Latin America and the money men

Yola Verbruggen

Creditors have descended on yet another Latin American country, Venezuela, as its economy unravels. After various unsuccessful efforts to regulate sovereign debt restructuring globally in recent years, Global Insight assesses what the future has in store for the country and the region.

For months, Venezuelans have been protesting against President Maduro who is desperately trying to stave off the country’s bankruptcy as he clings on to power. Dozens of demonstrators have been killed in political violence, while hundreds have been arrested and thousands injured.

Maduro is depleting the state coffers, once filled with oil money, to avoid defaulting on bond repayments. The country’s foreign reserves have dwindled and only about a third of the $30bn that Venezuela had at the start of Maduro’s term is left. The International Monetary Fund (IMF) has made dire predictions for the future of the country, forecasting high inflation. As default looms, creditors have descended on Venezuela and bonds issued by the state oil company Petróleos de Venezuela, (PDVSA), have gone up for sale.

Venezuela’s fire sale

Holders of PDVSA bonds reportedly include BlackRock, T Rowe Price, Fidelity, JPMorgan Chase and Ashmore. But, it was not until Goldman Sachs, the well-known American investment bank with a reputation for making high-risk investments, paid just $865m for bonds issued by PDVSA worth $2.8bn that protestors expressed anger at the deals. The opposition called it a sale of ‘hunger bonds’, thereby emphasising the hunger of the population as food has become scarce.

‘They are going to meet their obligations but starve their people. Money they do have goes to the military. How long that will continue is the big question. When people are not eating, they will rebel,’ says Chester Salomon, of counsel at Becker, Glynn, Muffly, Chassin & Hosinski in New York and an officer of the IBA’s Insolvency Section.

Venezuela’s opposition, in a letter to Goldman Sachs, said it would refuse payment if it were to gain power. The pari passu clause that obliges equal management of creditors, however, might make this an empty threat. If Venezuela were to favour one creditor over another, it would open the country to law suits, a fate that has already befallen other countries in the region in recent years.

When Argentina defaulted in 2001, so-called vulture funds refused to agree to any form of debt restructuring. Instead, they took Argentina to court and demanded full repayment plus interest for the bonds these creditors had bought at a bargain price. After lengthy litigation, Judge Thomas P Griesa of the Federal District Court in Manhattan ruled in favour of the hedge funds. Argentina had to pay the bonds back in full, plus any interest owed. To ensure payment in a case for which it had no enforcement mechanism, the court decided that Argentina was not allowed to make payments on any new bonds it issued, unless it also made repayments on the hedge funds’ bonds. The Supreme Court refused to hear the case after Argentina appealed and the United States Court of Appeals for the Second Circuit upheld the ruling.

This broad interpretation of the pari passu clause, which demands equal treatment of creditors, thus also affected those who had bought new bonds as part of a restructuring deal. The ruling could be bad news for other countries at risk of default, since it gives hedge funds that hold out in a restructuring agreement a significant financial benefit for doing so. Some experts, however, argue that the circumstances in Argentina’s case are very specific and therefore will not affect future litigation.

Basic principles on sovereign debt restructuring processes

A Sovereign state has the right, in the exercise of its discretion, to design its macroeconomic policy, including restructuring its sovereign debt, which should not be frustrated or impeded by any abusive measures. Restructuring should be done as the last resort and preserving at the outset creditors’ rights.

Good faith by both the sovereign debtor and all its creditors would entail their engagement in constructive sovereign debt restructuring workout negotiations and other stages of the process, with the aim of a prompt and durable re-establishment of debt sustainability and debt servicing, as well as achieving the support of a critical mass of creditors through a constructive dialogue regarding the restructuring terms.

Transparency should be promoted in order to enhance the accountability of the actors concerned, which can be achieved through the timely sharing of both data and processes related to sovereign debt workouts.

Impartiality requires that all institutions and actors involved in sovereign debt restructuring workouts, including at the regional level, in accordance with their respective mandates, enjoy independence and refrain from exercising any undue influence over the process and others stakeholders, or engaging in actions that would give rise to conflicts of interest or corruption or both.

