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June 2013

The push for reform

000 Cover Russia 2013.indd 1 25/06/2013 17:23

Russia in the Capital Markets EuroWeek 1

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EUrOWEEK

02 ECONOMIC OVERVIEW Action, not rhetoric, needed to kick-start reform

05 THE SOVEREIGN Sovereign Eurobonds: has Russia missed its best chance?

07 MOSCOW AS A FINANCIAL CENTRE Moscow lays foundations for financial hub

09 FINANCING INFRASTRUCTURE Russia seeks capital market finance for urgent upgrade

13 THE BANKING SYSTEM Dog-eat-dog banking full of scope for smaller breeds

16 FINANCIAL INSTITUTIONS ROUNDTABLE Banks face up to Basel III with funding diversity plan

26 BANK CAPITAL Cost of hybrids set to rise as central bank gets tough

28 CORPORATES IN THE DEBT MARKET Bonds galore and easy loans: corporates in clover

31 CORPORATES ROUNDTABLE Russian corporates face rising rates challenge

41 DOMESTIC BOND MARKETS Russian domestic bonds come of age

CONTENTS: RUSSIA IN THE CAPITAL MARKETS

001 Contents Russia Cap.indd 1 26/06/2013 17:47

Economic Overview

2 EuroWeek Russia in the Capital Markets

President Vladimir Putin talks a good talk on the need for far-reaching reform in Russia. Hours after his

inauguration in the Kremlin following last year’s presidential election, he was at it again. Russia, he said, would need to rise from 112th in the World Bank’s ease-of-doing-business survey to 20th by 2018.

Putin decreed at the same time that 25m new jobs would be created in the high tech industry by 2020, that salaries would grow by between 1.4 and 1.5 times by 2018, and that the investment to GDP ratio would rise from its dispirit-ingly low base. The president also pledged that huge swathes of industry outside the defence and energy sectors would be privatised.

Fighting talk. Probably the clearest signal that Russia was serious about struc-tural reform, however, was the adoption by the Duma in December of a tough fis-cal rule, which dictates that budgets will be based not on current oil prices, but on conservative long-term projections. Those projections will form the basis of a cap on government spending, which will be limited to revenues plus a maximum of 1% of GDP.

Although prime minister Dmitry Medvedev has insisted that his govern-ment has no intention of backtracking on this rule, analysts fear that Russia’s com-mitment to a strict monetary and fiscal policy may be slipping.

It is easy enough to grasp why Rus-sia may be tempted to compromise on its tough fiscal stance. With commodity prices no longer a one-way bet, the boom of the last decade, when Russia delivered annual average growth of 7%, is becom-ing a distant memory.

Below expectationsMore disturbing is that Russian growth is weighing in well below original expec-tations for this year. “The government’s target for growth this year was originally 5%, which was the level that Russia was seeing at the time of last year’s elec-tion,” says Jacob Nell, Russian economist at Morgan Stanley in Moscow. “In the

first quarter of 2013, it slowed to 1.6%. That’s not too bad in comparison with some Euro-pean economies, but not where it needs to be for a country that aspires to double its GDP per capita over the next 10 years.”

Economists insist that this slowdown needs to be put in perspective. “An economic slowdown is evident,” says Julia Tsepliaeva, head of market eco-nomics, Russia and CIS, at BNP Paribas in Moscow. “But I don’t think this is alarming, consider-ing that about 4% of the growth

we saw during the boom was attributable not so much to high oil prices, but to the effect of rises in the price of oil, which increased by 20% a year. The slowdown is the result of oil price stability combined with the economic slowdown in Europe.”

More broadly, say economists, Russia’s economic indicators continue to stack up very well in comparison with those in the US and across much of Europe. “Russia’s debt to GDP ratio is about 10% in 2013, which looks miraculous compared with western Europe or Japan,” says Maxim Oreshkin, chief economist for Russia at VTB Capital.

Although Russia’s debt to GDP ratio is expected by the government to rise in 2014, to more than 15%, it remains minuscule by comparison with many of the economies in the eurozone. But the Russian electorate may not be as ready to put the deceleration into perspective as many external analysts. This, says Peter Westin, chief economist at the independ-ent brokerage house, Aton, is why one of the principal challenges facing the gov-ernment today is managing expectations at a grassroots level.

“Between 2000 and 2007, wages grew in nominal terms by more than 25% a year,” he says. “Under Medvedev they have continued to rise, albeit at a slower level of about 10%. Now wages

Action, not rhetoric, needed to kick-start reformRussia has made some progress in implementing reform since the 2012 election. But it has delivered much less than it promised, and much less than it needs to do in order to make the transition from a consumption-led to an investment-led economic model. Philip Moore reports on the challenges that lie ahead for Russia.

Trust me, I’m a president... Putin talks a good talk when it comes to reform

Russia’s GDP growth

Source: Rosstat, VTB Capital Research

GDP growth


2.1%

-15%

-10%

-5%

0%

5%

10%

15%

2005 2006 2007 2008 2009 2010 2011 2012

Real GDP growth, SAAR Real GDP growth, % YoY, NSA

Sovereign international reserves

Source: MinFin, VTB Capital Research Source: MinFin, CBR, VTB Capital Research Source: MinFin, CBR, VTB Capital Research

-16%

-12%

-8%

-4%

0%

0%

25%

50%

75%

100%

2006 2007 2008 2009 2010 2011 2012 2013

Oil&gas revenues, 12m-rollNon-oil&gas revenues, 12m-rollNon-oil budget balance, % GDP, 12m-roll (RHS)

0

100

200

300

400

500

600

2007 2008 2009 2010 2011 2012 2013

CBR reserves, $bn Reserve fund, $bnNational welfare fund, $bn Stabilisation fund, $bn

597

5283,297

3,186

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2007 2008 2009 2010 2011 2012 2013

Outstanding OFZ, Rb bn

Oil and non-oil federal budget Outstanding OFZ002-04 Macro Overview2.indd 2 26/06/2013 17:35

Economic Overview


are broadly flat, which is why there has been a rise in social unrest over the last two years.”

Putin pushes itThe result is that although Putin’s approval rating remains high, at above 60%, according to the independent poll-ster, Levada, by the start of 2013 it had reached its lowest level since mid-2000. More than half (55%) of Russians now would like to see Putin stand aside when his third presidential term ends in 2018, with only 22% wanting him to stay on for a fourth term.

To date, the government has resisted the temptation to shore up its flagging popularity by loosening its purse strings. “Government spending is up by only 3% in nominal terms this year, which is of course negative in real terms,” says Oreshkin at VTB Capital. “That will have a significant impact on growth, while the end of the commodity price cycle is lead-ing companies from related sectors to scale back their investment plans.”

However, Andreas Schwabe, senior associate in the CEE research department at Raiffeisen Bank International in Vienna, says that one indication that Putin may be turning increasingly dovish was the rumour, at the end of May, of his plan to appoint economy minister Andrei Belousov as his chief economic advisor. Schwabe says that Belousov is a known advocate of reducing interest rates, loos-ening the fiscal rule by allowing the limit on the deficit to rise to 1.5% of GDP, and possibly using Russia’s sovereign wealth funds for infrastructure spending. “In terms of economic reform, I think the mood has darkened in recent months,” says Schwabe.

Structured reformEconomists say it is essential that Russia stays the course on long-term structural reform if it is to encourage more eco-nomic diversification. As Nell says, oil and gas accounts for two-thirds of exports and half of budget revenues, and this dependence makes Russia vulnerable to global commodity price volatil-ity. “There have been three economic crises in the last 25 years — in 1991, 1998 and 2008 — and all three have been preceded by a sharp fall in the oil price,” he says. “This vulnerability isn’t going to go away, because the share of oil and gas in Russia’s total exports has risen from half of exports in 2000 to two-thirds today, rather than fallen.”

Action rather than rhetoric is urgently required if Russia is to improve on its modest investment

rate. “Russia has made some progress in implementing reform since the 2012 election,” says Nell. “But it has delivered much less than it promised, and much less than it needs to do in order to make the transition from a consumption-led to an investment-led economic model.”

Nell says that the government’s tar-get is to increase investment from its current rate of around 20% of GDP to 27% by the end of Putin’s current term. That would still be low by compari-son with a number of Asian economies, with China’s investment to GDP ratio close to 50%. It also shows little sign of rising. “In the last couple of months, year-on-year growth in investment has been negative in real terms,” says Westin. “Companies would rather keep money in the bank than invest.”

Capital outflows described by Moody’s as “chronic” will also do little to inspire confidence in the outlook for investment. In a recent report, the ratings agency comments that Russia’s Ministry of Eco-nomic Development has forecast that net capital outflows from Russia will reach $30bn-$35bn in 2013. While high, says Moody’s, this is still less than the $54.1bn reported by the central bank in 2012.

Others are less hopeful on the pros-pects for a reduction in capital outflows. “Capital flight as reflected in private sector net capital flows, has remained significant in recent years despite high oil prices,” notes Standard Bank. “This reflects an underlying lack of investor confidence in Russia. Simply put, Russians have not been prepared to invest oil windfalls back in their own economy.”

It says a combination of weak growth prospects, lower commodity prices, flux on the political scene, and a more dovish CBR policy both on policy rates and the rouble, will increase capital flight.

FDI needs a boostForeign direct investment (FDI) into Russia, meanwhile, has also remained disappointingly low. The good news, says

Westin, is that in absolute terms FDI has risen over the last decade from 1% of GDP to 3%. The bad news, he adds, is that about half of this total has come from off-shore centres or tax havens. “True, money is money wherever it comes from,” says Westin. “But genuine foreign investment brings a positive spill-over in terms of technological and management knowhow. In real terms, Russia still has one of the lowest levels of FDI in central and eastern Europe, as it has for the last 15 years.”

One apparently perennial reason why FDI, and portfolio investment, into Russia remain low by international comparison is that corporate governance standards still leave much to be desired. “Many investors continue to perceive that Russia has lower standards of corporate govern-ance,” says Nell. “This perception con-tributes to Russian assets, notably equi-ties, trading at a discount to similar assets in other markets and can put off inves-tors, particularly direct investors, from bringing their technology and expertise into Russia.”

This is bad news for an economy which urgently needs to bolster produc-tivity. At VTB Capital, Oreshkin explains that Russia’s nominal jobless rate of between 5%-6% means that in real terms unemployment is virtually nil. “As there will be no expansion in the workforce in the coming years, the only way to gener-ate economic growth will be to improve the quality of jobs and the productivity of the existing workforce,” he says. “This is why we need to increase the proportion of investment to GDP.”

Oreshkin cautions, however, that it is a mistake to assume that the investment cli-mate in Russia is universally poor. He says Kaluzhskaya, to the southwest of Moscow, is an example of a region punching above its weight in attracting investment from companies such as Volkswagen, Peuge-ot and Volvo. Between 2006 and 2011, Kaluzhskaya attracted foreign investment of about $5bn, and by 2010 it accounted for 8% of all FDI in Russia, even though

its population and land mass are just 0.75% and 0.2% of the country’s total, respectively.

A good crisisWhile strategists say that the prospects for economic growth and investment remain subdued, Russia continues to hold out attractive opportunities for portfolio investment, in both the debt and equity market. At Morgan Stanley, Nell says that the prospects for the bond market are strengthened by the central bank’s recent track record on managing inflation. “The Russian cen-tral bank had a relatively good crisis,

Oil and non-oil federal budget

Source: MinFin, VTB Capital Research

GDP growth


2.1%

-15%

-10%

-5%

0%

5%

10%

15%

2005 2006 2007 2008 2009 2010 2011 2012




-16%

-12%

-8%

-4%

0%

0%

25%

50%

75%

100%

2006 2007 2008 2009 2010 2011 2012 2013


0

100

200

300

400

500

600

2007 2008 2009 2010 2011 2012 2013


597

5283,297

3,186

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2007 2008 2009 2010 2011 2012 2013


Oil and non-oil federal budget Outstanding OFZ

002-04 Macro Overview2.indd 3 26/06/2013 17:35

Economic Overview


and has built up credibility since then for its management of the move to a float-ing rouble,” he says. “CPI is above target at the moment, largely because of last year’s poor harvest. But with a conserva-tive central bank and a tight fiscal policy, we are expecting inflation to continue to fall towards the 4%-5% that the CBR is targeting.”

This, says Nell, should support a continued decline in GKO (Russian gov-ernment bond) yields, while accelerated liberalisation of the market, improving access for overseas investors, is broaden-ing the buyer base for Russian govern-ment debt.

The credibility of the central bank’s battle against inflation, say analysts, has also been strengthened by the recent appointment of the Putin loyalist, Elvira Nabiullina, as head of the central bank. “We believe the new central bank head will pursue a more proactive reform agenda,” says Andy Smith, head of equity research at Sberbank Investment Research.

Beyond oil and gasIn the equity market, the picture is more mixed. At Aton, Westin says that over-all, sentiment towards Russian equi-ties remains negative. “Volumes in the domestic equity market are down by about 40% compared with last year,” he says. “Even when we see prices rise, there is no pick-up in volumes, which is an indication of the lack of conviction among investors.”

Depressed sentiment towards the Rus-sian equity market, however, is a function of its domination by the oil and gas sec-tor, which accounts for about 60% of the index. At Sberbank Investment Research, Smith says that valuations in the oil and gas sector have not just been pulled down by poor appetite for extractive industries and a depressed commodity cycle. “One of the reasons why p/e ratios of Rus-sia’s oil and gas companies are so low is that their capex to depreciation ratios are extremely high,” he says. “Gazprom is the

most profitable oil and gas company in the world, but its investment pro-gramme absorbs the vast majority of its cashflow, so those profits aren’t necessarily translated into hard cash and returned to shareholders.”

Smith echoes a number of other equity strategists when he says that to focus, as index-based buyers are forced to do, on the extractive sec-tors is to miss where the most excit-ing potential of the market lies. “One area of the economy that is doing extraordinarily well is consumer spending,” he says. “We think this is a structural growth trend. Russia is an economy of 144m consum-ers and our analysis suggests that over the next three to four years it will overtake Germany to become the largest consumer market in Europe.”

It is not just the size of the Russian consumer market that excites equity strat-egists. It is sometimes easy to forget that little more than two decades have passed since the collapse of the Soviet Union, which brought to an end the asphyxiat-ing restrictions on consumer freedom which for the majority of Russians were a way of life until the 1990s.

Clear evidence that Russian consum-ers are continuing to make full use of this freedom is the country’s very low savings ratio, which Smith says is around 5% of GDP. “The psychology of the Rus-sian consumer is heavily skewed to spend rather than save,” he says.

Gung-ho investorsSmith says that since February Sberbank Investment Research has been publishing the Ivanov Consumer Confidence Tracker, a bimonthly survey of the “spending habits and opinions of middle class Rus-sian consumers”. The inaugural edition, published in February, found the Russian consumer in a gung-ho mood. Some 44% expected their personal wealth to improve in 2013, for example, while 42% planned to change their car within

the next two years and half intended to upgrade to a new home in the near term.

Remarkably upbeat aspirations such as these, say bankers, will continue to underpin demand for consumer credit, although some argue that Russia’s retail lending boom is demonstrably unsustain-able. Retail loan growth reached 25.5% in 2011 and 41.7% in 2012. That, according to research published by BNP Paribas, has unnerved the central bank. “Retail [lending] growth has been the main focus of CBR supervision in

2013-14,” it notes. “The bank is targeting a slowdown in consumer credit growth to 20% y/y and is very likely to achieve this goal, in our view.”

Whether this will dampen the enthu-siasm of the Russian consumer is open to question. Perhaps the most striking embodiment of Russia’s emerging, free-spending middle class is the retail giant, Magnit, which was founded in 1994 and is now the second largest retailer in Europe with a market capitalisation of about $25bn. Between 2002 and 2012, Magnit opened new stores at a breath-taking compound annual growth rate (CAGR) of 32%, increasing the size of its network from 368 outlets to more than 6,200 by the first quarter of 2012, and opening 1,575 new stores in 2012 alone.

Even after this dizzying expansion, Magnit reckons it has plenty of scope to keep on growing. According to its most recent investor presentation, the Russian food retail market was worth $227bn in 2011, which is slightly smaller than the German and UK markets (valued at $244bn and $238bn respectively). But modern retail penetration in Russia was just 53% in 2011, versus an average for developed nations of over 80%. This supports the projection made by Magnit that the Russian retail market will post a compound annual growth rate of 9.3% between 2011 and 2016, compared with 5.2% in the UK and just 2.5% in Germany over the same period.

Growth predictions such as these also support the view that consumer-related stocks remain modestly valued. Sber-bank’s Smith says these stocks across the retail, banking, telco, media, transport and real estate sectors trade on a p/e of about 14 times 2014 earnings, but are forecast to grow earnings by more than 20% over the next few years. “This means that the p/e to growth multiple is well under one, which is very attractive compared with other emerging markets such as China, India Brazil, Turkey and South Africa.”

Outstanding OFZ debt

Source: MinFin, CBR, VTB Capital

GDP growth


2.1%

-15%

-10%

-5%

0%

5%

10%

15%

2005 2006 2007 2008 2009 2010 2011 2012




-16%

-12%

-8%

-4%

0%

0%

25%

50%

75%

100%

2006 2007 2008 2009 2010 2011 2012 2013


0

100

200

300

400

500

600

2007 2008 2009 2010 2011 2012 2013


597

5283,297

3,186

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2007 2008 2009 2010 2011 2012 2013




Source: MinFin, CBR, VTB Capital

GDP growth


2.1%

-15%

-10%

-5%

0%

5%

10%

15%

2005 2006 2007 2008 2009 2010 2011 2012




-16%

-12%

-8%

-4%

0%

0%

25%

50%

75%

100%

2006 2007 2008 2009 2010 2011 2012 2013


0

100

200

300

400

500

600

2007 2008 2009 2010 2011 2012 2013


597

5283,297

3,186

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2007 2008 2009 2010 2011 2012 2013



002-04 Macro Overview2.indd 4 26/06/2013 17:35

The Sovereign


The Federation of Russia is the issuer that bankers and investors love to hate. It prints huge liquid

Eurobonds — when this year’s even-tually appears, it could be for around $7bn. But it also pays low fees, takes a long time deciding mandates and prints so tightly that it sometimes scuppers its own secondary market performance.

None of this usually seems to do it much harm. Investors cannot ignore the name and bankers still jump through as many hoops as it takes to win mandates.

This year, however, the sovereign’s inflexibility may have cost it dear even before it has released price guidance. Russia was originally expected to sell its Eurobond in the first quarter but pushed its plans back to the second quarter for reasons that bankers strug-gle to pinpoint. Analysts now reckon it may not issue until autumn.

It mandated banks in June — this year it is Barclays, Deutsche Bank, Royal Bank of Scotland, VTB, Gazprom-bank and Renaissance Capital that are being honoured. But rising US Treasury rates are forcing up the yield that it is likely to have to pay.

The catalyst for the latest bout of volatility was the indications from Federal Reserve chairman Ben Ber-nanke on May 22 that it could begin reducing quantitative easing this year if the US economic recovery gath-ered strength. Ten year Treasury yields spiked above 2% after his comments and had touched 2.18% by the start of June. Just one month earlier they had been at about 1.6%.

