By Richard J. Cooper, Ignacio Lagos, and Sean O’Connell (Cleary Gottlieb Steen & Hamilton LLP)*
In the aftermath of its recent devastating earthquakes, Venezuela might well take a moment to reconsider its rapid approach to a sovereign debt restructuring announced in May of this year.
The decision to pause a debt restructuring process is not necessarily a straightforward one. On the one hand, Venezuela’s desire to move ahead quickly is understandable. Venezuela’s debt is unsustainable and a clear impediment to the new investment it requires. The government wants to show prospective investors that there is a path to a restructuring and they need not wait to make critical investments to restore the productive resources of the Venezuelan state.
But an accelerated restructuring is hardly a sure thing: it could end in failure that delays new investment and diminishes the credibility of those involved. Or it could succeed on paper but leave Venezuela with an unsustainable debt load, which is likely to lead to a subsequent restructuring. This risk is particularly acute given Venezuela’s unusually fragmented debt stock that is in need of thorough verification and validation.
The decision to delay a debt restructuring process indefinitely or move forward quickly need not be a binary one. The authors, members of Cleary Gottlieb’s Global Restructuring and Sovereign Advisory Practice, believe there is another path that can advance the aims of a restructuring and create the essential building blocks for a future debt restructuring, while avoiding the risks of a counterproductive process.
Instead of choosing between a potentially fast but uncertain restructuring process and a more deliberate but credible one, Venezuela could instead begin its restructuring with a thorough claims-reconciliation exercise and, as that is underway, proceed to restack its debt stock so it is set up to achieve a comprehensive debt restructuring that is less vulnerable to subsequent renegotiation or legal challenge. Claims would be validated and then exchanged into new instruments, so-called “mirror bonds”, featuring proper anti-holdout contract tools. Participation would be encouraged through Brady Bond-style enhancements, which could be financed through a number of mechanisms, including by collateralizing those mirror bonds with revenues that accumulate on Venezuelan oil sales managed by the United States. As a condition to participating in the mirror bond exchange, participating creditors could be expected to require that some basic guardrails are incorporated into the process such that the claims pool is not inflated by invalid claims of dubious origin and the debt sustainability analysis is the product of credible data, realistic assumptions and thoughtful expert analysis.
Such a transaction would not, in and of itself, reduce Venezuela’s balance sheet debts. But it would do something almost as important: create the conditions for a successful debt reduction down the road. That ultimate restructuring can then occur once the in-depth claims reconciliation process is completed, a credible debt sustainability analysis has been generated, and the necessary legal reforms and changes in political conditions have occurred or are close at hand.
In a matter of months, Venezuela could transform its creditor landscape into one capable of supporting an orderly debt restructuring, while demonstrating to investors, creditors, official lenders, and the IMF that the process rests on a credible foundation.
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* The authors are members of Cleary Gottlieb’s Sovereign Advisory Practice. The firm has represented multiple clients in connection with Venezuela matters.