Russian issuers and investors proved sceptics wrong in 2019, in what many have called a phenomenal year for the country’s debt capital markets given the difficult circumstances.
“We were positively surprised by the high volumes of Russian bond issuance in international markets this year,” says Olga Gorohovskaya, co-head of DCM at Sberbank in Moscow. “In the second half, we saw a flurry of issuance from borrowers, including some companies that we did not expect to come to the market this year that took advantage of the low rate environment to print debt.”
In 2013, the year before US and European Union sanctions were placed on Russia, the country’s borrowers issued 94 bonds internationally. That number dropped to seven in 2015, as sanctions were extended and more countries got behind the US and EU.
However, by mid-November 2019, Russian issuers had issued 35 bonds internationally, according to Dealogic, accompanied by a tightening of spreads across the board, which some observers say shows some normalcy returning to Russian markets.
This is more impressive considering the sanctions that the US Treasury slapped on Russian sovereign debt in response to the attempted assassination of former Russian spy Sergei Skripal in 2018. Those sanctions prevent US financial institutions from purchasing new non-rouble denominated Russian sovereign bonds in the primary market, though US investors are still buying that debt in the secondary market.
While in the past, sanctions of this scale would have meant an almost complete shutdown of the Russian debt markets, they appear to have had little effect this time. Indeed, Russian issuers have not been deterred, with 11 of them raising bonds between August 2019, when the Skripal-related sanctions were imposed, and mid-November.
Borrowers include steelmaker Severstal that raised $800m just a month after the latest sanctions and achieved the lowest ever coupon for a Russian non-government corporate issuer of 3.15%.
While those tight spreads and higher levels of issuance are in part due to declining interest rates and quantitative easing being re-introduced by the ECB, investors say they are also a sign that sanctions do not inspire fear as much as they once did.
“Investors do not care as much about sanctions anymore — it’s in their peripheral vision but more important is the nature of the issuer,” says Richard Segal, senior investment analyst at Manulife Investment Management in London.
Banks involved in Russian debt capital markets agree that in the investor community sanctions have begun to lose some of their bite.
“We saw high participation from international investors this year, despite the geopolitical restrictions in place,” says Andrey Solovyev, global head of DCM at VTB Capital in Moscow. “International investors are less sensitive to politics — they will buy debt if they are comfortable with the fundamentals and credit ratings of an issuer. From a macroeconomic perspective, Russia is very strong. Putting aside the sanctions risk, the sovereign and most corporates are A-rated equivalent.”
Norilsk Nickel, one of Russia’s most frequent and well-known issuers, raised a $750m Eurobond in October, with its lowest ever coupon. “We have seen easing on the risk premium associated with sanctions,” says Igor Burlakov, head of capital markets at Sova Capital in Moscow.
Some participants are confident that Russian markets are on their way back to normality, believing the investor community no longer sees the country’s debt as “too risky”.
“The pricing that Russian issuers have achieved in the second half of this year have been some of the lowest values I have seen in two decades — the established corporates are achieving the lowest possible values,” says Gorohovskaya at Sberbank.
This strong performance is expected to carry into 2020 as global interest rates will remain low and the Russian economy continues to improve — the IMF forecasts GDP growth of 1.9% in 2020, up from a projected 1.2% in 2019. “We could see substantial issuance in the first quarter — some people thought because it has been a busy year that it will slow down in 2020, but that is not the case. We have a busy pipeline, especially in the first half of the year,” says Segal at Manulife.
Destination: diversification
The pipeline may get more exciting if Russian issuers continue to access a widening range of foreign markets, which some say is a “de-dollarisation” tactic to reduce the fallout from potential additional US sanctions.
While sanctions may have left investors mostly unscathed, they have had a structural impact on Russian capital markets. Since 2014, Russian banks and borrowers alike have been working overtime to develop a buffer to a potential increase in sanctions.
In October 2019, Russia’s deputy finance minister Alexei Moiseev confirmed Russia would issue renminbi government bonds by early 2020 as more Russian corporates begin eyeing Chinese markets.