The sell-off picked up pace in late June, when Bernanke repeated the Fed’s plans, adding that the country could look to stop QE altogether by the end of the first half of the year. The market turmoil has hit emerg-ing market bonds particularly hard, but liquid sovereigns like Russia had suffered worst because their tighter spreads offered less cushion to absorb

Treasury rises.In early May, Russia’s 2022s were

trading at a yield of 2.8%. By the start of June, that yield had hit 3.5% and bankers at the time reckoned that about half of that widening was due to the shift in Treasuries. Some said that the sovereign might choose to wait to see if that might reverse, but the risk is that the opposite will happen.

Andrey Solovyev, global head of DCM for VTB Capital, told EuroWeek before the latest sell-off that his firm’s advice was for the sovereign to come sooner rather than later, arguing that continued rate rises could change investors’ views of EM in the second half of the year.

The historical context of the current yields makes decisions on timing not quite so clear-cut, however. Compared to where they have been in the past, Russian sovereign yields are still low, even with some selling pressure now. Its $2bn 2022s were placed in March 2012 at a coupon of 4.5% — and are still trading 100bp below that.

In addition, the country has $480bn of FX reserves and so is under no pressure to issue. That, in turn, makes it unlikely to be willing to offer a juicy new issue premium whatever

the market environment. “The credit quality of the Russian

sovereign is undisputed,” says Vladimir Potapov, chief executive of VTB Capital Investment Management in Moscow. “After 2008 it was viewed as being in much better shape than many other countries, with no Eurobond defaults from it throughout the crisis. So the appetite for Russian sovereign debt this year will simply be linked to the yield it offers.”

One at a timeRussia has become infamous for print-ing only one deal a year. After its $5.5bn dual tranche return-to-mar-ket trade in 2010, it sold a Rb90bn ($2.74bn) seven year in 2011 — a Rb40bn new issue and Rb50bn tap — and then a $7bn triple tranche Eurobond in 2012.

In 2010, its aggressive style was heavily criticised after the deal sold off by several points immediately after pricing. But its last two have been much better received.

“Russia’s 2010 issue was tricky — the market was volatile and it was forced into it a little,” says a bank-er who has been mandated for the upcoming deal. “The more recent two

Sovereign Eurobonds: has Russia missed its best chance?The Russian sovereign is a notoriously inflexible and aggressive issuer — but a much sought-after client. It has yet to pull the trigger on its 2013 bond issue but could press ahead soon, betting on further US Treasury rate rises, or hold off, in anticipation of a fall. Francesca Young looks at how the country will deal with the challenge of EM volatility.

Russian sovereign five year CDS spreads

Source: Markit

100

120

140

160

180

200

220

240

260

14 Jun 14 Jul 14 Aug 14 Sep 2012

14 Oct 14 Nov 14 Dec 14 Jan 14 Feb 14 Mar 2013

14 Apr 14 May 14 Jun

Russian sovereign 5y CDS spreads

Source: Markit

005-06 Sovereigns2.indd 5 26/06/2013 17:35

The Sovereign


have been a lot smoother; the market environment has been better.”

Some, such as Solovyev, say that it is important that the sovereign contin-ues to stick to its strategy of doing all of its funding in one strike each year. “The market has got used to it doing one deal a year and that restraint helps pricing for its own debt and for corpo-rate and FI issues from the country.”

Michael Ganske, head of emerging markets at global fixed income special-ist Rogge Global Partners, disagrees. He says it would be more investor friendly for Russia to become a frequent issuer and borrow smaller amounts through-out the year. And this year’s volatility could provide Russia with the perfect reason to switch to this method.

“It would be much better for the sovereign to spread out its bond issues throughout the year than to print a massive amount like $7bn in one go,” he says. “Every year the secondary market sells off before the new issue because there’s such a huge amount coming.”

He argues there is no investor friendly reason for the sovereign to print so much all in one go.

“Russia is a fantastic recovery story but it’s made them arrogant about what they can do in the capital mar-kets,” he says. “The reason that they do their bond issue all in one go is because they can and it’s easy. It also gives them an advantage in some ways to not be viewed as a frequent issuer.”

An origination official in London agrees that the main reason is conveni-ence for the issuer. “Look how long it took to mandate for the deal this year,” he says. “If that process was happening three times a year it would be laugh-able. The market will give them $7bn in one go, so why not just take it?”

The deadline for responses to the RFP for this year’s mandate was Janu-ary 10, but it was another six months until the banks were publicly mandat-ed. It is not unusual for the process to be long for EM sovereigns, but Russia is seen as a sufficiently big and sophis-ticated issuer to be able to move faster and take advantage of market windows.

Euroclearability excitementOne thing bankers do agree on is that there is no pressing reason for Russia to diversify the currency of its bond issues. As an oil-based economy, Rus-sia needs dollars more than any other foreign currency. And the dollar market also offers the deepest pool of liquidity.

“The sovereign plans to come to the market regularly and will probably

look to do different currencies at some point, but it will probably only do that when it needs those other currencies,” says an origination official. “For the moment, the sovereign has done 10 and 30 year bonds and could look to develop its curve further in dollars.”

However, the focus for the coun-try’s debt this year has not been on the dollar market but on the domes-tic. OFZs — medium and long-term Russian domestic government bonds — became Euroclearable in February, making it easier for foreigners to buy them.

This partly explains why yields on OFZs have fallen by more than 100bp, to below 7%, and over $40bn of for-eign money is set to enter the Russian domestic market by the end of 2013. But as Denis Poryvay, an analyst at Raif-feisenbank International in Moscow explains, Euroclearability is not the only reason for the tightening of OFZs.

“The huge rally in OFZs was not just the effect of Euroclearability but also of US quantitative easing,” he says. “There was a lot of speculative money that flowed into the local market to pick up a higher yield. Because of that, though, there’s no further yield tight-ening expected in OFZs.”

For the sovereign, the domestic market cannot replace the attractions of dollar Eurobonds, however. “The sovereign is already an active issuer in domestic bonds, but it’s still much cheaper for them to issue in dollars,” says Ganske. “As Russia is a dollar-based commodity economy, it will continue issuing in both currencies.”

Lots of oil, less governanceDespite improvements in the country’s capital markets, Russia’s credit story still has some obvious weak points — the fact that its economic fate is shack-led to global oil prices is one.

In 2008 oil crashed to a low of $30.28 a barrel and Russia’s bond markets were plunged into turmoil. The primary market shut up shop and the country spent its FX reserves propping up its banks and corporates as their yields spiked to double digit levels.

There was much talk at that time of the country diversifying from oil and gas to avoid a similar problem in the future. But little progress has been made. If the eurozone crisis reaches a messy conclusion, Russia’s continued vulnerability to an oil price crash could be shown again.

Ganske notes, however, that a change in Russia’s FX policy has

helped. The government is now much more comfortable with a fluctuating rouble — and that means the country has the flexibility to soften moves in oil prices.

For example, if oil were to fall from $100 a barrel (where it was at the start of June) to $80, Russia’s central bank could halve that fall in rouble terms by simply allowing the currency to depre-ciate by 10%.

“It also means that the country can effectively target inflation rather than fighting to keep the rouble stable,” adds Ganske.

Many Russia-watchers argue that the biggest problem the sovereign faces in the market is questions over govern-ance and the rule of law. Ganske agrees this is a much bigger problem than the dependency on oil or the perception of president Vladimir Putin as an autocrat. But he also worries about the increas-ing market dominance of government controlled entities.

“The big state-owned banks, VTB and Sberbank, are squeezing out the private players like Alfa Bank or Renais-sance,” he says. “Gazprom now con-trols basically all energy reserves in Russia. Having situations like these is bad for the investment climate.”

Such a situation can, in turn, hurt the perception of the country as a credit. “If Russia could sort out these issues, FDI would go up and capital would come into the country, and that helps everything perform as an invest-ment, including the sovereign.”

Traditional EM investors no longer put Russia in the frontier market cat-egory, and it has benefited from the eurozone crisis as money has fled to the stronger EM names in search of yield at an acceptable risk. The cur-rent volatility is likely to push the country’s yields up, but bankers hope this will encourage it to adopt more measures that would help bring down its spreads. If that happens, it will no longer seem fanciful to imagine it leav-ing the EM sector altogether.

“It would be much better for the sovereign to spread out its bond issues throughout the year than to print $7bn in one go”

Michael Ganske, Rogge Global Partners

005-06 Sovereigns2.indd 6 26/06/2013 17:35

Moscow as a Financial Centre


Moscow has lofty aspirations to go with its status as the capital of Russia, at the heart of the

CIS and its 279m people. Kingsmill Bond at Sberbank Investment Research says Moscow, ultimately, sees itself com-peting with London.

Indeed, Russia is well positioned to capitalise on European woes. If it can draw in business from Europe’s increas-ingly decimated banking system, that could accelerate Moscow’s rise to prom-inence in financial services.

Moscow also has one of the greatest concentrations of wealth in the world, with estimates suggesting that more bil-lionaires call it home than any other city.

Therefore there are the beginnings of a solid foundation upon which to build a global financial centre. But more work is needed. Moscow lacks an insti-tutional investor community of pension funds or mutual funds that can form the bedrock of demand for deals across the various asset classes.

The city’s ambitions will take time to fulfil and its development as a finan-cial centre is a long term process, with the government having to amend legis-lation, as well as improve infrastructure.

“Capital markets have been the focus of development so far as they sit at the core of financial services,” says Chris Cummings, chief execu-tive of TheCityUK in London, which is working with the Moscow Interna-tional Financial Centre Taskforce, led by Alexander Voloshin, to change the perception of Russia as a difficult place to do business. “But the other sectors that support and feed these markets also need to be addressed and this is starting to happen. Focus is now being brought to the way the collective industries, such as pensions, life insur-ance and mutual funds, develop.”

It is sometimes said Russia has an image problem but this is incorrect, says Bond. “Russia’s problem is not a PR issue but rather a question of setting up better systems and structures, develop-ing a domestic capital base, and playing

to the undeniable strengths of the larg-est country and arguably the largest city in Europe,” he says.

Arndt Roechling, CFO at Raiffeisen-bank in Russia, says there are no par-ticular differences in banking products and services in Russia which require specific skills. “We are seeing growth in the Russian retail banking market across all standard types of products, such as credit cards, consumer loans but also deposits,” he says. “Products do not dif-ferentiate so much compared to other CEE or Western markets.”

Useful commodityBond adds that there are two particular areas of finance in which Russia has considerable advantages that it could exploit to become a leading global player: commodities trading and the trading of rouble assets. While Russia is a commodities-driven economy, its focus is squarely on exports, and there is no Russian commodities exchange. This is something it should look to address and as a producer at the heart of global commodities flows, it makes sense to trade in Moscow, the hub of a huge hinterland spanning most of Eurasia, says Bond.

With many predicting that com-modities have reached their peak and are set for a sustained period of falling prices, Russia could be pushed into loosening its grip on the strategically important resources sector. A round of privitisations would generate business in financial services and help its meta-morphosis into a global financial centre.

In finance terms the banking indus-try is dominated by the bond market, with the equity culture still underde-veloped. Rouble denominated bonds are a big market and there is consider-able scope for growth of rouble trading. “As a commodity currency the rouble should be a viable alternative to other liquid commodity currencies like the Norwegian krona or the Australian dol-lar,” says Bond.

Legal and regulatory changes will be

crucial for Russia, given that corruption is still high on any list of concerns for many business leaders. There are sketchy plans in place to create a super-regulator to bring all financial market regulation in Russia under the umbrella of the central bank. It is not yet clear exactly how this will work, but the change is expected this summer, in conjunction with the arrival of a new central bank governor.

This will lend more coherence to the framework in which the central bank oversees banking, while the Federal Financial Markets Service is responsible for securities.

More importantly, it will give a more powerful voice to the financial industry within the government, mak-ing policy more reactive to the needs of the industry. Legislation and regulation of finance has been poorly co-ordinated and even sometimes contradictory, but a single entity will be well placed to give clear strategic direction, and ensure changes that are needed can be dealt with swiftly.

Heavyweight VoloshinThe appointment of Alexander Voloshin to head the Moscow taskforce is testa-ment to the importance the government attaches to this project. Voloshin is a

Moscow lays foundations for financial hubIn terms of financial services, Moscow is a regional, not a global player. But authorities hope this will change with a new focus on the sector that will power Russian growth for years to come. Solomon Teague reports.

Voloshin’s Moscow role shows the city means business

The 2014 Sochi Winter Olympic: a $50bn hard lending

007-008 Moscow as a fin centre.indd 7 26/06/2013 17:55

Moscow as a Financial Centre


political heavyweight with the author-ity to bring about that coherence and urgency.

A traditional criticism of Russia has been the lack of dynamism and the length of time required to get things done. “Execution can be very slow in Russia, you need a lot of patience to do business here,” says Roechling. “At the same time, when something is urgent people have the ability to be flexible and innovative, specific problems can be resolved quickly.”

Cummings adds: “Russia is increas-ing transparency and accessibility across the sector and there have been a num-ber of significant developments recent-ly.” The authorisation of the NSD as the central securities depository, foreign nominee account access, the introduc-tion of T+2 settlement and ICMA’s mar-ket standard Global Master Repurchase Agreements being validated as enforcea-ble for cross-border use have all reduced risk in the securities markets, he says.

The derivatives changes will be particularly welcome. The business has grown from nothing in 2006 when the law changed to legalise what was until then considered a form of gambling.

But more work is needed to reform the civil code to encourage lending, says Joerg Bongartz, chairman of the board of Deutsche Bank in Russia. “The legal system is much better than it was and is relatively liberal, certainly when com-pared to China or India, but there are still deficiencies,” he says. Essentially it is about trust in the court system.

This too can be tackled by a central-ised regulator headed by a senior politi-cian who can advise what changes are needed to improve the legislative frame-work. “Courts do not always understand the intricacies of the financial markets they are ruling on, and we see wrong decisions from time to time,” he says.

Yet here again the problems pale when set in their historical context. “Russian commercial law has become far more transparent in recent years, and Moscow lawyers talk about the ‘expand-ing middle’ of good quality commercial law,” says Bond. Almost all listed Russian companies now have internationally audited accounts, suggesting Russia is falling in line with international norms.

For employers in Moscow hoping to lure the best talent to the city, the ace up the sleeve is a 13% rate of income tax. Combined with salaries that are high compared to many competitor financial centres, moving to Moscow can be a very lucrative. The law of high-ly qualified specialists, passed in 2011, has taken steps to make it easier to fill

the gaps in its own labour market with talented foreigners.

However, more work needs to be done to make it easier for foreign nationals to work in Russia. Depository and custody specialists require licences before they can legally work in Russia. “For development of the Moscow Inter-national Financial Centre it would be good if they allow foreign professionals to take exams in English,” says Bongartz.

Tough sellEven with the government clearing obstacles for foreign recruits, Mos-cow remains a tough sell. Compared to many other financial centres it does not have the same allure for people with young families. Its extreme winters and controversial politics will put many off.

However, other changes and ini-tiatives are planned to help boost the talent pool. A training programme is being created to improve skills in cor-porate finance.

Meanwhile, Moscow’s deputy mayor, Andrei Sharonov, has made a name for himself as a tireless advocate for the city, encouraging investment, champion-ing infrastructure projects and fighting traffic, perhaps the biggest scourge on life in the capital. The recent introduc-tion of paid parking in the city centre should improve the lives of all Musco-vites, while investment in trains between the centre and the airports will be a big help in developing the city as a business centre.

How much of an issue the labour market is now is debatable. “The labour market has improved substantially but there is still a shortage of financial mar-kets specialists, which makes hiring a challenge because it is expensive and difficult to manage,” says Bongartz.

Deutsche is especially well placed to comment on this challenge, having

lost a third of its Russian workforce to VTB Capital in 2008. While this was an extraordinary event banks will rarely be forced to cope with, the underlying dynamic — the expansion of Russian banks as they look to become more international in scope and outlook — remains an issue, as might be expected in a city with close to 100% employ-ment. It remains common for whole teams at one bank to be poached by a rival, a situation that will not change any time soon, says Bongartz.

It is bad enough that some banks are moving their less sophisticated business functions out of the capital to cheaper locations where attrition rates are lower. Raiffeisenbank for example has an office in Yaroslavl where it has a call centre and conducts some other operations, including credit underwriting. “We could bring at a later stage also other functions such as credit analytical works or accounting functions to our shared service centre,” says Roechling.

Even if there is still fiercer than usual competition between banks in Russia for staff, meaning investment in training can be wasted if people jump ship for a competitor, movement between insti-tutions can bring benefits, reinforcing business links. And while it can be dif-ficult to deal with labour market rules that only require a two week notice period, it cuts both ways, allowing banks to lay off staff quickly if necessary.

Pressure on staff is accentuated by the extreme concentration of Russian financial activity in Moscow, where up to 80% of bank business takes place, according to the central bank. How-ever, the importance of the regions is growing, and as lower-end bank func-tions are moved from Moscow it should relieve pressure on the capital — while increasing interest in finance careers among students in the regions.

Moscow can be highly lucrative for ex-pats. But it’s still a tough sell for people with young families

007-008 Moscow as a fin centre.indd 8 26/06/2013 17:55

Financing Infrastructure


Maxim Oreshkin, chief econo-mist at VTB Capital, fully agrees with the politicians

who have hailed the newly construct-ed bridge connecting the city of Vlad-ivostock with the island of Russky as a highly impressive engineering feat. Spanning 1,185 metres, the gleam-ing new construction is a source of much national pride, given that it has eclipsed China’s Sutong crossing to become the world’s longest bridge.

The snag, says Oreshkin, is that the economic benefit of the new suspen-sion bridge is questionable. Built at a cost of about $1.1bn, the bridge was opened in time for it to be shown off to delegates travelling to last year’s Apec summit, which was held on Russky Island. But Russky has a population of little more than 5,000, which is why the new construction has been labelled by some sceptics as a “bridge to nowhere”.

“It’s a fabulous bridge,” says Oreshkin. “But it will turn out to be very expensive in terms of its IRR, which will probably be negative.” He has similar reservations about much of the infrastructure being built in

advance of next year’s Winter Olym-pics in and around the city of Sochi on the Black Sea coast, much of which has called for extensive (and expensive) tunnelling.

Oreshkin’s unease is shared by other analysts. In a recent update, Morgan Stanley notes that “there are concerns about the efficiency of infrastructure spending, particularly given the high cost of some projects against international comparisons, and the steep rise from initial esti-mates.”

“For example,” adds Morgan Stanley, “the cost of the Sochi Win-ter Olympics, which… does include extensive associated infrastructure, has risen from an initial $12bn esti-mate in 2007 to a forecast $50bn today, which is more than any other Olympics, including the Beijing Sum-mer Olympics.”

The resources being channelled into swanky showcase projects such as the Russky Bridge and the Sochi developments worry analysts because Russia has many more pressing, long term projects that are in urgent need of funding.

