Just a substitute solution – Kommersant

More than a year after the large-scale blocking of Russian assets abroad, the majority of investors in the Russian Federation have no problems with obtaining income from Eurobonds of Russian issuers. Owners receive payments on accounts in Russian depositories, however, in rubles. At the same time, the holders of replacement Eurobonds are currently in a better position – securities issued to solve payment problems with practically frozen “primary” securities. Buyers of replacement Eurobonds receive not only cash flow (coupon payments), but also the opportunity to sell the paper at any time. The experience of replacing bonds seemed so successful to the financial authorities and some issuers that the mandatory introduction of this mechanism for all issuers of Eurobonds is being actively discussed. And this is where new risks arise.

Money on the way to investors

The problem of payments to local investors on Eurobonds arose in March 2022 after the imposition of sanctions against the Russian Federation and is due to the fact that most Russian Eurobond holders use NSD as a depository, to which Euroclear / Clearstream must transfer funds from issuers of foreign debt securities. However, foreign infrastructure organizations stopped such operations, and, as a result, payments on Eurobonds did not reach Russian bondholders, even if the issuers made regular payments.

And the solution of this problem for the majority of issuers dragged on for many months. So, on March 5, 2022, Presidential Decree No. 95 was published, which gave the Ministry of Finance and the Central Bank the authority to issue permits for payments in the same order in foreign currency. Direct payments in response to external infrastructure barriers have become the next trend in terms of organizing external payments on corporate Eurobonds of Russian issuers, says Ilya Vinokurov, Board Member of the Association of Bondholders (ABO).

In the future, the regulation of the issue was improved. On July 5, Presidential Decree No. 430 was issued, abolishing the requirement for the repatriation of foreign exchange earnings for Russian companies. And in order to make payments on Eurobonds through Euroclear, exporters no longer needed permission from Russian regulators, Mr. Vinokurov explains. According to INGVARR partner Igor Kokin, the Russian regulator currently offers two possible options for Russian Eurobond issuers: either pay coupons and make redemptions to Russian holders in the Russian circuit, or issue replacement bonds. On August 8, Presidential Decree No. 529 was issued, which gave the right to corporate borrowers to make payments to non-residents and residents with rights in Euroclear using D accounts (in rubles, but with the possibility of further conversion into foreign currency).

Under these conditions, ABO distinguishes three groups of companies. The first includes issuers that did not agree on an alternative payment method option (in particular, Gazprom, Borets, MMK) and therefore could not pay holders directly according to the documentation. The second group includes issuers that agreed on this option in a narrow interpretation: the payment mechanism was changed only for resident holders, who were provided with payment in rubles. This category includes Metalloinvest, Polyus, Norilsk Nickel, NLMK, and Uralkali. The third group includes issuers who agreed on this option in a broad interpretation. In this case, according to the documentation, the issuer has the opportunity to pay non-residents as well (in foreign currency or in rubles, depending on its sanctions status). Among such companies are Global Ports, LUKOIL, MTS, PhosAgro, Severstal, SIBUR, Sovcomflot. As a result, a significant number of companies held a vote of Eurobond holders to amend their issuance documentation, in particular, to separate payments and allow direct payments to NSD holders.

Bonds instead of bonds

On July 14, 2022, Law 319-FZ came into force, allowing issuers of Eurobonds to issue replacement Eurobonds under a simplified scheme, these papers should provide investors in the “primary” debt securities of the respective companies with temporarily unavailable payments. The issuance procedure under the simplified scheme was valid until December 31, 2022.

To date, six companies have issued replacement bonds (Gazprom, LUKOIL, Sovcomflot, HC Metalloinvest, MMK, Borets). Most of the issues came from Gazprom (through its subsidiary Gazprom Capital). A total of 19 issues (including additional placements) were placed in dollars for $10.5 billion. In addition, nine issues were placed in euros (for €3.6 billion) and one issue each in pounds sterling (£481 million) and Swiss francs (33 .6 million CHF).

Alexander Shurakov, a leading debt market analyst at Otkritie Investments, explains that the replacement bonds have the same parameters as the original Eurobond issue (currency, maturity, payment frequency and coupon rate.— “b”), and the decision on the issue directly states the mechanism for exchanging Eurobonds for local securities. According to the results of the placement, the replacement ratio (the ratio of the volume of the local issue to the volume of the initial issue of Eurobonds) ranged from 19% to 75%, and on average – about 50%.

