Weekend Economists Go Eat Worms March 27-29, 2015

[Demeter]

11. Ilargi: Kiev, Moscow, Bonds and Haircuts By Raúl Ilargi Meijer

editor-in-chief of The Automatic Earth. Originally published at Automatic Earth

http://www.nakedcapitalism.com/2015/03/ilargi-kiev-moscow-bonds-haircuts.html

When money managers talk outside their narrow field, nonsense is guaranteed to ensue. No better example than this Bloomberg piece on Ukraine’s ‘debt restructuring’ plans, which are as much a political tool as they are anything else at all. Ukraine’s American Finance Minister has announced a broad restructuring plan with a wide range of severe haircuts for creditors, and she – well, obviously – wishes to include Russia in the group of creditors who are about to get their heads shaved. And despite all obvious angles to the issue that are not purely economical, Bloomberg presents a whole array of finance professionals who are free to spout their entirely irrelevant opinions on the topic. If you didn’t know any better, you’d be inclined to think that perhaps Russia is indeed just another creditor to Kiev.

Putin Plays Wildcard as Ukraine Bond Restructuring Talks Begin

As Ukraine begins bond-restructuring talks, it finds itself face-to-face with a familiar foe: Russia. President Vladimir Putin bought $3 billion of Ukrainian bonds in late 2013. The cash was meant to support an ally, then-President Yanukovych.

That is, for starters, a far too narrow way of putting it. Russia simply wanted to make sure Ukraine would remain a stable nation, both politically and economically, because A) it didn’t want a failed state on its borders and B) it wanted to ensure a smooth transfer of its gas sales to Europe through the Ukraine pipeline systems. Whether that would be achieved through Yanukovych or someone else was a secondary issue. Putin was never a big fan of the former president, but at least he kept the gas flowing.

While his government fell just two months later, Russia was left with the securities. Now, those holdings take on an added importance as Putin’s stance on the debt talks could affect the terms that all other bondholders get in the restructuring. Russia, which is Ukraine’s second-biggest bondholder, has maintained that it won’t take part in any restructuring deal. Here are the three most likely tacks – as seen by money managers and analysts – that Putin’s government could pursue.

Here’s the biggest issue here, one which Bloomberg conveniently omits. Not only was Russia left with the securities after the Maidan coup (or revolution if you must), but the money provided through them to Ukraine began to be used to organize and fund various battalions and other groups, thrown together into a Kiev ‘army’, that started aiming for and at the Russian speaking population in East Ukraine. 6000 of them did not survive this. The same would have happened in Crimea (Moscow is convinced of this) had not Putin made it part of Russia before that could happen. Do note that one of the very first decrees issued by US installed PM Yatsenyuk and his ‘cabinet’ was one that banned Russian to be used as an official language by millions of people who speak only Russian. That Yats withdrew the decree within a week didn’t matter anymore, the game was on right then and there.

Ukraine, after gaining a lifeline from the IMF, included Russia’s bond among the 29 securities and enterprise loans it seeks to renegotiate with creditors before June. Finance Minister Natalie Jaresko has promised not to give any creditor special treatment. The revamp will include a reduction in the coupon, an extension in maturities as well as a cut in the face value, she said.

Russian Deputy Finance Minister Sergey Storchak said March 17 that the nation isn’t taking part in the debt negotiations because it’s an “official” creditor, not a private bondholder. If the Kremlin maintains this view, it would be “negative” for private bondholders as “other investors will be more tempted to hold out as well,” according to Marco Ruijer at ING. He predicts a 45% chance of a hold out, while Michael Ganske at Rogge in London says it’s 70%.

Here’s where we get into la-la land, with money managers speaking out on things they don’t know anything about. Which can then be used to lead up to a goal-seeked conclusion, as we will see. Because of the situation I painted above, Russia cannot and will not take part in the ‘debt negotiations’ the west tries to shove down its throat through Jaresko’s restructuring plans. If only because as soon as the restructuring has given Kiev some financial breathing space, is will use it to reinforce its troops and go after its Russian speaking compatriots again. It’s a not a finance issue at all, it’s life and death, and that makes percentages thrown around by money guys behind desks in high rises not just futile, but positively inane.

There is little precedence of sovereigns and private bondholders taking part in the same talks, given that a nation’s debt considerations include a “foreign-policy dimension,” according to Matthias Goldmann at the Max Planck Institute in Heidelberg, Germany. Ukraine and Russia may need to find an “appropriate forum,” such as the Paris Club, for separate negotiations, he said.

Holding out can lead to two outcomes: Russia gets paid back in full after the notes mature in December, or Ukraine defaults. The former option is politically unacceptable in Kiev, according to Tim Ash at Standard Bank, while the latter would likely start litigation and delay the borrower’s return to foreign capital markets, which Jaresko expects in 2017. “Russia will be holdouts, to try and force a messy restructuring,” Ash said by e-mail on March 19.

No, Russia is not interested in a ‘messy restructuring’. It will simply refuse to throw Kiev’s aggression against its own people a lifeline, and it will insist on finding that “appropriate forum”, instead of the one Jaresko tries to force it into. Russia will demand to be paid in full, and if that means a Ukraine default, it is fine with that. Don’t forget that the $3 billion in bonds is by no means the only debt Ukraine owes Moscow. There are many billions in unpaid gas purchases, and undoubtedly many other bills.

If Russia holds out and litigates, there is a “real threat” that Ukraine will deem the Eurobond an odious debt, Lutz Roehmeyer at Landesbank Berlin said. This refers to a legal theory that a nation shouldn’t be forced to repay international obligations if they don’t serve the best interests of the country and its citizens.

Nice theory. Why don’t we have Greece use it too? Russia would obviously never accept this. At the very minimum, gas would stop flowing through Ukraine to Europe.

The chance of Russia joining the talks is about 10%, according to ING’s Ruijer and Rogge’s Ganske. If Russia joins it would be “somewhat positive as all investors will be treated equally, and then it can be resolved quicker,” Ruijer said.

These guys really have no idea what’s going on. They see the planet exclusively in dollar terms. And they have no idea why they said 10%, might as well have been 5% or 25%. Hot air.

Bank of America said in a note last week that Ukraine will seek a principal reduction of about 35% in its opening salvo, which may be rejected by creditors. It said that bond valuations around 40 cents on the dollar, indicate a probability of a 20% reduction in principal as well as a reduction in interest rates. Ukraine’s benchmark 2017 dollar notes traded at 37.8 cents on the dollar on Thursday.

Sounds like things in the real world are already much worse than in BoA notes.

“By participating in the talks, Russia would have a better chance of getting a deal it wants,” Liza Ermolenko at Capital Economics, said. “However, it seems that politics, rather than economics, will be behind whatever Russia decides to do.”

No kidding, Liza.

There is no collective-agreement clause which could make any deal binding for Russia, Anna Gelpern, a Georgetown law professor, said.

And there we get to the core of the matter. If Jaresko wants to force anything on Russia, she’ll have to move outside of the law. Which I’m sure she, and the US cabal that rules Kiev, would be more than willing to do, but it would mean a default no matter what happens, simply because time is of the essence, and the issue would drag on for a long time.

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