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Russian corporates face rising rates challenge

Russian corporates have had a storming year. They printed a record breaking $21bn of Eurobonds in the first half of 2013, eclipsing their full year issuance of $15bn in 2012.

Long regarded as being clumsy in the international markets, these issuers are becoming ever more polished, reacting quickly to the wider market, printing inflation-linked deals and being careful to not expose themselves to currency risk. They are also innovating, finding new ways of attracting pension fund money and encouraging international investment.

With the corporate domestic market likely to become Euroclearable later this year, these issuers will have a deeper pool of funding open to them. Local money represents a cheaper and easier option for them than the international market and with careful fostering could be a big opportunity for corporates that have shied away from issuing Eurorouble notes thus far. 

But there are storm clouds ahead. Amid US Treasury volatility, Russian companies have, of late, struggled to drum up the same levels of demand that they were able to attract just a few months ago. A period of reappraisal as far as pricing, maturities and execution is surely ahead as borrowers and their bankers adapt to the new, tougher market conditions. 

Some of the country’s leading company borrowers gathered in Moscow in early June to discuss their future funding options at the EuroWeek Russian Corporates Roundtable.

Participants in the roundtable were:

Pavel Aananienko, treasury director, Sibur

Oleg Gordienko, head of the investment banking division, Raiffeisenbank

Pavel Isaev, head of fixed income, Gazprombank

Olga Kirichenko, global head of debt, Gazprom Neft

Elena Lukovkina, head of capital markets and international tax, Evraz

Maria Merzlikina, head of corporate finance, Federal Grid Company (FSK)

Aleksey Nikonov, treasury director, Vimpelcom

Tatiana Orlova, head of DCM and investor relations, Russian Railways

Nicolas Pascault, CFO, Brunswick Rail

Svetlana Ushakova, director for corporate finance, Megafon

Moderated by Francesca Young, emerging markets editor, EuroWeek


EUROWEEK: This year so far has been a record breaking one for Russian corporate bonds, with over $20bn already issued. With fears of rising US Treasury rates, can the second half of the year be as busy?  

Nicolas Pascault, Brunswick Rail: US Treasury rates have been increasing and as a result, our yields have increased as well versus a few weeks ago, but so far the credit risk premium has been quite stable. So it’s still a good time to print even though it’s a more challenging environment. We’re going to need to be prepared for it to get more expensive so we think it’s good to try to use this current window.

For us, leverage is quite important, and it’s a huge part of our P&L, so yields are very important. But there is no point in us raising money if there is no use for it.

Our need for raising bonds and loans will be driven by our M&A transactions.

Pavel Aananienko, Sibur: At the beginning of the year Sibur issued a $1bn Eurobond that, for some time represented the lowest coupon to ever be achieved by a Russian corporate for a five year dollar deal. From a pricing point of view it is extremely difficult to justify a second, substantially more expensive issue in 2013, having had the record breaking transaction in the first half. It would raise a lot of questions. The most obvious one being ‘why didn’t the company borrow more in January?’ 

From this point of view, I think 2014 is a better year for issuing, because by then, whatever successes people had in the first half of 2013 are already forgotten. 

Also a large size Eurobond issuance frees up a lot of bank limits, and creates a massive overhang of credit appetite from the banks versus the company’s credit needs. A good treasurer uses such competitive situations in order to achieve lower rates on the bank side, immediately after the massive bond issuance.  

It’s a kind of game, where there’s always an arbitrage between two markets — the public market and the bank market.

EUROWEEK: So does this mean that the second half of the year could be focused more on funding opportunities away from the Eurobond market?

 

Olga Kirichenko, Gazprom Neft: Gazprom Neft is more or less done this year in Eurobonds, but if the market situation changes for the better, we would still consider going to that market.

But not only have there been rising US Treasury rates and the eurozone situation to make yields higher, but we have also recently had this situation in Turkey. That country was an island of stability in an emerging market sea, and look what has just happened — it makes people question the quality of the emerging markets overall. I’m afraid that investors will be scared about this, and will put even more pressure on our trading. Spreads and yields could go up even more than the US Treasuries in the coming few months.

Svetlana Ushakova, Megafon: As opposed to many of the other corporates here, Megafon is a Russia-focused company with the majority of its revenues derived in roubles, so for us, the domestic bond market is quite important. We have also fulfilled our financing plans for this year, by going to the domestic bond markets early. However, as opposed to the dynamic of rising costs in the Eurobond market the local bond market could offer some good opportunities later on this year. There is potential in the local market in the second half of the year as the corporate bond market becomes Euroclearable and also in anticipation of Central Bank of Russia rate cuts.

It’s no longer the question of if we see the CBR cut rates, it’s just by how much and when exactly.  

Ultimately though, you cannot predict the market and have to tap it when you have the need as the windows still are quite short term.  