But it is the euro that offers the deepest alternative to dollars. Indeed, in September at the Loan Market Association’s syndicated loans conference in London, Penelope Smith, head of developing markets corporate loan origination at Commerzbank, said that the newest trend lenders were seeing in Russia was the rise of euro-denominated lending.
In 2018, 15.79% of loans raised in Russia had a euro-denominated tranche. By mid-November this year, the euro’s share had risen to 35.71%.
“Euro funding is attractive for borrowers for two reasons: firstly, it is less subject to sanction consequences, although it is not completely insular from it, and secondly, it is the natural funding base of European banks, a number of which are part of the lender landscape in Russia,” says Zvi Wohlgemuth, head of project, asset financing and emerging markets syndicate EMEA at Société Générale in London.
Siberian Anthracite raised a dual currency loan in September, effectively adding a new euro-denominated tranche to its existing dollar debt. While that is in part due to the base rates for euros dipping lower this year, many say it is also part of a broader effort by borrowers to reduce their reliance on the dollar.
“A significant number of corporates seek to avoid US dollar financing as it implies additional currency risks given that their revenues are denominated in local currencies,” says Dmitry Gladkov, acting head of investment banking at Renaissance Capital in Moscow. “Hence the interest in placing debt instruments in other currencies, including local ones, which are naturally hedged by a company’s revenues.”
Creativity among Russian borrowers has not been limited to currencies. In 2019, green financing became a focal point of discussion in Russia, with the country’s first green bond and syndicated loan signed.
In May, state-owned Russian Railways signed the country’s first international green bond, a €500m eight year bond and in October aluminium company Rusal inked a $1.1bn sustainability-linked syndicated loan, just 10 months after the US Treasury’s Office of Foreign Assets Control removed Rusal from its list of sanctioned companies.
Going green offers borrowers several benefits including improving a company’s ESG profile and drawing in new investors. Green or sustainability-linked loans look set to be feature in 2020, with one European lender saying his bank was in discussions with a number of Russian borrowers to raise ESG-linked loans in the coming months.
Low loans
Offering ESG-linked loans will be one advantage international banks will hope to press home in 2020.
They will need to play to their strengths as local banks are in a strong position, having built up high levels of deposits and reserves ,and liquidity, since sanctions were first imposed.
“There is plenty of foreign currency entering the Russian market, and ends up either in the CBR fund or in corporate accounts,” says Burlakov at Sova Capital. “That is our internal mechanism of sustaining liquidity. Over the last five years, a lot of dollar liquidity has accumulated in Russia because of its export capacities — but there are not enough financial instruments to put those funds to work.”
This vast abundance of liquidity available to Russian banks — no longer just in roubles, but also in dollars — that has translated into a strong desire to lend has proved challenging for international lenders, who are complaining of a drought in what was once a key emerging market for them.
In 2013, the year before sanctions, Russian borrowers raised 67 loans internationally. By mid-November 2019, only 14 deals had been signed.
“We have seen very low volumes in Russia with very little supply of transactions,” says Wohlgemuth at Société Générale. “It is difficult to predict volumes for 2020, but we think it will be a similar story to 2018 and 2019. We are primarily seeing depressed volumes because of low issuance rather than lack of demand, which may in part be down to local liquidity, which can be competitive.”
While in the past international banks dominated the dollar-denominated loan market, Russian corporates are finding it increasingly easy to raise non-rouble funds at competitive rates from Russian banks that are frequent users of FX swap markets.
“Russian banks are making bigger efforts to lend in foreign currencies and are offering competitive rates by swapping rouble funding into dollars in the swap market,” says a European banker who chose to remain unnamed.
International banks’ lending teams have not been aided by an increasingly attractive bond market.
“In Russia, banks are primarily working with large corporates that have access to both markets,” says Vladislav Chiriac, head of CEEMEA loan syndicate at UniCredit in London. “This increases the competition for loan products. Volumes in Russia may pick up slightly in 2020, but we expect them to remain flat.” GC