Equitable treatment imposes on states the duty to refrain from arbitrarily discriminating among creditors, unless a different treatment is justified under the law, is reasonable and is correlated to the characteristics of the credit, guaranteeing inter-creditor equality, discussed among all creditors. Creditors have the right to receive the same proportionate treatment in accordance with their credit and its characteristics. No creditors or creditor groups should be excluded ex ante from the sovereign debt restructuring process.

Sovereign immunity from jurisdiction and execution regarding sovereign debt restructurings is a right of states before foreign domestic courts and exceptions should be restrictively interpreted.

Legitimacy entails that the establishment of institutions and the operations related to sovereign debt restructuring workouts respect requirements of inclusiveness and the rule of law at all levels. The terms and conditions of the original contracts should remain valid until such time as they are modified by a restructuring agreement.

Sustainability implies that sovereign debt restructuring workouts are completed in a timely and efficient manner and lead to a stable debt situation in the debtor state, preserving at the outset creditors’ rights while promoting sustained and inclusive economic growth and sustainable development, minimising economic and social costs, warranting the stability of the international financial system and respecting human rights.

Majority restructuring implies that sovereign debt restructuring agreements that are approved by a qualified majority of the creditors of a state are not to be affected, jeopardised or otherwise impeded by other states or a non-representative minority of creditors, who must respect the decisions adopted by the majority of the creditors. States should be encouraged to include collective action clauses in their sovereign debt to be issued.

Vultures circle the region

The largest creditor in the case of Argentina had sued Peru years earlier in the US, after the defaulted nation tried to negotiate restructuring deals. Hedge fund Elliot Management bought $20.7m worth of defaulted Peruvian loans at a huge discount – paying $11.4m. The fund refused to negotiate and demanded repayment in full. When Peru decided to start repaying creditors it had negotiated with, Elliot Management claimed that Peru had not treated its creditors equally and thus violated the pari passu clause. Peru was forced into a remarkably expensive $58m settlement.

The case of Puerto Rico was slightly different. The island is not a sovereign country but dependent US territory to which bankruptcy protections available to US cities and companies do not apply. Title III of Promesa, a federal law enacted by the US Congress to deal with Puerto Rico’s debt crisis, paved the way for Puerto Rico’s debt restructuring deal at a time when more than 20 creditors had reportedly already filed lawsuits against the island. It owes investors a total of $74bn.

Eric LeCompte, Executive Director of the Jubilee USA Network, a non-profit financial reform organisation based in Washington, DC, sees the law as a victory for defaulting countries. ‘The Puerto Rico case is very significant as it shows a legal framework for a comprehensive bankruptcy process is possible. More importantly, the Puerto Rico legislation retroactively binds all creditors and prior bond contracts into one process. The Puerto Rico case shows that a framework for sovereign bankruptcy is possible. The case also shows that it is possible to prevent holdout and predatory behaviour. The Puerto Rico process is a model for future bankruptcy processes,’ he says.

The downside of the law, however, is the creation of a financial oversight and management board that makes fiscal policy decisions for the island.

Reining in the money men

After Argentina’s default in 2001, the IMF proposed a sovereign debt restructuring mechanism (SDRM), a regime that would have governed the issue globally, but it was voted down. Influential countries voting against it included the US.

The institution’s then Deputy Managing Director, Anne Krueger, was the main advocate of the proposal. ‘The objective of an SDRM is to facilitate the orderly, predictable, and rapid restructuring of unsustainable sovereign debt, while protecting asset values and creditors’ rights,’ she wrote in a manifesto.

The proposal was rejected and so was a similar, toned-down proposal about a decade later. Instead, countries reached agreement on the introduction of collective action clauses (CACs). These clauses are now being included in most bonds and prevent creditors from holding out if the majority of bondholders agree on a deal.

