Main conclusion: New reason to buy Russian Eurobonds
We look forward to the imminent emergence of a single channel for settlements through NSD in rubles for all corporate borrowers. With its appearance, the premium on the domestic market to the external one should decrease to a minimum (bonds held by the NSD are mostly valued approximately at face value). Thus, securities within the Euroclear perimeter, which are still traded at a significant discount, look like an attractive investment object for buyers from Russia and “friendly” countries.
We also remain of the view that the risk of a cross-default on Russia’s foreign debt is extremely low due to the fact that the largest funds in the US and Europe sold the bulk of their bonds at the beginning of the year, so there will not be enough votes of holders who did not receive payments to declare default (they should be at least 25%).
What happened? Last Friday, June 3, the EU approved the sixth package of sanctions against Russia. Under restrictive measures, among other things, the National Settlement Depository (NSD) fell under the pretext that it plays a key role in the Russian financial system, being under the indirect control of the Russian government.
We have already written earlier that the sanctions against the NRM by themselves do not change the current state of affairs. They are only a legal justification for blocking depositary payments with Euroclear (which have already been suspended since the end of February). However, this event, in our opinion, may have positive consequences. It may bring investors in Russian Eurobonds closer to understanding how payments on Russian external obligations will be made.
Our view. Currently, Russian corporate borrowers do not have a unified scheme for fulfilling obligations under Eurobonds. Depending on the status of the issuer (whether on the sanctions list or not), funds are transferred either as before to Euroclear, or in ruble equivalent to NSD. The payment scheme is shown in more detail in the chart below.
Payment scheme for Russian corporate Eurobonds
Data: Ministry of Finance of Russia, ITI Capital
In view of the latest restrictions, we believe that the Russian government is highly likely to finally unify the repayment process for corporate borrowers in the near future and offer them to pay strictly in rubles using the Russian payment infrastructure.
Now the only settlement channel is being formed, the launch of which will lead to the fact that the securities in NSD, which are currently traded almost at par, will reduce the premium to offshore bonds! With sanctions against NSD, the EU has deprived all hopes of restoring the Euroclear-NSD bridge, so Russia will have to create its own internal settlement channel with all holders, which will lead to a reduction in the discount by two to three times.
In March, Presidential Decree No. 95 was issued, which determines the temporary procedure for fulfilling financial obligations. However, until now, non-sanctioned issuers have generally requested special permission from a subcommittee of the Russian Ministry of Finance to make payments in the loan currency.
Issuers have chosen this scheme to the detriment of local investors (the funds do not reach them due to the non-functioning bridge between Euroclear and NSD) in order to prevent violation of the issuance conditions, i.e. default, which could be announced by foreign holders.
Now, as more and more actively they are trying to push Russia towards a sovereign default (we do not rule out that NSD will soon be included in the US SDN sanctions list), we expect that the Ministry of Finance will soon stop issuing such permits. According to media reports, various schemes for further interaction with investors are being worked out.
Rubleization of external debt obligations
In addition to transferring payments into rubles through NSD, there is a project of the Ministry of Economic Development, which involves the issuance of “substitute” bonds. This instrument is proposed to be issued under a simplified scheme for the purpose of redemption of circulating Eurobonds (a program similar to the cancellation of depository receipts). A similar scheme, involving the replacement of currency bonds with similar ones with circulation on the Moscow Exchange, was recently chosen by Sovcombank.
Whichever way is chosen, we look forward to the soon emergence of a single settlement channel for all corporate borrowers. With its appearance, the domestic market premium to the foreign market should be reduced to a minimum (bonds held by the NSD are valued mainly at face value). Thus, securities within the Euroclear perimeter, which are still trading at a significant discount, look like an attractive investment for buyers from Russia and “friendly” countries.