It’s becoming a common strategy to borrow for all the refinancing and capital expenditure requirements in the first half of the year when the markets are there and then wait to see if there are opportunities later to take advantage of and further optimise the debt portfolio.

Tatiana Orlova, Russian Railways: Russian Railways intends to raise around Rb200bn in 2013, including refinancing plans. We have been quite active, both in international and local markets. We’ve so far done two transactions internationally, one in the international market in Swiss francs and another in euros. We did two transactions in the local market. 

I also see some dramatic and positive changes on the local market. In April, we issued seven year roubles in the local market and demand was so outstanding that we could lower the coupon twice, and fix it even lower than the lowest rate suggested to the market.

Yesterday, we closed our first infrastructure bond in the domestic market, which has a 30 year maturity. That is the longest from the corporate segment ever.

So we see some real developments on the local market, I think that it could offer better potential for Russian issuers than international markets.  

We are monitoring what’s happening on the international market as well, and we see that these spreads are going wider and sometimes there are good windows, but they are available for only a very short period of time, so you have to be waiting for them and be quick to take advantage. And our estimate is that the spreads on the international market will go even wider in the second half of the year.  

We don’t intend to be in the international market before the end of this year. We’re going to mainly focus on the local market.

EUROWEEK: Do many of you think the domestic market will be better than the international one for funding in the second half of the year?

Oleg Gordienko, Raiffeisen Bank: Investors in the rouble bond market are just more relaxed than the international ones. They take it for granted that the markets can be volatile, but they still put on their teeth and bite. We closed a Rosneft deal today, together with Gazprombank, at a record low coupon rate, and that was Rb40bn, a fairly nice size.

Pavel Isaev, Gazprombank: Let’s be straightforward, it’s a huge size!

Gordienko, Raiffeisen Bank: So we managed to do a Rb40bn 7.95% bond even though the wider environment is a bit murky. Eurobond yields have, meanwhile, jumped up around 100bp in yield in just five days, so to be able to close a sizeable rouble market deal like this underlines that Russians have much more nerve for it, so volatility is less of a problem.

Isaev, Gazprombank: I don’t see any argument for bond volumes to grow in the second half. If you look around at the companies at this table, everybody has already issued in at least one market, domestic or local and many have even used both! It’s the same for the whole market of Russian corporates.

I doubt people have put aside huge amounts for refinancing needs, but those can be addressed by banking lines, and I don’t believe there are huge capex plans to justify increased borrowing in the second half of the year.

The international market is still not bad though. And in the domestic market our corporate bond market is remarkably calm compared to global markets.

EUROWEEK: But will the domestic market become more volatile when the local corporate market becomes Euroclearable and more foreign money comes in?

Isaev, Gazprombank: Exactly, it will. Compare the current corporate domestic bond market not only to global markets, but also to the domestic government bond market. Because OFZs are Euroclearable the volatility of that market is, two times, three times more than the corporate bond market. When corporate bonds become Euroclearable I predict more volatility.

EUROWEEK: But the increased interest from foreigners in the rouble domestic market has partly been driven by the low rate environment that has existed elsewhere in the world. Investors have been looking for the extra yield available by buying rouble denominated debt. So if global rates rise, will this limit the foreign inflows once Euroclearability is in place?

Isaev, Gazprombank: Domestic liquidity is in the hands of the Russian Central Bank. The CBR and the state budget are the two main forces. When the budget is in deficit, there is an inflow of money into the banking system and doesn’t absorb this money very quickly. When the budget is in deficit it spends more than it takes from the economy and immediately this money flows into the market. The fastest way to absorb it is in the corporate bond market, which is an immediate beneficiary.

But the same happens vice versa when the budget is in surplus, which it seems likely to be for a couple of years. When we see that liquidity decrease in the banking system, I don’t think it will be equally substituted by international flows because those investors are not yet in a position to buy rouble bonds locally because of the delays in the deciding about taxation of the corporate bonds and some other technical things. So Euroclearability may still be delayed.

Overall, I don’t think we see such a fantastic environment in the domestic market in the second half, compared to the first half.

Ushakova, Megafon: Euroclearability will help in terms of international demand. We saw it happen in government bonds last year. In the domestic market the spreads between corporate bonds and government bonds are still quite wide, compared to where they have been historically. 

It’s just a case of risk perception, what the disclosure requirements will be and the timing of Euroclearability for the corporate bonds.

That most likely won’t offset the reduced liquidity of the banking system, but nonetheless there will be more demand from the international investors.

EUROWEEK:What is your prediction for how much you think that your yields in the domestic market will fall as a result of increased foreign access to the market?

Ushakova, Megafon: It’s very difficult to make predictions, because the market will be affected by two things and Euroclearability is not the prime thing. The prime driver is what rate cuts the CBR introduces and what the effect on the market will be from that.

But there is definitely a lot of potential. If you look at where domestic bonds of investment grade issuers are trading compared to OFZs, there is at least 30bp-50bp of potential in yield reductions. But it is very difficult to predict whether that will be realised. 

