Venezuela’s path to a debt restructuring grows more treacherous

Venezuela’s path to a debt restructuring grows more treacherous

New sanctions from the US will complicate any restructuring in the event of a default

Venezuela’s predicament went from bad to worse last week, with the US unveiling financial sanctionsand a legal setback in its battle with creditors. For now, the country will shrug off the setbacks, but in the longer run they augur potentially the messiest debt restructuring in history.

The Trump administration last week prohibited US institutions from involvement in any new debt or shares issued by the Venezuelan government or its state-controlled oil company, PDVSA. Dividend payments by PDVSA’s US oil refinery arm Citgo were also blocked.

The broad aim is a financial embargo of the Latin American country to prevent it from raising more money in the US.

“The message is that the US doesn’t want its financial system enabling the Venezuelan government in any way,” says Charles Blitzer, of Blitzer Consulting, who is a former International Monetary Fund official. Meanwhile, Venezuela suffered a loss in the US courts, where a judge said Canadian miner Crystallex could seize Venezuelan money held in an account at Bank of New York Mellon to cover a $1.4bn judgment awarded by a World Bank tribunal.

Adding to the headwinds, a big US clearing house said this week it would stop settling some Venezuelan bonds, and Cantor Fitzgerald has stopped trading them altogether, according to investors.

In the near term the impact will probably be minimal. Given Venezuela’s messy finances, the country is in practice already shut out of the international bond market. And while Crystallex won a legal skirmish, it is far from winning the war. It is unclear how much money Venezuela holds at BNYM and it may still be protected by sovereign immunity.

Underscoring the investor view that little has changed, Venezuela and PDVA’s bonds have largely traded sideways. But the latest developments underscore how any Venezuelan debt restructuring — which most investors expect to happen eventually — is likely to become one of the messiest, most contentious in financial history.

Venezuela has kept servicing its debts because of concerns that a default would spur creditors to try to seize the payments for PDVSA’s oil exports. That would sever the country’s only financial lifeline and deepen the economic crisis. “If they default they will be out of government within three months,” says Federico Kaune, head of emerging market debt at UBS Asset Management.

“The calculation is that they’re either in government, in exile or jail.” However, Crystallex’s pursuit of Venezuela underscores how creditors already have some legal avenues to explore. Venezuela owes about $100bn and several billion more in various promissory notes to commercial creditors like pharmaceutical companies with unpaid bills, or foreign companies whose local assets have been expropriated.

Venezuela has been taken to the World Bank’s ICSID tribunal 43 times. Only Argentina has been subjected to more claims. Of these 24 are still pending, including claims from Anglo American, ConocoPhillips, Air Canada and Vestey. The Eurasia Group estimates that Venezuela owes a total of $3.7bn as a result of ICSID rulings, and Crystallex’s progress is likely to embolden other creditors.

“Crystallex is the camel’s toe under the tent,” says Mark Weidemaier, a law professor at the University of North Carolina. “It will be a slow burn, but I wouldn’t be surprised to see people use the courts to ferret out where Venezuela’s assets are . . . and break down the barriers between the government, PDVSA and other entities.” Moreover, the US sanctions pose a particularly thorny challenge if Venezuela restructures its debts. In a sovereign bankruptcy, creditors negotiate some kind of debt relief and trade their old, defaulted bonds for less valuable new ones. 

But such a debt exchange would fall foul of the US sanctions regime, precluding any US banks from arranging one and any US bondholders from tendering their debts. In practice, it would mean indefinite financial purgatory for Venezuela until the US administration decides to lift the prohibition.

“If these sanctions stay in place, then Venezuela cannot restructure and it goes into limbo,” says Edward Al-Hussainy, a senior analyst at Columbia Threadneedle. Torino Capital, a Latin American-focused investment bank, argued that this might counter-intuitively make a restructuring less likely.

“It is possible that, faced with this choice, Venezuelan authorities end up deciding that the negative effects of a disorderly default on PDVSA’s capacity to generate export revenue are worse than the contractionary effects of further import cuts,” the bank wrote in a note to clients.

The question is whether Venezuela can avoid one. It has managed to service its debts for much longer than expected thanks to asset-stripping of the oil company, shaking down local institutions of spare dollars and the largesse of China and Russia.

But China is owed an estimated $20bn and analysts say it might be wary of throwing more money at an increasingly unstable situation. Russia has been more willing, but cannot bankroll Venezuela indefinitely. The first test will come this autumn, when Venezuela and PDVSA have about $3.6bn of repayments due.

Last September the oil company needed a debt swap to lengthen its repayment reschedule, but with the US sanctions that is no longer possible. The tropical storm that has hammered Texas could also disrupt oil revenues, posing another challenge at an acutely sensitive time.

Mr Kaune of UBS reckons that if Venezuela surmounts this hurdle then it might be able to manage the easier debt repayment schedules of 2018-19. But the prices of bonds maturing this autumn have fallen back as investor nerves have set in. If a default happens, it could result in pandemonium. “It’s already messy socially and economically. But when Venezuela has to restructure it’s going to be a train wreck,” Prof Weidemaier says.

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