Ilargi: Kiev, Moscow, Bonds and Haircuts

Yves here. Ilargi explains why the proposed Ukraine bond restructuring is a geopolitical matter, part of the US push against Russia via Kiev, and not mere high finance.

By Raúl Ilargi Meijer, editor-in-chief of The Automatic Earth. Originally published at Automatic Earth

When money managers talk outside their narrow field, nonsense is guaranteed to ensue. No better example than this Bloomberg piece on Ukraine’s ‘debt restructuring’ plans, which are as much a political tool as they are anything else at all. Ukraine’s American Finance Minister has announced a broad restructuring plan with a wide range of severe haircuts for creditors, and she – well, obviously – wishes to include Russia in the group of creditors who are about to get their heads shaved.

And despite all obvious angles to the issue that are not purely economical, Bloomberg presents a whole array of finance professionals who are free to spout their entirely irrelevant opinions on the topic. If you didn’t know any better, you’d be inclined to think that perhaps Russia is indeed just another creditor to Kiev.

Putin Plays Wildcard as Ukraine Bond Restructuring Talks Begin

As Ukraine begins bond-restructuring talks, it finds itself face-to-face with a familiar foe: Russia. President Vladimir Putin bought $3 billion of Ukrainian bonds in late 2013. The cash was meant to support an ally, then-President Yanukovych.

That is, for starters, a far too narrow way of putting it. Russia simply wanted to make sure Ukraine would remain a stable nation, both politically and economically, because A) it didn’t want a failed state on its borders and B) it wanted to ensure a smooth transfer of its gas sales to Europe through the Ukraine pipeline systems. Whether that would be achieved through Yanukovych or someone else was a secondary issue. Putin was never a big fan of the former president, but at least he kept the gas flowing.

While his government fell just two months later, Russia was left with the securities. Now, those holdings take on an added importance as Putin’s stance on the debt talks could affect the terms that all other bondholders get in the restructuring. Russia, which is Ukraine’s second-biggest bondholder, has maintained that it won’t take part in any restructuring deal. Here are the three most likely tacks – as seen by money managers and analysts – that Putin’s government could pursue.

Here’s the biggest issue here, one which Bloomberg conveniently omits. Not only was Russia left with the securities after the Maidan coup (or revolution if you must), but the money provided through them to Ukraine began to be used to organize and fund various battalions and other groups, thrown together into a Kiev ‘army’, that started aiming for and at the Russian speaking population in East Ukraine. 6000 of them did not survive this.

The same would have happened in Crimea (Moscow is convinced of this) had not Putin made it part of Russia before that could happen. Do note that one of the very first decrees issued by US installed PM Yatsenyuk and his ‘cabinet’ was one that banned Russian to be used as an official language by millions of people who speak only Russian. That Yats withdrew the decree within a week didn’t matter anymore, the game was on right then and there.

Ukraine, after gaining a lifeline from the IMF, included Russia’s bond among the 29 securities and enterprise loans it seeks to renegotiate with creditors before June. Finance Minister Natalie Jaresko has promised not to give any creditor special treatment. The revamp will include a reduction in the coupon, an extension in maturities as well as a cut in the face value, she said.

Russian Deputy Finance Minister Sergey Storchak said March 17 that the nation isn’t taking part in the debt negotiations because it’s an “official” creditor, not a private bondholder. If the Kremlin maintains this view, it would be “negative” for private bondholders as “other investors will be more tempted to hold out as well,” according to Marco Ruijer at ING. He predicts a 45% chance of a hold out, while Michael Ganske at Rogge in London says it’s 70%.

Here’s where we get into la-la land, with money managers speaking out on things they don’t know anything about. Which can then be used to lead up to a goal-seeked conclusion, as we will see. Because of the situation I painted above, Russia cannot and will not take part in the ‘debt negotiations’ the west tries to shove down its throat through Jaresko’s restructuring plans.

If only because as soon as the restructuring has given Kiev some financial breathing space, is will use it to reinforce its troops and go after its Russian speaking compatriots again. It’s a not a finance issue at all, it’s life and death, and that makes percentages thrown around by money guys behind desks in high rises not just futile, but positively inane.

There is little precedence of sovereigns and private bondholders taking part in the same talks, given that a nation’s debt considerations include a “foreign-policy dimension,” according to Matthias Goldmann at the Max Planck Institute in Heidelberg, Germany. Ukraine and Russia may need to find an “appropriate forum,” such as the Paris Club, for separate negotiations, he said.

Holding out can lead to two outcomes: Russia gets paid back in full after the notes mature in December, or Ukraine defaults. The former option is politically unacceptable in Kiev, according to Tim Ash at Standard Bank, while the latter would likely start litigation and delay the borrower’s return to foreign capital markets, which Jaresko expects in 2017. “Russia will be holdouts, to try and force a messy restructuring,” Ash said by e-mail on March 19.