If you need to borrow, you have to just go and do it, and if you have the luxury of time to wait, then it is perhaps worth trying to wait and see what happens.

Kirichenko, Gazprom Neft: I didn’t believe that Euroclearability would help in the OFZ market, but if you will look at the statistics, which already exist, it does indicate that it does. At the end of 2012 foreigners only accounted for 5.4% of the OFZ market. But now it’s between 21% and 25%, depending on the statistics you use.

Aananienko, Sibur: But are these real foreigners? Rather than say, Russian money reinvested via offshore accounts?

Kirichenko, Gazprom Neft: Well that happens less now!

Aananienko, Sibur: Euroclearability is no more than the ability to clear rouble denominated instruments somewhere other than Moscow.

To have more ‘real’ foreign appetite for rouble bonds, investors need to have confidence in the currency. They need to want roubles, and they need to want a certain level of rates. So Euroclearability is an important but a secondary factor to the behaviour of the Central Bank of Russia. 

In my view, as soon as we see a combination of more liquidity and lower Central Bank or inflation rates, corporates are going to rush to issue rouble bonds. There will be a psychological moment when investors will want to lock in long term rates. This is when smart issuers will go to the market with long term rouble paper. 

A fundamental question in this line of thought is whether Russia can have low inflation over a long term period. If the view is negative, then as soon as issuers see a window, they should issue. If the view is positive, then issuers should quietly wait for the market to improve over time. I think a more realistic assumption is that over the long term, inflation will remain an issue.

Elena Lukovkina, Evraz: The expectations of the market are too high for Euroclearability. I think that foreign investors who really want to invest in rouble bonds already do so, and find the infrastructure to do so.

Euroclearability might change this marginally, but this is not the thing that really prevents people from investing.  It’s a technical check point that people who are willing to invest might circumvent right now.

But the people who are not willing to invest for some other reason such as their outlook for the currency, will not invest in any case, even if the market is Euroclearable.  

Gordienko, Raiffeisen Bank: We’re forgetting though that there’s one more thing that the investors care about, and that’s documentation. Most foreigners do not speak Russian and neither do their legal departments. Rouble bond prospectuses are, unsurprisingly, in Russian.  

From an investor’s perception, if there is a default on an international bond, at least they have the prospectus and they can go to court and pick over the details of that. Some do have their reservations about Russian courts in general, but coupled with a Russian language prospectus, it makes a local market investment even less attractive.

Ushakova, Megafon: There’s also an issue regarding covenants. International investors are used to covenants, whereas Russian bonds do not typically provide them. We see foreigners investing in government domestic bonds and expect that the benefits of Euroclearability will be mostly for investment grade companies where people are not as concerned about default. High yield names are unlikely to see the same kind of inflows.

Maria Merzlikina, Federal Grid Company: Overall though, more foreign investors being here, investing in the Russian economy is a good development for Russian corporates as it makes the domestic market a good alternative for investors to other markets. We are very much for it.

We did our debut Eurobond issue last December, and we also have infrastructure bonds in the domestic market with a 35 year tenor.

We’re hoping that in particular, foreigners will look for long term bonds. That longer term money is very important for the Russian market and the government understands that.

EUROWEEK: How is the increased demand for domestic rouble issues expected to affect appetite for Eurorouble issues?

Aleksey Nikonov, Vimpelcom: Vimpelcom issued its first ever rouble Eurobond as part of a bigger dollar Eurobond launch in February. We issued in total $2bn — $1bn of 10 year Eurobonds, $600m of six year and a Rb12bn five year tranche in roubles.  

We wanted to try this instrument in order to establish a benchmark in this market and chalk up some experience with the investors who buy this kind of paper. 

It’s a new market in development and has not as much liquidity as the domestic rouble market but attracts other international investors.

For VIP this was a new source of funding and we’re pleased with the result.

We will always monitor the yield in the domestic rouble market and Eurobond market to decide which market suits our funding requirement better. The documentation on the rouble Eurobond is based on existing Eurobond documentation which makes it easy to issue in this market from a documentary point of view.

Being a market in development we expect the liquidity to increase over time.

EUROWEEK: Would those investors that bought the Eurorouble be just as keen to invest on the domestic rouble market when access for them is easier?

Nikonov, Vimpelcom: No, my impression is that these investors’ limited demand for Euroroubles would be even more limited for domestic roubles with domestic documentation, covenants, courts, language, disclosures.

Gordienko, Raiffeisen Bank: I agree with that absolutely.

Nikonov, Vimpelcom: So it’s hard to compare the performance of the Eurorouble bond and domestic rouble bonds, because the markets are different. Russian Railways has also issued Euroroubles, some time before we issued our bonds and maybe they had a more positive experience, but my view is that for rouble issuers, the domestic rouble market is already a better place to issue.

