April 11, 2019 / 8:45 PM / 2 months ago

Venezuela debt placed on 'index watch' by JPMorgan

(Reuters) - Venezuela’s debt is another step closer to being removed from a key emerging market bond index series after JPMorgan Chase & Co placed the country’s securities on “index watch” because of trading disruptions caused by U.S. sanctions against President Nicolas Maduro’s government.

In an advisory to JPMorgan index clients seen by Reuters, the bank said the “index watch” designation covered both Venezuelan sovereign bonds and those issued by state-run oil company PDVSA in its widely followed EMBIG Diversified, EMBIG and EMBI+ indexes.

During the review period, JPMorgan will evaluate liquidity and transactional viability, while watching for official communications around secondary market trading in Venezuela debt. When the period ends on June 28, “a more definitive course of action for Venezuela in the index will be determined,” the bank said.

“It’s a classic case of a potential bonanza for active managers like us and a terrible disaster for passive managers,” said Jan Dehn, head of research at Ashmore Group, a specialist emerging markets investment manager.

“If JPMorgan’s final decision is to exclude these bonds from their index those passive investors (who track it) will be forced to sell at exactly the wrong time as the direction of travel in Venezuela is quite clear. Once the regime change happens, which is inevitable, you’re going to want to hold these securities as they’re going to double in value.”

The sanctions imposed by the Treasury’s Office of Foreign Assets Control (OFAC) have impaired secondary market trading, liquidity and price discovery on Venezuela’s sovereign bonds and on PDVSA’s securities, the notice said.

In January, U.S. President Donald Trump’s administration imposed sweeping sanctions on PDVSA intended to prevent Maduro’s government from siphoning funds from the oil company to maintain his grip on power. Washington has also put curbs on trading in the country’s sovereign debt.

JPMorgan said 76% of investors responding to a recent index client survey said their approved counterparties did not offer them the ability to unwind their PDVSA or sovereign bond holdings.

“These conditions constitute a de-facto market disruption event from the index standpoint,” it said.

Unless market conditions improve by the end of the review period, JPMorgan may begin a reduction of the index’s exposure to Venezuelan bonds.

“A prolonged market disruption may result in the reduction of Venezuela’s index weight to zero in a phased manner,” the advisory said. Any such phase-out could take three to five months, with the process likely ending in late November. But additional restrictions on secondary market activity could trigger an accelerated wind-down.

The status of Venezuelan debt in the JPMorgan indexes has been a central concern for investors since the sanctions were imposed earlier this year.

Currently, 20 bonds from Venezuela - 12 sovereign issues and eight from PDVSA - are in the benchmark EMBIG Diversified index with a total weight of 0.97%. That is down from 1.19% in early February.

Under Maduro’s government, the oil-rich nation has defaulted on most of its $63 billion of debt as it has spiraled into its worst-ever economic crisis, with rampant hyperinflation and a food shortage.

The Venezuelan securities rallied earlier this year after the United States and other major Western powers recognized opposition leader Juan Guaido as the country’s legitimate leader. The OFAC sanctions, however, have effectively brought activity in its bonds to a halt.

Reporting by Rodrigo Campos; Additional reporting by Tom Arnold in London; Writing by Dan Burns; Editing by Jonathan Oatis and Peter Cooney

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