A “nuclear option” to resolve Venezuela's debt woes

It's only been a couple of weeks since Lee Buchheit announced his upcoming retirement from law firm Cleary Gottlieb, but the sovereign debt restructuring veteran may soon have a new gig. According to people familiar with the matter, Venezuela's parallel government, led by opposition leader Juan Guaidó, has approached Buchheit to become an advisor in the event that President Nicolás Maduro finally succumbs to international and domestic pressures and steps down.

The potential appointment is striking. Firstly, if it materialises, it would pit Buchheit against his soon-to-be former colleagues at Cleary Gottlieb, who currently represent a big group of bondholders with billions invested in Venezuelan debt. But also, it suggests the parallel government is considering the so-called “nuclear option” proposed by Buchheit and Duke law professor Mitu Gulati, in order to break the impasse in what is likely to be one of the most complicated sovereign debt restructurings ever.

In October, Buchheit and Gulati argued that the only way to redress Venezuela's sovereign debt problem is to do something unconventional. Given that the country owes a lot of money to a lot of different entities, as well as the fact that it derives 95 per cent of its foreign currency earnings from oil sales to the US, Buchheit and Gulati warn that without some ability to ringfence Venezuelan assets held on US soil, the country's economic recovery could be taken hostage by creditors unwilling to accept large haircuts. The lack of collective action clauses and Venezuela's inability to file for bankruptcy — a tool unavailable to sovereigns — complicates matters further.

Here's the problem as they see it (emphasis ours):

If even a small group of unpaid creditors were to find an effective legal strategy in the United States that resulted in seizures of Venezuelan oil or the cash proceeds from the sale of that oil, the economy of the entire country could be strangled. Any restructuring of Venezuela’s debt will therefore need to be intolerant of holdout creditors of any type because even a marginal holdout community could pose a lethal threat to the prospects for the recovery of the economy.

As such, Buccheit and Gulati suggest the US government should issue an executive order shielding Venezuelan assets Stateside from seizure by holdout creditors.

Something similar occurred roughly 16 years ago in Iraq. Like Venezuela, Iraq during the Saddam Hussein era defaulted on most of the $140bn or so of debt it owed to a wide variety of creditors. On its tab sat $48bn due to members of the Paris Club, an informal consortium of creditors, some $70bn due to 60-plus non-Paris Club lenders and another $21bn due to a smattering of commercial banks, insurance companies, hedge funds and the like, according to numbers aggregated by Buchheit and Gulati.

In Iraq's case, it was the UN Security Council that issued the directive forbidding all UN members from “any form of attachment, garnishment, or execution” on Iraqi assets. President Bush implemented the ban through executive order in 2004, and every year until the end of his second term under the auspices of it being a matter of national security. Once the UN restriction expired in 2011, President Obama extended it for Iraqi assets on US soil through 2014 via executive order as well.

In doing so, Iraq was able to restructure its debt swiftly, but with substantial pain to investors, per Buchheit and Gulati:

The terms called for a write-off of 80% of outstanding principal and accrued interest with a significant stretch-out of the repayment period for the balance. In net present value terms, Iraq inflicted an 89.75% loss on holders of Saddam-era claims. By the time Iraq’s debt restructuring was winding down in 2008, the Iraqi authorities had settled 13,164 separate claims tendered by 576 commercial creditors from 50 countries — a commercial creditor participation rate exceeding 96% (by value of claims).

According to Jeromin Zettelmeyer at the Peterson Institute for International Economics, the Iraq analogy for Venezuela is “persuasive”. A UN resolution is unlikely to come to pass given Russia and China's positions as both major lenders to Venezuela as well as members of the UN Security Council, which would decide on such matters. Instead, as Zettelmeyer told Alphaville, a US executive order is more politically viable in light of the humanitarian crisis hamstringing the country today, as well as the Trump administration's actions and rhetoric, which have to date indicated an anti-Maduro stance.

Creditors unsurprisingly find fault with Buchheit and Gulati's proposal, and argue that it not only tips the balance away from US investors towards Russian and Chinese counterparts, but also that it could undermine Venezuela's own recovery in the long run. In an email to Alphaville, Mike Conelius, a portfolio manager at T Rowe Price and a member of the creditor group advised by Cleary Gottlieb and seasoned restructuring expert Mark Walker, raised the following concerns:

Besides playing fast and loose with US creditor rights, Buchheit declares by fiat that Venezuela’s debts are not susceptible to consensual resolution by good faith negotiations and market-tested mechanisms before we’ve even gotten to the table. Bondholders have already organised into a cohesive group, ready to engage with a legitimate government... Attachment of assets is not in our interest, and we are convinced that Venezuela’s US assets can be protected without recourse to unilateral action by the United States as he proposes. Rogue ideas that impair US investors’ rights tilt the field in favour of China and Russia.

Conelius goes on to warn the following:

Such ideas will impair access to desperately needed financing from the private sector and are unconstructive distractions from the important work at hand.

As recently as December, advisor Mark Walker published a paper echoing similar worries.

Duke's Gulati is sensitive to the points raised by Conelius and Walker, but he stresses that any executive order must only apply to debt incurred prior to regime change, not afterwards. To bind new debt to such parameters would be “idiotic”, he told Alphaville. “Venezuela needs to raise money, and this action would effectively kill any market for the country's debt.”

In fact, this stipulation is laid out in the proposal crafted with Buchheit (emphasis ours):

The sole purpose of such a measure would be to encourage prospective holdouts to join a negotiated, consensual restructuring of the sovereign’s debt; it would therefore have no application whatever to the legal enforceability of any new debt instruments issued by the sovereign as part of that restructuring.

All that being said, restructuring talks remain a long way off as Maduro continues to dig in his heels, and the opposition makes small inroads in gaining support from pivotal parties. But with Buchheit a free agent as of April 1, this process could quickly get a lot more complicated.

Related Links:
Bond ETFs grapple with fresh US sanctions against Venezuela - FT Alphaville
Venezuelan bondholders face an uphill battle for repayment
- FT Alphaville
Bondholders brace for Venezuelan regime change
- FT

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