No, Russia is not interested in a ‘messy restructuring’. It will simply refuse to throw Kiev’s aggression against its own people a lifeline, and it will insist on finding that “appropriate forum”, instead of the one Jaresko tries to force it into. Russia will demand to be paid in full, and if that means a Ukraine default, it is fine with that. Don’t forget that the $3 billion in bonds is by no means the only debt Ukraine owes Moscow. There are many billions in unpaid gas purchases, and undoubtedly many other bills.

If Russia holds out and litigates, there is a “real threat” that Ukraine will deem the Eurobond an odious debt, Lutz Roehmeyer at Landesbank Berlin said. This refers to a legal theory that a nation shouldn’t be forced to repay international obligations if they don’t serve the best interests of the country and its citizens.

Nice theory. Why don’t we have Greece use it too? Russia would obviously never accept this. At the very minimum, gas would stop flowing through Ukraine to Europe.

The chance of Russia joining the talks is about 10%, according to ING’s Ruijer and Rogge’s Ganske. If Russia joins it would be “somewhat positive as all investors will be treated equally, and then it can be resolved quicker,” Ruijer said.

These guys really have no idea what’s going on. They see the planet exclusively in dollar terms. And they have no idea why they said 10%, might as well have been 5% or 25%. Hot air.

Bank of America said in a note last week that Ukraine will seek a principal reduction of about 35% in its opening salvo, which may be rejected by creditors. It said that bond valuations around 40 cents on the dollar, indicate a probability of a 20% reduction in principal as well as a reduction in interest rates. Ukraine’s benchmark 2017 dollar notes traded at 37.8 cents on the dollar on Thursday.

Sounds like things in the real world are already much worse than in BoA notes.

“By participating in the talks, Russia would have a better chance of getting a deal it wants,” Liza Ermolenko at Capital Economics, said. “However, it seems that politics, rather than economics, will be behind whatever Russia decides to do.”

No kidding, Liza.

There is no collective-agreement clause which could make any deal binding for Russia, Anna Gelpern, a Georgetown law professor, said.

And there we get to the core of the matter. If Jaresko wants to force anything on Russia, she’ll have to move outside of the law. Which I’m sure she, and the US cabal that rules Kiev, would be more than willing to do, but it would mean a default no matter what happens, simply because time is of the essence, and the issue would drag on for a long time.

The restructuring of each bond must be agreed to by a majority of its holders, according to Olena Zubchenko, a lawyer at Lavrynovych & Partners, a legal adviser to Ukraine during the bond issue to Russia in December 2013. The Eurobonds are governed by English law and traded on the Dublin Exchange. The Russian bond has a covenant allowing the holder to call it if Ukraine’s public debt tops 60% of economic output, which the IMF said took place last year.

Another noteworthy detail: Russia could have called the bonds quite a while ago, but has so far decided against that. They could still do it at any moment, though. And since the IMF has approved another loan to Ukraine recently, and Capitol Hill has agreed to send deadly offensive weapons to Kiev, they have good reason to do it. The Jaresko idea of ‘we will saddle you with losses, so we can go kill more Russian speaking people’ will certainly not appeal to Moscow, not will it be condoned.

“It’s a kind of nuclear option, evaporating their leverage,” Rogge’s Ganske said. “If Russia accelerates, then Ukraine has to pay or default on it — i.e. game over.”

This bond issue is of course just one of many ways in which the west seeks to aggravate Russia. If and/or when the US starts shipping arms to Kiev, and the internal civil war restarts, Russia will have to take measures. Which is exactly what the west has been trying to provoke it to do for at least a full year now. It is therefore Russia’s task to find those measures that take ‘the other side’ by surprise and leaves it scrambling for answers.

Over the past year and change, after the Kiev putsch and the subsequent aggression on the side of the newly installed ‘government’ against its own citizens in East Ukraine, Russia has always insisted on talking about the EU and US as its ‘partners’, even as the language thrown at it deteriorated at a rapid clip. It must already be about a year ago that Hillary Clinton first referred to Putin as Hitler. As for the anti-Moscow utterances by the Kiev ‘government’, let’s not even go there.

The Russians have shown recently that they understand very well what the intentions are behind the NATO build-up and all the hollow accusations and innuendo in the western media. They have also made clear that they are ready and prepared to activate any and all defense systems, including nuclear, at their disposal.

Russia sees the world as one in which multiple major powers can govern together. The US sees Russia as a power that must be defeated by any means necessary, and subdued. One of these worldviews must prevail in the end. Perhaps we won’t know which one that will be until the third power, China, raises its voice. What we do know is that Russia will back down only so far, and then it will no more.