In fairness, says Jacob Nell, Rus-sia economist at Morgan Stanley in Moscow, in recent years Russia has seen a notable rise in infrastructure investment, from an average of 4.4% of GDP between 1995 and 2006 to 6.8% between 2007 and 2011, which he says stacks up well compared with peers such as South Africa, Brazil and Turkey. In 2011 alone, however, infra-structure investment reached Rb4tr ($130bn) or 7.3% of GDP, which according to Morgan Stanley, was the highest level since the end of the Soviet Union.

Nevertheless, the consensus is that Russia’s infrastructure, most of which

Russia seeks capital market finance for urgent upgradeRussia’s infrastructure, most of which was inherited from the Soviet Union, is in desperate need of wholesale modernisation. According to most estimates, that upgrade will cost $1.5tr over the next 20 years. Philip Moore looks into the crucial role that the capital markets will play in helping to plug the infrastructure deficit.

“It is difficult to put together a lending syndicate under Russian law as security cannot be shared among lenders with the same ranking”

Sergey Zhukov, Gazprombank

Bridge to nowhere? The new link connecting Vladivostock with Russky is much admired but its economic benefit is under question.

009-12 Financing Infrastructure 2.indd 9 26/06/2013 17:51



was inherited from the Soviet Union, remains in urgent need of wholesale modernisation. “Almost all sectors of the Russian economy will face huge capex requirements over the com-ing decades,” says Sergey Nekrasov, first vice-president at Gazprombank in Moscow. “Some industries, notably oil and gas, did enjoy high levels of investment following the collapse of the Soviet Union, but more is needed. The power industry requires upgrad-ing and is in need of new capacity. The transportation sector, including railways, also needs to respond to the challenges of a modern economy.”

Drag on developmentIt is critical that Russia plugs this gap not just to deliver an infrastructure compatible with the living standards expected by the country’s aspirant and growing population. Infrastruc-tural inefficiencies, say bankers, are creating a meaningful drag on eco-nomic output. “Existing obsolete infrastructure in Russia may become a real barrier for economic growth,” says Gazprombank’s Nekrasov. “According to some Russian econo-mists, the current level of investment in infrastructure may restrict annual GDP growth to 2%-3%.”

It is also essential that Russia upgrades its infrastructure in order to improve on its feeble record of attracting the foreign direct invest-ment (FDI) it needs to wean the economy away from its dependence on oil and gas. Most obviously, crum-bling and inadequate transport infra-structure limits the appeal of Russia as a manufacturing base for companies looking to distribute their products through it and the Commonwealth of Independent States. Bottlenecks in the transportation sector, notes Mor-gan Stanley, are “delaying success-ful development of the economy. The current state of the transportation sys-tem poses significant obstacles to the government’s economic development plans, we think.”

Peter Stonor, global head of infra-structure and transport at VTB Capital, agrees that Russia’s rundown trans-portation facilities have a quantifi-able negative impact on trade. “It is estimated that about 25% of the cost of finished products in Russia is accounted for by transportation costs, which is two to three times what you would expect in a developed econo-my,” Stonor says. Little wonder, then, that only about 1.5% of the container trade between Asia and Europe passes via the northern Russian route, he adds.

Estimates of how much Russia will need to invest in infrastructural mod-ernisation over the coming 15-20 years vary. Morgan Stanley forecasts that the current level of infrastructure investment (7% of GDP) will con-tinue up to 2018, when Russia will host the Fifa World Cup. “The mar-ket doubts the scale of infrastructure spending due to the lack of detail and the expense,” Morgan Stanley acknowledges. “However, our analysis shows that infrastructure spending will grow at a 3% CAGR …to $157bn in 2017, in line with Russian GDP growth.”

Looking further ahead, a recent McKinsey study puts Russia’s likely infrastructure expenditure between 2013 and 2030 at $1.5tr, which VTB Capital’s Stonor says is broadly in line with other estimates. “The run rate most people talk about in terms of future infrastructure spending is around $100bn a year, roughly half of which will be accounted for by transportation projects,” he says. “We expect about 80% of this to be gov-ernment-funded, with the remain-ing 20% of finance coming from the private sector.”

Historically, says Pavel Brusser, managing director and head of infra-structure in the project and structured finance department at Gazprombank, equity for large scale Russian infra-structure projects has been provided by a limited number of major banks, large Russian engineering, procure-ment and construction (EPC) con-tractors, international operators and investment funds.

“Regarding lending,” he adds, “for the larger projects, in particular, only Sberbank, VTB and Gazprombank are regular players. As the Russian banks’ cost of funds in foreign currencies for medium to long term tenors is higher than that of foreign banks, they do not usually focus on euro or dollar-denom-inated projects, which is typically cov-ered by the international banks.

“However, the Russian banks can be competitive in projects generat-ing rouble revenues, for certain types of structured facilities and in the case of clients that the major international banks find more difficult to under-stand.”

Capital market solution?To date, says Denis Shulakov, first vice-president at Gazprombank, the capital market has been regarded as an attractive but generally elusive source of project finance. “Relatively few projects have been able to secure significant funding on capital markets for a number of reasons,” he explains. “Projects can be too complex to sell to investors, the liquidity may or may not be there at the moment of fund-ing, and intercreditor issues can prove tricky if there are other financing sources.

“Add to all this the element of Russian risk, and projects can appear

“Existing obsolete infrastructure in Russia may become a real barrier for economic growth”

Sergey Nekrasov, Gazprombank

The 2014 Sochi Winter Olympic: a $50bn hard landing




daunting for the capital market. That is not to say that Russian borrowers have been unable to access the capital market. There are plenty of examples of very successful corporate issues in Russia. But the combined effects of all these elements can be an uphill battle for Russian borrowers.”

One funding option is so-called infrastructure bonds, which have been the subject of animated debate in Russia for a while. According to a recent presentation from the Renais-sance Group, state corporations, in particular Russian Railways (RZD), have lobbied for the issuance of infrastructure bonds that would be bought by pension funds. The same presentation adds, however, that this proposal has traditionally met with resistance from the Ministry of Finance, which has argued that infra-structure bonds would worsen Rus-sia’s debt position. Additionally, the Renaissance presentation advises that private pension funds are “strongly encouraged by government rules not to invest in infrastructure”.

Much of this opposition seemed to melt away in January, when president Vladimir Putin announced that pen-sion funds should be used as a fund-ing source for railway projects. This paved the way for RZD to announce plans to issue Rb100bn worth of infrastructure bonds in each of 2013, 2014 and 2015, with maturities of between 15 and 30 years.

Bankers say that RZD has been issuing bonds in the domestic as well as the international market for a number of years, which are — almost by definition — infrastructure bonds. “There is no legal definition of infra-structure bonds in Russia, so we can’t describe these as a separate asset class,” explains Alexander Kudrin, head of fixed income research at Sberbank Investment Research in Moscow. “The main difference between the recently announced infrastructure bonds and corporate bonds issued by companies raising funding for infrastructure projects is their maturity and interest rate.”

The maturity of the so-called infrastructure bonds has extend-ed the yield curve in the domestic market, with a Rb25bn bond from RZD in early June led by VTB Capi-tal, Gazprombank and Sberbank CIB offering investors an opportunity to buy 30 year corporate debt in the rouble market for the first time.

The coupon, meanwhile, was in line with the pricing formula estab-

lished for the new infrastructure bonds, which is 100bp over con-sumer price inflation (CPI). “Right now Russian inflation is 7.4%,” says Kudrin. “So compared to the yield on long-term sovereign bonds of 7.5%, a 100bp premium over inflation looks attractive.”

Small buyer baseFor the foreseeable future, say bank-ers, demand for infrastructure bonds will be confined largely to the state pension fund and other government-owned entities such as Vnesheconom-bank, which has publicly announced that it will be buying infrastructure bonds issued by RZD and the Federal Grid (UES FGC). “The bulk of insti-tutional investors in Russia are com-mercial banks, which have relatively short-term investment portfolios, so their demand will be limited,” says Kudrin.

Whether or not foreign inves-tors will be attracted by these issues — effectively corporate inflation-linked bonds — will depend chiefly on their broader appetite for rouble denominated corporate bonds. Ana-lysts expect this to increase markedly following a series of financial market reforms, including the creation of the Russian Central Securities Depository (RCSD) and the opening of access to international depositories such as Cleastream and Euroclear.

Commenting on these and other reforms in a recent report, Moody’s forecast that they would encourage foreign investment in the corporate rouble bond market to rise to around 10% of the total, or between $10bn and $15bn, over the next two to three years, from less than 2% to 3% today.

Others agree that international

investors are set to become much more active in the domestic bond market and, by extension, more influ-ential in the funding of infrastruc-ture via the capital market. “Tectonic changes are already taking place in the rouble bond market,” says Nekra-sov at Gazprombank. “It is expected that global investors, with more than $60tr in assets under management, will be given access to all segments of the Russian bond market as a result of liberalisation.”

Easier access to the domestic market will complement the oppor-tunities international investors have already been offered to buy into the Russian infrastructure story via the international funding programme of Russian Railways. “Russian Railways has been very active in the capital markets, issuing in five currencies, including sterling and Swiss francs as well as dollars and euros,” says VTB Capital’s Stonor.

Russian Railways’ most recent international transaction, in April, was a €1bn eight year issue led by Natixis, RBS, Société Générale and VTB Capital and priced at a 3.375% yield. “Recent transactions from Russian Railways have been very competitively priced, and its issue in April was notable for achieving the lowest ever corporate

Morgan Stanley forecast for infrastructure spending: set to stay at current level of 7% of GDP to the 2018 World Cup

Source: Rosstat, Morgan Stanley Research e=Morgan Stanley Research estimate

Exhibit 1

We forecast that infrastructure spending will stay at the current level of 7% of GDP to the 2018 World Cup

4052

76

10389

104

135 134 138 143 148 152 157

6%7% 7% 7% 7% 7% 7% 7% 7%

6%5% 5%

7%

0

20

40

60

80

100

120

140

160

180

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

e

2013

e

2014

e

2015

e

2016

e

2017

e

0%

5%

10%

15%

20%

Infrastructure spending ($bn) Infrastructure spending as % of GDP

e = Morgan Stanley Research estimates Source: Rosstat, Morgan Stanley Research

“Russian banks are competitive in projects generating rouble revenues, for some structured facilities and for clients that international banks find difficult to understand”

Pavel Brusser, Gazprombank




fixed yield for any tenor from a CIS borrower,” says Stonor.

Another play on the Russian rail sector is the freight lessor, Brunswick Rail, which was last in the interna-tional market in October 2012, with a $600m five year issue. Led by Gold-man Sachs, Raiffeisen, UBS and VTB Capital, the Brunswick Rail issue was priced at 6.5% and generated orders of around $3bn.

PPP growthStonor says that beyond the straight Eurobond market, private-public partnerships (PPP) are building an increasingly encouraging track record as a viable financing mechanism for infrastructure projects in Russia. Rus-sia’s first PPP project, in 2010, was the Pulkovo airport development in St Petersburg, which was regarded at the time as establishing an important blueprint for future infrastructure projects in Russia.

The construction of the new ter-minal at Pulkovo, aimed at doubling traffic numbers at the airport, was supported by a €716m long term debt package put together by the European Bank for Reconstruction and Development (EBRD), Interna-tional Financial Corp (IFC), Eurasian Development Bank (EDB), Nordic Investment Bank (NIB), and Black Sea Development Bank (BSDB). The bor-rower was Northern Capital Gateway, a consortium made up of VTB Group, Germany’s Fraport and Horizon Air Investment, which has a 30 year con-cession from the City of St Petersburg to rebuild, finance and operate the St Petersburg airport.

Another showcase project for PPP in Russia, says Brusser at Gazprom-bank, is the Western High Speed Diameter (WHSD), which at $6.4bn is the world’s largest toll road project. The 46 kilometre highway will relieve traffic congestion in St Petersburg by redirecting haulage trucks from the city’s seaport to the fed-eral highways, bypassing the city.

Gazprombank is the sponsor, financial advis-er and mandated lead arranger on the WHSD project, the funding for which is also being pro-vided by VTB Capital, Vnesheconombank, EDB and EBRD. According to EBRD, the significance of this project, the first

PPP in the Russian road sector, “goes beyond the project’s specific scope and lies in its ability to demonstrate the effectiveness of PPP structuring as a means of attracting private sec-tor funding for the significant trans-port network upgrading and expan-sion programme in St Petersburg.” This, says the EBRD, will “increase the capacity and effectiveness of not only the city’s transport system but also that of the region”.

VTB Capital’s Stonor agrees. “St Petersburg has led the way in terms of having the most developed PPP con-cession framework, but other regions are expected to follow,” says Stonor. “Both the Pulkovo terminal and WHSD PPP project have demonstrated that there are viable alternatives to govern-ment funding and bank lending.”

The EBRD also has exposure to the Russian infrastructure story through its holding in the Macquarie Renais-sance Infrastructure Fund (MRIF), which was set up in 2008, and has some $670m under management. Other investors in the fund include the Eurasian Development Bank, the IFC, the Kazakh sovereign wealth fund (Kazyna Capital Management) and Vnesheconombank.

The returns that have been earned by investors in some major projects have clearly been a draw for investors such as these. Nekrasov says that even allowing for inflation, IRRs in some projects have reached 25%-30%.

Governance concernsWhile returns in the Russian infra-structure market may be appeal-ing, bankers concede that corporate governance and the legal regime in Russia remain concerns for some investors. “It is true that there remain certain challenges in using limited recourse finance structures in Russia, many of which are the result of the

legal environment,” says Sergey Zhu-kov, managing director in the project and structured finance department at Gazprombank. “For example, it is dif-ficult to put together a lending syn-dicate under Russian law as security cannot be shared among lenders with the same ranking. Pledges of accounts are not effective as it is legally impos-sible to prevent a borrower from deb-iting an account it owns, even if that account is pledged.”

Zhukov adds: “Russian law does allow a borrower, or even any obligor, including guarantors, to keep foreign sales proceeds abroad to pledge them in favour of lenders, but that facility is reserved for exporter-borrowers, not exporters in general, and only with respect to the loans provided by foreign lenders for a period of more than two years. These and other restrictions explain why it is common to structure loan and equity participa-tion documentation in Russia under English law (but this requires partici-pation of at least one foreign entity) and why specific ‘Russian solutions’ have been devised over the years.”

Nekrasov says many other regula-tory aspects need to be taken into account for Russian projects. “For example, the requirement to obtain permits for projects requires care-ful planning process depending on the industry,” he says. “Tariffs for

pipelines, airport fees, road tolls, property rights, construction, operation of some classes of assets and many other economic issues are regulated and must be understood. There is an on-going deregula-tion process in the gas and power industries, which is profoundly changing the landscape and prospects for investment. A good understanding of the pro-cess and the constraints is the key to successful pro-ject planning.”

“Projects can be too complex to sell to investors, the liquidity may or may not be there at the moment of funding, and intercreditor issues can prove tricky”Denis Shulakov,

Gazprombank

Infrastructure investment still dominated by large state owned enterprises

Source: Company reports and presentations, Morgan Stanley Research

Gazprom* 268 463 810 647 Russian Railways 266 317 395 428 Transneft 234 263 252 229 Rosatom 193 210 283 283 Federal Grid 90 141 152 171 IDGC Holding 77 87 130 124 Rushydro 53 82 89 81 Avtodor 55 71 113 Rostelecom 45 52 83 63 Total, in Rb bn 1,227 1,670 2,265 2,137 Total in $bn 39 55 75 70 as a % of GDP 3.2% 3.7% 4.1% 3.5% as a % of infrastructure investment 44% 53% 57% na* Including transportation, distribution, storage and power/heat capex on IFRS basis, excludes production and refining

State owned enterprises, Rb bn 2009 2010 2011 2012e


The Banking System


A thousand banks is far too many, even for a country the size of Russia. Some 17m square

kilometres and 143m people should ultimately be served by a tenth of that number, or fewer.

The country’s financial authorities have not hung around in attempting to cut their sprawling banking system down to size.

On October 1 this year Russia will integrate into the global Basel III framework, barely a year after the Central Bank of the Russian Federation published the first draft of the new regulations.

Under current plans, banks will be required to maintain a 5.6% core equity tier one ratio, a 7.5% tier one ratio and a total capital adequacy ratio of 10%.

“Further consolidation of the Rus-sian banking sector can be expected, due to a great overall number of banks and their low level of capitalisation, in comparison to the banking systems of some developed countries,” says Ekat-erina Trofimova, first vice-president at Gazprombank.

“Among the possible factors that could accelerate this process are increasing competition, further asset quality deterioration and the policy of the regulator and its requirements.”

Smoothly does itWhile the regulator is keen to set Rus-sia’s banking sector on a path to a more sustainable structure, it is equally keen not to try the faith of Russian depositors, who provide banks with a large proportion of their funding.

“The tactic of the central bank, certainly over the last eight years, has been to introduce new measures grad-ually,” says Elena Romanov, a senior analyst at Raiffeisen Research.

“It wants tougher regulations but it should be a smooth transition to Basel III. I do not expect sudden bankrupt-cies or public punishments, nothing that could cause a panic. The Central

Bank of Russia understands that the trust of depositors is fragile.”

The CBR’s measured approach was made clear in June when a senior offi-cial said banks would be given an extra month to comply with the new rules, and the proposed minimum capital requirements could still be relaxed.

The transition will be smooth, but that doesn’t mean it can’t give the industry a much-needed shake-up.

The CBR has already introduced stricter rules for the eligibility of banks’ tier one and tier two debt, which since March 1 has had to include loss absorption features. That could put pressure on smaller institu-tions, which, unable to issue capital at a competitive price, may struggle to survive (see page 26).

Oliver Hughes, president of Tinkoff Credit Systems, the online bank, agrees Basel III will not force banks to consol-idate or go out of business, but he sees three things that could put pressure on the smaller banks to do one thing or the other.

“The first is mandatory reporting to IFRS, which means getting a decent accounting firm, adding an overhead,” he says. “Second is the central bank actually enforcing the minimum capi-tal requirement of $10m. There are plenty of banks under $10m but it’s not enforced too strongly. And third is unilateral regulatory action from the central bank, aimed at individual insti-tutions.”

Stars and drossConsolidation must happen, and it will in time. But many of the acquisitions in the last five years were rescues aided by the state, as some banks struggled with the effects of the 2008 financial crisis.

In future, there will have to be a positive business case for mergers and acquisitions. “The top 10 banks have got their own dynamic and there will not be much consolidation going on,” says Hughes. “From positions 10 to 50

there are many indistinguishable banks that lack strategy, growth and capital, so there is a business case for others to follow the likes of Nomos Bank and Otkritie Capital [by merging]. Then from 50 to 100 there are some ris-ing stars and a lot of dross. The dross will either be gobbled up or go out of business. There is a lot of potential movement there.”

Sberbank, VTB, Gazprombank and the commercial banks in the VEB group accounted for 53% of total banking assets at the end of 2012, according to a May 2013 report by Raiffeisen Research.

And in the volatile climate that

exists for private banks in Russia, the rest is up for grabs.

There have been some impressive growth stories among the vast group of smaller private banks in the years since the financial crisis.

In terms of assets, Nomos and Promsvyazbank have powered into the top 10, at the expense of rivals like Uralsib and MDM.

