EMTA SPECIAL SEMINAR
VENEZUELA: THE PATH FORWARD (NYC)
Tuesday, January 9, 2018
31 West 52nd Street, 4th Floor
New York City
2:30 p.m. Registration
2:45 p.m. Panel Discussion
Deborah Zandstra (Clifford Chance) - Moderator
Charles Blitzer (Blitzer Consulting)
Rodolfo Belloso Guzmán (LEC Abogados)
Timothy B. DeSieno (Morgan, Lewis & Bockius LLP)
4:00 p.m. Panel Discussion
Carl Ross (GMO) - Moderator
Robert Koenigsberger (Gramercy)
Hans Humes (Greylock Capital Management)
Siobhan Morden (Nomura)
5:00 p.m. Cocktail Reception
Additional Support Provided by Morgan, Lewis & Bockius LLP & Nomura.
Due to space limitations, this event is not open to members of 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 the Path Forward for Venezuela Following Default
EMTA’s Special Seminar “Venezuela: The Path Forward” was held on January 9, 2018 at Clifford Chance’s NYC offices. The Seminar was comprised of two panels – legal/academic and market. Deborah Zandstra (Clifford Chance) moderated the legal/academic panel, with Charles Blitzer (Blitzer Consulting), Rodolfo Belloso (LEC Abogados) and Tim DeSieno (Morgan, Lewis & Bockius) as panelists. Tradeweb sponsored the panels, with additional support from Morgan, Lewis & Bockius and Nomura.
Ms. Zandstra’s introductory remarks included a summary of the current state of play in Venezuela – a “profound” economic crisis, hyperinflation, difficult political landscape, government controls, PDVSA in distress, sanctions taking a toll, 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 PDVSA’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, sanctions and the inability to deliver a deal legally properly 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, Mr. Blitzer replied “it’s murky” and we don’t have the answers yet. Some bonds have passed their grace period and that will likely continue; there are considerable delays in payments, with PDVSA being favored, with its arrears being covered faster and more comprehensively due to its bonds having more positive cash flows. He posited that this was not just a payments issue, politics was also involved. For the government to say it was going to pay and also restructure is a “halfway house” and a puzzlement as to what is really going on. Mr. Belloso suggested that this was not necessarily a strategy – to obfuscate – but possibly a genuine confusion on the government’s part.
Zandstra questioned whether bondholder acceleration and the pursuit of a contentious strategy would be warranted, given the enforcement challenges creditors face in these situations, to put pressure on the government (with the Crystallex and Sinopec cases showing some willingness by the authorities to settle claims), and also whether, in light of sanctions, there is another alternative to the contentious route (apart from merely waiting, of course). Mr. DeSieno suggested that one should look at the practical utility of legal remedies at the moment, as well as alternative steps that may be more sensible now in the broader context. Venezuela has been building its budgets and planning to protect its assets for the last decade. Many of the relevant stakeholders have managed to protect or position themselves – Venezuelan Government bodies local officials, and foreign official creditors – via expropriation, currency controls, joint venture arrangements, material lending, share security, and sanctions. Remedies may not be the best course of action for bondholders at the moment, but remaining absent would not seem to be the best course either. Bondholders should consider active participation in discussions about how an impending debt restructuring should go, as opposed to letting all others determine their fate, with predictably painful consequences. Zandstra agreed, claiming that a rush to the courthouse may not be the best option, one needs to look at all the other players as well.
Zandstra then asked Belloso for an update of his understanding as to the status of any discussion between the government and the opposition and efforts by the OAS to bring parties together. He said that tensions were high and that the government often used sanctions as the reason for delay in payments, lack of food, etc. Whether elections would take place before sanctions are lifted was another query, and he thought that constitutionally elections should be held at the end of the year
(although constitutions can be modified). He also thought that the new administration‘s business plan could be to increase production, and that the Constitutional Assembly is yet another chapter in the power struggle.
DeSieno shared views on what may be significant drivers of behavior in this case, related to how the bonds are held and the motivations of the various involved governments. He posited that the story may not be so “murky”. First is the fact that Venezuela and PDVSA bonds are widely held by locals in power who matter, who the Republic wants to make happy. Confusion in the markets about the Government’s intentions with respect to the bond debt can help significantly. Many other countries engage in similar behavior – make/save money by tanking prices and then buying their bonds back at a discount, and collecting the coupon payments. Second, China and Russia are part of the Venezuela behavior mix and chaos in Venezuela may be good for those nations, as depressed asset prices, and reduced Venezuelan debt, can help them gain control of resources and operate them at a greater profit.
Blitzer agreed that bond prices were being manipulated. He was also puzzled since he couldn’t think of a rational reason for Venezuela to do what it’s doing other than insider trading (corruption) – saying it’s going to restructure and then setting up non-meetings; promising to pay, but then paying only some bonds. Clearly, domestic corruption and power interests are at play here. Conflicting signals are being sent for domestic reasons. Both China and Russia are interested in the oil sector, but they’re also interested in stability, “less insane” policies, a better run economy and forward progress. They are potential allies, not just creditors. Zandstra agreed, but also stated that it would be a grave mistake to think both countries have the exact same interests (banks in China may well prefer a stable debt environment in Venezuela in which to continue to do business). She also mentioned that cross-defaults on various debt could be triggered, thus possibly aligning interests.
