Page 93 - IFR Opportunities in Russian capital markets

CHAPTER04
ifrintelligence reports/Opportunities in: Russian Capital Markets
In 2006, local sovereign bonds outstanding increased by US$9.5bn, including US$2bn raised via the GSB placement. In 2007, ING expects total bonds outstanding to increase by another US$9.1bn, including US$3.1bn of new GSBs.
By the end of 2007, ING says the total amount of traded federal bonds will reach US$39.3bn, up US$6.1bn for the year. This estimate is based on the government's plans to place US$8.5bn of OFZs in 2007 and the redemption schedule of traded bonds as of the start of 2007.
The OFZ market
The big bond story of 2005 was the recovery of the domestic sovereign bond market – the OFZ and to a lesser extent the MinFins (Ministry of Finance Bonds) – that has lain moribund since the 1998 financial crisis.
OFZs are ruble-denominated bonds issued by the Ministry of Finance with maturities of between one and 30 years, OFZs pay annual, semi-annual or quarterly coupons; coupon payments may be fixed or variable; interest income is not subject to income tax. MinFins are Russian treasury bills, denominated in US dollars and issued on behalf of the Ministry of Finance.
The rally took off at the start of August 2005 and sent prices up 6% in two weeks, just as the RTS passed its all-time high. The longest maturity bonds were leading the charge: the yield on the OFZ 46018 bond, which matures in November 2021, saw its face value rise by 5.8% over the first two weeks of August and its yield fell below 8% for the first time in the market’s history.
The OFZ had been trading on a par with Gazprom and City of Moscow’s benchmark domestic bonds, which are still in high demand from foreign investors. Gazprom issued its cheapest ever RUB5bn four-year bond in August with a yield of just 6.95%, well below lead manager Renaissance Capital’s expected yield of 7.25–7.36% and about 150bp less than comparable bonds from the likes of the Russian Railways corporation. Russian bond traders say the Gazprom bond was as cheap as an OFZ and driven artificially low by foreign demand.
The other major event in this asset class was the issue of the first 30-year OFZ, which fills in the missing box at the long end of the yield curve.
The OFZ market has been de facto closed to foreign investors, due to special reserve requirements forcing them to freeze a portion of their ruble assets for 12 months with the CBR, without interest. These restrictions were removed as of 1 July 2006, when the ruble became a fully convertible currency, opening the doors to the OFZ market (as well as to all other financial markets) and reinstating the OFZ as the key benchmark curve on the local market, which was lost in 1998 after the financial crisis.
The OFZ are becoming particularly popular among foreign investors and hedge funds, which appreciate their low risk and were switching out of corporate bonds into the state bonds as the rally built up some momentum. Traders said everyone was getting into the game by the middle of the month, including small banks that are not normally players on the bond markets.
The rally in the OFZ was due to a change in policy by the Ministry of Finance in 2005. The government issued eight times more domestic debt in 2006 than the US$1.1bn it plans to raise abroad – mainly from the EBRD and World Bank for structural reforms – and is willing to pay a bigger yield premium to bring in the investors.
Domestic bond ownership
Foreign investors are thought to hold about half of the domestic bonds outstanding. Numbers are sketchy, however, as most foreign investors have bought via one of the Russian-registered legal entities, so their investment shows up in the statistics as banks, which are the single biggest players on the domestic market with a 60% share (see Figures 4.14 and 4.15).
The second largest class is institutional investors, which hold around 36% of total domestic debt securities. This class comprises the State Asset Management Company (Russian acronym: GUK) and insurance companies, mutual funds, non state pension funds and other asset management companies, and has grown significantly over the last two years, increasing its market share. This process has been influencing the market's development and pricing, since institutional investors enjoy essentially free funding and are thus indifferent to the state of the money market and currency exchange rate, and depend mostly on the inflow of funds under their management.
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