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My wife, Marina, and I are headed to Paris to present to a group of major energy investors.
Unfortunately, in what is becoming an all-too-frequent scenario, a major development upon my departure has completely revised the risk management discussion I planned on presenting.
This time, the change in the agenda comes from the International Swaps and Derivatives Association (ISDA).
On Nov. 16, the ISDA declared that Venezuela's decision to delay payment on both sovereign debt and bonds issued by state oil company PDVSA constitutes a "credit event."
The decision, made by an ISDA committee comprised of representatives from 15 financial institutions, was unanimous and now allows holders of credit default swaps to redeem the paper.
Credit default swaps provide insurance when bonds are not paid back. They are derivative paper used both by the holders of the bonds in question and investors who believe a default is likely and seek to profit from the "event."
The amount of the credit default swap is not large by international standards. Estimates put the amount at about $1.4 billion for the sovereign bonds and less than $300 million for the PDVSA paper.
However, the redemption of this paper is going to open up a tidal wave of financial problems for Caracas nonetheless.
The crisis was hardly unexpected. Venezuela began delaying interest payments on both categories of debt last month, with some holders receiving nothing and others realizing only partial (and late) interest payments.
As is common in such situations, a 30-day grace period is introduced before any action is taken. That period ended earlier this week, and the ISDA finally called the credit event yesterday.
Venezuela had paid nothing on its more than $1 billion in combined principal that became due on Nov. 2.
It is still uncertain whether the sovereign or PDVSA debt triggered the credit action. The ISDA has indicated it will have more information on Monday. And while no one is publicly using the D-word ("default") yet, a paraphrase of William Shakespeare seems in order.
A default by any other name is still a default…
A New "Failed State"
The ISDA move now allows for credit swap holders to be participants in an auction that will determine how much they are actually paid. That auction is scheduled for Nov. 20.
That means there are several considerations I will have to take into account while traveling.
To begin with, the small amount of credit default swaps involved are misleading.
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There is additional "bridge" derivative paper connecting both of the bond categories, along with additional issuances to cover the risk. This acts much as options do in offsetting risk for crude oil futures contracts.
That expands the financial exposure.
Then there will be additional composites of both finance and assets that may be compromised.
Don't forget how an apparently small amount of bad subprime mortgages paralyzed trillions of dollars' worth of global dollar-denominated paper and assets in the credit crunch a few years ago.
That happened because of the way in which paper had been used as collateral or surety for other transactions (and other paper).
The Venezuelan problem is a more contained situation.
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.