How Russia's battle for Eurobond went to the brink

18 November 2016
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By Lidia Kelly, Katya Golubkova and Sujata Rao

When Russia sought to raise money on Western debt markets this year with a Eurobond, only three people at the state-run investment bank organizing the issue were told in advance about the date and details of the launch.

The reason for the clandestine preparations: the Eurobond was a crucial step for Russia's limping economy and Moscow feared its Western adversaries might try to sabotage it by pressuring foreign financial institutions to steer clear.

"I had not experienced such secrecy in my life before," said Andrey Solovyov, head of debt capital markets at the state-run investment bank, VTB Capital, and one of the three people in the know.

Western governments led by Washington have imposed sanctions on certain Russian individuals and entities, over Moscow's annexation of Crimea and its role in the separatist conflict in eastern Ukraine, aiming to hinder access to Western financing.

The sanctions do not, however, forbid Western firms from taking part in a Russian Eurobond - an international bond denominated in a foreign currency.

Reuters interviews with about a dozen government officials, bankers and investors involved in the deal shows the lengths that Russia was willing to go to secure Western finance. The May 23 launch was shrouded in secrecy, even from managers who were going to handle it.

And it came close to collapsing in the fraught hours that followed.

Russian Deputy Finance Minister Sergei Storchak said the U.S. administration "found a way to pressure its financial institutions" to eschew the placement.

And at the eleventh hour, in a highly unorthodox move, officials had to turn to a local intermediary to handle the technicalities of the issue after two European clearing houses declined to handle it – one of them hours into the launch day, according to two banking sources familiar with the placement.

In the end, Russia placed the Eurobond in the market and raised $1.75 billion, as targeted. 

Views differ about whether this was a triumph.

Moscow said it showed it could still access Western credit markets, despite U.S. resistance. Buyers included at least one big U.S. asset manager which declined to be named due to the political sensitivity of the matter.

But some Western financial industry insiders said the issue was a hollow victory, because some of the biggest financial institutions - including the likes of BNP Paribas and JPMorgan - kept away from the primary issue, and they have the capital Russia needs in the long term.

Clearing conundrum

The fact Russia was planning a Eurobond was not a secret. This had been announced by Moscow in February and, according to multiple sources in Russian and Western financial institutions, around that time the Obama administration had advised Western players not to participate.

A U.S. Treasury spokesman told Reuters it had not barred U.S. entities from taking part, but "highlighted potential risks that could arise if sanctioned entities were indirectly involved in the issuance".

He did not elaborate, but lawyers said the main risk was that investors' money might end up going to sanctioned entities, which could theoretically breach the sanctions.

Russian officials and bankers say they acted specifically to catch U.S. officials off-guard. From about two months before the launch, they did not tell VTB Capital managers or workers - apart from the select three - about the details of the issue, such as the date and the terms offered.

Once the day of the launch came, it was a rollercoaster.

The bond was launched in the morning Moscow time, so VTB could talk to would-be clients in Europe and Asia at least for a few hours to assure them there was no sanctions risk before they received countervailing calls from the U.S. Treasury, the sources said.

The terms were attractive; the yield was 4.75 percent - a significant premium on the ultra-low yields on offer in European markets, and on existing Russian sovereign bonds.

On May 23, a Monday, the order was given to VTB Capital bankers to start pitching to clients. Would-be investors put in their bids. Business was brisk. The expectation among the organizers, and on the market, was that the order book would be closed quickly.

Yet by lunchtime, the first glitch occurred: the order book was still open.

The problem, according to two banking sources familiar with the discussions around the placement, was with the clearing houses crucial to placing such a bond.

The two big houses, Euroclear and Clearstream, act as intermediaries, taking money from investors and holding the securities on their behalf. Rules at most big banks prevent them taking part in a Eurobond if one of the two is not on board.

Before the bond launch, Clearstream had declined to get involved in the deal, according to a government source who said this was the result of political reasons, without elaborating on this.

