Venezuela wants to sell bonds, but who is going to buy them?

There still has been no so-called “firesale” of Venezuela‘s government bonds after global investment bank JPMorgan removed them from its popular bond market indexes earlier this month, but the situation is set to become more interesting.

The bank will officially begin a five-month phase-out process of the bonds on Wednesday. But for a money manager who still needs to sell its Venezuelan debt holdings, finding any buyers is a tough task.

Most of the $60bn worth of bonds issued by the Venezuelan government and the country’s state oil firm PDVSA has not paid interest for years. The market has been virtually frozen since the sanctions imposed by the United States banned their trading in January.

Washington hoped the move would prevent President Nicolas Maduro‘s administration from siphoning off funds from the oil company to maintain his grip on power. That has not worked, but the bond squeeze has.

The sudden stop in trading meant JPMorgan had little choice but to cut Venezuela. While it avoided the nuclear option of ejecting the country’s debt altogether, it cut the index weight down to zero, which has a similar effect.

That means the thousands of fund managers that benchmark their performance against JPMorgan’s indexes face a dilemma: sell the bonds at whatever price – they are currently marked at just 15 cents on the dollar – or keep them and veer away from the index.

“We will start doing something this week as we will have to realign the funds to the benchmark,” said a senior fund manager at a major US investment bank who requested anonymity while the sale was in process. “We will see what the market is like.”

Exchange-Traded Funds (ETFs) which most closely mimic indexes like JPMorgan’s are also expected to be forced sellers of Venezuelan debt.

ETFs are estimated to own around three percent of the $3.2 trillion of emerging market debt now in circulation, so if that reads across to Venezuela’s $60bn of bond then as much as $1.8bn might potentially be up for sale.

The biggest in the emerging market sphere, BlackRock’s iShares JPMorgan USD EM Bond ETF, has almost $80m of Venezuela and PDVSA bonds according to its latest filing. It does, however, have the wiggle room to invest as much of 20 percent of its assets away from the index in special cases. A spokeswoman declined to say what it would do in Venezuela’s case.

“This is a nightmare for passive funds,” said Jan Dehn who works at Ashmore, a London-based active emerging market fund.

It owns defaulted Venezuela government bonds, as well as the more sought-after PDVSA 2020 bonds secured by the oil firm’s US refining offshoot Citgo.

Dehn is watching closely for any bargains that pop up. “There is nothing better in finance than forced selling. It is a beautiful thing,” he said.

Cheeky Enquiries

However, plenty of Venezuela holders are sitting tight.

Big-name US funds T Rowe Price, Greylock Capital, Fidelity, and GMO are part of a creditor group that has formed hoping to shape a potential restructuring deal should Maduro be forced from office.

Aberdeen Standard Investments portfolio manager Viktor Szabo said his firm had received “cheeky enquiries” from would-be buyers – mainly small European or other little known non-US funds – in recent weeks but had not been tempted either.

“They wanted a few million of this or that particular bond,” Szabo said. “But I think they were just fishing for forced sellers.”

Washington’s sanctions also mean there will be no US buyers, ruling out the flock of specialist US funds that pecked at Argentina for over a decade, although they may have built some stakes already.

Venezuela would be prime fodder for litigation-loving funds according to Rodrigo Olivares-Caminal, chair in Banking and Finance Law at Queen Mary University in London.

Close to $40bn of its bonds have no collective action clauses (CACs), terms typically spelling out that any restructuring can go ahead with a 75 percent or 85 percent approval from investors.

That includes all of the $35.6bn issued by state-owned oil company PDVSA, which could thus easily be exposed to a lengthy legal grapple with holdouts.

“If you don’t have CACs, you will always have the threat of having holdouts,” Olivares-Caminal said.

With the JPMorgan move, “many institutional investors will offload [their bonds], so that is how the bonds will end up in the hands of a different type of investor.”