Russia Finds Way Back to Eurobond Market Riddled With Potholes

  • Lingering sanctions, local settlement risks cited as concerns
  • VTB collects $5.5 billion bids but leaves some funds wanting

Russia’s complicated return to the international bond markets may help plug a budget deficit, but it’s done little to burnish the nation’s profile with bond investors in the U.S. and Europe.

The deal, which had attracted almost $6.3 billion of bids as of Tuesday, is being managed solely by the investment banking unit of sanctioned VTB Group and may leave out money managers in Europe and the U.S. whose internal compliance departments forbid them from doing business with blacklisted dealers. The prospectus said there could be “no assurance” the bonds would be eligible for major international clearing systems, such as Euroclear Bank SA and Clearstream Banking SA, on which many foreign funds rely. Instead, they will be settled on Russia’s own National Settlement Depository.

“This issuance has just proven the difficulty of getting around sanctions, and further affirmed Russia’s isolation from international capital markets,” said Tim Ash, head of emerging-market strategy at Nomura International Plc in London. Given the hurdles for foreign investors to buy the bonds, it’s “difficult to understand why Russia would bother,” he said.

U.S. Warning

The deal has important symbolic value for the Kremlin, which has sought to minimize the impact of penalties since they were imposed in 2014 over the conflict in Ukraine which have all but frozen international markets to its companies. The finance ministry and central bank have flooded the banking industry with dollar loans and ruble funding from a rainy-day oil fund to help sanctioned companies stave off default. EU officials are expected to extend the restrictions next month or in early July.

Final pricing is expected later Tuesday and VTB is still accepting bids, according to people familiar with the matter not authorized to speak publicly about the deal. The finance ministry didn’t indicate how large the issue would be, but this year’s budget authorizes as much as $3 billion.

The government’s attempt to find underwriters for the Eurobond in February failed after warnings from the U.S. and EU led banks including Goldman Sachs Group Inc. and Deutsche Bank AG to drop out of the bidding process. Russian officials had said they wanted prominent U.S. or European banks involved to ensure the success of the issue and had shelved the plans when it became clear they wouldn’t join.

Sanctions Assurance

None of the proceeds from the new Eurobond is destined for entities subject to U.S. and EU restrictions, according to the prospectus. That assurance wasn’t enough for Giuliano Palumbo, a Milan-based money manager at Arca SGR who holds Russian Eurobonds.

“I’ll not buy on primary because I actually don’t know who can trade it and where it will trade,” Palumbo said.

Russia’s existing Eurobonds have handed investors 6.6 percent this year as the recovery in oil spurred investor appetite for assets of the world’s biggest energy exporter. The yield premium investors demand to hold Russian 2023 dollar bonds over Treasuries is 217 basis points, compared with about 190 basis points at the time of the 2013 sale. That offering included four parts, with $3 billion of 10-year securities yielding 5.112 percent.

Cash Need

Russia needs cash to finance its widest budget shortfall since 2010 after the collapse in oil, its biggest export earner, prompted efforts from talk of selling stakes in state jewels to trying to extract bigger dividends from state companies, a plan that has run into opposition.

The initial price guidance on the 10-year dollar-denominated notes is for a yield of 4.65 percent to 4.9 percent. That’s a modest premium to the 3.9 percent yield for Russia’s September 2023 Eurobond.

“At the current levels, which is about 50 basis points cheaper than the curve, it’s fairly attractive,” said Peter Kisler, who runs an emerging-market fund at North Asset Management, which oversees $1 billion of assets. He said he will participate depending on the pricing.

Investors have demonstrated a taste for more exotic bond sales this year. Argentina raised $16.5 billion in its first Eurobond since its 2001 default after receiving bids for four times that amount. Saudi Arabia is preparing its debut foray into international debt markets as its neighbors, including Abu Dhabi in April and Qatar later this week, end a dearth of issuance from the oil-exporting region. 

Sovereign dollar and euro bond sales from emerging markets have reached $65 billion this year, more than half of last year’s volume, according to data compiled by Bloomberg.

“They are certainly looking to prove a point that they can claim to be able to access international capital markets despite sanctions and everything else,” Kisler said. “I would expect it to be fairly successful despite the non-standard structure.”

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