By Maximilian Hess
The Russian government has continued to tap Western bond markets despite worsening relations between Russia and the West since Moscow’s 2014 invasion of Ukraine, the annexation of Crimea, and the sanctions that followed. Foreign investors have continued to strongly back Russian eurobonds as well. The sales highlight that investors are still willing to underwrite the Russian government in the search for yield. That may be about to change.
Post-Crimea Russian bond sales
Russian sovereign and sub-sovereign bond sales in Western markets did grind to a halt after the initial round of sanctions; issuances from private Russian firms also slowed to a trickle. This began to change in October 2015, when Gazprom issued a EUR1bln three-year Eurobond organized by JP Morgan and Unicredit. Demand clearly remained healthy despite the intervening war and sanctions, sufficient for more than three-times the issuance. By the following March, it appeared that such issuances would be widely welcomed in the market again – Gazprom issued a CHF500m note that also saw heavy demand. It was organized by Gazprombank, Deutsche Bank, and UBS.
Two months later in May 2016, Russia returned to the Eurobond market issuing a US$1.75bln ten-year note. However, its sole organizer was VTB Capital – the Russian state-run investment and trade bank. The issuance was seen as a test. Initially the clearing agencies that process such transactions for investors – Euroclear and Clearstream – held off on accepting them over concerns they could invoke the ire of US regulators. Despite the inclusion of sanctions clauses in the bonds, there were concerns the funds could be used to circumvent US sanctions limiting financing to certain Russian entities. However, by July such concerns were sufficiently assuaged.
Russia’s next sovereign Eurobond issuance, again organized by VTB, raised US$3bln in June 2017. Demand for the notes among western investors was as was demand for renewed sub-sovereign issuances from Gazprom. Issuances by Rosneft, Transneft, Gazpromneft, and Russian state-owned banks, however, dried up as they were blocked by EU sanctions placed on those firms in July and September 2014. Nevertheless, the hunt for yield and general boom for emerging market credits that has been witnessed in the last few years meant that Russia continued to maintain healthy access to Western capital.
The contrast between diplomatic and investment relations became a political matter itself this March. Gazprom sold EUR750m in debt in London the same day that British Prime Minister Theresa May announced Britain believed Russia was responsible for the use of a nerve agent on British soil. Two days later, the Russian sovereign issued US$4bln in bonds out of London as well. Again they were primarily invested in by foreigners despite Russia’s attempt to market them as an instrument for repatriating capital. The contrast provoked Conservative MP Tom Tugendhat, chair of Parliament’s Foreign Affairs Committee, to suggest to Secretary of State Boris Johnson that Britain consider banning such sales.
Johnson only described Tugendhat’s proposal as interesting but the issue will be debated further. The Guardian After all, London aims to retain and even bolster its status as a home for global capital once Britain leaves the European Union in just 11 months’ time. This is a significant part of the Brexit strategy being put forward May’s Conservatives, and a bond ban would damage proposals for recasting London as the Singapore of Europe if geopolitical interests are allowed to affect business policy.
US-UK Joint Effort?
The only real competitor to London for sovereign and sub-sovereign bond issuances is New York. If Russian state bond sales were to be banned in the US, it would make it politically and strategically digestible for Westminster to follow suit. The impact on Russian sovereign credits would likely be devastating as well and it is difficult to imagine a new alternative sovereign debt market emerging anytime soon.
On 5 April, Democratic Congressman Joaquin Castro and Republican Congressman Mike Turner introduced a bill that would bar Russia from selling bonds and foreign exchange swaps with a maturity longer than fourteen days in the United States. The bill would also proscribe a number of Russian state-owned banks from doing so: Sberbank, VTB Bank, Gazprombank, the Bank of Moscow, Rosselkhozbank, Promsvyazbank, and Vnesheconombank. However, Directive One of Executive Order 13662 already proscribes all of these banks, except Promsvyazbank, which is likely to be sanctioned in due course, from doing so.
Castro and Miller’s bill must still go through the committee stage and there will be earnest lobbying against it if it does appear to be proceeding. After all, bankers in New York will be worried that unilaterally passing it could bring fallout from the sword of Damocles known as Brexit hanging over their counterparts in London upon them if Parliament does not also introduce the measure. Misalignment of policy would boost London’s attractiveness for sovereign debt issuances over New York. The pair’s bill is, however, directly tied to the UK – indeed it is named the “Stand with UK against Russia Violations Act.” If a Russian bond ban is to be passed, it would quite likely have to be coordinated between the US and British governments.
There is precedent for the US to ban bond issuances. The most recent example is Executive Order 13808 issued in August 2017 that barred Venezuela from selling new bonds in the US. Venezuela subsequently defaulted, although this was already expected. Nevertheless, the move is expected to cause significant difficulties for any eventual restructuring. A more applicable example may be Executive Order 8832, which froze Japan’s financial assets in the US in July 1941. The move halted Japan’s ability to repay bonds and forced the Yokohama Specie Bank, the closest contemporary equivalent to Russia’s VTB, into insolvency.
There are those who argue E.O. 8832 played a role in Tokyo’s decision to launch the attack on Pearl Harbor. While that is perhaps hyperbole, the geopolitical significance of a Russian bond ban would also be significant; those private Western investors willing to underwrite Moscow and its firms would have to be replaced. Other lenders such as China may step in to fill their shoes. Banning Russian sovereign bonds would have potentially immense ramifications for the Russian economy even if such a savior were found. Yields even on its ruble-denominated debt, which foreign investors have also been scoping up, could spike and it would probably affect global oil and gas markets as well – perhaps the reason Gazprom and Rosneft were not included in Castro and Miller’s initial bill although they are often used explicitly as geopolitical tools.
As a result, careful consideration should be undertaken before the US or UK move forward with such a ban. Russian sovereign bond sales could likely be limited by additional sanctions targeting VTB, the sole organizer of such issuances since 2014, by further amending E.O. 13662 and EU Regulation 833/2014 if the aim is to restrict rather than completely cut off Russia from Western finance. While a bond ban may be brewing, so far proposals in London and the US make for rather weak tea.