Otkritie Financial Corp acquired several distressed regional banks, and its takeover of Nomos will create a formidable enterprise in domestic banking.

As Raiffeisen notes in its report, St Petersburg’s Bank Rossiya has gone from being a top 50 to a top 20 bank in just five years, while consumer lending bank Orient Express has joined the top 30, having been ranked 89 by

Dog-eat-dog banking full of scope for smaller breedsThis year’s shift to Basel III will be further stimulus to much-needed consolidation, and with the country’s quasi-sovereigns thinking globally, smaller players have a huge opportunity to grab market share, writes Tom Porter.

“The dross will either be gobbled up or go out of business. There is a lot of potential movement there”

Oliver Hughes, Tinkoff

013-14 FIGt2.indd 13 26/06/2013 17:35

The Banking System


assets in 2007.The onus may very well fall on

these new powers, and others in the top 10 to 50 bracket, to drive consoli-dation through mergers and acquisi-tions.

Raiffeisen’s Romanov does not expect any mergers between the small-er banks.

“The regulatory approval procedure is quite cumbersome and for the banks it is easier to either grow organically or disappear,” she says.

For those hoping for consolida-tion in the sector, it may be a case of waiting for banks outside the top 100 to die, rather than expecting them to merge and attempt to grow their busi-nesses.

“Mergers between regional banks are quite possible,” says Gazprom-bank’s Trofimova. “Voluntary acquisi-tions of the banks that are not in the top 100 are very unlikely as the qual-ity of their assets is not always good enough. However, the government can be expected at some point in time to urge bigger banks to acquire small-er ones to ease the pressure on the Deposit Insurance Agency.”

But the CBR can only go so far in actively encouraging banks to merge or acquire competitors.

It cannot force privately held insti-tutions to load up their balance sheets for the greater good. The CBR has more sway over state-owned insti-tutions, but Sberbank and VTB have made it clear they have little further part to play.

Sberbank, along with the govern-ment that owns it, is loath to put its 100m customers’ deposits at risk, and VTB is still digesting its full takeover of Bank of Moscow from the government in September 2012.

Russia’s two banking beasts appear content with their domestic market share and have started devoting more energy to competing with global rivals.

Local knowledgeSo can smaller lenders compete with them in the domestic market and by doing so foster competition and drive consolidation?

Absolutely, says Romanov. “There are still a lot of opportunities for the smaller banks,” she says. “The banking system is still developing and there are plenty of products and customers in Russia that have not yet been tapped. A good example of where smaller banks can compete is SME lending, where they benefit from their regional pres-

ence and knowing their clients well.”VEB’s SME Bank has taken this

route. It relies on the local knowledge of a network of regional agents to allo-cate funds to businesses across Russia.

“It is quite challenging for smaller banks to compete with banks like VTB or Sberbank, because their funding costs are considerably lower,” says Tro-fimova. “Yet, interest margins on large corporate loans have decreased in the Russian economy. Considering this, smaller banks can compete with the bigger ones for small and medium-size corporates and individual customers, by providing conditions that are more flexible.”

There are other areas that remain largely untapped, where nimbler operators can compete with the behe-moths, and none more so than con-sumer lending.

Banks for the massesThe consumer finance market has grown so fast in recent years that concerns about a future bubble have arisen, and the CBR is set to intro-duce stricter rules for such lenders to combat it.

The growth has been phenomenal, but it has started to slow this year and consumer lending still only accounts for 13% of GDP in Russia, meaning it has some time to run before reaching bubble proportions.

“We are going to see lots of growth in consumer lending over the next few years,” says Hughes at Tinkoff. “Credit card penetration across the market is 18%, but it is heavily skewed to the big cities. In five years we could see the level of credit card penetration we have seen in other emerging markets like Turkey, Poland and Mexico, in the 40%-70% range.”

Tinkoff is one of the rising stars taking on the biggest banks by reach-ing regional customers through its online model. The credit card issuer has grown at more than 100% for the last three years and is now knocking

on the door of the top 50.“There are proactive medium-

sized banks that are now growing very fast,” says Romanov. “Credit Bank of Moscow, for example, has changed its strategy and is now growing well organically, and Orient Express Bank is benefitting from its consumer finance specialisation.”

The Russian market needs institu-tions like these to take on VTB and Sberbank, whose size enables them to set the rates in corporate and retail lending. Fiercer competition should lead to cheaper prices and better ser-vice for domestic customers.

But there are benefits to the two leaders’ dominance.

“To a certain extent, the size of Sberbank and VTB distorts the market, because they enjoy certain privileges such as an implied state guarantee for corporate and retail depositors, and they have a much lower cost of fund-ing,” says Hughes. “Our average cost of funding at the moment is about 12%, theirs is around 4%.”

But there is a positive side to the big two’s dominance, in that they create infrastructure in under-served segments, he argues: “In credit cards, Sberbank having a 22% and growing market share is a good thing, because they are establishing the product, educating customers, and driving the spread of acceptance infrastructure.”

Russia’s banking system mirrors its economy in the way it still serves many consumers poorly.

Tinkoff, for example, has been forced to create an in-house courier service to reach its most remote cus-tomers – the multinational couriers simply don’t deliver beyond their city hubs. The bank’s service now covers 600 cities through over 1,200 couriers and is probably the biggest in Russia.

It is a neat example of how by focusing on untapped markets, smaller players can squeeze their way on to the banking table, between the elbows of much bigger diners.

Russian banking sector, market share by assets, 2012

Source: Raiffeisen research

Others, 37.8%

Promsvyazbank, 1.4%

Rai�eisenbank, 1.2%

Nomos Bank Group, 1.9%

SocGen, 1.7%

UniCredit, 1.7%

Alfa Bank, 2.6%

Russian Agricultural Bank, 3.2%

Gazprombank, 5.6%

VTB Group, 15.4%

Sberbank, 27.4%

Market share by assets, 2012

source Rai�eisen Research

013-14 FIGt2.indd 14 26/06/2013 17:35


Financial Institutions Roundtable

EUROWEEK: The implementation of Basel III in Rus-sia is set for October 2013. Will it will help provide stability to your banking sector or is it too soon for Russia

Ksenia Nefedova, VEB: First, I would like to mention that VEB is governed differently from the commercial banks. Being a state corporation our aim is to foster development of the country’s economy. We are governed by a particular law on the Bank for Development and we are not subordinate to the CBR. Still, most of our meth-odology is based on CBR requirements. However, taking a look at this systemic change from the outside, you have to remember that it took Western countries about 20

years to adapt to these Basel requirements. Now we are trying to reach what the banks in other countries have done in a much shorter space of time. There’s been a nine month delay, but still, by end of the year, the whole Russian banking system is expected to comply.

It’s going to have quite an important and drastic im-pact on the system, burdening the commercial banks in terms of their capital requirements and as a result curb-ing their lending activities. That is likely to lead to much slower development of our banks within our system.

However, the implementation of Basel III certainly makes the banking system as a whole safer by making the individual risk profiles of the banks sounder. Bearing in mind that consumer lending is rapidly expanding in

Participants in the roundtable were:

Konstantin Chernov, deputy head of debt management and investor relations, Gazprombank

Marina Kareeva, deputy director of financial institu-tions and international capital markets department, Promsvyazbank

Ksenia Nefedova, head of the debt finance and investor relations division, Vnesheconombank (VEB)

Tim Nicolle, adviser to the management board, Svyaznoybank

Natalia Peksheva, head of the securities sales and service division, Raiffeisenbank

Alexander Smolin, head of debt finance, global treasury, VTB

Moderated by Francesca Young, emerging markets editor, EuroWeek

Banks face up to Basel III with funding diversity plan

Wholesale change is sweeping through the Russian banking sector. Basel III is earmarked for implementation in Russia this October and the country’s banks are having to grow accustomed to complying with the new banking regulation framework. Euroclearability of the rouble domestic market for banks and corporates is also expected later on this year, with the e�ect of potential foreign in�ows therefore yet to be seen. Meanwhile, bank funding teams are busily diversifying funding and working on strategies for coping with increasing US Treasury volatility.The Russian banking sector has boomed in the years since the �nancial crisis �rst hit, grabbing market share in both retail and investment banking from the big international banks. But with these new challenges ahead, it is questionable whether they can continue with the same pace of growth.At EuroWeek’s Russian �nancial institutions roundtable held in Moscow on June 11, borrowers and bankers exchanged views on whether the introduction of new regulations is right for Russia and what are likely to be the best opportunities for funding in the capital markets over the next 12 months.

016-23 Banks RT.indd 16 26/06/2013 17:34



Russia, these measures from the CBR’s point of view are a necessary safeguard.

EUROWEEK: Does it a�ect the growth ambitions of some of the smaller banks in Russia?

Tim Nicolle, Svyaznoybank: Basel III, for consumer finance specialists, should actually be good news. Russian banking regulation currently sits somewhere between Basel I and Basel II, with some Russian features added on, and moving to more of a risk-based regulatory model sounds like a good thing. I imagine that if we adopt IRB, the internal ratings based approach, we would find that our capital requirements would reduce, relative to current Russian Central Bank requirements.

At the same time though, you can take an old-fashioned view of banking regulation, which is that no amount of mathematics will make the banks better or stronger.

In the UK, not that the UK has anything to be proud of, there’s a concept of a fit and proper person running a bank, and that overrides any amount of capital regulation or capital requirements.

What’s impressed me with the interactions we’ve had with Russian Central Bank is that they do pay more at-tention these days to the spirit of the rules as well as the formality of them. That’s certainly been the case in how they regulate Svaznoybank.

What’s probably more important than we’re under Basel I, I and a half, II, or III, is how the Central Bank polices the system in its substantive, rather than norma-tive models. That’s the biggest concern in Russia. So Basel III sounds like an opportunity to pay consultants a lot of money. It also sounds like an opportunity for consumer finance banks to reduce the amount of capital they hold relative to today’s requirements. But at the same time, the focus should be on who runs the banks and how they are run, rather than the mathematics that are defining their capital bases.

EUROWEEK: Do you think that the central bank could be unfair in its implementation of Basel III? Could state banks be given a bigger say in how things unfold?

Nicolle, Svaznoybank: Svaznoybank is a well regulated institution by the Central Bank. They monitor the bank extremely closely, and very sensibly. I can’t speak about the relationship they have with other banks. But my sense is that the culture of banking regulation in Russia in 2013 is significantly better and stronger than it was in 2007, for

example, and that’s a very good thing.I don’t think the state banks get any kind of special

treatment. They do have the luxury of a state treasury to help them with their capital needs, but that is a different question.

Alexander Smolin, VTB: In the case of VTB there is no question who runs the bank. The state runs the bank, and that is of course the main factor in the life of the bank.

The change in regulation has definitely been quick and it’s continuing to be done quickly, with new initiatives, new laws and new regulations, especially in the field of capital treatment.

That means that for the state owned banks, particu-larly for VTB, life is becoming harder because we need to support our capital. Last year we used very innova-tive instruments to do this like the hybrid capital bond, which was half equity, half debt, but that has turned out unfortunately not to be in full compliance with the new regulation and will be subject to earlier amortisation.

The problem is that we have a part of our capital in the form of subordinated debt, not just from the state, but also from the international market in the form of Eurobonds — usually lower tier two — and also a hybrid tier one capital instrument. That means that we are going to be creative with regards to liability management ideas when planning the future of these instruments.

EUROWEEK: There are close to 1,000 banks in Russia at the moment, which is a very large number com-pared to other countries. Will Basel III will be used as an opportunity for the CBR to weed out some of the weaker institutions? Can you see it prompting much M&A business between the banks?

Marina Kareeva, Promsvyazbank: I do not think that we will see many mergers and acquisitions in the next few years though there have been a couple of transactions already, such as Nomos Bank and Otkritie and MDM Bank and Ursa Bank. The market reception to these deals has been very varied though and no one can say with certainty that they were 100% successful.

There’s been a lot of talk about these mergers and ac-quisitions for many years, but we don’t see many happen-ing in reality and I can’t see that changing in the future. The ones we have recently seen have just been one-offs, not part of a trend.

EUROWEEK: So will that mean a lot of defaults from banks that can’t comply with Basel III?

Kareeva, Promsvyazbank: No, but they will have to decrease their assets and growth. Large banks will have less capital so will not have much room for acquisitions. In 2008, and before that, Promsvyazbank considered a few small banks for acquisition, but after proper due diligence we decided not to do a lot of them. We did do three acquisitions but those were of small, regional banks, and the purpose of that was to acquire their market share in certain segments of business in these regions.

Nicolle, Svaznoybank: I think that the weeding-out process is independent of the flavour of banking regula-tion. It’s a policy matter, rather than a regulatory matter. I think the authorities have got plenty of tools to reduce the number of banks in the system already available if they wish to use them. Adding to the toolkit is not needed.

It’s not necessarily a bad thing that there are hun-

Tim Nicolle, SVYAZNOYBANK

016-23 Banks RT.indd 17 26/06/2013 17:34



dreds of banks in Russia, because apart from the top 50, 75 banks, the balance of the banking system operates, effectively, below the international radar screen. It’s a domestic matter, and there are healthy reasons for having all these banks, and some unhealthy reasons as well. I’m sure the authorities pay very careful attention to it.

EUROWEEK: Bearing in mind potential changes in capital regulation, what are your plans for raising debt over the next year or so?

Smolin, VTB: VTB has been active for a number of years in exotic currencies such as Australian dollars, Chinese renminbi, Singapore dollars and Swiss francs, though Swiss francs is not something new for Russia — many issuers use that market.

The number of potential new, exotic markets that could be immediately available for Russian issuers is not really big, but still we see particular opportunities. We’re considering some Asian ideas. We’re looking at other different structures and also considering some Islamic financing. We’re also thinking about tapping developing markets such as Korean won or South African rand.There are always two potential routes to be used. The first is to use the usual Eurobond format, issuing in exotic cur-rencies. The second route is to tap the local markets and try to reach local investors under local regulations, which is a much more complicated idea, but still sometimes that can work. When it works it can serve to increase your investor base and reach local accounts which would never participate in the Eurobond transactions.

The main target here though is not to issue in different currencies for the sake of it, but to use those currencies which can provide a good arbitrage opportunity on an after-swap basis. Those can be less expensive than the usual benchmark Eurobond dollar issuance. When issuing in exotic currencies we usually use a swap into dollars or roubles or whatever else suits the bank’s liquidity needs.

It’s a simple economic rationale — we don’t tend to need the exotic currencies directly so if a deal is more expensive on an after-swap basis, we will not issue.Generally we are over-liquid now, so we don’t need money immediately in this part of the year.

EUROWEEK: But you mentioned that you are also looking to do liability management trades?

Smolin, VTB: Right. We can spend our time looking at our existing and outstanding instruments and working out what is best to do. Some of our older instruments that we placed many years ago have different covenants to what we tend to use now, for example, so we may have some ideas on how to change the debt profile of the bank.

Chernov, Gazprombank: It has been an important development of the last two years for the Russian top bor-rowers that different markets have become available. It’s useful both for the expanding of an issuer’s investor base and also for doing opportunistic trades and saving costs.

Earlier this year we raised Rb20bn in the Eurorouble market and Rmb500m in the Dim Sum market. Both those transactions represented a substantial arbitrage to the domestic rouble market or the dollar denominated Eurobond market.

The currencies we choose to use this year will depend on our liquidity requirements and the market conditions — what is available and what opportunistic situations arise in different markets. We’re currently working on

developing several markets and actively undertaking investor relation activities there.

EUROWEEK: Is the recent volatility in US Treasury rates a�ecting your plans in terms of how soon you want to issue?

Chernov, Gazprombank: We’re expecting that high volatility in the US Treasury market will continue until the end of this year. That means that we will not have such prolonged open periods to place a transaction as we had during last few months. It will be a time of choosing the right windows to do a deal and being very selective in terms of the currencies and markets to use.

Smolin, VTB: We expect the rest of the year to be driven by the opening and closing of market windows. We will have to follow this volatility and that will probably deter-mine when the best moment is to find good momentum for issuing.

The first half of the year was, for us and others, very good. Many Russian issuers were doing deals in dollars as well as more exotic currencies like renminbi. It is interest-ing how much the renminbi market has developed. VTB was only the third foreign issuer in this market in 2010, straight after McDonald’s and Caterpillar. At that point the market was so young and so new, but it’s been great how much China is trying to open itself to allow investment in international borrowers.

There is a special renminbi offshore market in Hong Kong which is available for foreign issuers. It shows that the regulators in China understand how to manage this process and make the market interesting for such emerg-ing market issuers like VTB and Gazprombank.

Chernov, Gazprombank: Talking about the develop-ment of local markets, the Russian regulators have been rather active in developing the Russian local bond market. They’ve so far taken some good steps with the Eurocleara-bility of OFZs and hopefully by the end of this year, it will also be easier for foreigners to invest in the corporate and bank issues as well. There is still a taxation issue, which needs to be resolved to completely open the Russian local bond market for foreign investors.

EUROWEEK: Natalia, what are you recommending with regard to banks accessing bond funding before the end of the year? Do you have any thoughts on the attractiveness of the dollar Eurobond market versus the local rouble market?

Konstantin Chernov, GAZPROMBANK

016-23 Banks RT.indd 18 26/06/2013 17:34



Natalia Peksheva, Rai�eisenbank: Actually I don’t think that bond market will ever close. If you are a bor-rower ready to issue and ready to pay, investors are in a place to buy bonds and even more sophisticated debt structures at any time. Of course, it depends on the price.

If a compromise between the issuer and the investor cannot be found the market is said to be closed. In real life it’s not closed, because secondary trading goes on and investors do the trades.

Recently the market has become more volatile and there is a constant fear that rates will continue to rise. So investors are demanding a higher premium for taking the same risk. But if the issuer is ready to pay, the deal can be done even in the turmoil.

So it is mainly about whether the attractive yield levels from an investor point of view are acceptable for Russian banks. It largely depends on their financial position — ROE, ROA, net interest margin, etc — and growth strategy.

As for the timing and currency preferences I believe that banks in Russia are advanced enough to consider all existing options, including currency, deal structure and price at the time they want to raise funds.

We are certainly not in a crisis situation. Even after this recent minor sell-off, yields aren’t comparable to what we saw in 2008-2009. Russia is not an isolated island in the global financial ocean.

Nefedova, VEB: VEB is more conservative than our colleagues here today, but we have the same strategy of diversifying currencies and have done something new this year — our debut euro denominated Eurobond. That deal presented a good pricing opportunity for us as it was lower than our dollar curve. So it was a great success for us and we expect to do more trades like this, though perhaps not in euros later this year.

We’re most interested in roubles and dollar funding. As far as stepping into different markets, that’s again a matter of liquidity available there as we are very price-sensitive. Our mandate as the Bank for Development restrains us from competing with commercial banks. We provide project financing to corporates at levels which are not sometimes acceptable to commercial banks.

