While Cuba is intent on updating its socialist economy and keen for the US embargo to be lifted, the workings of commercial creditors in pursuit of repayment reveal the extent of the challenges facing the country. This is sovereign debt restructuring, but not as we know it.

Cuba's debt cloud embedded

On the one side there is a former communist country in default for more than 30 years, now willing to re-engage with the international community but still on the world’s most punishing sanctions list: the US embargo. On the other side is a group of investors hoping to cash in on their claims on the country’s sovereign debt before it is allowed to re-enter the international community. The debt in question dates back to more than 30 years ago.

The tale of Cuba and the commercial creditors under the umbrella of the London Club is one of formal correspondence, unofficial talks and unique opportunities for all involved. The London Club group has three official members: specialist investor Adelante Exotic Debt Fund, family office Stancroft Trust, and CRF I, a fund solely dedicated to investing in Cuban foreign debt. In April, Rodrigo Olivares-Caminal, a banking and finance law professor at Queen Mary University of London who advised two creditors in the recently closed Argentine default saga, was appointed as the group’s coordinator; he is talking to other investors as well as banks about joining the trio. One bank in particular is about to take part in a subcommittee of the group, according to a person familiar with the situation.

Talking to The Banker in early July, the academic had yet to receive formal acknowledgement of his initial letters to the Cuban authorities, but the fact that its ambassador to the UK, Teresita Vicente Sotolongo, took part in a recent roundtable discussion on the country in London, where he also spoke, is considered to be an encouraging sign. “We are ready to engage in meaningful discussions with the Cuban government. Whenever it is ready, we are ready; but my advice would be to try and settle before the US embargo is lifted,” says Mr Olivares-Caminal. Other investors outside of the group have attempted to engage in unofficial talks with the country, according to one source.

Race against time

So why the rush? Surely waiting a little while longer cannot matter to anybody taking on Cuban debt, especially as the decades-long US embargo has practically made the country off-limits for most international investors (finding a bank willing to act as custodian of the paper is next to impossible). But there is more to the story. When sanctions are fully lifted – and the most optimistic experts say this might happen as early as 12 to 18 months from now – Cuba will become an acceptable target for US hedge funds, which may tempt existing creditors with a quick and painless sale.

In that case, the country would be confronted by more aggressive counterparties, and the potential for a deal that would open up longer term opportunities for existing creditors would diminish. One expert familiar with the situation says that he would consider a debt-for-equity swap, hoping to get a stake in the opening economy. 

“At the moment, the group of investors under the London Club is very united in trying to do a mutually beneficial deal with Cuba. If the embargo is lifted and the big US firms get involved, such as those that were involved in Argentina, a deal will be much harder to do,” he says.

Jacques-Alexandre Genet, founding partner of Archipel Law, which advised Elliott Management, the lead hedge fund in the long legal battle against Argentina, says: “If you’re Cuba, you’re standing alone right now. You need partners, you need to reassure everybody that you welcome foreign investment, and a settlement with commercial creditors is the typical sign you’d need to send now, rather than in two, five or 10 years’ time after litigating the Argentine way.”

He adds that a protracted legal battle would damage both the defaulted government and the funds suing it. “Everybody focuses on the returns the funds supposedly made in the settlement with Argentina. But if you look at the time it took them to get there, I’m not sure many of these funds, small or big, would like to a have a remake of Argentina. It was an increasingly tiresome and painful process for everybody,” he says.

The London Club group owns about $1.2bn of Cuban paper, and total claims are estimated to be between $6bn to $8bn, including interests and late payment charges, according to Mr Olivares-Caminal. Some believe that this paper represents about 40% of all defaulted debt lent by commercial creditors.

Decades of stalemate

In 1986, Cuba declared a moratorium on commercial banks and Western governments that had lent it money; by 2011, following plans to update its economic model, it began talking to foreign lenders again; in 2014 it approved a law that facilitates foreign direct investment; and a year later, almost three decades after the moratorium, it closed a deal with sovereign creditors. On December 12, 2015, news emerged that Cuba had reached an agreement with a group of 14 countries out of the 20 members of the Paris Club, under which the country would pay $2.6bn over 18 years, with the first payment due in October 2016. The Group of Creditors of Cuba’s total claims were $11.1bn, including interest and late fees. After relatively short negotiations, following the rapprochement that began in 2011, the deal marked Cuba’s first step towards rejoining the international community.

Full content of the agreement will remain unclear until each creditor discloses the final details of its own bilateral agreement with Cuba, but according to documents seen by Mr Genet, 100% of punitive interest was cancelled provided that the country makes the repayments on time. Such punitive interest may have represented up to 70% of the group’s claims, he believes. 

