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Fund Managers Set to Mark Down Venezuela Bond Holdings

  • ‘Acceleration becomes the next step,’ says Russ Dallen
  • Recommendation doesn’t apply to debt of state oil firm PDVSA

Fund managers holding Venezuela government bonds face a day of reckoning after months of waiting for more than half a billion dollars in late interest payments.

Since November, investors following guidelines established by the Emerging Markets Traders Association have marked their Venezuela bond holdings to include all the interest they were owed, even though it hadn’t shown up yet. The trade group decided to scratch that rule Monday, and say that beginning today the nation’s debt will trade flat, or without accrued interest. If the coupons are eventually paid, they’ll go to whoever holds the bonds that day.

The decision, which followed a week of talks with market participants, comes two months after rating companies deemed Venezuela to be in default. Typically, defaulted bonds begin to trade flat after the grace period on missed debt payments expires. But with President Nicolas Maduro and his allies repeatedly saying the nation would honor its debt -- and with several delayed coupons on bonds issued by the state oil producer eventually making their way to creditors -- the market had given Venezuela the benefit of the doubt. Recently, the government’s gone silent on its bonds, spurring concern it’s selectively defaulting.

“It’s pretty clear the government does not intend to make payments on Republic debt,” Rich Cooper, a partner at Cleary Gottlieb Steen & Hamilton LLP, said in an interview. “You can talk about payments getting held up by financial intermediaries and the like, but at some point that becomes less credible and I think we are now comfortably past that point.”

Those creditors who’d been following EMTA guidelines will now have to write off the accrued interest they’d accounted for on Venezuelan notes from their net asset value. They should also write down any missed coupons they’re entitled to to reflect their expected recovery value. By making these changes in January, money managers avoided suffering the loss in their 2017 performance.

The revaluation may be somewhat offset by the market rally Tuesday, which was fueled in part by pent-up demand and the adjustment to a so-called all-in price. Venezuela’s $2.5 billion of notes due in 2019 climbed 2.6 cents to 22.75 cents on the dollar at 12:06 p.m. in New York.

The recommendation doesn’t apply to debt issued by state-owned Petroleos de Venezuela, which will continue to trade with a payment for accrued and unpaid interest.

The back-and-forth between EMTA, its board members -- which include representatives from Ashmore Group Plc, Loomis Sayles & Co., Barclays Plc and JPMorgan Chase & Co. -- and other players had caused trading to seize up this month. Traders have cited the lack of appetite by investors to pay for a bond knowing that at any moment, the rules could change.

“If you change the convention too often the issue is it freezes the market and it creates a lot less liquidity, and makes bonds more volatile and keeps investors away,” Yerlan Syzdykov, head of emerging-market debt at Amundi Asset Management, said in an interview. “It’s been very unfortunate for the market because this confusion prevents the market from clearing buyers and sellers.”

At the same time, the rule change has created a degree of chaos concerning bonds with missed coupons that have already been sold. Per the previous EMTA guidelines, stipulated on Nov. 15, a bond-seller kept the right to the missed coupon, in addition to receiving compensation for accrued interest. Because the new guidelines dictate that rights to a missed coupon go to the bond-buyer, the previous holder may be left chasing his or her claim to the missed interest payment, if and when it’s ever paid.

“There’s no way the government, when and if it restructures or makes the relevant interest payment, can take responsibility for that -- it’s got to pay the record owner as of such date,” Cooper said. “Ultimately the responsibility for making good on any of these arrangements will be in the hands of the beneficial holders and whatever agreements or lack thereof exist between the parties or the broker-dealers who brokered the trade.”

Another impact from the change may be that Venezuela’s creditors that had patiently waited for their interest payments may now seek to demand immediate repayment of their principal -- a process known as acceleration. Most bonds require holders of just 25 percent of an outstanding security to agree to do so.

“Acceleration becomes the next step -- and a check to see if Venezuela will quickly cough up the money to pay the coupon and halt a potential acceleration,” Russ Dallen, the managing director at Caracas Capital, wrote in a note to clients. “Venezuela’s reaction to the potential acceleration could be the final clarification for still-hopeful bondholders about whether they were actually going to get paid or not.”

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