BlackRock: Russian Bond Market “Freezing Up”

“Let’s not be hypocritical about it,” an executive of Total, France’s global oil company, told the Wall Street Journal on condition of anonymity. “All oil majors seek a piece of the Russian cake because they all need to put their hands on new resources, new fields, and Russia is the largest cake that is reachable….”

At first, the sanction spiral concocted by the US and the EU with its growing blacklist of oligarchs appeared to be cosmetic, nothing more than a signal to President Vladimir Putin to take the warnings seriously and back off from the Ukrainian fiasco. They seemed to be designed to cause as little havoc as possible; all economies involved are fragile and don’t need additional upheaval in their own house. But it’s getting complicated.

The oil majors are confessing that they would not cut ties to their multi-billion-dollar projects and joint ventures in Russia, where they see their source of future growth. Exxon had already made clear that it would continue to chase after oil and gas deposits in the Russian Arctic seas.

And Total is standing by its man in Russia, oligarch Gennady Timchenko. He is the co-founder of oil trading company Gunvor, in which Putin allegedly has a direct financial interest. And he is the second-largest stockholder of gas company Novatek. Last fall, France awarded him its highest honor, the Légion d’honneur, for his part in assuring that Russia would become Total’s most productive region by 2020. Total’s ownership of Novatek is going to grow to 19.6% by the end of this year. The companies are trying to get a $27-billion liquefied natural gas project in the Russian Artic to start producing by 2017.

Yet Timchenko is on what the US government affectionately calls the “Specially Designated Nationals and Blocked Persons List,” or “SDN List,” or more evocatively, “Blocked Persons List.”

These entanglements can put US executives in delicate situations, like sitting in a boardroom next to a “blocked person.” BP owns 19.75% of state-controlled oil major Rosneft, and BP CEO Bob Dudley is one of its directors. So he rubbed elbows with Rosneft’s president and major shareholder Igor Sechin, whose name graces the SDN list. But as US citizen, Dudley is barred from doing business with him, or with any entity in which Sechin has a direct or indirect interest of 50% or more, even if the entity itself is not on the list. And that problem is gnawing its way into the Russian bond market.

“The glue of sanctions is starting to dry,” Sergio Trigo Paz told the Financial Times. He is the head of emerging market fixed income at BlackRock, the world’s largest asset manager. “People thought sanctions were about visas for oligarchs wanting to visit Disneyland. But they are much more important.”

SEC lawyers had gotten on the phone as early as March to warn fund managers with exposure to Russia to properly disclose their holdings to investors, to manage the risks of that exposure appropriately, and to prepare for different outcomes. Time for asset managers to get nervous.

They “will have their legal people looking very closely at the impact of being on the sanctions list,” Trigo Paz said. Investors are worried that the bonds of a Russian company could be blocked because a “blocked person” has a direct or indirect interest of 50%, in which case bond holders would not be able to receive interest payments. “All transactions could start to freeze,” he said. “Even companies where individuals on the list own less than 50% are being looked at by compliance officers as a potential risk.”

So in mid-April, his EM fixed income funds dumped all their Russian local and foreign currency bonds, sovereign and corporate. And now the market for Russian bonds, he said, was “freezing up.”

Not all asset managers have hit the dump-button yet. Only one other large fund manager had sold its Russian bonds, from what he heard, while other fund managers are simply underweight. “We hear that many US banks are trying to keep inventories very light,” he said, and non-US banks were “getting more and more uncomfortable.”

It shows. While 10-year government bond yields of Eurozone debt-sinners Spain and Italy are just above 3%, the 10-year yield of Russian government bonds is nearly 9%. Due to lack of demand even at these yields, the government had to scuttle and cancel its bond auctions since the Crimea debacle erupted. On April 23, when an auction for 20 billion rubles ($560 million) in bonds failed – the second fail in 8 weeks – the Finance Ministry claimed that the offer did not “adequately represent” Russia’s “credit quality.”

The government planned to sell 825 billion rubles in bonds this year, now likely a pipedream. Russia – with its budget nearly balanced, unlike debt-sinners Italy and Spain – has minimal funding needs, which is taking off some pressure. But Russian corporations aren’t so lucky. So if everything else failed, Russia’s state-controlled banks would buy ruble bonds of all kinds, Trigo Paz pointed out.

“If sanctions escalate, we don’t know what Russia’s answer would be,” he said. “We hear that Russian banks are repatriating dollar deposits to Russia, which is one reason why the ruble is not selling off as much as expected.”

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