Some supporters of an international restructuring mechanism are sceptical about the CACs. ‘They’re not in most sovereign debt contracts, they ordinarily don’t address aggregate – across debt issues – voting, and even the new aggregate-voting CACs are only beginning to be included,’ says Steven Schwarcz, Professor of Law & Business at Duke University and Senior Fellow of the Centre for International Governance Innovation.

Schwarcz is a strong advocate of a model-law approach to solving the sovereign debt problem, which would not face the ‘political impediments’ that the IMF proposal faced. The model law approach, instead of an international treaty, provides a framework of uniform laws enacted by each government choosing to do so. In a paper presented on the topic to the UNCITRAL congress in Vienna in early July, he says that research shows a ‘drastic rise in sovereign debt litigation by holdout creditors’. ‘The model-law approach, especially if enacted as New York and/or English law, could virtually solve the sovereign debt problem overnight if such enactment adopted the model law’s optional retroactivity,’ he says.

They are going to meet their obligations but starve their people. Money they do have goes to the military. How long that will continue is the big question

Chester Salomon
Becker, Glynn, Muffly, Chassin & Hosinski, New York;
officer of the IBA’s Insolvency Section

The ability of creditors to hold out caused the problem for Argentina. Ricardo Beller is a partner with Marval, O’Farrell & Mairal in Buenos Aires and represented several debtor companies in their restructuring processes during the Argentine crisis. ‘Argentina managed to do two debt exchanges in 2005 and 2010 for an aggregate amount of approximately 93 per cent of its debt,’ he says. ‘The main problems Argentina faced were with aggressive holdouts, which owned not more than seven per cent. Most of these were distressed funds that purchased bonds after the default occurred at a highly discounted value with the aim of litigating against Argentina to collect the full price of these. If you have a collective action clause in place, with 93 per cent these aggressive bondholders clearly would have been crammed down, as occurs habitually in debt restructurings of private companies restructuring under the bankruptcy laws of almost all jurisdictions. Argentina would thus not have had a problem if we had the collective action clause.’ Beller emphasises that, even though the US court enforced the pari passu clause, judges in other jurisdictions would not necessarily follow Judge Griesa’s lead.

Statistics based on The World Bank’s International Debt Statistics Report, 2017

According to Carlos de Sousa, an economist at Oxford Economics in London, it’s unlikely Venezuela will have CACs included in its bonds. Unlike pure sovereign bonds issued by the government, PDVSA securities lack legal mechanisms, like CACs, which can help a government negotiate favourable terms with foreign bond holders if it defaults on its debt.

Similar to Argentina’s initial response to some of its creditors, Venezuela could refuse to pay. That would not be a long-term solution, however, as it would further isolate Venezuela and put it outside the international financial community, says Beller. ‘If you want to become part of the international financial community again, you have to start paying your debt and come into agreements with your creditors,’ he says.

To force a country to pay, its overseas assets could be in jeopardy. In the case of Argentina, an enforcement strategy used by Elliot Management was the seizure of a large Argentine naval ship, the Liberal, in Ghana. Beller thinks that a global insolvency regime would benefit particularly poor, underdeveloped countries that become hostages of creditors and are unable to recover from default on their own.

Fearing that the Argentine judgment in the US could set a dangerous precedent for impoverished nations in default, Jubilee USA submitted a brief in support of Argentina, an amicus curiae, to the court. It stated that ‘the unusual interpretation given to the pari passu clause and the remedy affirmed by the Court of Appeals in this case will undermine United States debt relief policy and harm many of the world’s poorest people’. Christine Lagarde, the IMF’s Managing Director, threatened to submit a brief as well, but withdrew this recommendation after it became clear that the US would not support it.

The objective of a sovereign debt restructuring mechanism is to facilitate the orderly, predictable, and rapid restructuring of unsustainable sovereign debt, while protecting asset values

Anne Krueger
Former Deputy Managing Director,
International Monetary Fund

At the IBA’s Annual Conference in Washington, DC, last year, Lagarde warned against unethical behaviour by financial institutions and described lawyers as society’s ‘merchants of trust’. ‘Unethical behaviour in the private sector can have devastating consequences. This is particularly the case for the financial industry. Few would disagree that unethical behaviour and excessive risk-taking in the financial sector played a major role in precipitating the global financial crisis. The goal of the financial industry must be not only to maximise the wealth of its shareholders, but also to serve society by supporting sustainable – and stable – economic activity,’ she said.