In addition, three issuers – PIK, Sovcombank, SUEK – issued “substitute” bonds. Unlike replacement papers, their issue was combined with direct redemption of “old” Eurobonds from the former owners. At the same time, “substitute” bonds may have different parameters (a different coupon rate, for example), and the decision to issue local securities does not indicate the exchange mechanism, Mr. Shurakov notes.

Standing apart among Russian issuers of Eurobonds is STLC (see interview). The AVO noted that the state-owned company does not pay on Eurobonds, waiting for a license from Western regulators. STLC stated that they are considering the issue of replacement bonds, taking into account the planned changes to Decree No. 430.

From a Russian investor’s point of view, replacement bonds have clear advantages over other Eurobond settlement options. In particular, their owners can sell these securities on the Russian market without waiting for redemption. In addition, as Capital Lab partner Evgeny Shatov points out, investors have tax benefits for long-term holding (three years after the purchase, the investor may be exempt from paying tax on the currency revaluation of the bond). Disadvantages of substitute bonds, according to Mr. Shatov, include their low liquidity, as well as limited choice of issuers and difficulty in forecasting returns due to the pegging of payments to other currencies. In particular, the face value of bonds of individual issues is $200,000, which limits the opportunities for private investors.

We have no irreplaceable

At present, the fundamental and key issue regarding the fate of Eurobonds of Russian companies is the mandatory replacement of Eurobonds by Russian bonds, said Nikolay Titov, a lawyer, co-founder of the law firm atLegal. In particular, the Ministry of Finance, together with the Bank of Russia, is currently working on a draft presidential decree. As Ivan Chebeskov, director of the financial policy department of the Ministry of Finance, said in mid-April, “there is already a top-level decision that, in principle, such a substitution should be.” At the same time, “there will be exceptions for companies through the decision of the government subcommittee on foreign investment not to do such a substitution in some cases,” the official explained. The draft document is currently under consideration by the presidential administration.

“Issuers are in a difficult position, because, on the one hand, they are under pressure from investors, on the other hand, they are worried that they will have to pay twice,” Evgeny Shatov points out. A large industrial company said that they do not plan to issue replacement bonds: “Substitute bonds were introduced for those cases when the company could not provide a separate payment to foreign and Russian holders. We were able to carry out such a separation, there is no need to replace something, ”the company explained.

The ICB said that they are waiting for additional regulatory acts and are working on the issue of making payments to holders in foreign infrastructure. “A mechanism for mandatory substitution of Eurobonds registered in the Russian contour could simplify the substitution procedure. For example, automatic conversion of Eurobonds into local bonds will help to avoid the risk of doubling the instrument,” the bank noted.

“The exchange of Eurobonds for Russian replacement bonds is the most effective way to ensure payments to Russian holders against the backdrop of blocking coupon payments by Western infrastructure,” Gazprom believes. At the same time, in March 2023, the company began placing additional issues for holders who were unable to participate in the initial replacements, and the work on replacing Eurobonds is planned to be completed by the end of the year.

The transition from the recommendation to the introduction of the obligation to place replacement bonds by Russian issuers will facilitate the entry of new issuers to the “replacement” market, an increase in the number of issues, and an increase in the exchange liquidity of the segment, Alexey Kovalev, an analyst at FG Finam, believes. And investors, according to him, will receive an expanded menu of tools that allow them to get exposure on hard currency in a safe inner loop. ACRA estimates the potential for additional placement of replacement bonds at $25-30 billion.

The issuance of replacement bonds is highly likely to increase local yields and fall in value as long as the discount on toxic Russian assets remains high, which provides an attractive investment opportunity for local investors to place cash in high dollar yields, while the Euroclear carousel – replaced issues – works, believes Alexander Dorozhkin, head of the share management department of Ingosstrakh-Investments Management Company. He believes that the proposed measures will have a positive impact on all investors, “some will be able to place funds at a high interest rate in high-quality issuers, global investors receive liquidity from investors participating in the carousel more than once.”

Ksenia Kulikova, Polina Trifonova