Zandstra asked: aside from sanctions, could (and is it even feasible) bond creditors agree to give some breathing space or provide some debt relief without good data, without a plan to turn the economy and PDVSA around, without Venezuelan political support across the spectrum? Or is the ongoing discussion just preparation for a time where there is regime change or some national coalition, including opposition parties? What might the role of the IMF be, now or in some future time, given their non-presence for many years? Blitzer responded that the current government could, even given its policies and human rights issues, put together a restructuring that was acceptable to bondholders if they were anxious not to continue holding bonds that were in default. But the underpinnings of such a restructuring – without major economic policy changes -- would not be credible. Consequently, it was not advisable for bondholders to enter into any restructuring without policy changes that made sense in the future for payment on the new bonds. A call to the IMF may not happen unless Venezuela falls into an even deeper crisis which would require the government to impose a near-complete payment moratorium on its bonds. Venezuela should follow the “standard rule book” – engage a broadly accepted creditors’ group with discussions over an adjustment program, changes in maturities and coupon interest rates, add “serious” warrants, restructure both Venezuela and PDVSA debt at the same time, etc. He emphasized that once policies are pursued to stabilize the economy, Venezuela’s potential for significant growth was strong. For bondholders, the worst time to agree to a restructuring is when the economy is still in crisis and has not yet hit bottom. This period is precisely when debt sustainability will look worst and needed NPV haircut appear highest. As for the IMF, if the G7 is behind it, together with Argentina, Brazil and Mexico, the Fund certainly will move forward quickly to engage with Venezuela. In Blitzer’s view, the first year IMF program should be an emergency one with relatively little conditionality, with a more conventional program following once a great deal more is known about the underlying economic and financial situation. He argued it would be better for Venezuela and for bondholders to initially focus on macroeconomic stabilization and hold off immediately jumping into debt sustainability analysis and into a debt restructuring operation.
Zandstra then asked DeSieno if the pari passu legal risk could repeat itself, especially if the authorities are making payments on some bonds, but not others. And also, what about the alter ego theories that are getting much attention? Are these ideas likely to be material drivers in any future process? He replied that legal theories are largely probably irrelevant. The pari passu argument will likely only “rear its ugly head in Argentina” (he cautioned, “don’t use the Argentine recipe!”), where bad actions such as the Lock Law provided a basis for the US courts to conclude Argentina had subordinated its holdout bonds. He posited that Venezuela will be better advised, and even if it needs debt relief, it will follow a more standard approach of confirming its intentions to pay all of its debt consistent with its best abilities. As for alter ego, it likely is going to be more sensible to restructure two entitles together, and on the same basis, so the alter ego battle may not be necessary (although the restructuring horizon is likely not to come for some time).
The nature of PDVSA as a state-owned corporation and its purpose (for example, does it benefit from special protections under Venezuelan law?) was the next topic of discussion. Belloso explained that the oil reserves were owned by the State, not PDVSA, and what can be done with those reserves is limited. PDVSA was created to develop activities reserved for the State, it’s wholly-owned by the Republic and there is nothing in Venezuelan law as to whether PDVSA can go bankrupt. It can be considered a government instrumentality though, so it would not be subject to insolvency procedures.
Zandstra reflected that, given that Venezuela bonds have CACs and PDVSA’s don’t, PDVSA is the largest contributor to GDP and any economic turnaround will require investment at PDVSA and the holdout topic still looms, it may be easier for the authorities to focus on restructuring the sovereign bonds first, or maybe a more holistic approach is warranted. Blitzer posited that there likely will be some litigation and holdouts, but the trick is to deal with both at manageable levels. Based on past restructurings, holdouts are a tax to the market that wants to move on. In response to whether exit consents would be prejudicial in the long term, Blitzer stated that he has never viewed them as particularly productive, and including strong minimum participation thresholds in any exchange offer is a far more effective way to encourage high participation. Creditor engagement is essential, the restructuring process is sped if bondholders form a committee and don’t fight amongst themselves.
Zandstra asked, in a world where advisors and creditors supporting a restructuring would work to avoid holdout risk, what other techniques could be used? DeSieno responded with examples of Iceland and Ireland, and immunization of Iraq’s assets, likely in the context of IMF involvement.
Finally, Zandstra asked the panelists if they thought that, in view of sanctions and the political situation currently in Venezuela, realistically for now is the wait and see approach the best, albeit together with prepping for a change of circumstances, or should a contentious approach be contemplated already? Can Venezuela resolve this piecemeal without a restructuring? Blitzer posited that confrontation would be fine if it leads to a good result, while actions with respect to PDVSA may prove more difficult. Belloso was in the wait and see camp as few expected Maduro to have the power he has and the situation remains unclear. DeSieno posited a Goldilocks approach for bondholders – not starting with remedies immediately (although always assessing when that may change), but being present in the forums that matter for protection and allocation of the value of Venezuelan assets. Probably just sitting and waiting will not be the best course of (in)action.
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.