“I was a bit surprised that Cuba didn’t immediately use the momentum created by the Paris Club’s group agreement to settle with commercial creditors. Given the time this debt has been in default, there’s a tremendous opportunity for the Cuban government to negotiate more than fair conditions with those creditors,” says Mr Genet.

Although there do not seem to be concerns about Cuba’s ability to meet the first payment, the international community has been left guessing as to the country’s foreign currency levels – data has never been made available – and whether there is any scope for paying commercial creditors too. Furthermore, official figures on gross domestic product (GDP) are unreliable and those regarding passive debt out of date, according to Stuart Culverhouse, chief economist at Exotix Partners, an investment bank specialising in frontier markets.

One country, two currencies

There are other complications when attempting to analyse Cuba, such as its dual currency system. According to Cuban authorities, GDP is about $80bn at the official exchange rate to the dollar; foreigners would buy Cuban convertible pesos, one of the country’s two currencies, at this rate. But if the government’s internal transaction rate of 24 pesos to the dollar is used, GDP would plummet to just $3.5bn. This is the value of the Cuban peso that the population is paid in and uses to buy most essential products.

Exotix believes that a figure between $30bn and $50bn is a more plausible value for the economy. It estimates that in 2014 foreign debt was about 43% of GDP, based on officially reported GDP and an estimated claim value for defaulted official and commercial debt. Despite Cuba’s efforts to generate more data, authorities have backtracked in some cases: data on passive debt, for example – accumulated debt that it is not repaying – has not been made available since 2011, according to Mr Culverhouse. Adjusting for the recent Paris Club’s group agreement, foreign debt would fall to 28% of official GDP.

The US has levied comprehensive economic sanctions on Cuba since 1960 as part of its larger Cold War against communism, prohibiting US businesses from engaging in any activities with the country or any of its counterparties, including the purchase, holding or selling of Cuban property and financial assets of any kind. US citizens were not allowed to visit the Caribbean island. Despite the announcement in late 2014 of a package of measures to normalise relations with Cuba, it remains untouchable for US investors as well as banks, and European lenders have been hit by severe fines for failing to obey US rules. In 2014, US courts fined Paris-based BNP Paribas $8.9bn for breaking sanctions against Cuba and other blacklisted states. Last year, Commerzbank agreed to pay $1.45bn to settle similar allegations and separate charges.

But times have changed for both the US and Cuba. Washington has started to relax its stance, formally re-opening its embassy in Havana in 2015 and easing restrictions on tourism and dollar transactions with the country. Experts believe that irrespective of who inhabits the White House after presidential elections in November, the US will not backtrack on the normalisation of its relations with Cuba.

In search of foreign money

Having grown dependent on benefactors aligned with its political principles – particularly Venezuela and Russia – Cuba now finds itself in a tight spot. After the collapse of the Soviet Union, Venezuela became a key partner and source of cheap oil, which it provided in exchange for the expertise of Cuba’s well-trained professionals, particularly doctors. But with Venezuela near economic collapse itself, its contribution to Cuba’s cause is in question. Furthermore, sympathetic Russia is dealing with its own financial troubles, while a lack of growth in Europe, which has an open trade relationship with the country, has further blocked the flow of capital.

Cuba now needs foreign investment, foreign currency (to buy its many imports), and to insert itself in international supply chains to chart a sustainable growth path. It also needs to provide more employment options to its citizens. In 2011, Cuba announced the opening of certain retail sectors to self-employment. The economy continues to be heavily run through state-own enterprises led by the political and military elites, but change is coming to the everyday lives of ordinary Cubans, who can now supplement their income by using their home as tourist accommodation or a restaurant, for example.

According to the US Central Intelligence Agency’s World Factbook, there are about 476,000 so-called cuentapropistas (self-employed people), among Cuba’s population of 11 million. Reforms have also allowed private ownership and the sale of real estate and new vehicles, as well as allowing private farmers to sell produce directly to hotels. A law was passed in 2014 to facilitate foreign direct investment and, a year later, the first Cuba-based companies were allowed to operate in the newly created special economic zone around the Port of Mariel, west of Havana, which aims to attract overseas firms.

Scrutiny will be intense on Cuba’s repayment to the group of 14 sovereign creditors in October, amid speculation about a deal with the London Club group. Nicholas Berry, chairman of Stancroft, has been investing in the country for 16 years. He has no time concerns, no clients to satisfy and no lenders to return money to: Stancroft is his own, self-sufficient family trust. He acknowledges both the risks of hedge funds swooping into Cuba as well as the difficulties of settling before US restrictions are lifted, though he may be in a minority as others feel the urgency of reaching a timely agreement. It is unclear if Cuba has the same concerns. As one anonymous professional puts it: “The London Club is the last piece of the puzzle Cuba needs to go back to international markets, but it doesn't see the game theory around it: it’s worth more than the other pieces they already have.”


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