The Bond Market Has Decided Venezuela Is Too Big to Fail

The art of not pulling the trigger on a default rests on how much you're owed.
Carlos Becerra/Bloomberg

The first rule of being in debt is to keep talking to your creditors. This seems to be just about working for Venezuela, since its main lenders are giving it the benefit of the doubt.

Russia has just confirmed new terms of an existing $3.15 billion loan, an important indication that it still has sovereign backers.

But it is not just Venezuela's friends who are confirming their faith. It's the rough, tough western bond markets who aren't panicking either. There is simply too much at stake. About $150 billion, in fact. Pushing it over the edge now will not help bondholders recover their money. 

The controlling bodies of the emerging bond and credit derivatives markets are certainly holding fire. The International Swaps and Derivatives Association will, in theory, decide Thursday on whether the failure of the state-owned oil company, PDVSA, to make its coupon payments constitutes a credit event, and therefore a default. The group has already postponed this decision at least once.

If ISDA decides a credit event has occurred, then the holders of the credit default swaps would have to be paid in full. This in itself doesn't have to be calamitous. The notional outstanding on PDVSA credit insurance of $250 million pales in comparison to its $30 billion of outstanding bonds. It does not necessarily mean the sovereign defaults in turn. But as the world learned in 2008, one default can create a raft of unexpected problems. As Gadfly has already noted, the complexity of the Venezuelan debt universe suggests a thicket of hidden entanglements.  

As PDVSA has paid the $1.12 billion principal on its bond maturing Nov. 2, maybe it makes sense for creditors to be patient. The Venezuelan finance ministry has tweeted that the $200 million in coupons due on two of its bonds is in the process of being paid. That's at least some progress.

Similarly, the Emerging Market Traders Association has taken the view that, for now, trades involving Venezuelan state-owned debt should include accrued interest. Normally if a company or sovereign has been placed on default status by the credit rating companies, bond trades would be for the principal amount only. EMTA's decision suggests its members prefer to operate under the expectation, or illusion, that the country will make its coupon payments.

Though Venezuela hasn't paid creditors about $650 million in interest income on a group of bonds, according to Stuart Culverhouse at Exotix Partners, investors are not clubbing together to demand immediate payment on any one of these. This would amount to an acceleration, and would push trustees for a security into declaring the bond to be in default.

This is where it gets worrying. The bulk of the securities that have missed coupon payments most likely have what are known as a cross-default clauses, where a default on one bond triggers a default on the issuer's other securities. However, the documentation and structure of Venezuela's borrowings are so complicated that it's extremely difficult to know which bonds have what terms. Each is a minefield in its own special way. And anyway, even if there's one lucky bond that doesn't have the cross-default clause, a declaration of default would create such a shift in sentiment that all investors would probably capitulate and run for the exit anyway. Either way, it's Jenga time.

It makes sense for investors to stay well away from this contagion game, particularly while the borrower is making reassuring noises and there is still a chance of getting at least some of their money back. The shadow of Lehman Brothers looms long over Venezuela.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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