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  1. Gerard Pierce

    This could of course, be complete insanity , but I have a daydream where Russia (for $1.00 and other valuable considerations) transfers their Ukrainian bonds to Greece.

    Greece then uses these bonds to pay the IMF and German banks and whoever else has the mojo to force the US to cough up the dough that was going to be be used to prop up Ukraine.

    If necessary, Russia could cut a one-time 10% off deal with Ukraine for oil and gas supplies, possibly with the 10% discount deposited in a Chinese bank for the benefit of whatever Ukrainian oligarch can see the handwriting on the wall. Mene, Mene WTF.

    1. Demeter

      That’s really deviously brilliant! So of course, nobody will dare to be so bold…

      Besides, I don’t think poor Greece deserves to hold the baby.

    2. Peter Pan

      This could of course, be complete insanity , but I have a daydream where Russia (for $1.00 and other valuable considerations) transfers their Ukrainian bonds to Greece.

      That other valuable consideration may be a Russian military base in Greece. I’m only mentioning this to feed into the clueless paranoia of NATO leadership.

      1. Gerard Pierce

        That’s why the unspecified “other valuable considerations”. You don’t want to make it too explicit, and Greece probably doesn’t really want to dump NATPO. Just the possibility is enough for Gen. Philip Breedlove to have a hissy fit. He’s usually looking for an excuse anyway. You leave it ambiguous so that Putin and Varoufakis can say “Who Me?”

  2. RBHoughton

    I find this article even-handed which is delightful for an English-language article about Ukraine these days.

    I am keeping a copy as it sets out the political and economic criteria well and shows who should be ashamed which, right now, is me as a member of western society.

    1. insooth

      I was thinking the exact same thing about the “even-handed” tone of the post. Excellent. That such a sane analysis can not be found ANYWHERE in western media really speaks volumes – and the message is not good.

  3. JTMcPhee

    This site, thank goodness and its builders, is a lot about unobvious or hidden connections between apparently disparate stuff. Speaking of which, one wonders about the ontology, semiotics and etymology of that “haircut” imagery. Given, e.g., the kind of stuff that Google turns up with a random query about the word: “Minami Minegishi: The Long, Strange History Of Head-Shaving As Penance And Punishment,”

    And speaking of random, a little plaintive query from the distant past, 2008, that might be worth updating: “Rich People and Their Private Armies,”

    I’m told that there’s a lot of profit to be made in being the first to “capitalize” on an otherwise unnoticed or overlooked trend, like betting short on bubbly mortgage derivatives, and managing manufactured demand for the Next Big Silliness. Other interesting pathways to Change and the processes that moved the political-economic foundations: “Connections,” Too many people, driven by the wetware in the ol’ limbic system, are busily cranking up the speed of the ol’ Spindizzy,, in hot and demanding pursuit of “points” and “extra time,” both of unapparent and negligible real-world value.

    Not that there’s an apparent mapping process that lets ordinary people see where or how to nudge the vectors in a direction that might let them and their offspring live, and live out, decent comfortable lives…

  4. susan the other

    Not that I’m equating Putin with Stalin, but Stalin bought time too as he tried to play Germany off on England. There had always been great sentiment in Germany that the British empire was their mortal foe. He thought he had the situation under control because he couldn’t believe Germany would be so stupid as to attack Russia… and then all hell broke loose. Let us all hope that Putin is able to convince today’s great war power hallucinators that it isn’t in their best interest to attack Russia. Especially using Ukraine as the pawn. Too bad Putin doesn’t have a good scapegoat to use against American paranoia.

    1. susan the other

      The big problem for Russia is that we are too hard-nosed, cold-blooded and single-minded. We want control of the Middle East and all the oil in it. Period. The best scapegoat Putin could come up with would be one he wants to avoid – that oil is a born again dinosaur. Clean technology is the biggest enemy of those in power.

      1. JTMcPhee

        Just wondering: Is “Putin,” as a linguistic shorthand for the complexity that is “Russia,” in any significant way directing efforts toward adoption of “clean techonolgy” (a possible oxymoron)? And supplanting the other stuff that is so curiously and hilariously apparent if one spends any time watching the many youtube videos under the general rubric “We Love Russia!”?;_ylt=A0LEViy.kxVV0icAL_0nnIlQ;_ylu=X3oDMTBsa3ZzMnBvBHNlYwNzYwRjb2xvA2JmMQR2dGlkAw–?p=youtube+we+love+russia&hspart=mozilla&hsimp=yhs-001

        And for some more fun, “Is it time to start loving bankers?”,;_ylt=A2KLqIDOkxVVDBcAN94snIlQ;_ylu=X3oDMTFkcnJtZW1hBHNlYwNzYwRzbGsDaHF2aWQEdnRpZAMEdmlkAzAwMDE1MzQwOTg2BGdwb3MDOA–?p=youtube+we+love+russia&vid=00015340986&l=2%3A12&×300%2F8d32889e29177b74112fc7b1ea989adc&

  5. Kris

    I can’t believe the hubris of the US-installed government in the Ukraine (and their US backers). Who is Natalie Jaresko to be handing out dictums to those her (now) country owes money to? Imagine if Greece took the same tack and told her cerditors exactly how and then they would be repaid and what haircut to expect? Incredible.

