar as the legal currency or, as a weaker option, as per a Latin American Treaty entered into those countries where such currency was used as a way to foster the integration of Latin America (like El Salvador).
Zandstra asked the panel whether a wait and see approach was advisable at this time, or whether creditors should take more proactive steps. Olivares-Caminal agreed with a more passive approach, but creditors shouldn’t “put their feet up” and get too comfortable as the restructuring will be contentious, so having their “ducks in a row” might be the better approach. Cooper stated that the restructuring process will be long, with lots of stakeholders and probable litigation by holdouts. Belloso was in the “active” wait and see mode.
Following the legal panel, EM strategists and portfolio managers offered market perspectives on Venezuela. GMO’s Carl Ross led the discussion, inviting speakers to assess the situation to date, and to offer their views on whether President Maduro might in fact be outwitting investors.
“Maduro has defied expectations in being able to survive the economic crisis thus far, so you have to give him credit for that,” opined Nomura’s Siobhan Morden. However, she rejected the idea of Maduro executing a sophisticated game plan, other than simply retaining the army’s support. “His strategy for now seems to be surviving day by day…and this survival really depends on Venezuelan’s threshold for pain.” Morden further specified that the government lacked an innovative approach to resolving the country’s debt issue. “There are no technocrats in the government, nothing like a strategy to buy up debt in the secondary market…no one is producing great ideas how to address problems; they are just stumbling through.”
Gramercy’s Robert Koenigsberger concurred that the end-game appeared limited to basic survival. Creditors had been willing to buy short-term debt in the past, “but the capacity to pay is now gone, and we are probably facing a long-term debt crisis.” He rejected the use of the term “murky” in the first panel, arguing, “It is not murky at all…the state has failed.”
Greylock Capital Management’s Hans Humes argued that Maduro had in some ways lucked out by the imposition of US sanctions. “They gave him something to hide behind; his approval rating increased to 30% after sanctions were imposed.” Humes characterized Maduro as “street smart,” and that he had proven himself adept at keeping the opposition divided. Finally, moderator Ross worried that Maduro might be, directly or indirectly, under the control of Cuba’s leadership and that he was, “a vessel through which various agents enrich themselves to the detriment of the Venezuelan people.”
Speakers were unanimous in their prediction that Maduro would no longer be in power at year-end. Morden predicted the catalyst would be internal, as the economic crisis deepened and despite the high tolerance for economic pain that Venezuelans have thus far demonstrated. Humes speculated that that a sanctions-driven starvation of the oil business could prompt regime change. However, he warned that if sanctions didn’t quickly result in the fall of Maduro, similarly affected countries would be drawn together, and could combine economic forces, possibly using cryptocurrencies and other solutions. Humes concluded that Maduro would not be forced out of power by an invasion; US military intervention was “off the table, the US can’t get away with it.”
Speakers agreed that a new regime need not represent a radical change in government. In Humes’ view, “all they need to do is figure out the least they need to do for the rest of the world to accept that a change has occurred.” Koenigsberger agreed, forecasting a shuffling in the current power structure as more likely an outcome than a transfer of power to the opposition parties. He reminded attendees that similarly, in the past, Maduro had been presented as “the moderate Chavista.”
Morden’s most optimistic scenario was for some economic reform in the next government, which would understand its need for CAPX inflows to rebuild the economy. She stressed that import dependence and capital flight were Caracas’ real economic challenges, not debt stock. Ross concurred that the most likely political outcome was a modest regime change, with the potential for a quick recovery because of its dollar-generating export. Access to the market for a new Venezuela should be reasonable, based on the historical effort to service debt even in dire situations. A less likely possibility was for the country to remain frozen, with just a couple of similarly-shunned trading partners.
Panelists analyzed the potential restructuring of Venezuelan debt. Starting with a debt sustainability analysis was key, in Koenigsberger’s view. He proposed a FLIRB-type approach and judged the issue as a liquidity, not solvency, problem. “There is long-term value in Venezuelan debt based on trading levels today… but a lot of mark-to-market in the near-term,” he reasoned.
Humes expressed frustration at the lack of clarity regarding debt negotiations-- “we don’t even know who would be the counterparty for talks.” He cautioned that a restructuring could be a ten-year process, although a post-restructuring Argentine-style tax amnesty could provide a quick jolt to the economy.
The panel concluded with discussions of acceleration (“impractical and it takes years, as we old-timers now know,” according to Humes) and downside risk. Koenigsberger underscored that prices were vulnerable to selling from large holders, or a general market downturn, while Morden noted that current holders have already weathered a plethora of bad headlines, and forced sales by accounts unable to hold defaulted paper.