Orlova, Russian Railways: When we were on the roadshow with our Eurobond deal in April this year we were talking to key accounts about the potential Euroclearability of the local market later this year and general demand for roubles and the foreign investors said they were especially interested in CPI-linked domestic bonds.  

And when we did our CPI-linked bonds last year, which were mostly bought by Russian investors and pension funds, we also saw some demand coming from foreign investors. 

I think there’s a lot of potential in this segment when they see that Euroclearability is working. They’re looking for diversification, for longer terms and a way of protecting themselves against the level of inflation in Russia.

EUROWEEK: Could we see the Eurorouble market disappearing over time?

Gordienko, Raiffeisen Bank: The people investing in the Eurorouble market think completely differently to those in the domestic market. Eurorouble investors care more about the rouble as a currency than the credit quality of what they are buying. They see in the issues three different types of risk: market risk, rouble risk and credit risk. They want to make sure they leave one of those outside the picture — always the credit risk.

So for example for Russian Railways which carries a very good investment rating, they see the credit risk as almost non-existent, so they feel that they are mostly betting on whether the rouble will appreciate. But they also want all the protection that this market gives them.

In the rouble domestic market, investors are betting on credit risk. 

Foreigners bought OFZs last year, and that drove the interest rates lower. But they started buying those before the Euroclearability even came through and that hasn’t happened in the corporate world just yet. That indicates that the Eurorouble market for corporates may remain.

 

EUROWEEK: Can you see documentation for domestic bonds developing to look like international bond documents with covenants, disclosures etc?

Gordienko, Raiffeisen Bank: When in 2008 we were in the middle of the financial crisis, we counted the domestic prospectuses with covenants, and there were only 26 out of 650 that were in the market at the time. It’s still this way.  

Nikonov, Vimpelcom: One of the reasons there are no covenants in Russian bonds is the quality of its core legal system. Investors understand that it would be almost impossible for them to go to the courts and fight for compensation because certain provisions in the documentation were breached.

Isaev, Gazprombank: I agree. In this country, people have lost money so many times, on so many different occasions when investing. There’s been very little success from arguing in courts. So when people play in debt investing, they don’t think that any limitations put on the borrower are enforceable. Instead, they play the risk in the purest form, by essentially trusting that the people will return the money they have invested. Because if they don’t, what do you do anyway?  

Because there is no enforcement the investor base is heavily skewed to high quality names, and is unreceptive to low quality names. Before 2008, investors would have maybe said if there’s no rating or a single-B rating they needed to be paid more. After 2008, single-B rating names pay a lot and it’s much more questionable whether a company with no rating can issue at all. And the funds eligible to invest in these lower quality kinds of instruments are very limited and single-B is also dubious for many funds.

  

Gordienko, Raiffeisen Bank: There is, however, a great misunderstanding about this. People have the notion that there are covenants in the Eurobond market and no covenants in the rouble market. But for good quality borrowers, there are no financial covenants put in place for Eurobond documents.

Covenants in the Eurobond market are put in place for the class of borrowers that are perceived as higher risk, and they’re put there because they are believed to be enforceable. As Pavel said, in the Russian domestic bond context, the group that looks higher risk is simply excluded from the equation.

Lukovkina, Evraz: There is no incentive for an issuer to put covenants in domestic market documentation, because it’s easier not to. People buy the bonds without covenants, and including them, there will be no substantial saving on coupon.

For example, we initially inserted a cross-default with our Eurobond into our rouble bonds documentation. So if we defaulted on our Eurobonds, it would also be a default on rouble bonds, so it offered domestic investors more protection. But when we registered the prospectus, we received a lot of advice from banks to remove the cross-default. ‘Nobody has it there, why do you want to keep it? No one even bothers reading it, no one will notice if you remove it,’ they said. Our point of view was that it costs us nothing and we’re not planning to default, so we kept it.

But there is absolutely no incentive on the issuer side to have these covenants. 

I can only see the situation changing if there is a huge wave of defaults and the courts hold issuers to them. Then people will understand that this kind of protection is in some cases useful. Then there could be issuers that would otherwise be unable to issue bonds that may be able to alter documentation and people will buy it. But I do not see a high probability of that happening.

EUROWEEK: Nicholas, when I last saw you a fortnight ago, you mentioned that you were looking at potential acquisitions and if those were to come to fruition, then you would look for rouble funding, either in the Eurorouble market or the Russian domestic market.  How will you make your decision?

Pascault, Brunswick Rail: From what I’ve heard today, the domestic rouble bond market looks more attractive, especially with regards to covenants. What we would want is a longer maturity than our last deal, and of course we care about the potential pricing, but the covenants we would have to include are for us an important consideration as we are planning M&A and want to grow rapidly.  