Aside from that, one of our focuses is implementing the possible ways of attracting foreign investors into our economy. To that end, we have just done some innova-tive work in updating our domestic bond programme — with the help of some banks such as Raiffeisenbank. The idea was to adapt our EMTN programme to Rus-sian legislative requirements for use on the domestic market. Doing that provides investors with a certain sets of covenants, which is similar to what we have in our international EMTN programme, and increases the level of disclosure, such as providing risk factors.We are hopeful that those measures will help attract foreign investors and thus expand the investor base in Russia.

Moreover, we’ve also pioneered issuing foreign cur-rency bonds in the domestic market. We placed dollar bonds in it earlier this year. At the moment they work as a kind of commercial paper for the Russian local mar-ket because the tenor is not very long — it is three year paper but there is a put option after one year, so the instrument tends to be used mostly for liquidity manage-ment.

EUROWEEK: What other big changes need to be made to bring the local market to international standards?

Nicolle, Svaznoybank: In terms of conforming Russian domestic securities arrangements to international stand-ards, in Russia we’re still missing collective representa-tion of investors and the enforceability of a broad range of financial covenants under Russian law.

Nefedova, VEB: There is still quite a long way for us to go to bring the market to international standards. First of all, the markets are governed differently and the dif-ference of law makes is quite drastic, but still we are pre-paring ourselves so that eventually the market moves in this direction and becomes more investor friendly.

Nicolle, Svaznoybank: But do you think general finan-cial covenants (other than a covenant to pay) are enforce-able under Russian law?

Nefedova, VEB: We believe so, yes. There are still some issues with regards to the way the court will decide on those matters. The legal platform which is being built is already quite an important step.

Nicolle, Svaznoybank: I think it would be excellent if there were a platform! Speaking rather generally, in Russian law nothing is allowed unless there’s a law that lets you do it, whereas, for example in the English legal system, everything is allowed, unless there’s a law that says you can’t. It’s a different approach (civil code instead of common law) and a different conceptual basis of the legal system. But if a platform is being built to uphold financial covenants, that is a good thing — what we have to do here to make something work is get laws passed that enable it to work. So all of these changes inevitably involve the state institutions and the regula-tors, whether that’s securities regulators or banking regulator, or the Duma. There’s a lot of work to get from where we are to where we’d like to be.

Nefedova, VEB: We’re working pretty hard together with the financial monitoring authorities, the regulator, and the stock exchange. It’s a co-operation between all these institutions.

Pekcheva, Raiffeisenbank: I’ve participated in several workshops to monitor, improve and develop the leg-islation. The concept of investor representation in the fixed income market is just underway, and I hope that the respective amendments should be soon in the state Duma for the second reading.

It’s not that the regulator doesn’t care about these differences between the international standards and the

Ksenia Nefedova, VNESHECONOMBANK (VEB)

016-23 Banks RT.indd 19 26/06/2013 17:34



local ones, but the defaults during the crisis affected both Eurobond and the local markets. Some defaults on the Eurobond market ended up in bankruptcy with zero recovery for investors. Even if the market is governed by the English law you still may not get anything back.

Nicolle, Svaznoybank: Collective representation is only a good thing if you have a representative that does something. One of the lessons we learned from the Eurobond market and the CLN market through the crisis — not specifically in Russia — was that trustees often don’t move when they should because they wait for instructions. And because investors don’t know who their fellow investors are, they can’t easily group togeth-er to make decisions.

Pekcheva, Raiffeisenbank: That’s why the Russian approach to these situations is expected to be a bit differ-ent. We’re hoping to build on the experiences in other markets.

Nicolle, Svaznoybank: It’s a great opportunity to do it better.

EUROWEEK: But at this point is it worth altering documentation to look more investor friendly when the rest of the system is not yet in place?

Smolin, VTB: We’re continuing to work with the finan-cial regulators in Russia and with the stock exchange and discussing these things. We are doing the same thing as VEB — we are in the process of preparing our own local rouble bond programme, which will be of a more international style.

We are finding that the regulation itself is being changed. Starting from July 1 there will be some new tools for the local rouble bond market. The market will become a bit more flexible in terms of the tenors avail-able and some matters of documentation, all of which shows that the regulator is trying to be flexible.

But I would completely agree with the people here, that the difference is so big between the international standards and local that there is still a long way to go.

If you look just at the Russian bond prospectuses and the international ones, there are big differences in the style of disclosure and the style of how the document itself is prepared. The Russian one is much more formal. The international one is a bit more creative, there are risk factors included, it is split into sections and it is more readable.

It’s a big thing for the regulator and the banking

community to modify but it’s in the interest of all the participants to get it done.

The other big technical problem — this one in the international market — is that on a practical level Russian issuers cannot issue directly into the international mar-kets still. Formally there is a law saying that borrowers can issue foreign bonds, but in terms of registering those bonds it’s much too complicated.

So instead, Russian borrowers have to issue through a loan participation note structure using a special purpose vehicle as an intermediary in another jurisdiction. That’s another thing that should be investigated by the regula-tor. There are still a lot of changes that could be made in local laws to benefit the development of the market.

EUROWEEK: How else is the market changing? Russian banks seem to be becoming more flexible with regards to currency, but are they also getting more adventurous with regards to private place-ments, ECP and other structures?

Kareeva, Promsvyazbank: This year we’ve already been in the market with a private placement and a lower tier two subordinated issue, but our strategy is not wholly de-pendent on Eurobonds or the financial markets in terms of funding. We think that our loan portfolio should also be funded by local customers’ deposits with us. That kind of funding now represents around 60% or more of the total liability mix of Promsvyazbank.

We’ve considered setting up an ECP programme for the sake of diversifying our instruments but we have not yet done anything because our liquidity remains at a very high level and we don’t need to fund ourselves from the financial markets at the moment. But that ECP programme should be registered very soon and we will just use it as a tool for short-term liquidity.

In terms of diversification we are also working on funding via mortgage securitisations, which is a part of the state programme to support the mortgage market and AHML [The Agency for Housing and Mortgage Lending).

AHML has introduced several programmes that Rus-sian banks can participate in — we know that there are no independent market investors who are ready to buy Russian mortgage-backed bonds, but AHML is offering to purchase them. Quite soon you should see Promsvyaz-bank issuing mortgage-backed securities.

This year our situation is unusual as we don’t have any particular plans to go to the capital markets as our liquidity remains high and we don’t have any major maturities that we have to repay by year end. Because of that our funding will be opportunistic. We may consider the syndicated loan market later this year but we have not decided yet.

Nicolle, Svyaznoybank: Svyaznoybank is a very dif-ferent animal to the institutions represented by my colleagues here today. We’re at a much lower end of the credit spectrum and a very young institution as well. Our bank is pretty much entirely funded by retail. That actually gives us some problems because the Central Bank would much rather we had a mix of wholesale and retail in our funding mix. So as we grow over the next 12 months we’re planning to increase the amount of wholesale funding for the bank by a significant amount — maybe to 25%-30% of the balance sheet.

Whether we do that through domestic transactions or international transactions will depend on what opportu-nities are there in each market. It’s unlikely the funding

Natalia Peksheva, RAIFFEISENBANK

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we need to do can be satisfied entirely from the domestic market with conventional rouble bonds.

Our view of the domestic market rouble bond market is that liquidity in the second half of the year is going to principally be driven by where inflation is sitting and the Central Bank interventions in the market to manage li-quidity, particularly in the banking sector. So if inflation looks like it is within policy parameters — somewhere near 6%-8% — there will probably be a bit more liquid-ity in the banking system and we’ll probably then be able to do more domestically. Our rouble bonds trade at 12%-13% whereas OFZs levels are at 6%-7%, so we look attractive.

For wholesale funding, the securitization market is also very interesting for us. There is no domestic securitiza-tion market outside mortgage-backed securities because there’s no law that allows it. But we have designed a structure which will allow us to issue domestic rouble bonds backed by credit cards, which is the asset class we have, as we don’t have mortgages to securitize. We are working actually with some of the banks around this table on a transaction to come in the fourth quarter of this year which we are expecting to trade significantly inside our rouble bonds but also substantially above the credit curve of the rating of the transaction.

We’d really like to see a Ba2 securitization market developing rather than an investment grade market. That is important for Russia because there are a lot of banks that will struggle to do a structured transaction to invest-ment grade. Developing some colour and depth within the market would be very helpful for the Russian markets generally and we’d like to try to foster that.

We won’t be the first bank bringing a domestic, non-mortgage securitization transaction. My team is also advising one of the other consumer lenders on a transac-tion that will be based on cash loans, which should be coming to the market in July or August. So there’s a new market developing here in Russia for domestic securitiza-tion and a lot of technology involved, which my team is very much part of.

EUROWEEK: In terms of currency risk, are you exclu-sively focused on issuing in roubles because of your Russian retail business?

Nicolle, Svyaznoybank: Yes. We’re a rouble-only bank. So when we look at the international market the main challenge for us is the basis swap. There’s a clear set of comparables on a relative value basis so we can see where we would price. We’re not well known outside the Russian market, so before even considering an international deal, it would be essential for us to do a non-deal roadshow and then follow up a month or even two or three months later with a transaction.

The main challenge would be cost because the basis swap cost of swapping the dollars that we might receive into the roubles can be as much as six points.

There’s a chance that we could issue internationally in roubles, but that’s a complicated market and investors tend to see it as more of a substitute sovereign play, and prefer not to mix currency risk with credit risk. It works well for some of the state owned banks. We’re a B3 rated credit so I think Eurorouble paper from us is not some-thing that would find an easy home.

Kareeva, Promsvyazbank: Even for Promsvyazbank the Eurorouble market is challenging. And when you com-pare the prices available on the local rouble market and

the international market it is not advantageous for us.

EUROWEEK: Before the OFZ market became Euroclearable, there was a lot of forerunning of that event and yields declined considerably before it even happened. Is the same happening for bank bond yields and/or do you expect a tightening of yields after domestic financial institution bonds become Euroclearable?

Kareeva, Promsvyazbank: There’s been no yield com-pression yet and I can’t see huge yield compression in the future as a direct result of Euroclearability. Euroclear-ability of OFZs was actually my personal project brought to the Ministry of Finance three years ago and I’m very happy with how successful it’s been for those govern-ment bonds. Last year we saw a soaring OFZ market due to speculation on the market liberalisation.

But I’m not sure that this will happen for the banks and financial institutions because the issuers that could be of interest to foreign investors from a credit perspec-tive are already present on the international market. So the investor who wants to buy that credit risk can do so just by investing in the Eurobonds. And if you compare the yields, then in rouble terms once a swap is applied, it is much cheaper for an investor to buy bonds in the international market. So at the moment there is no great economic sense in foreign investors entering the rouble market to buy Russian FI paper.

Those investors who want to play the currency use government debt. The Russian Federation doesn’t have a big presence in the international market — there are some nine Eurobond issues outstanding compared to 34 local OFZs — and the curve is not as long and liquid as on the local market. The Ministry of Finance is not a bank and cannot swap all its dollar exposure to roubles so they naturally prefer rouble funding of the budget deficit.

The Eurorouble market was originally opened because foreign investors really wanted the rouble risk. But due to infrastructural problems they couldn’t invest directly into the local market so this Eurorouble market was the only opportunity for investors to get the right currency risk under the infrastructure that they had been using for decades. And that’s why only top issuers from our country are welcome there. It’s as Tim said, not a very easy market for issuers with a real credit risk.

Last year we talked to many funds who invest precisely in the sovereign debt of emerging market countries and they said they were waiting for the Euroclearability of

Marina Kareeva, PROMSVYAZBANK

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the state bonds as they were keen to invest. But on the corporate and bank bond side, there are other asset man-agers and funds, and they say they have the Eurobond market to invest in so they don’t care that much about the Euroclearability.

EUROWEEK: The Russian banking landscape has changed signi�cantly over the last couple of years as the state-owned banks have grown quickly both domestically and abroad — Sberbank’s acquisition of Troika Dialog for example, and VTB Capital’s inter-national expansion. How is this changing competi-tion between the banks in Russia?

Nicolle, Svyaznoybank: From our point of view, Sber-bank’s main challenge is that they know where they want to get to but they’re starting from where they are. They are a huge bank but one that by virtue of its size is quite clunky and not easy to implement changes in.

Svyaznoybank is much smaller and only three years old. Our business is based on customer service, tech-nology and on being easy, accessible and simple for customers to use. It’s similar for our competitors in the consumer finance market — Tinkoff Credit Systems, Rus-sian Standard and Home Credit.

Sberbank, with its tens of thousands of branches and thousands of employees, is a slow giant. They are doing a lot of things really well but it’s going to take them a long time to get there. There are still going to be plenty of queues in Sberbank for quite a few years to come.

But if you roll the clock forward 10 years I think the picture could be different. So in the medium term, things will be fine. Sberbank does, however, have a big competi-tive advantage and sooner or later they will get it right.

I don’t see the banking landscape in Russia really changing yet, but certainly you can see the direction of travel. And that actually is good news for everybody as competition is good for a sector.

EUROWEEK: That seems a very optimistic response. Surely Sberbank’s size and rapid growth is going to inhibit other banks in Russia?

Nicolle, Svyaznoybank: No, I don’t think so. The intro-duction, for example, of the deposit insurance scheme, which insures retail deposits in the same way that we have in Western countries, has meant that it’s become been quite easy for Svyaznoybank to raise funding. There was one month last year when Svyaznoybank actually took more in retail deposits in the month than Sberbank did. We have, effectively, the second largest branch net-work in Russia because we operate through 3,400 points of Svyaznoy shops and each of those shops provides banking services now on an affiliated basis.

So I don’t think it’s a glass half full response. All that is happening is that our business models and our invest-ments in technology and customer service mean the Sberbank is sharpening up its act quickly — or as quickly as Sberbank can. But as Sberbank sharpens up its act we’ll have to sharpen up again. It’s a continual process of healthy investment and healthy change that will make Russian financial lives for ordinary people here easier. That is a welcome change because it’s not very easy today.

Kareeva, Promsvyazbank: I would agree with Tim. We cannot compete with the likes of Sberbank, VTB or Gaz-prombank in terms of the pricing offer to our customers. But for sure we can be better in terms of the quality and the

relationship with our customers. We’re paying a lot of at-tention to improving our internal processes, implementing innovative products and developing our internet banking platform. That’s why our customers want to stay with us.

EUROWEEK: What are the ambitions of the state banks here today? Is there any particular part of the banking business that will be especially pursued in the next few years? Is there a risk of crowding out other Russian players?

Smolin, VTB: VTB consists of three major lines of busi-ness: corporate commercial banking, retail via VTB24 and investment banking.

We’re definitely seeing a growth of competition on the investment banking side. VTB Capital has been very ac-tive in this over the last few years and has been a leader of this market. There is now definitely more competition, first of all from Sberbank having merged with Troika Dia-log. They are the biggest competitor to VTB Capital and are getting many mandates here internally. Gazprombank too is doing very well with its strengthening in capital markets activity. Both VTB Capital and Gazprombank are on the mandate for the new Russian sovereign bond.

So competition is definitely there and it’s a positive thing for the market generally because a high concentra-tion of big players doesn’t compel people to innovate and make services better.

I know the VTB Capital team works very hard. I see the rotation of the personnel there and them trying to be ever more competitive. That very much means that life is not becoming easier for them. They are having to now compete with players — both Russian and interna-tional — who have not been as active in previous years. That’s a big challenge for VTB, but again, it’s a positive thing.

But as Tim mentioned, it’s really hard to compete with Sberbank in this country because they have a retail network dating from the Soviet area and because of that they are popular still and famous. Some people in the country, I believe, still don’t know other retail banks ex-ist! We need to change this, obviously.

The Russian banking system consists of two major parts — the big state-owned banks, which cover the major part of the banking business in the country, and the rest. But this is a model that has worked for 20-25 years. The story is changing though and if anything we’re seeing increased competition from smaller players rather than a crowding out of them. That’s positive.

Chernov, Gazprombank: Gazprombank is developing the same three key businesses: corporate banking, retail banking and investment banking, with corporate banking being the backbone of our business profile. In corporate banking we focus on the top Russian corporates. We continuously occupy one of the top three positions in the investment banking field competing primarily with Sberbank and VTB. We’re also actively developing our retail banking franchise where we’re using our corporate relationships to expand our client base.

EUROWEEK: In the syndicated loan market, how aggressive are banks being when extending funding to Russian banks?

Kareeva, Promsvyazbank: At the moment this is not a very active market, especially when you compare it to what it was like before 2008, when all the major Russian

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banks could drum up participation in syndicated loans from investors all over the world. I recall some of our transactions having 50-60 banks participating in our syndicated loans! These days they are very much done as club deals and it is done strictly on the basis of relation-ship lending. So I wouldn’t say that the banks are back to being aggressive in that market. They are just doing enough to gain some other business from borrowers.

EUROWEEK: Is it the same for the bigger banks?

Smolin, VTB: Lenders are definitely not aggressive in the syndicated loans market, but borrowers are trying to be. We’ve closed one this year for $2bn, but I completely agree with Marina that it has become a club deal market.

We understand that it is becoming more and more difficult for lenders to participate because the rates we are offering are really low. It’s definitely a relationship market. We speak to those banks who are interested in developing their business with VTB. But the number of banks who are available for these deals, even with VTB, is decreasing.

Having said that though, we closed a deal for $3bn two years ago, which was the biggest ever from Russia and we moved to the next idea of this $2bn deal and have now closed that too.

I believe that this market will become more and more a refinancing market with borrowers raising money to refinance maturing loans.

Nicolle, Svyaznoybank: Some of this is driven by regulation because Basel III is not designed with emerg-ing market risks in mind. Speaking as a B3 bank, lending money to us is effectively a deduction from capital. So can we do a syndicated loan? Forget it, because it’s like an equity transaction for an internationally regulated bank.

Even for a triple-B bank, the economics for a Western commercial bank of lending money to VTB, for example, are pretty poor unless they’re using a sophisticated IRB approach for their capital allocation, and that’s really only the bigger players who do that.

So you end up with club deals because it’s only the bigger players that have a sophisticated capital allocation and regulation model and are also providing sophisti-cated added-value products, which in combination make up the capital return that they need on the balance sheet they’re employing.

That means that inevitably you end up with smaller players not able to participate because they’re not using sophisticated capital regulation models and they don’t

have the income make-up opportunities of more sophisti-cated products. So it closes the market to some invest-ment grade emerging market risks.

This brings us back to our first discussion on the implications of Russian banks adopting Basel III. It has to be with significant caution because it’s not completely designed for a triple-B rated country.

EUROWEEK: Who are the banks that can offer the likes of VTB these relationship levels?

Smolin, VTB: There are three big teams of banks. US banks — big players like Citi, JP Morgan and Bank of America Merrill Lynch. There are European banks who are traditional participants of this market, like Barclays, BNP Paribas, other French banks. And now we are see-ing more demand from Asia, which is a great develop-ment. Chinese banks are trying to explore the market here in Russia so they are trying to be very flexible with the local big players to build their relationship with us. We had two Chinese banks in this year’s loan.

Nefedova, VEB: It’s not only Chinese banks but the Asian banks more broadly are entering the market such as the Japanese as well. It’s partly because of the differ-ent type of liquidity profile they have versus Western banks and their own funding, which makes it cheaper for them to get involved in those types of club deals.

