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bne March 2020
only make the problem more complicated as each of these has its own agenda.
The issue comes to a head in Russia’s sovereign bonds, which are a part of all emerging markets indices, widely held by foreign investors and key to running Russia's financial and banking systems.
Ironically one of the unintended consequences is that thanks to the fiscal fortress Russia currently has become a safe haven for international investors, which have been piling into its bonds and stocks: both the bond and equity markets soared last year, which ended with Russia among the top three best performing markets in the world.
As bne IntelliNews has reported foreign investor participation in the OFZ market currently lies at over 30% of total outstanding debt. Excluding less-liquid instruments, it is closer to 50%, says the IIF. Demand for these bonds has been so strong that the bonds have been issued at a discount to their price on the secondary market – a very rare phenomenon.
“The OFZ market attracted around $16bn in non-resident flows in 2019 alone, and such inflows made up more than two-thirds of net OFZ issuance. To put this number into
Foreign investors have reengaged in OFZ
Opinion 51 perspective, the total outstanding OFZ stock at this point
is $142bn,” says the IIF.
Of the foreign share of OFZs it is only possible to identify the country of origin for about a fifth of the bonds, but more than half of that fifth are from the US with another 40% coming from Europe. So any sanctions on Russia’s sovereign debt hits US investors hardest.
Sanctions preventing US investors buying primary issues
of Russian sovereign bonds last year had little effect. No
one sold the bonds they already held and Russia doesn't
rely on international borrowing to fund its budget: the total outstanding Eurobonds only account for 2% of GDP, or some $40bn as of 3Q19. Indeed, more sanctions on the sovereign Eurobonds will only stop the government from issuing more, but the scarcity of Russian Eurobonds will actually drive demand for the existing ones up, argues the IIF.
And new sanctions on Russian Eurobonds can be dodged, as it is possible to issue a US dollar-denominated Eurobond using another currency. Indeed, recently issued Russian Eurobonds now have a “sanctions clause” that allows the issuer to settle in another currency, like rubles, if the bonds are sanctioned.
Sanctions on the secondary market for Russian bonds is
a different kettle of fish and could have major consequences. Everything will depend on just how comprehensive these sanctions are. They could range from a ban on buying any new issues to the extreme of forcing investors to divest their entire holdings.
Forcing US investors to sell would mean US investors would have to write off their circa $20bn worth of holdings of OFZs: if you are not allowed to own them then there is no one who can buy them. The Russian Ministry of Finance has said it may buy investors out in this case, but the losses to US investors would still be substantial as they would be sold at default prices.
Another consequence of sanctions on OFZ primary issues (but none on buying on the secondary market) would be to boost the income of Russia’s domestic banks, while killing off the business of the foreign banks working on Russia’s capital markets. While the share of foreign owned banks in the Russian market is small (6.5%) their share of the OFZ trading is large, on a par with the Russian banks, as they act as intermediaries for international bond traders. Sanctions on the primary issues would kill this business entirely and drive it into the hands of the domestic, largely state-owned, banks.
Sanctions would also affect the currency markets and have far-reaching consequences. Over the last few years the ruble has become one of the most heavily traded foreign currencies on the FX markets and the OFZ is highly important to these markets, where they are used to manage liquidity and as
a value store to park cash. Any restriction placed on trading OFZs could cause this currency trade to dry up.
Source: Central Bank of Russia, IIF
U.S. investors hold large share of OFZ
Source: Bloomberg, IIF
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