In the Eurobond market you can reduce the number of covenants that you have to strictly a minimum, as debut issuers. But probably for good reasons, we were pushed to have a few more limitations put in than we wanted in our debut Eurobond. For our second bond we will push to remove some of that. We definitely want roubles as opposed to dollars, because the M&A will likely be of a rouble business and we don’t want to take any FX risk.

Isaev, Gazprombank: You have to remember though that there are still limits to the domestic market, particularly with regards to duration. In the second half of last year, it was hard to issue above three years domestically, but it was quite possible to issue in Euroroubles for seven years, like Russian Railways or for six years as FSK did.  

The international investor base is still more enthusiastic about longer tenors. 

EUROWEEK: Are you expecting Russian pension fund reform to have a big impact on what is available in the domestic market in terms of tenor?

Isaev, Gazprombank: There have already been changes in the declaration of the State Trust Management Company (VEB) where the limit of investment per issue and per issuer were doubled. That is making a big difference already. These funds are hugely untapped and want long term paper, like infrastructure bonds.

For issuers that are eligible to have their bonds bought by pension funds the positive effect of the pension reform is obvious.

Aananienko, Sibur: The pension funds’ need to beat inflation makes them more sought-after by some issuers than others. For those issuers whose revenues are correlated with inflation, inflation-linked rouble bonds are a perfect play. For those who are less exposed to domestic inflation on the revenue side, it is just an exotic instrument.

A typical Russian exporter already has Russian inflation disproportionately on the cost side and by issuing inflation-linked bonds such a company would further increase its cost-side exposure to inflation. But a company that sells goods and services domestically would benefit from inflation-linked instruments as they would represent perfect alignment with company’s revenue.

Gordienko, Raiffeisen Bank: Pension fund reform could change the face of the rouble bond market entirely. There are issues currently where pension funds buy 100% of the issue, such as some CPI bonds and more than 50% of some long term fixed rate deals. 

If the pension fund reform changes their ability to do that, we could be looking at a completely new environment and it could be devastating for some issuers.

Merzlikina, Federal Grid Company: We hope that pension funds will be much more active than today. At the moment there is a big problem with the re-evaluation of assets, which is why nowadays they mostly invest in short term deposits, rather than the companies that make up the economy like Federal Grid.

We’ve spent a lot of time with the Ministry of Economic Development, saying that it is very important to change some rules, and let the pension funds build a more diversified investment portfolio.

Ushakova, Megafon: Arguably it’s likely that we could see changes only from 2014 once the reform is implemented. Potentially the government pension fund system and liquidity could shrink slightly as a result and it is likely that there will be a redistribution of liquidity towards the non-government pension funds which are becoming more and more prominent. These pension funds normally have a more aggressive strategy in terms of investment declarations compared to VEB, particularly as VEB is now very much focused on infrastructure bonds and projects.   

We can expect to see buying of more sub-investment grade bonds and even equities in the long run as a result, because private management companies may be allowed to be more active in these areas.  

At the moment, over 50% of pension fund money is still in commercial deposits, and as rates will probably go down if the CBR cuts rates this will be an additional factor for greater liquidity from pension funds.

In any event the pension funds will remain an extremely important source of liquidity over the coming years particularly in the longer durations.    

EUROWEEK: Maria, is the CPI-linked bond market also a big opportunity for you as a Russian electricity provider?

Merzlikina, Federal Grid Company: We are already there. We are one of the companies that the government allows investment from government pension funds. We’ve printed Rb30bn of bonds with a 35 year tenor that pay Russian CPI plus 100bp.  

It’s a huge sum of money from the government via the pension funds. We see it as proof of government support for us. Today we’re realising an intensive investment programme with a long payback period, so it is very important to have this kind of money available. However, we understand that diversification of funding is important, so we will look at the market for other ideas to see how to get cheap money for our investment programme.

Orlova, Russian Railways: Russian Railways started talking to the government in 2011 about needing to use pension fund sources, and sources of other state owned funds, including the national wealth fund to invest into the Russian economy. We are prepared to pay for the maturities and it’s beneficial for investors too — these coupons are better than pension funds could get by investing in other instruments of comparable maturities and risks.

The initial reaction to the bonds was actually mostly quite negative, because the investment declaration of VEB, the biggest state management company of pension funds, was very limited. It is able to invest only in a limited portion of instruments, even though there are some good triple-B rated names on the market that are the same level of risk as the sovereign, and who are prepared to pay more than the sovereign!

In 2012, we started to meet with non-state owned pension funds to get their feedback. We were very surprised to hear that most of them have maximum maturities in their portfolio of three years so they are short term players. But that is because of accounting reasons. Each year, they have to make a revaluation of assets, and long term investments can create negative results for them, so this is why they prefer to play short.  

When we did an inflation bond for Russian Railways as a market instrument last year we wanted to invite as many local pension funds as possible as well as VEB. So we suggested a price of CPI plus 210bp to the market, which was accepted.  We sold Rb10bn 10 year bonds, and that was the maximum Russian Railways was able to print under these terms. We did sell to some local pension funds, just trying to explore the instrument, but we actually realised that the main long player on the local market is VEB. 