While fighting its long legal battle with the country’s creditors in court, Argentina put forward a resolution that would limit the risk-taking investments funds are allowed to make, to the United Nations. South Africa, Chair of the G77 and China in 2006, submitted the resolution to the General Assembly. The resolution outlines nine core principles for sovereign debt restructuring and was passed in September 2015. These core principles are sovereignty, good faith, transparency, impartiality, equitable treatment, sovereign immunity, legitimacy, sustainability and majority restructuring. The US voted against, together with the Canada, Germany, Israel, Japan and the United Kingdom. Forty-one others abstained. The resolution is not binding.

‘The set of principles on debt restructuring passed today by the UN General Assembly reflects customary law and general principles of international law to a large extent and, as such, are legally binding,’ the UN’s Independent Expert on the effects of foreign debt and human rights, Juan Pablo Bohoslavsky, said in a statement made on the day the resolution was adopted.

Roberto E Silva, lawyer with Marval, O’Farrell & Mairal and Past Chair of the IBA’s Banking Law Committee, questions the impact the principles could have had, had they existed at the time of Argentina’s default. ‘I do not believe it would have changed anything. Argentina incorporated such principles into its legislation, but most debt issues are governed by non-Argentine law,’ he says.

The wolves of Wall Street

Venezuela is not the first country in which Goldman Sachs has made a contentious deal, nor has it only done so in Latin America. As Greece’s economy unravelled, Goldman Sachs helped it hide just under $3bn of its debt by lending the country money at a fictitiously low exchange rate, thereby making the debt appear lower than it really was. Though legal, the deal has been subject to much heated debate as Goldman made millions while Greece descended further into debt.

At Goldman’s offices in Manhattan earlier this year, demonstrators complained that many former Goldman employees were appointed to top positions in the Trump administration. Pointed out in an earlier piece by Skip Kaltenheuser for Global Insight, this is a
long-standing practice in Washington. Kaltenheuser wrote: ‘Robert Rubin was a co-chairman of Goldman before becoming Bill Clinton’s Secretary of the Treasury, where he was a central figure in the deregulation of derivatives and other financial services. Stephen Friedman ran Goldman before entering the Bush Administration, and still sat on Goldman’s board while chairing the Federal Reserve Bank of New York, until he made a large purchase of additional Goldman stock at an awkward time.’

Elliot Management, the hedge fund that held hostage Argentina’s debt repayments with its subsidiary NLM Capital, is widely known to be influential in Washington. Paul Singer, a tough businessman and a major donor for top Republicans, runs the hedge fund. In the mid-1990s, Singer reportedly received $58m from the settlement with Peru and later he received $90m for repayments on Congolese debt bought for about $20m. A lawyer formerly employed by Elliot, Mark Brodsky, runs the Aurelius hedge fund that was one of the hold out creditors in the Argentina case.

The goal of the financial industry must be not only to maximise the wealth of its shareholders, but also to serve society by supporting sustainable – and stable – economic activity

Christine Lagarde
Managing Director, the IMF

Lobbyists are reportedly trying hard to overhaul the 2010 Dodd Frank Act that saw tougher federal oversight of hedge funds, the work of Obama. The measure restricts US banks from making certain kinds of speculative investments.

LeCompte of Jubilee USA is a strong supporter of a global insolvency regime that would rein in the risk-taking of large hedge funds. ‘From an economic perspective, a legal perspective and a moral perspective, a global bankruptcy process is needed. Adam Smith advocated for a global bankruptcy regime. Pope Francis calls for a process to protect poor economies from crisis. We’ve seen a lot of movement forward on a process. I believe moving forward a legally binding process will eventually happen. It’s no longer a question of “if”, it’s now a question of “when”,’ says LeCompte.