Clearstream declined to comment.

That left Euroclear.

The two banking sources, who spoke on condition of anonymity about private discussions, said that shortly before VTB Capital opened the order book for its issue, it reached a loose agreement with Euroclear that it would act as clearing agent.

Yet by midday in Moscow on May 23, Euroclear had still not given a formal, definite answer on whether it would clear the issue or not, according to one of the bankers.

Launching without one of the two houses on board was a highly unusual if not unprecedented move for a country issuing a Eurobond, an indication of Russia's determination to place the bond.

The two banking sources said Euroclear held back because it was worried about the risks stemming from the U.S. government's attitude to the bond.

Euroclear declined to comment.


By the end of Monday, with the bond still not placed - and no international clearing house to handle the issue - investors were getting anxious.

"Rumours started to spread that 'the goods are sub-standard, rotten, that you should make a run for it'," said the first banking source. "Investors started to gradually take back their orders."

The next morning, VTB staff were fighting a rearguard action, trying to persuade customers not to withdraw orders. Senior executives at the bank kept pressing Euroclear to say if it would take part or not, the source said.

VTB Chief Executive Andrei Kostin personally called Euroclear executives, said the first banking source. Asked about this, VTB said that as sole arranger, "the bank was in contact with all parties involved in this process".

The issue had reached a make-or-break point by late on Tuesday.

"At the end of the second day, we took the decision that we're going ahead without Euroclear," said Solovyov, the VTB Capital head of debt capital markets.

It is unclear if Euroclear ever came back with an answer - but Moscow anyway had a plan B.

A month earlier, the finance ministry had got in touch with the National Settlement Depository (NSD), Russia's domestic clearing house, asking it to handle the Eurobond in case Euroclear did not take part, said NSD head Eddie Astanin.

"It was unexpected," Astanin said of that request to the depository, which had never handled a Eurobond. He had assigned his team to draw up a plan, which was ultimately put into action.

Hitting the phones

It was now evening on day two in Moscow.

VTB bankers knew they were still on thin ice regarding potential clients. While the terms offered better returns than outstanding Russian Eurobonds, the bond would not be "euroclearable" - so buyers would need to take a leap of faith, handing over their money to a Russian settlement system that was untried.

Bankers hit the phones at VTB Capital, where patriotic anthem "Rise up, vast country" was played in the VIP elevator after sanctions were imposed in 2014. Unusually, the bank's senior management also picked up the phones to clients to offer "all sorts of assurances", said the first banking source.

Some investors could not be persuaded. "We were honest and gave them feedback that because of the spirit of the sanctions we would not be taking part," said Bryan Carter, head of emerging markets fixed income at BNP Paribas Investment Partners.

One London-based hedge fund manager, who declined to be identified, said his fund wanted to buy but missed the deadline because the fund's compliance department, worried by U.S. warnings, took a long time to give the green light.

For those who did buy, there were arguments in favor.

Pavel Mamai, portfolio manager at UK hedge fund Promeritum Investment Management, for example believed U.S. investors who did not take part in the initial issue would want to buy the bond later, allowing him to sell at a profit.

"I wasn't sure it would become euroclearable but I still thought it would have upside as it came so cheap," he said. Mamai did later resell the bond, twice, and made money each time, he said.

The order book was closed soon after 8 p.m. Moscow time, 6 p.m. in London, with the primary issue raising $1.75 billion. The finance ministry said around 75 percent of it was bought by foreign investors, though Reuters cannot independently verify that.

The next morning, the bond started selling on the secondary market. Over the following days, Western investment banks included the bond in their indices, making it easier to trade.

On July 28, Euroclear started clearing the bond - meaning every investor in the world could buy it.

(Additional reporting by Kira Zavyalova and Yelena Orekhova in MOSCOW, Karin Strohecker in London, and Joel Schectman in Washington; Writing by Lidia Kelly and Christian Lowe; Editing by Pravin Char)

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