VEB is only interested in the triple-B names, in accordance with their declaration. For a second issue, they were prepared to buy even more than the 30% they bought of the first issue which was the maximum level allowed by their declaration at that time. We showed this to the government. We also showed them the precedent we had set — that for CPI-linked bonds, this is the tenor and the price and there are some limitations in terms of tenor and demand from the market players .

After we had shown how it worked in the market the decision was taken in October last year for the government to enhance VEB’s investment declaration allowing them to buy up to 100% of issues printed by triple-B infrastructure companies. They can now invest Rb100bn of pension proceeds managed by VEB annually in infrastructure companies with this triple-B level risk bearing the rate of inflation plus 100bp. The one we closed yesterday had a 30 year maturity.

It’s still better for VEB than previously as now they get this safety over inflation for a longer period.  It’s a good instrument but it’s a first step. We now need to convince private pension funds that a CPI-linked instrument is something that they should have in their portfolios because this is a natural instrument for them.

The issue that closed yesterday for Rb25bn was purchased by VEB. It was within this programme approved by the government for some companies including Russian Railways. We intend to do another Rb25bn before the end of June, and Rb50bn before the end of this year.

There is only VEB at the moment, who is prepared to buy 30 year paper. But, we think that when we do our 15 year bond, which is planned for before the end of June, then there might be some private investors too. That demand would be very welcome though many are still not prepared to buy, both psychologically and on a technical level.

Aananienko, Sibur: So the sovereign pension fund limits its exposure to only BBB- rated issuers, and those ratings are provided by international rating agencies. These agencies, in turn have been consistently punishing most of the Russian economy through substantial notching down imbedded into their ratings methodology. These agencies continue assigning A level ratings to borrowers outside of Russia with absolutely unsustainable debt levels, while assigning junk ratings to strong Russian borrowers with sustainable levels of both debt and revenues. 

As a result, this system implicitly prevents good quality local companies from accessing long term money, which is needed for the development of the Russian economy. 

I believe that an amendment to the Russian sovereign funds credit policies could open the gate for good quality Russian companies to access the long tenor roubles that today are only available to the state-controlled corporations via infrastructure bonds.

Orlova, Russian Railways: The focus is on the infrastructure companies because most of our investment projects need longer term investments and railway infrastructure will boost the whole economy of Russia. But Pavel makes a good point. This should only be the first step. Probably in the future, when they see that this instrument is really working, they will make the changes needed. It is an evolving market. 

But, whether we like it or not — and we are a company that often fights with the rating agencies on this Russian discount issue — there is no alternative measurement system for credit quality for the government to use.

Aananienko, Sibur: An alternative system would be a methodology that removes the rating agencies’ country discount for intra-country transactions. The concept of Russian risk is a cross border risk. For intra-country transactions, especially between the country’s top industrial players and the country’s top financial institutions a different risk matrix should be used.  

Orlova, Russian Railways: But the government also has to prepare the system for potential foreign investors coming into this instrument and they want to show a risk system that is clear to foreign investors as well.

Aananienko, Sibur: Take, for example $1bn of money in some sovereign fund, welfare or pension, etc, and according to the fund’s declaration it can only be invested in investment grade paper (mostly outside the country) on which the fund probably earns a 2% yield. Meanwhile, a Russian corporate borrows from outside of the country, for example at a 6% rate. The total loss to the country is 4%. And this is done on the basis that the international rating agencies provide correct risk measurements to the sovereign fund. This is ridiculous.

Lukovkina, Evraz: The inflation-linked bond is a great achievement, and very well done. But have I understood correctly that for the 30 year CPI-linked bond, there was only one investor?

Orlova, Russian Railways: Yes. We received some enquires from some other local investors asking about the maturity and the price, but they were not keen to speculate for 30 years. They said they would be more interested in shorter maturities. So when we do our 15 year bond before the end of June, we’ll see if there is more demand from them, but as last year we did a 10 year bond and we paid CPI plus 210bp, private investors may not be interested in something paying CPI plus 100bp.  

Lukovkina, Evraz: How did you agree on the plus 100bp pricing with VEB if there is only one investor? 

Orlova, Russian Railways: Last year we agreed with the government on the new approach to the financing of our investment programme by dividing all our projects into three categories. The first category is for projects with a ‘bankable’ payback period. Everything which is payable within 10 years Russian Railways is financing through regular market instruments on its balance. The second category assumes projects with a payback period of up to 30 years which we are able to finance only with very limited instruments and in foreign currencies and for which we require some sort of government support. Two years ago, we did a Eurobond in British pounds with a 20 year maturity, which represented real appetite, but it was in foreign currency, which we have limited interest in issuing in. The third category is projects with a length of more than 30 years, and the majority of other companies don’t have such projects. For that third category we require government support. 