EUROWEEK: Are there any obvious pitfalls for the Russian banking sector ahead?

Kareeva, Promsvyazbank: The slowdown in the Rus-sian economy and just the suggested forecasts for Russia is one of the threats for the banking sector. When the economy slows, our customers become cautious with regards to further borrowing, which directly impacts on our business.

Nicolle, Svyaznoybank: There’s very little, apart from catastrophic events that affect the Russian macroeconom-ic picture, that could derail the Russian banking sector at this point. Even in the event of increased eurozone turmoil Russian financial institutions have largely become domestically funded and so with some exceptions, they are much more resilient than they were in 2007-08.

There are things that can mean we have a good year and there are things that can mean we have an average year. But there’s very little domestically that is appearing in front of us that might mean that we get derailed.

EUROWEEK: For the Russian banks, what’s the ideal backdrop for the year ahead?

Nicolle, Svyaznoybank: The most promising elements are those within Russia. Lower interest rates and a lower inflation rate in Russia could make international borrow-ing a lot more attractive because the basis swap would move into a more attractive position. So macroeconomic factors could mean that Russia becomes a more interest-ing opportunity for international investors and provides more interesting borrowing opportunities for us.

In terms of the domestic market, improving macro-economic factors would also allow the Central Bank to improve liquidity in the banking system. Liquidity in the banking system leads in turn to an increase in the money supply and potentially greater economic activity. But the opposite can unfortunately also be true.

Alexander Smolin, VTB

016-23 Banks RT.indd 23 26/06/2013 17:34

Bank Capital


Russia enjoys doing things dif-ferently from the rest of the world. That is one of the rea-

sons its banking system was less badly affected by the global finan-cial crisis of 2008 than those in the West.

The state stepped in to aid the acquisition of some struggling banks by bigger players. But the country did not have to deal with a Lehman Brothers, or a Royal Bank of Scotland – banks so integral to the system that anything short of a bail-out would have meant disaster.

The Central Bank of the Russian Federation is taking no chances from now on. It is set to integrate Russia’s banks into the global Basel III regula-tory framework later this year, and here, too, it is forging its own path.

From October 1, under the lat-est proposals, banks will have to comply with a minimum 10% total capital ratio, when Basel III requires just 8%.

But the most immediate concern for banks is the new capital eligibil-ity rules, which all capital issues have had to reference since March 1.

The CBR has introduced loss absorbency features for tier two debt, linked to two triggers. The first is a breach of a 2% common equity tier one ratio. The second is hit if the country’s Deposit Insurance Agency becomes involved with bankruptcy prevention measures at the issuing bank.

Out with the old...The central bank’s chosen method for grandfathering old tier two capital, which it began on April 1, should ensure Russian banks bring new trades to market much more quickly than their peers elsewhere in Europe.

“Russia is doing instrument-based grandfathering, so having old tier one and tier two outstanding will become inefficient for Russian banks,” says Gerald Podobnik, head of capital

solutions at Deutsche Bank. “There is a bigger incentive to replace the old instruments, so we should see a quicker move in Russia to issue new securities.”

However, bankers don’t expect issuance to really get going until the new requirements are finalised in October.

When the supply does arrive, issuers hope it will be welcomed by international investors.

“Bank loan portfolios are still growing, though more slowly, and the need for capital continues,” says Dmitry Gladkov, head of debt capi-tal markets for Russia at JP Morgan. “For the rest of this year I envisage a heavy focus on capital, subordinated and hybrid issuance, based on new Basel III-compliant instruments. But it will depend on the price because the domestic deposit base, corporate or retail, is providing relatively attrac-tive funding costs [for banks] at the moment and the focus on margins persists.”

...in with the newHow new-style tier two capital should be priced, relative to old paper, has already been the subject of intense debate among emerging market bond bankers.

When Credit Bank of Moscow printed its $500m 5.5 year bullet note with an 8.7% yield in April, the leads claimed it was priced on top of where an old-style instrument would have been.

Some observers away from the deal agreed, but several others said it paid investors a pick-up of 50bp-80bp.

Whatever the premium, the bond traded down three percentage points in the first few days after pricing, suggesting investors had not been as comfortable with the new structure as first thought.

Opinion was more unanimous when Sberbank stepped up to print a

$1bn new-style lower tier two bond in mid-May. The 10 year bullet note was sold at 324bp over mid-swaps, just 12bp wider than the bank’s old-style 2022s.

“The pricing on the two new tier two trades came virtually flat to the old-style tier two,” says Podobnik. “The argument was that the old tier two doesn’t have any form of loss absorption, while the new style has loss absorption — but the trigger is so low, at 2%, that this is seen as barely any additional risk. Investors accepted that logic.”

But some are already pointing to signs that the anticipated flood of tier two Eurobonds from Russian banks is cooling investors’ appetite for the paper.

Just a week after Sberbank’s suc-cess, Russian Standard Bank, rated Ba3/B+/B+, had to postpone a 10 year non-call five lower tier two bond after already collecting $200m of orders at initial price guidance of a 10% yield.

The lead managers blamed market conditions — with some justifica-tion. The deal came amid a sell-off in credit markets, the day after US Federal Reserve chairman Ben Ber-nanke had hinted that the Fed might begin tapering its bond purchasing programme.

But some emerging market bank-ers away from the deal said the large volume of Russian subordinated

Cost of hybrids set to rise as central bank gets toughRussian banks will spend much of the second half of 2013 replacing old-style tier two capital with new, as they switch to Basel III-compliant rules. The market has already produced some successes, but not all lenders will have access at a competitive price, writes Tom Porter.

“Basel III will have a cost impact on raising capital and that causes concern. Banks will need to scale down growth plans or transfer the costs to their loan customers”Ignat Dirks,

Gazprombank

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Banks Capital


paper expected could be draining demand.

Another worry is whether banks can rely on enough of their typical investor pools being happy with the new-look sub debt.

“The traditional investor base for subordinated bonds from Russia — private banks in Switzerland and particularly Asia — are not yet uni-versally comfortable with contractual loss absorption, which has moderated demand,” says Simonas Eimaitis, head of emerging market bond syndicate for EMEA at HSBC.

“As a result, issuers have been more reliant on institutional demand, primarily from UK-based investors who are more comfortable with eval-uating new loss absorption features, and require a premium.”

Raising the barInvestors have shown they don’t need much of a premium for names like Sberbank, but for most Russian lend-ers loss absorbency will raise their cost of capital. That could have seri-ous consequences for some.

Subordinated debt was previously rated one notch below the senior rat-ing, but harsher rating approaches may now be applied.

That would put some lower rated banks’ sub debt into triple-C or unrated territory. They could face a tricky choice between selling at a very steep yield and trying to pass the costs on to their customers, or not placing the deal at all.

“The advent of the new require-ments may prompt some inves-tors to differentiate larger, systemic, state-owned entities from smaller private sector banks,” says Nik Dha-nani, global head of capital solu-tions at HSBC. The latter group, he adds, “may be assessed with a higher degree of scrutiny on a case-by-case basis, to gauge the potential likeli-hood of loss absorption being trig-gered.”

Many, perhaps including the cen-tral bank, are hoping that this raising of the capital cost bar will force stag-nant smaller banks to either disappear or be gobbled up by rivals, speeding up the much-needed consolidation of the sector (see article on banking competi-tion, page 13).

“It is pretty obvious Basel III will have a cost impact on raising capital, and that causes concern within the sector,” says Ignat Dirks, head of debt management at Gazprombank. “It will put pressure on profitability and

banks will either need to scale down their growth plans or transfer the higher costs to their loan customers.”

A tougher challengeWith all the noise over tier two capi-tal, it is easy to forget that banks will also have to issue tier one instru-ments at some point.

The only one that has so far done so, referencing Basel III, is VTB, which printed a $1bn perpetual tier one deal in July 2012, in anticipation of the new rules.

The bad news is the cost impact of the regulatory overhaul is likely to be even greater for tier one capital. The new loss absorbency trigger of 6.4% core equity tier one is getting awfully close to the ratios of even Russia’s biggest banks.

Investors will have to be compen-sated for the heightened risk of being written down.

“Banks will be incentivised to issue new additional tier one securi-ties,” says Dirks. “But it may be tricky, because recently released data on the capital adequacy of Russian banks shows the buffers over the proposed trigger levels are pretty thin, as com-pared to European precedent deals.

“Gazprombank’s core tier one ratio is at 8.2% and the trigger is 6.4%. It is a similar story in the rest of the sector.”

The good news, says Podobnik, is most issuers do not need to think about raising additional tier one just yet.

“We should see banks issue some new tier one securities,” he says. “But the big Russian banks usually have quite high common equity tier one ratios, because they have equity and a bit of tier two.”

Because of this, banks are likely to wait until after the first wave of new-style tier two trades before consider-ing selling additional tier one, should they need it, in order to have more pricing reference points and be sure of persisting demand.

Global appealOverall, bankers say the bigger banks need not worry about investor appe-tite for their capital trades when the market is in good shape and they are priced correctly.

“The new capital instruments and structures are all well understood,” says Gladkov. “Buyers are familiar with most of the names that would come with those structures. So it is all about the pricing, that is where

the debate will be this year. We have to find a new point of equilibrium between the increased risk for inves-tors and the price the issuer wants to achieve.”

Russian banks’ capital issues in the last 12 months have enjoyed good support from international investors, and their allocations are expected to grow as Russia further integrates into the global regulatory regime.

Foreign buyers still have concerns over certain quirks in the country’s banking sector, but those trying to sell their debt overseas can put up a robust defence of the way they do things.

“The most typical concern raised by investors is about concentrations in banks’ balance sheets,” says Dirks at Gazprombank. “Such concentra-tions are driven by the fact that the economy is quite concentrated, it is driven by large corporates that have substantial financing needs. To serve them properly you need banks capa-ble of extending that financing to them.”

The more recent global ambitions of Sberbank and VTB are helping to put Russian bank risk on the radar of more and more international inves-tors, and the new Basel III rules may allow them to draw favourable com-parisons with their contemporaries in Europe and the US.

Ultimately, argues Gladkov, Russian banks do not face many challenges in the capital markets in the years to come. “The Russian market is still growing, it is still underbanked, even after years of expansion,” he says.

“The ratio of retail banking pen-etration in Russia is still lower than in some of its EM peers like Turkey, which are still considered to be fast growing emerging markets. The chal-lenges will be domestic — growth, portfolio quality, risk management — but I spend a lot of time talking to investors and they are very comfort-able and often excited by the credit stories in Russia.”

“There is a bigger incentive to replace the old instruments, so we should see a quicker move in Russia to issue new securities”

Gerald Podobnik, Deutsche Bank

026-27 Bank Capital2.indd 27 26/06/2013 17:33

Corporates in the Debt Market


Life has rarely been better for Russian corporates in the inter-national debt capital markets.

With bond issuance in 2013 already smashing full year bond volume records, investors and corporate issuers have had to adapt quickly to keep up.

This year has already seen around $21bn of Russian corporate bonds priced, compared to a full year 2012 issuance of about $15bn, according to analysts at Citi. In April this year alone, $11bn of corporate deals were priced — the highest for any single month in Russia’s history.

The bond market is buzzing for two reasons. The first is that investors are looking more to emerging mar-kets generally as they hunt for yield — or at least they were until the US Federal Reserve spooked markets on May 22. The second factor is the Rus-sian government’s transition to inter-national financial reporting standards in 2012. Now, the country’s biggest corporates are now putting out quar-terly financial reports, rather than half yearly and annually as they have traditionally.

“That is why we have seen much more issuance,” says Blazej Dankowski, director, CEEMEA DCM at Citi. “Reporting on a quarterly basis allows corporates to come to the market in the first quarter. If you’re doing semi-annual reporting then you don’t have this window to issue.”

Deals done in January and Febru-ary 2013 were based on Q3, 2012 quarterly reports while deals from March through to May were based on the full year results.

And Russia’s corporates have been taking advantage of their newfound opportunity to print. They raised $3.5bn in January, $3.8bn in Febru-ary and $3bn in March. This is up from just $1.8bn signed across the entire first quarter of last year, with no deals in the first two months of

2012 at all, according to Dealogic. Debut issuers in particular found

a warm market reception. Petro-chemicals firm Sibur printed its debut $1bn five year Reg S/144A bond in January. The company was swiftly followed by fertiliser pro-ducer Phosagro with a $500m five year debut in February. In April, port operator Fesco Transportation Group sold $800m of debut bonds and potash firm Uralkali printed a debut $650m Eurobond from a $2.3bn order book.

“We want to raise funds to try to keep our debt portfolio at an appropriate level of 30% of debt in our capital structure. Right now, this represents about $4bn,” says Victor

Belyakov, chief financial officer at Uralkali. “This helps make the cost of capital cheaper.”

The issuer will now do regular roadshows in the debt capital mar-kets, matching its efforts in keeping equity investors informed, Belyakov adds.

And companies are also being attracted to the bond market by tightening yields, according to Andrey Solovyev, head of DCM at VTB Capital.

“Issuers understand that the rates on offer for borrowing in bonds at the moment are very good so they’re keen to get the money in,” he says. “Some are already looking at pre-funding for next year.”

But the bond story has not been entirely smooth for Russian issuers, particularly down the credit curve. In February, oil and gas firm Ruspet-ro postponed a senior unsecured five year bond for around $350m after releasing price guidance of low to mid-11%. And oil producer Exillon Energy pulled a debut Reg S/144A bond of around $300m after releas-ing price guidance in April. Both firms are rated B-.

Investors were not prepared for

Bonds galore and easy loans: corporates in cloverRussia’s corporates have borrowed more money from bond investors this year than ever before. And with the newfound confidence that a diversified funding strategy brings, Russian companies are putting new pressures on the loan market, writes Michael Turner.

“We want to raise funds to try to keep our debt portfolio at an appropriate level of 30% of debt in our capital structure. Right now, this represents about $4bn”Victor Belyakov,

Uralkali

Russian corporate loans and DCM bonds by quarter

Source: Dealogic

0

5

10

15

20

25

2008 2009 2010 2011 2012 2013Q4Q3Q2Q1 Q4Q3Q2Q1 Q4Q3Q2Q1 Q4Q3Q2Q1 Q4Q3Q2Q1 Q2 (01/04-24/05)Q1

Bonds*

Loans

Russian corporate loans and DCM bonds by quarter

* Includes international bonds and disclosed domestic issuance

Source: Dealogic

$bn

028-30 Corps in debt mkt2.indd 28 26/06/2013 17:33



the high volumes and found it dif-ficult to cope with all the extra roadshows and credit work they had to do, particularly with new issuers which require more due diligence, says Dankowski at Citi, speaking generally and not about the Exillon or Ruspetro deals.

“This year is phenomenal in terms of the volumes,” he adds. “To some extent, this has created some fatigue among investors.”

Indeed, the deals that did get away soon after the first quarter showed signs of investor strain. At the end of April, Russian metals pro-ducer Norilsk Nickel priced a $750m five year bond in line with guidance at 4.375% from a modest book of $1.5bn.

“The market was overcrowded when we issued our Eurobond,” says Artem Pozdnyakov, head of corpo-rate finance at Norilsk. “After us, some refused to place their bonds. But the demand is certainly there, especially for good names, and I do not expect that it will change in the near future.”

Hoping for M&AThe roaring bond market has come at the expense — and perhaps because — of the quiet syndicated loans market. While bond volumes have soared, loans have dragged along at much lower levels this year.

In the first quarter, $17bn of loans were signed by Russian corpo-rates, according to Dealogic. How-ever, $14.2bn of this was the second tranche of Rosneft’s $31bn loan for its TNK-BP acquisition and due to its size is considered a one-off, or even anomaly by loans bankers.

Only one loan was signed for a Russian corporate in April and May

— a $1bn term and revolving loan facility for Gazprom Neft from nine banks.

“The loan market won’t pick up fully until companies begin to grow inorganically again through M&A,” says Ashu Khullar, managing direc-tor, co-head, EMEA loan structuring and syndications at Citi in London. “It’s difficult to imagine that there’s going to be [a boom in M&A] in the near future. Everyone’s hoping but I can’t see where it would be.”

The metals and mining indus-try looks particularly unlikely to offer M&A activity anytime soon because of volatility in commod-ity prices, Khullar adds. Nickel is down by around 12.7% over the last 12 months, while iron ore is down around 7% and aluminium 9% over the same period.

And it’s not just a lack of M&A that is suppressing loan volumes. “Corporates are not going for the big capital expenditure programmes that they used to do, either,” says Yuri Korsun, head of the structured finance department at Sberbank CIB. “There are sporadic project finance proposals, but they require more work and will hardly be ready for the market in the near future.”

But those that have ventured into the loan market have found lenders willing to improve terms on previ-ous deals. Norilsk Nickel sent out a request for proposals in May for a $2bn five year facility. The deal is unsecured, an improvement in terms on the pre-export finance (PXF) structure that Norilsk used in its last loan — a $1.5bn deal signed in January 2012.

“Since the banks are ready to accept unsecured risk on us it is bet-ter for the company to borrow on an

unsecured basis,” says Pozdnyakov at Norilsk. “There were not so many transactions in the first quarter in the syndicated loan market and now the banks are keen to do business.”

Norilsk is not the only firm mov-ing to unsecured loans. Uralkali is also planning to increase the propor-tion of unsecured debt in its port-folio.

“We do not have a target amount, but we have already discussed opportunities to raise loans from Russian and foreign banks and we see that they are quite eager to pro-vide us with such facilities,” says Belyakov at Uralkali. “Now we have options to raise money through debt capital markets and loans, our bar-gaining power with banks is much higher.”

Pre-export finance facilities have been popular among Russia’s export focused borrowers since the sover-eign defaulted on its domestic debt in 1998. The technique was a way of increasing a loan’s credit rating for lenders’ credit committees and it also matched the dollar-denominated export businesses of the borrowers.

Indeed, half of the $20.6bn of Russian corporate loans signed in 2009 were pre-export finance facili-ties. This ratio dropped to around 30% in the following two years, according to Dealogic.

But now the structure is becom-ing less relevant, as Russian coun-try risk has fallen sharply since the state defaulted on its debts, says bankers. The country’s CDS levels were around 150bp at the end of May, down from a five year high of 1,246bp seen in October 2008, according to Markit.

As of the end of May this year, no pre-export finance facilities had

Though the pre-export finance structure is becoming less popular among Russia’s largest corporates, the secured route can still produce strong results in the loan market. At the beginning of June, Russian potash firm Uralkali signed its five year PXF at $1bn, after commitments saw the deal oversubscribed by 100%.

Uralkali began speaking with lenders at the end of 2012 and launched the self-arranged club deal at $700m after hiring Bank of America Merrill Lynch as co-ordinator in January.

Demand from the bank group pushed commitments to $1.4bn.

BNP Paribas, Natixis, Société Générale, Sumitomo Mitsui Banking Corporation and UniCredit joined Bank of Ameri-

ca as bookrunners and initial mandated lead arrangers.Deutsche Bank, ICBC, ING, Intesa Sanpaolo, Nordea,

Mizuho Corporate Bank, Raiffeisen Bank and RBS also joined the deal.

