Artisan Canvas

The Dog Days of VRIs

Value Recovery Instruments (VRIs), also known as warrants, are instruments that provide contingent payouts to creditors under specific scenarios. They are typically structured as call options or warrants that are tied to a state variable (such as GDP or exports), which is strongly correlated with the borrower’s ability to repay debt.

Often seen as deal “sweeteners”, VRI’s expedite debt restructurings by helping bridge the expectation gap between creditors and debtors.

Why Should Investors Pay Attention to VRIs?

• VRI issuance has become more common in recent restructurings and can offer upside payouts to creditors.
• They are often excluded from the benchmarks.
• VRIs offer cross default provisions, meaning governments cannot default on these without doing a full restructuring.

Investment Considerations

• Each VRI issuance is different, therefore understanding the nuances, risks, and potential payoffs is critical.
• VRI pricing can be volatile.

 

Sweet or Sour? Recent Examples

Argentina GDP Warrants (2005)

Context

During sovereign debt restructuring, Argentina implemented a haircut for bondholders and issued GDP warrants that would pay coupons if the country grew at a rate higher than projected.

Takeaways

Argentinian government and bondholders failed to establish how to measure growth rates. As a result, the government manipulated economic data in order to decrease their obligated payouts.

Verdict: Sour

 

Ukraine GDP Warrants (2015)

Context

In the 2015 debt restructuring, the Ukrainian government issued GDP warrants to bondholders in exchange for a 20% haircut on the bonds’ original value. To prevent the issues encountered with the Argentinian GDP warrants regarding data manipulation, Ukrainian GDP warrant payoffs are tied to data reported by a third party, the IMF. However, the Ukrainian government did not set a limit on the extent of liabilities, leaving them obligated to compensate warrant holders whenever GDP and real GDP growth surpass expectations until the warrants reach maturity — posing an uncapped liability for the Ukrainian government.

Takeaways

The war against Russia severely cut growth in 2022, and as part of the debt moratorium, the Ukrainian government capped warrants temporarily, reducing payout obligations for the government. However, since 2023 growth is back at the levels where the warrants would be paying out. Reconstruction is expected to boost growth even more, leaving the government liable to growing obligations.

Ukraine GDP Warrant

 

 

 

 

 

 

 

 

 

 

Source: Bloomberg. As of 31 May 2024. Based on Ukraine 08/01/2041 VRI

Verdict: Sweet and sour  

 

Suriname Oil VRIs (2023)

Context

Suriname is poised to emerge as a significant player in the oil industry following the discovery of a major oil reservoir off its coast called Block 58. TotalEnergies is expected to make a final investment decision on the off-shore well by the end of 2024, with expected production beginning in 2028.

As part of the recent sovereign debt restructuring, Suriname implemented a haircut on existing bonds and issued an oil-linked VRI. This instrument will trigger contingent payments if Suriname generates oil royalty revenues from Block 58.

If/when oil is produced on Block 58, the Surinamese government will get the first $100M and after that they will share 30% of the revenues from that field with investors until bondholders are compensated for the haircut they consented to.

Takeaways

Suriname oil VRIs offer a unique solution that benefits both the country and investors:

• Suriname is immediately provided with necessary debt relief through this restructuring agreement.
• If development of Block 58 and the oil boom in Suriname never happens, the government is not on the hook for large payments to bondholders
• If development of Block 58 happens and Suriname becomes a key player in the oil industry, investors get to participate in the upside and the government has the means to pay back its debt and warrants, but the liability is capped at the value of the initial haircut, so it is not at risk of paying more than it is capable of.

Suriname Oil VRI

 

 

 

 

 

 

 

 

 

 

 

Source: Bloomberg. As of 31 May 2024. Based on Suriname 12/31/2050 VRI

Verdict: Sweet!

 

The Future of VRIs

Each VRI issuance continues to have unique nuances that require in-depth research and may offer potential upside rewards. Since there is no standardization in VRIs, countries are becoming more creative in their approaches. Suriname was one of the first countries to link VRI payouts to the outcome of a specific project. El Salvador recently issued VRIs that offer adjustable interest rate increases from 0.25 – 4.00% if the nation does not get an IMF program by a certain date or a credit ratings upgrade. Also, Zambia issued two new Eurobonds during its restructuring. One acts as a VRI that would deliver higher repayment terms and coupons if either: Zambia’s debt carrying capacity, as assessed by the IMF and World Bank’s Composite Indicator, improves from weak to medium or Zambia continues to meet or exceeds current IMF projections, as measured by exports of goods, services and fiscal revenues.