We concentrated on the second category where we needed to find an instrument with matching maturities that Russian Railways would be able to pay the coupon on, knowing that the railways tariffs have historically had a strong correlation with CPI. We also needed to stay within our covenants. This is how together with VEB we developed this new instrument — an infrastructure bond which represents the combination of government support and marketable security. 

We are at present talking to the government about establishing long term tariff policy, which will also reflect this correlation with the CPI and this new instrument suited that. 

By issuing our debut inflation-linked bonds we showed that the wider market is not prepared to go for longer than a 10 year maturity and that the market price for us for 10 year debt is CPI plus 210bp.

The CPI plus 100bp number represents some government support of the company, because the market price for us was CPI plus 210bp.

Lukovkina, Evraz: So Russian Railways is being financed at the expense of the Russian pension system?

Orlova, Russian Railways: Well, it is a kind of government support, however we are paying a CPI plus 100bp coupon so it is a win-win situation — the main target for investing pension proceeds is to make sure they are protected from inflation, and this does that.

Lukovkina, Evraz: So it’s bilateral agreement with the government really.

Isaev, Gazprombank: The paper is developing, the first bond Russian Railways sold is now traded at a price of around 102. So that means that the market price for these deals is not 100bp over CPI or 210bp over but around 190bp over. So certain investors’ appetite is increasing, the margins are shrinking and so the subsidy from the pension fund is lower than it originally seems.

Nikonov, Vimpelcom: But how do you establish a margin for a traded CPI-linked instrument when there is no CPI curve?

Isaev, Gazprombank: It is an approximation. But it’s only margin playing, and only a very limited number of participants are trading inflation domestically, though there are many offshore players surprisingly willing to trade our inflation.  

Aananienko, Sibur: But, in this case, wouldn’t you say that these people actually are not playing the corporate risk at all?

Isaev, Gazprombank: They are usually not playing corporate risk. Many people perceive Russian Railways risk as almost no credit risk. You’re playing purely inflation risk.

I am actually surprised how many players want to play in that market.  

EUROWEEK: But how much appetite from issuers is there really for this kind of bond anyway? How closely linked do revenues have to be? For the telecommunications companies for example, is it an attractive option?

Nikonov, Vimpelcom: We’re looking at the inflation-linked bonds, but we don’t have as close a correlation of our tariffs with inflation as Russian Railways, or some other big companies have. If you look at the development of the tariffs for the past 10 years or so, because of market competition and improved efficiency our tariffs are decreasing, rather than rising at the speed of inflation.

Ushakova, Megafon: It’s similar for us in terms of rationale for this type of funding. Our pay-offs are much shorter than for long term infrastructure projects. We can achieve better yields and a lower risk profile by printing shorter bonds, so it’s not the instrument for us yet.  

However, where infrastructure projects do exist I think that longer term money should be available to such projects, irrespective of the rating. If it is a good project, and if it has social benefits and contributions, why shouldn’t it be funded by the government through the infrastructure bonds as well?

Aananienko, Sibur: When these infrastructure bonds were placed, it was huge news in the market. Everyone in the borrowing business knew about it within 24 hours, and everyone had the same question, from their CFO or CEO: ‘shall we do the same thing?’

It was a ground-breaking transaction and made a new market.  

Now each company looks at it from the point of view whether their revenues are correlated with inflation and whether the instrument is suitable. Our revenues are not that much connected to inflation, so it was thought that such an instrument was not suitable.

Lukovkina, Evraz: It is the same for Evraz.

Pascault, Brunswick Rail: We are a railway company so would love to have a longer maturity of 10 years, inflation-linked. The question for us would be how often the CPI number could be adjusted. Ideally, it would be three years to match the average length of our fixed contracts. 

If it’s done on a quarterly basis, that then introduces some risk. Tatiana, how often do you adjust the valuation of CPI?  

Orlova, Russian Railways: We take annual CPI and our coupon is semi-annual.

Merzlikina, Federal Grid Company: Ours is a quarterly coupon.

Isaev, Gazprombank: The dynamics are so quick that there is already a lag between how the economy moves and how the CPI moves. If it is fixed only once in three years, the lag would be too much. You could end up with your market growing and inflation falling, or vice versa.

EUROWEEK: Pavel, you mentioned earlier that having done a bond, you feel like you have to do a loan next, to take advantage of the bank market.  How is the cost of bank loans moving?

Aananienko, Sibur: Investment grade corporates have recently successfully re-opened the syndicated loan market. Gazprom Neft provides a good example. I think many borrowers are looking at the recent transactions by investment grade companies, and wondering whether they can repeat the same success.

EUROWEEK: Are the margins that you’re offered from the banks comparable to what you pay to issue a Eurobond or are those loans done at relationship levels?