What next for Venezuela?

Venezuela was one of the most vocal supporters of Argentina within the Organization of American States (OAS), backing its call for relaxed repayment rules. Venezuela’s then foreign minister called for a regional network that would provide protection against vulture funds, but nothing has since developed. No such support has come from the regional block for Venezuela as it battles financial troubles at home. The OAS has repeatedly called on Venezuela to stop its violence against protestors and voiced concern about measures taken by Maduro to consolidate his power.

Maduro continues to divide the country further between those who want him to leave and the Chavistas, who are followers of the socialist policies of the now-deceased Hugo Chavez and support Maduro’s United Socialist Party, the PSUV.

In June, the OAS Secretary-General, Luis Almagro from Uruguay, voiced strong criticism towards the Venezuelan government. ‘Over the last months, the regime in Venezuela has buried democracy, the separation of powers, justice, civil guarantees, political, economic, and social rights as well as all the principles that constitute a legitimate government,’ he said in a statement. Going as far as to call the government ‘illegitimate’, he singled out the President of the National Electoral Council, Tibisay Lucena, as being ‘crucial’ in Venezuela’s institutional collapse. ‘Based on a regressive and forced interpretation imposed by the Constitutional Chamber of the Supreme Court, which substitutes the right to universal suffrage for indirect mechanisms of election.’

It has been strong criticism like this that led to Venezuela’s announcement in late April that it would withdraw from the regional body, which will further isolate the troubled nation. Withdrawal would also mean that Venezuela is no longer subject to monitoring mechanisms of the Inter-American Commission of Human Rights which, according to Human Rights Watch, has been ‘key in bolstering human rights in the region’. Almagro had earlier threatened to suspend the nation from the regional body.

OAS’ 34 member states had tried to reach a resolution on Venezuela in which it would call for an end to the violence but the effort, led mainly by Mexico, Peru and the US, failed. ‘The OAS resolution on Venezuela should indicate our concern about the cancellation of elections, lack of respect for the National Assembly, the existence of political prisoners, the use of military courts to try civilians,’ Mexico’s Foreign Ministry had said in a statement preceding the meetings. Earlier, in March, Peru recalled its ambassador to Venezuela.

In the last few days of June, removal proceedings against Attorney General Louisa Ortega, who had been working hard to uphold the rule of law and disagreed openly with Maduro, began. She is barred from leaving the country and her bank accounts are frozen. The court has said that it is investigating her for misconduct, which could see her removed from office. The Office of the High Commissioner for Human Rights has called the decision ‘deeply worrying’, together with the ongoing violence in the country:

‘We are also disturbed by the decision on 27 June by the Supreme Court’s Constitutional Chamber to declare her appointment of a deputy attorney general to be null and void, and to appoint instead a temporary deputy, in violation of the appointment procedure under Venezuelan law. The Chamber also granted some of the Attorney General’s, until now, exclusive functions to the Ombudsperson.’

Dissent continues to be crushed and the President uses increasingly dangerous language, including threats to use weapons to stay in power. An attack on a government building by an alleged rogue unit of the security forces has left Venezuelans mystified about how the helicopter used to throw grenades on the Supreme Court and fire at the Interior Ministry managed to get away unharmed, despite the high military presence, and why nobody was hurt. People are unsure whether this was bravery or deceit on the part of the perpetrator, Oscar Pérez.

The US stepped up pressure on the regime in the days leading up to its vote for a constituent assembly that will rewrite the Constitution. It sanctioned 13 government officials and, after Maduro claimed victory for establishment of the assembly, the US also sanctioned the President.

In July, Maduro reportedly announced that the minimum wage would go up 50 per cent. But, with inflation much higher than that and the country’s supermarkets and pharmacies deprived of stock, this offers little comfort to Venezuelans. Another test for the regime will come at the end of October and in November, when the next big payment is due on PDVSA bonds.

Yola Verbruggen is Senior Reporter at the IBA and can be contacted at