Uralkali initially indicated that it would only marginally increase the size of the loan, said bankers in May.

The borrower is paying a 215bp margin for the loan. This is 35bp cheaper than the 250bp margin that Ural-kali paid for its $205m five year PXF from August 2012. However, it is 35bp more than the 180bp margin the firm paid on its last $1bn plus deal — a $1.02bn five year PXF signed in September 2011.

The loan will be used to refinance existing debt and for general corporate purposes.

Uralkali shows that PXFs can still shine despite falling risks




been signed by Russian corpo-rates from $29bn of loans in 2013, according to Dealogic.

“It’s a surprise that it’s taken so long for Russian firms to move to unsecured loans,” says Khullar at Citi. “ PXFs came about to mitigate cross-border or country risk, and while that is useful when the country is not very mature — like in some African countries where it’s important to have these structures — in Russia this has ceased to be an issue for quite a long time now.”

Domestic banks priced outThe lack of supply from Russia’s top tier name has led to stiff competition among international lenders. This has pushed domestic lenders out of some deals. “Most of these transactions are not achievable for Russian banks in terms of price. The pricing levels are below cost of funding for Russian banks,” said Korsun at Sberbank.

However, Russian banks are in many cases the only source of bank debt for corporates outside the top tier names because international lenders are only interested in the biggest borrowers. And companies outside the top tier generally prefer rouble loans as they have little dol-lar revenue if they do not have large export businesses, assuming they export at all.

“Retailers and telecoms are good examples of this,” said Korsun. “They would have to swap dollars into roubles should they decide to go to the international market.”

Equity outletAway from bonds and loans, the equity capital markets have given Russian firms a chance to raise mod-est funds. One company to success-fully tap the equity markets this year was Russia’s largest property developer PIK Group. It completed a $275m capital raise at the end of May from an all domestic syndicate.

The deal was covered up to $270m the day before completion, and the final amount raised was well over the $150m target that PIK released as guidance.

But ECM has traditionally not been a big source of capital for Rus-sian corporates when compared to the loan and bond markets. Only $1.6bn had been raised by Rus-sian corporates this year through the equity market by June, up from $533m by the same time in 2012, according to Dealogic.

However, this market looks set to grow as Russian state owned corpo-rates have begun finalising timelines for privatisation. Diamond company Alrosa and Russia’s largest state-owned shipping company Sovcom-flot are likely to be privatised this year. Alrosa’s IPO is expected to hit the Moscow bourse in September with analysts valuing the business at up to $15bn, while Sovcomflot’s pri-vatisation has been pencilled in for the autumn.

“After us, some refused to place their bonds. But the demand is certainly there, especially for good names, and I do not expect that it will change in the near future”Artem Pozdnyakov,

Norilsk

Russian syndicated loans volume

Source: Dealogic

Credit Date Pre - Export Russian Loans % of Pre-Export of by Year Deal Value $ (m) No. Deal Value $ (m) No. Russian Loans2008 24,025 14 64,232 123 37%2009 10,274 7 20,597 33 50%2010 9,431 8 31,955 62 30%2011 16,977 15 51,113 79 33%2012 3,549 10 42,712 53 8%2013 YTD 0 0 29,453 16 0%

WITH THE exception of Rosneft’s $55bn purchase of TNK-BP in March, M&A bankers have had little to do in Russia this year.

Companies are still shying away from M&A growth as they continue to be buffeted by macroeconomic problems in Europe, said bankers.

But there are some firms on the hunt for M&A oppor-tunities, even at the risk of breaking bond covenants. Rus-sian rail freight lessor Brunswick Rail is this year con-sidering “a few M&A deals,” says Nicolas Pascault, the company’s chief financial operator. “We’re looking to increase our fleet to 40,000 cars plus by 2016.”

However, this will not likely be financed through the loan market. “We would look to raise a bond,” says Pas-cault. “We want to raise as much as we can while abiding by the covenants of our existing bonds and keeping our rating in place. It’s not the plan, but if there is an M&A opportunity and there is no other way to close it, then we could temporarily move beyond the covenants of our bonds. But we are going to try not to.”

Brunswick’s covenants include keeping under four times debt to Ebitda. The ratio was at 3.5 times at the

beginning of June. “What we can raise will depend upon how highly lev-

ered any target company is,” Pascault says. “We’d need to look at the full picture.”

Brunswick already has a combination of Russian and international banks lined up to provide a bridge loan.

Banks that have been involved in Brunswick’s bonds, loans and private placements have been contacted about the loan. Goldman Sachs, RBI, UBS and VTB were bookrun-ners on Brunswick’s $600m November 2017s, while the IFC, ING, RBI, Société Générale and UniCredit were lenders on the firm’s last loan of $180m that was signed in May 2012.

“We’re hoping to have the same covenants for the bridge loan as the bond,” says Pascault. “And the bridge lender will be pari passu with the bond investors.”

Pascault adds: “We’re actually a bit overbanked at the moment so we don’t want to do that transaction with too many banks as it becomes a bit too difficult to organise, so we’re going to be very selective.

“The most important factors in picking banks is pric-ing, relationship and the ability to close the deal quickly.”

Brunswick Rail could ‘move beyond covenants’, says CFO



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

Russian corporates face rising rates challenge

Russian corporates have had a storming year. They printed a record breaking $21bn of Eurobonds in the �rst 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 in�ation-linked deals and being careful to not expose themselves to currency risk. They are also innovating, �nding 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.

031-40 Corporates RT.indd 31 26/06/2013 17:32



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

Nicolas Pascault, BRUNSWICK RAIL




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!

Svetlana Ushakova, MEGAFON




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.

Maria Merzlikina, FEDERAL GRID COMPANY (FSK)




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

Oleg Gordienko, RAIFFEISENBANK




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

Pavel Isaev, GAZPROMBANK




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

Pavel Aananienko, SIBUR

Tatiana Orlova, RUSSIAN RAILWAYS




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

Elena Lukovkina, EVRAZ




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

Olga Kirichenko, GAZPROM NEFT




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.

Aleksey Nikonov, VIMPELCOM


Domestic Bond Markets


Just a few years ago, the Russian domestic fixed income market was seen as an obscure, difficult and

highly risky place to invest — a pet pro-ject of the EBRD, but one with an uncer-tain outcome as it was feared that the Russian government had little inclination to put in place reforms.

Fast forward to June 2013 and the market has developed to the point of being almost unrecognisable. The vol-ume of paper outstanding has grown to more than $200bn-equivalent. And there is pressure on it to grow further, from issuers and investors.

In 2007 many domestic market issu-ers were eager to break into printing dollar bonds to take advantage of lower funding costs and the prestige of access-ing an international market. But since the financial crisis, borrowers are much more focused on matching the currency of their assets with that of their liabili-ties. Domestic documentation is a lot easier too.

As a result, foreign investors wanting exposure to certain industries in Rus-sia must now venture into the domestic market rather than waiting for borrow-ers to print in dollars.

Unusually for an EM country, the pressure on the local market to grow is being matched by the pace of reform. This year the market has already started to shake off its most restrictive shackle: OFZs, Russian government debt, became Euroclearable in February. And later this year the country is set to release its entire domestic market when it does the same for its corporate and bank bonds — once the remaining questions over disclosure and taxation for foreign nom-inees have been resolved.

The changes mean that foreigners can now buy domestic Russian bonds much more easily and without the need for local brokerage accounts. Inflows have already surged: some $9bn entered the market in 2012 in anticipation of the change, and analysts reckon that up to $40bn of new money will be put to work there this year. Fixed income trad-

ing volumes on the Moscow Exchange doubled in the first quarter of 2013.

Foreign investors now own about a fifth of OFZs, compared to a meagre 3% before the introduction of Euroclear. If global rates remain low, Russian domes-tic bonds could increasingly be seen as an attractive high yielding alternative investment.

“Eurocleability has been a success on the OFZ market and the proportion of international investors has definitely increased, so there’s no logical reason why the same won’t happen now for corporates,” says Andrey Solovyev, head of global DCM at VTB Capital Moscow.

Vladimir Potapov, CEO of VTB Invest-ment Management, a firm that manages over $3bn in Russian fixed income, is looking forward to a tighening of cor-porate spreads.

“The current spread of tier one cor-porates to OFZs isn’t justified, it’s more a function of liquidity,” he says. “We made a lot of money holding Russian govern-ment paper as that market became Euro-clearable and hope to do same rotating the strategy to the corporate side.”

Nonetheless, analysts argue that the tightening of domestic corporate and bank spreads will not be so marked as it was in OFZs. Tier one corporates cur-rently trade at around 160bp-200bp over OFZs.

“We’re expecting some apprecia-tion in prices as corporate Euroclear-ability is introduced but we only expect that spread to narrow to 120bp-150bp over OFZs, so a tightening of up to 50bp,” says Denis Poryvay, an analyst at Raffeisenbank International in Moscow. “OFZs have rallied by more than 100bp over the course of the last year, to yield less than 7%.”

Poryvay says this is because the for-eign demand in the domestic market is largely driven by the outlook for rouble exchange rates and rouble interest rates rather than by credit risk, which is why there is naturally much more interna-tional interest in government bonds than the corporate sector.

“If international investors want to play the credit risk, there’s plenty of opportunity in the Eurobond market,” he says.

Pension powerBut Euroclearability is not the only turbo boost expected for the domestic corpo-rate market in the near future. Russia is planning to scrap a law that requires the country’s pension funds to return posi-tive growth every year, Alexei Moiseev, the country’s deputy finance minister told EuroWeek earlier this year. The state also plans to limit investors’ ability to switch funds in a bid to increase stability.

Russian domestic bonds come of ageThe Russian domestic bond market broke through a big barrier to investment in the country when it made government bonds Euroclearable in February. But with corporate bonds up next for the same treatment this year and pension fund reform edging closer the opportunities to make money investing in local debt may have only just begun, writes Francesca Young.

Annual domestic DCM issuance in Russia

Source: Dealogic

0

5

10

15

20

25

30

35

40

2013 YTD201220112010200920082007

$bn

50

100

150

200

250Number of issues (RHS)

041-42 Russian Domestic2.indd 41 26/06/2013 17:31

Domestic Bond Markets


Because at the moment pension funds must show positive returns every year, they are only comfortable investing in government bonds and keeping their funds in deposits. At the end of 2012, Russian pension funds had $90bn-$100bn of assets under management. The loosening of the annual no-loss law means that the scope of investment for these funds will be much broader and both the equity market and corporate and bank bond market should benefit.

Pension fund money tends to add stability to a market and a longer term of investment, meaning that longer maturities and different types of instru-ment can be printed.

“The pension fund reform will have a very strong impact on the market,” says Solovyev. “There’ll be much more of a need to have longer dated instru-ments. There were domestic CPI-linked bonds last year from Russian Railways and Rusnano and they act as a good hedge for those companies.

“There will be more of these and the Russian pension funds will be natural buyers of those to beat inflation. There’s a lot of international interest too in this kind of note, which when the domestic corporate market becomes Euroclearable will also become involved.”

Potapov agrees, saying that Russian pension fund money will be a big driver of domestic debt over the next few years. By 2020, he expects the local pension funds to have $400bn to deploy.

But the boost to the rouble corpo-rate bonds may come at the expense of simultaneous pressure on OFZs.

“Pension fund reform in Russia is decreasing pension money inflow to the State Trust Management Company (VEB), which is the core holder of OFZs, in favour of private asset management companies, which prefer investing into corporate bonds as they offer higher yields,” says Poryvay. “So we expect VEB to show low demand for OFZs this year and later. The fact that long-dated OFZs are trading flat with CPI does support interest from local players.”

Rouble or Eurorouble?The domestic market is deepening and could eventually offer maturities and yields comparable with the internation-al bond market. But the market is still growing and the maturities and sizes that the international rouble bond mar-ket offers are at the moment much big-ger than the domestic market.

The domestic market mostly offers three to five year financing, which is unsuitable for the funding of companies’ longer plans such as infrastructure pro-

jects. And those are some of the biggest deals in the Eurorouble market, from the likes of Russian Railways.

Brunswick Rail priced its debut $600m Eurobond last year but is this year looking for rouble-denominated bond financing as it seeks to increase its fleet either via an M&A transaction or through organic growth.

“Longer term we need roubles for the sake of currency management as any potential M&A transaction would take place in roubles, although in the short term we can finance it through a bridge to bond in dollars,” says Nicolas Pascault, CFO of Brunswick Rail. “The targets we are talking to have rouble contracts. Whether we use the domestic market or the Eurorouble market to refinance any acquisition package will probably depend on what maturity we need.

“We’d perhaps do Euroroubles as that offers longer maturities. We will make the decision based on pricing, maturity and liquidity.”

Pascault adds that even if the com-pany doesn’t go through with an acqui-sition, it has an increasing need for roubles and wants to raise more money in that currency to gain more flexibility and balance its assets and liabilities.

ArbitrageBut even as the domestic market grows, bankers say they do not see an imminent end to the Eurorouble market because of differences in the laws that govern the two.

“There’s still an arbitrage between domestic and Eurorouble issues, and I expect that spread to remain because of the differences in enforceability between Russian law and English law,” says Solovyev. “If something goes wrong, do you want the dispute settled in Rus-sian courts or UK courts? Some investors have a strong view on this.”

But though some more cautious international investors may still cling to the Eurorouble format, domestic inves-tors see no need for it in the longer term, once there is good liquidity and a varied investor base locally.

“We’re comfortable with domestic debt and Russian law, so for us the dif-ference between the international market and the domestic market is mostly about taxes, convenience of holding the paper, liquidity and pricing,” says an emerging markets fund manager based in Russia.

“If the yields and the infrastructure for holding Eurorouble debt is the same as for domestic debt, there’s no need for the extra layer of difficulty of issu-ing Eurorouble paper. It is logical for the markets to converge on to the local

market rather than having two separate markets for rouble paper.”

Foreign issuers to step inAs part of the liberalisation of the Rus-sian domestic bond market, it is now also easier for foreign companies to issue in it and take advantage of that pool of liquidity.

A European issuer can now simply translate its EMTN documentation into Russian to use with domestic Russian investors — avoiding the complex pro-cess it had to deal with before in order to access rouble liquidity for Russian operations. Société Générale is one bank that says it has a queue of these deals now ready to be executed and is expect-ing to bring at least a couple this year.

The global financial crisis has undoubtedly strengthened the appeal of the Russian domestic bond market. But despite the euphoria, stumbling blocks remain.

Anticipation of Euroclearability played a part in the rally in OFZs in 2012, but so did quantitative easing in the US. Real interest rates in the Russian domestic market were high, so a lot of speculative money flowed into the local market to pick up a higher yield.

No further tightening is expected in the short term for OFZs and, should US Treasury rates continue to rise, there could even be a reversal.

The domestic fixed income market will also be driven by Central Bank of Russia policy and, specifically, whether it decides to cut interest rates if infla-tion falls.

“We’re anticipating a 50bp rate cut, and there will undoubtedly be a response in the local market if that hap-pens,” says Poryvay. “We’re also keeping an eye on oil prices, which could still fall because of the global slowdown and that would have a negative reaction on the trading of OFZs.

“But our base scenario for oil prices is that the drop will happen but it won’t be significant — the price will stay between $90-$100 a barrel.”

“Longer term we need roubles for the sake of currency management”

Nicolas Pascault, Brunswick Rail

041-42 Russian Domestic2.indd 42 26/06/2013 17:31


Gazprom

Gazprom

Rating Baa1/BBB/BBB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

50

100

150

200

250

300

350

400

5YR CDS PRICING

Pricing date April 18, 2013Value €750mMaturity date April 26, 2018Coupon 2.933%Pricing details 215bp over swapsBookrunners BNP Paribas Credit Agricole Gazprombank JPMorgan Pricing date March 13, 2013Value €1bn / €500mMaturity date Mar 2020 / Mar 2025Coupon 3.389% / 4.364%Pricing details 210bp / 240bp over swapsBookrunners Gazprombank JP Morgan Credit Suisse Pricing date January 30, 2013Value $800m / $900mMaturity date Feb 2020 / Feb 2028Coupon 3.85% / 4.95%Bookrunners BNP Paribas Gazprombank JPMorgan Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 JPMorgan 4,795 13 26.62

2 Gazprombank 2,990 10 16.6

3Credit Agricole CIB

2,803 8 15.56

4 BNP Paribas 2,649 7 14.71

5 Credit Suisse 2,250 1 12.49

6 VTB Capital 1,300 2 7.22

7 Morgan Stanley 625 1 3.47

8SG Corporate & Investment Banking

598 1 3.32

Subtotal 18,011 19 100

Total 18,011 19 100

Source: Dealogic (January 1, 2009 to May 29, 2013)

TOP BOOKRUNNERS 2009-13

Source: Dealogic (as at May 28, 2013)

$ bn

0123456789

2007

2008

2009

2010

2011

2012

2013

PUBLIC BOND ISSUANCE

Source: Gazprom

Rb tr

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

2008

2009

2010

2011

2012

NET PROFIT

Source: Gazprom

Rb tr

00.5

11.5

22.5

33.5

44.5

5

2008

2009

2010

2011

2012

NET SALES

Source: Gazprom

Rb

0

10

20

30

40

50

60

2008

2009

2010

2011

2012

EARNINGS PER SHARE


Gazprombank

Gazprombank

Rating Baa3/BBB-/BBB-

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

100

200

300

400

500

600

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.5

1

1.5

2

2.5

3

3.5

4


Source: Gazprombank

Rb bn

0

10

20

30

40

50

60

70

2010

2011

2012

NET PROFIT

Source: Gazprombank

Rb tr

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

20

0.5

1

1.5

2

2.5

3

TOTAL ASSETS

Source: Gazprombank

%

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

28.5

9

9.5

10

10.5

11

11.5

TIER 1 RATIO

Pricing date January 15, 2013Value Rb20bnMaturity date July 25, 2016Coupon 7.875%Reoffer price 100.00Bookrunners Barclays Citi Gazprombank Issue type Tier 2Pricing date October 19, 2012Value $1bnMaturity date PerpetualCoupon 7.875%Reoffer price 100.00Bookrunners Credit Suisse Gazprombank Goldman Sachs HSBC Pricing date September 18, 2012Value Rb15bnMaturity date December 15, 2015Coupon 8.617%Reoffer price 100.00Bookrunners Barclays Citi Gazprombank HSBC Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Gazprombank 1,050 7 18.34