Kirichenko, Gazprom Neft: Our loan price set a new low for the market. Banks were scared because they want to have a relationship with us and they understand that this is an opportunity to build that. So the transaction was very good, and it was oversubscribed twice. Gazprom Neft’s management considers banks which participated in our loans and has exposure for the company as a strategic partners. But these kinds of much lower rates are a new reality for the banks.

There is competition between all of the different types of instruments and their different benefits. We like 10 year funding, but five years is still not bad. If we can achieve good pricing, well go for syndicated loans with pleasure as that is a more flexible instrument rather than Eurobonds or rouble bonds.

EUROWEEK: In a post-financial crisis world, the Russian state owned banks have been rising up to compete more strongly with the internationals.  Has that made any difference with regard to how aggressive banks are being in lending?

Kirichenko, Gazprom Neft: Immediately after Lehman Brothers, there was a big period of uncertainty and we’re still in that period. Some think we might be about to go into a new crisis.

But the numbers speak for themselves — for the whole of 2012, Russian corporates did around $40bn of syndicated loans. In the first five months of the 2013, they’ve already done more than $26bn and there could be even more from Russia later this year. Maybe not though as most programmes are now funded.

Gordienko, Raiffeisen Bank: We see the margins shrinking, and they’re almost zero now. It’s getting even worse day by day, so yes, we’re suffering. I ask our clients to please not go any further!

Lukovkina, Evraz: A lot of corporates and banks moved from bank lending and financing to capital markets financing via Eurobonds or rouble bonds in the first half to cover their financing plans.  

That means that there’s actually very little use for money from the banks. Banks are saying that there is a very limited number of good quality firms who want to borrow directly from banks, because they do not have the financing need. That puts downward pressure on the margins of the loans.

Pascault, Brunswick Rail: We switched to bond financing, and the difficulty now with the banks is not just the pricing but also the covenants. It’s difficult for them to switch from maintenance covenants to the incurrence covenants to be as flexible bonds, and that is what we want.

Ushakova, Megafon: As opposed to many borrowers here, we are a rouble-based company so are hugely reliant on rouble liquidity. There is always demand for good names, particularly for those with investment grade ratings. 

We feel that we are in a position to choose and ensure that we fund most appropriately to match our asset base and with liabilities. The domestic loans market is still a bilateral market primarily dominated by the state owned banks.  

In Russia, I think liquidity is sufficient and there is huge demand from the banks. Everyone has the luxury of choosing what they believe is the best form of funding.

Nikonov, Vimpelcom: When we are looking for roubles, we get them mostly from domestic bonds or bilateral loans from state owned banks. There is no real sense in syndicated loans.  

When we are looking for long term dollars Eurobonds are the best solution, because the banks can only offer limited tenors. So we are not considering this as part of our investment plan.

EUROWEEK: The pay-off of the incredibly low fees is supposed to be ancillary business such as bond mandates. From the issuers’ point of view, what is the most important criteria when picking banks for bonds?  

Nikonov, Vimpelcom: The experience of the people you hire and experience of the bank, the track records of the bank and their past performance. Sometimes you also have to repay a lending relationship immediately, if for example we have a bridge loan to Eurobonds. Then of course the banks that have lent you the money have to be given the mandate. 

When we select a bank for a bridge loan facility, we see the bond as part of the tender — we advertise it as a bridge plus Eurobond so consider the bond mandate before we take the loan.

Lukovkina, Evraz: Every corporate is completely different in this respect. But generally it is the quality and experience of the team, the quality of the platform and the position of the bank in that respective market, the level of relationship and presence in other financing businesses of the group, and maybe a good level of fees. But for a Eurobond the fees are really a choice of the issuer than the banks.

EUROWEEK: Is there any temptation to try and push those bond fees lower?  

Lukovkina, Evraz: Our fees are currently at the levels where you could certainly push them lower, but we also realise that this would be at the expense of lowering the inducement of the bank to properly work for you and you then may not get enough attention for a deal to work well.

The fees for good quality names are already quite often reasonable. But that is our choice. No bank refuses to work with you because the fees are too low.

Aananienko, Sibur: We understand that there are professionals on both sides of the fence, and people with that professionalism deserve to be fairly paid. So I guess, if you see your banker driving a much better car than you, you are over-paying.

Gordienko, Raiffeisen Bank: I can show you my metro ticket if you’d like?

Ushakova, Megafon: Ultimately the net objective for everyone is exactly the same — to get the best possible terms while at the same time minimizing any execution risk and ensuring everyone is happy — the investors, the borrowers and the banks.  

Pascault, Brunswick Rail: We mostly we focus on borrowing from one Russian bank which likes big tickets and that makes things easier. It is the same with a few foreign banks as well, so we focus on them too. 

As far as bond mandates are concerned, our bond was 65% subscribed to by US investors. We have seen a very different ability to distribute between the banks so fees are important, but we’ve very much aware that other factors are too.  

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