2 Barclays 869 5 15.16

3 UBS 700 4 12.23

4 Goldman Sachs 501 3 8.75

5 Credit Suisse 425 2 7.41

6 BNP Paribas 381 3 6.65

7 HSBC 373 2 6.5

8 Citi 343 2 5.99

9 RBS 292 2 5.1

10Mitsubishi UFJ Financial Group

251 2 4.38


251 2 4.38

Subtotal 5,436 11 94.9

Total 5,728.15 11 100




LUKoil

LUKoil

Rating Baa2/BBB/BBB-

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

50

100

150

200

250

300

350

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.5

1

1.5

2

2.5

3

3.5


Source: Lukoil

$ bn

0

2

4

6

8

10

12

2008

2009

2010

2011

2012

NET PROFIT

Source: Lukoil

$ bn

0

20

40

60

80

100

120

140

160

2008

2009

2010

2011

2012

SALES

Source: Lukoil

$

0

2

4

6

8

10

12

14

16

2008

2009

2010

2011

2012

EARNINGS PER SHARE

Pricing date April 17, 2013Value $1.5bnMaturity date April 24, 2018Coupon 3.416%Pricing details 255bp over swapsBookrunners BNP Paribas Citi Pricing date April 17, 2013Value $1.5bnMaturity date April 24, 2023Coupon 4.563%Pricing details 270bp over swapsBookrunners BNP Paribas Citi Pricing date October 29, 2010Value $1bnMaturity date November 9, 2020Coupon 6.125%Yield 6.25%Bookrunners Barclays ING RBS Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Citi 1,500 2 27.37

1 BNP Paribas 1,500 2 27.37

3 RBS 827 3 15.09

3 ING 827 3 15.09

3 Barclays 827 3 15.09

Subtotal 5,481 5 100

Total 5,481 5 100




Nomos Bank

Nomos Bank

Rating Ba3/NR/BB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0100200300400500600700800

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8


Source: Nomos Bank

Rb bn

0

2

4

6

8

10

12

14

16

2010

2011

2012

NET PROFIT

Source: Nomos Bank

Rb bn

0100200300400500600700800900

1000

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TOTAL ASSETS

Source: Nomos Bank

%

9.5

10

10.5

11

11.5

12

12.5

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TIER 1 RATIO

Issue type Senior unsecuredPricing date April 19, 2013Value $500mMaturity date April 25, 2018Coupon 7.25%Pricing details 638bp over swapsBookrunners Citi Gazprombank JPMorgan VTB Capital Issue type Lower tier twoPricing date April 20, 2012Value $500mMaturity date April 26, 2019Coupon 10%Reoffer price 100.00Bookrunners Citi JPMorgan VTB Capital Issue type Senior unsecuredPricing date October 15, 2010Value $400mMaturity date October 21, 2013Coupon 6.5%Reoffer price 100.00Bookrunners RBS UBS Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 VTB Capital 467 3 23.93

2 JPMorgan 392 3 20.09

3 UBS 375 2 19.23

4 Citi 292 2 14.96

5 RBS 200 1 10.26

6 Gazprombank 125 1 6.41

7 Deutsche Bank 100 1 5.13


Total 1,950 5 100




Rosneft

Rosneft

Rating Baa1/BBB/BBB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

050

100150200250300350400450

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.5

1

1.5

2

2.5

3

3.5


Source: Rosneft

Rb tr

0.28

0.29

0.3

0.31

0.32

0.33

0.34

0.35

2010

2011

2012

NET PROFIT

Source: Rosneft

Rb tr

0

0.5

1

1.5

2

2.5

3

3.5

2010

2011

2012

REVENUES

Source: Rosneft

Rb

2728293031323334353637

2010

2011

2012

EARNINGS PER SHARE

Pricing date November 29, 2012Value $1bn / $2bnMaturity date Mar 2017 / Mar 2022Coupon 3.149% / 4.199%Reoffer price 100.00 / 100.00Bookrunners Bank of America Merrill Lynch Barclays Citi Deutsche Bank Gazprombank JPMorgan Morgan Stanley VTB Capital Pricing date January 27, 2010Value $500m / $500mMaturity date Feb 2015 / Feb 2020Coupon 6.25% / 7.25%Bookrunners Barclays Credit Agricole CIB RBS

Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Barclays 704 4 17.66



2 JPMorgan 375 2 9.41



2 Citi 375 2 9.41

2Bank of America Merrill Lynch

375 2 9.41

9 RBS 329 2 8.25


329 2 8.25


Total 3,987 4 100




Russian Agricultural Bank

Russian Agricultural Bank

Rating Baa1/NR/BBB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

50

100

150

200

250

300

350

400

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.5

1

1.5

2

2.5

3


Source: Russian Agricultural Bank

$ m

0

2

4

6

8

10

12

14

2010

2011

2012

NET PROFIT


$ bn

05

101520253035404550

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TOTAL ASSETS


%

12.2

12.4

12.6

12.8

13

13.2

13.4

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TIER 1 RATIO

Pricing date January 29, 2013Value Rb10bnMaturity date February 7, 2018Coupon 7.875%Reoffer price 100.00Bookrunners Citi Deutsche Bank JPMorgan VTB Capital Pricing date January 23, 2013Value CNY1bnMaturity date February 4, 2016Coupon 3.6%Reoffer price 100.00Bookrunners JPMorgan RBS Pricing date August 23, 2012Value $450mMaturity date December 27, 2017Coupon 5.298%Pricing details 355bp over USTsBookrunners Citi JPMorgan VTB Capital Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Citi 2,019 8 29.32

2 JPMorgan 1,252 8 18.18

3 VTB Capital 1,172 7 17.02

4 Barclays 767 2 11.13



7 UBS 235 1 3.42

8 RBS 80 1 1.16

Subtotal 6,886 13 100

Total 6,886 13 100




Russian Federation

Russian Federation

Rating Baa1/BBB/BBB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

50

100

150

200

250

300

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

1

2

3

4

5

6

7

8


Data for 2013 is forecast. Source: IMF World Economic Outlook

% change

-10

-8

-6

-4

-2

0

2

4

6

2008

2009

2010

2011

2012

2013

REAL GDP


CPI %

0

2

4

6

8

10

12

14

2008

2009

2010

2011

2012

2013

INFLATION


%

0

2

4

6

8

10

12

14

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-0

8

31-D

ec-0

9

31-D

ec-1

2

31-D

ec-1

3

GOVERNMENT DEBT AS % GDP

Pricing date March 28, 2012Value $2bnMaturity date April 4, 2017Coupon 3.25%Pricing details 230bp over USTsBookrunners BNP Paribas Citi Deutsche Bank Troika Dialog VTB Capital Pricing date March 28, 2012Value $2bnMaturity date April 4, 2022Coupon 4.5%Pricing details 240bp over USTsBookrunners BNP Paribas Citi Deutsche Bank Troika Dialog VTB Capital Pricing date March 28, 2012Value $2bnMaturity date April 4, 2042Coupon 5.625%Pricing details 250bp over USTsBookrunners BNP Paribas Citi Deutsche Bank Troika Dialog VTB CapitalSource: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 VTB Capital 3,392 7 21.75

2 Citi 2,748 5 17.62

3 Deutsche Bank 2,026 5 12.99

4 Sberbank CIB 1,381 3 8.86

4 BNP Paribas 1,381 3 8.86

6 Credit Suisse 1,367 2 8.76

6 Barclays 1,367 2 8.76

8Renaissance Capital ZAO

645 2 4.13

8 JPMorgan 645 2 4.13

8 HSBC 645 2 4.13

Subtotal 15,595 7 100

Total 15,595 7 100




Russian Railways

Russian Railways

Rating Baa1/BBB/BBB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

50

100

150

200

250

300

350

400

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.5

1

1.5

2

2.5

3


Source: Russian Railways

Rb bn

01020304050607080

2008

2009

2010

2011

2012

NET PROFIT


Rb tr

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

2008

2009

2010

2011

2012

REVENUES


Rb tr

00.05

0.10.150.2

0.250.3

0.350.4

0.45

31-D

ec-0

9

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

DEBT OUTSTANDING

Pricing date April 12, 2013Value €1bnMaturity date May 20, 2021Coupon 3.3744%Reoffer price 100.00Bookrunners Natixis RBS SG CIB VTB Capital Pricing date January 29, 2013Value Sfr150m / Sfr525mMaturity date Feb 2021 / Feb 2018Coupon 2.73% / 2.177%Reoffer price 100.00 / 100.00Bookrunners Barclays Credit Suisse VTB Capital Pricing date October 10, 2012Value Rb12.5bnMaturity date April 2, 2019Coupon 8.3%Bookrunners JP Morgan RBS VTB Capital Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 VTB Capital 2,320 10 31.86

2 JPMorgan 1,403 5 19.27

3 RBS 1,224 5 16.82

4 Barclays 1,096 5 15.05



321 1 4.41

6 Natixis 321 1 4.41


Subtotal 7,281 10 100

Total 7,281 10 100




Russian Standard Bank

Russian Standard Bank

Rating Ba3/B+/B+

Source: Markit

bps

01-M

ay-12

01-Ju

n-12

01-Ju

l-12

01-Au

g-12

01-Se

p-12

01-O

ct-12

01-N

ov-12

01-D

ec-12

01-Ja

n-13

01-Fe

b-13

01-M

ar-13

01-Ap

r-13

01-M

ay-13

0100200300400500600700800900

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

00.10.20.30.40.50.60.70.80.9

1


Source: Russian Standard Bank

$ bn

- 0.2-0.15-0.1

-0.050

0.050.1

0.150.2

0.250.3

2008

2009

2010

2011

2012

NET PROFIT


$ bn

0

2

4

6

8

10

12

31-D

ec-0

9

31-D

ec-0

8

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TOTAL ASSETS


%

0

5

10

15

20

25

31-D

ec-0

9

31-D

ec-0

8

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TIER 1 RATIO

Pricing date March 13, 2013Value CNY750mMaturity date February 14, 2015Coupon 8%Bookrunners BNP Paribas HSBC Pricing date November 8, 2012Value $175mMaturity date July 11, 2017Coupon 9.25%Reoffer price 102.25Bookrunners Citi JPMorgan Pricing date October 3, 2012Value $350mMaturity date April 10, 2018Coupon 10.75%Reoffer price 100.00Bookrunners Goldman Sachs UBS VTB Capital

Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 JPMorgan 264 2 24.5

1 Citi 264 2 24.5


3 UBS 117 1 10.81


6 HSBC 100 2 9.29



Total 1,079 5 100




Sberbank

Sberbank

Rating Baa1/NR/BBB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

50

100

150

200

250

300

350

400

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

1

2

3

4

5

6

7


Source: Sberbank

Rb bn

0

50

100

150

200

250

300

350

400

2008

2009

2010

2011

2012

NET PROFIT

Source: Sberbank

Rb tr

02468

10121416

31-D

ec-0

8

31-D

ec-0

9

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TOTAL ASSETS

Source: Sberbank

%

9.5

10

10.5

11

11.5

12

12.5

31-D

ec-0

8

31-D

ec-0

9

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

CORE TIER 1 RATIO

Issue type Tier 2Pricing date May 16, 2013Value $1bnMaturity date May 23, 2023Coupon 5.25%Pricing details 324bp over swapsBookrunners BNP Paribas JPMorgan Sberbank CIB UBS Pricing date February 26, 2013Value TRY550mMaturity date March 4, 2018Coupon 7.4%Reoffer price 100.00Bookrunners HSBC JPMorgan Sberbank CIB Pricing date February 6, 2013Value Sfr250mMaturity date February 28, 2017Coupon 2.065%Reoffer price 100.00Bookrunners Credit Suisse Sberbank CIB UBS

Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Sberbank CIB 2,493 10 19.32

2 JPMorgan 2,021 7 15.66

3 BNP Paribas 1,594 8 12.35

4 Barclays 1,550 7 12.01

5 HSBC 1,019 3 7.89

6 UBS 773 4 5.99

7 RBS 753 3 5.83

8 Citi 719 4 5.57

9 DZ Bank 503 2 3.89

10 ING 417 2 3.23

Subtotal 11,840 17 91.75

Total 12,905 17 100




Severstal

Severstal

Rating Ba1/BB+ /BB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

100

200

300

400

500

600

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.5

1

1.5

2

2.5


Source: Severstal

$ bn

-1

-0.5

0

0.5

1

1.5

2

2.5

2010

2011

2012

NET PROFIT

Source: Severstal

$ bn

02468

1012141618

2010

2011

2012

REVENUE

Source: Severstal

$

-1

-0.5

0

0.5

1

1.5

2

2.5

2010

2011

2012

EARNINGS PER SHARE

Pricing date March 13, 2013Value $600mMaturity date March 19, 2018Coupon 4.45%Pricing details 344bp over swapsBookrunners Citi JPMorgan Sberbank CIB Pricing date October 4, 2012Value $750mMaturity date October 17, 2022Coupon 5.9%Pricing details 426bp over USTsBookrunners Citi ING JPMorgan SG CIB VTB Capital Pricing date July 19, 2011Value $500mMaturity date July 26, 2016Coupon 6.25%Pricing details 482bp over USTsBookrunners Barclays Goldman Sachs

Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Citi 607 3 18.05


2 Barclays 583 2 17.34

4 JPMorgan 350 2 10.4

5 RBS 333 1 9.91


7 Sberbank CIB 200 1 5.94



150 1 4.46

8 ING 150 1 4.46


Total 3,365 5 100




Sistema

Sistema

Rating Ba3/BB/BB-

Source: Markit

bps

01-M

ay-12

01-Ju

n-12

01-Ju

l-12

01-Au

g-12

01-Se

p-12

01-O

ct-12

01-N

ov-12

01-D

ec-12

01-Ja

n-13

01-Fe

b-13

01-M

ar-13

01-Ap

r-13

01-M

ay-13

0

100

200

300

400

500

600

700

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

00.10.20.30.40.50.60.70.8


Source: Sistema

$bn

0

0.5

1

1.5

2

2.5

2010

2011

2012

NET PROFIT

Source: Sistema

$ bn

0

5

10

15

20

25

30

35

40

2010

2011

2012

TOTAL REVENUES

Data at December 31, 2012. Source: Sistema

$ bn

0

1

2

3

4

5

6

2013

2014

2015

2016

2017

+

DEBT MATURITY PROFILE

Issuer Mobile TeleSystems (MTS)Pricing date May 23, 2013Value $500mMaturity date May 30, 2023Coupon 5%Reoffer price 100.00Bookrunners Gazprombank JPMorgan RBS Issuer Sistema Financial CorpPricing date May 11, 2012Value $500mMaturity date May 17, 2019Coupon 6.95%Reoffer price 100.00Bookrunners Deutsche Bank Morgan Stanley VTB Capital Issuer Mobile TeleSystems (MTS)Pricing date June 15, 2010Value $750mMaturity date June 22, 2020Coupon 8.625%Pricing details 532bp over USTsBookrunners BAML Credit Suisse RBS

Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 RBS 417 2 21.04



3Bank of America Merrill Lynch

250 1 12.63


5 JPMorgan 167 1 8.42




Total 1,980 4 100




Vimpelcom

Vimpelcom

Rating Ba3/BB/NR

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

100

200

300

400

500

600

700

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

00.5

11.5

22.5

33.5

44.5

5


Source: Vimpelcom

$ bn

0

0.5

1

1.5

2

2.5

2010

2011

2012

NET PROFIT

Source: Vimpelcom

$ bn

0

5

10

15

20

25

2010

2011

2012

TOTAL OPERATING REVENUES

Source: Vimpelcom

$

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

2010

2011

2012

EARNINGS PER SHARE

Pricing date February 7, 2013Value $600mMaturity date February 13, 2019Coupon 5.2%Reoffer price 100.00Bookrunners Barclays Citi ING RBS Pricing date February 7, 2013Value $1bnMaturity date February 13, 2023Coupon 5.95%Reoffer price 100.00Bookrunners Barclays Citi ING RBS Pricing date February 7, 2013Value Rb12bnMaturity date February 13, 2018Coupon 9%Reoffer price 100.00Bookrunners Barclays Citi ING RBS Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Citi 1,996 14 12.95

2 RBS 1,815 12 11.77

3 Barclays 1,571 12 10.19

4 BNP Paribas 1,551 13 10.06

5 Intesa Sanpaolo 991 10 6.42

6 ING 954 8 6.18

7 JPMorgan 754 6 4.89


754 6 4.89

9 UniCredit 723 6 4.69



Subtotal 12,430 18 80.62

Total 15,419 18 100




Vnesheconombank

Vnesheconombank

Rating Baa1/BBB/BBB

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

50

100

150

200

250

300

350

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

0.5

1

1.5

2

2.5

3

3.5


Source: VEB

Rb bn

0

5

10

15

20

25

30

2010

2011

2012

NET PROFIT

Source: VEB

Rb tr

0

0.5

1

1.5

2

2.5

3

3.5

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TOTAL ASSETS

Source: VEB

%

0

5

10

15

20

25

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

CAPITAL ADEQUACY RATIO

Pricing date February 14, 2013Value €1bn / €500mMaturity date Aug 2018 / Aug 2023Coupon 3.035% / 4.032%Reoffer price 100.00 / 100.00Bookrunners Barclays Commerzbank ING SG CIB Pricing date June 26, 2012Value $1bnMaturity date July 5, 2022Coupon 6.025%Pricing details 440bp over USTsBookrunners Credit Agricole CIB Deutsche Bank HSBC JPMorgan Pricing date February 2, 2012Value $750mMaturity date February 13, 2017Coupon 5.375%Reoffer price 100.00Bookrunners BNP Paribas JPMorgan Morgan Stanley RBS Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 Barclays 1,154 5 14.65

2 HSBC 1,053 5 13.37


910 4 11.55

4 JPMorgan 838 4 10.63

5 Citi 803 4 10.2


650 3 8.25

7 ING 507 2 6.43

7Commerzbank Group

507 2 6.43



Subtotal 7,103 9 90.16

Total 7,878 10 100




VTB Bank

VTB Bank

Rating Baa1/BBB/NR

Source: Markit

bps

28-M

ay-12

28-Ju

n-12

28-Ju

l-12

28-Au

g-12

28-Se

p-12

28-O

ct-12

28-N

ov-12

28-D

ec-12

28-Ja

n-13

28-Fe

b-13

28-M

ar-13

28-Ap

r-13

0

100

200

300

400

500

600

5YR CDS PRICING


$ bn

2007

2008

2009

2010

2011

2012

2013

0

1

2

3

4

5

6

7

8


Source: VTB

Rb bn

0102030405060708090

100

2010

2011

2012

NET PROFIT

Source: VTB

Rb tr

012345678

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TOTAL ASSETS

Source: VTB

%

0

2

4

6

8

10

12

14

31-D

ec-1

0

31-D

ec-1

1

31-D

ec-1

2

TIER 1 RATIO

Issue type Tier 1Pricing date November 1, 2012Value $1.25bnMaturity date PerpetualCoupon 9.5%Reoffer price 100.50Bookrunners VTB Capital Issue type Tier 2Pricing date October 4, 2012Value $1.5bnMaturity date October 30, 2022Coupon 6.95%Reoffer price 100.00Bookrunners BAML Barclays SG CIB VTB Capital Pricing date August 28, 2012Value Sfr600mMaturity date December 16, 2016Coupon 3.15%Reoffer price 100.00Bookrunners BNP Paribas Credit Suisse VTB Capital Source: Dealogic

RECENT DEALS

Rank Lead Manager

Amount $m

No of Issues

% Share

1 VTB Capital 6,542 20 44.13

2 Citi 1,167 3 7.87

3 BNP Paribas 1,098 6 7.41

4 JPMorgan 917 3 6.18



7 ING 559 2 3.77

8 UBS 558 3 3.76


10 OCBC 423 3 2.86

Subtotal 13,111 24 88.44

Total 14,825 25 100



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