    1. Demeter

      Ukraine has a bunch of rich uncles: Uncle Sam, of course; then there’s Uncle George (Soros), Uncle Pinchuk, who was so generous to the Clintons’ foundation, the Chocolate Uncle, who is going to suffer the fate of a chocolate Easter bunny, and Uncle Bankster K with his private army, gas pipeline and more…

      1. Demeter

        Greece had Uncle Onassis, who must have had a lot of pull somewhere, to shelter Jackie Kennedy from the CIA. But he’s been dead since 1975…he was transporting oil for US companies at low, low prices! He’s a fascinating figure in history, and no one in Greece compares to him nowadays. Too bad.

  6. wroblon

    “Russia simply wanted to make sure Ukraine would remain a stable nation (…) because (…) it didn’t want a failed state on its borders”


    “Russia will demand to be paid in full, and if that means a Ukraine default, it is fine with that.”

    I lol’d.

  7. Olaf Lukk

    “The Russians have shown recently that they understand very well what the intentions are behind the NATO build-up” and all the hollow accusations and innuendo in the western media”. Say what?

    NATO was formed in 1948 in response to the Soviet refusal to disgorge those nations it had either annexed or occupied during and after WWll. The Soviets responded in 1954 by forming the Warsaw Pact, which included its satellite nations: Poland, Hungary, Czechoslavakia, Hungary, Bulgaria, Romania, and Albania.

    Fast forward to 1991, when the “prison of nations”- the USSR- collapsed. All of the nations named above, plus those which had been illegaly annexed and occupied for 50 years- Estonia, Latvia, and Lithuania- reclaimed their sovereignty. As did Ukraine, and even Russia itself
    In subsequent years, all of these nations actively sought out NATO membership, not to encroach on Russian “interests”, but to make sure that the Russians did not return to do even more damage.
    Now the ex-KGB apparatchik Putin has the chutzpah to whine about the hostility of former Soviet “republics”, conveniently forgetting that he has no one to thank for this situation more than his Kremlin predecessors.

    Meijer is just another Putin apologist masquerading as an objective observer. Hollow accusations? Innuendo? Maidan was a “coup”, not a revolution? Ukraine is going after its “Russian speaking compatriots”? “Kiev’s aggression against its own people”? “The US cabal that rules Kiev”? “The Jaresko idea of…’go kill more Russian speaking people’ “? All phrases designed for a Pavlovian (sorry) response for those already inclined to swallow his propoganda.

    I’m surprised that he didn’t mention neo-Nazi militias and Victoria Nuland, two staples of the juvenile viewpoint that NATO and the West, and not Putin and his oligarchs using Ukraine as a foil for their own ambitions, are responsible for this mess.

    And I’m disappointed that Naked Capitalism- the best economics blog on the Web- would lend credence to this misguided view. Ask anyone in Eastern Europe whether the Russians can be trusted. After all, that’s the question that precipitated the Maidan protests in the first place.

    1. Yves Smith Post author

      You have completely airbrushed out of the picture that Russia was given assurances that the US would not move NATO into former Warsaw Pact countries. That was a key reason why it was willing to let all of the former Warsaw Pact countries go peacefully.

      This understanding was widely recognized in the US intelligence community. When the Clinton repudiated that understanding in 1997, none other than the dean of cold warriors, George Kennan, said it would prove to be the worst geopolitical mistake the US ever made.

      And what happened in Kiev was most assuredly a coup. A democratically elected government was overthrown by force when elections were weeks away, and the constitution was replaced. And the US hand in this is heavy indeed. Did you manage to forget that the new finance minister, Natalie Jaresko, is a former State Department employee who then ran a fund in Ukraine sponsored by the US government? That story was reported in the German media, BTW. And if you think the IMF decided to waive its long-established rules about not lending to a country at war, and never having lent on a scale to GDP to one that in as disastrous shape as Ukraine is, absent US pressure, I have a bridge I’d like to sell you.

      1. Krzys

        Russia was given no assurances. Even more so, Russia has no business deciding what alliances other countries should enter. Especially, after murdering and deporting hundreds of thousands from the very countries. In case you haven’t heard, here’s an example:

        As to Maidan, it’s just screaming ignorance. Yanukovitch was trying to implement the Putin model of democracy. He already corrupted the courts, which had overturned the constitution of 2004 to give him more power. Couple more years of his power and the elections would be as real as the ones to Duma in 2011.

    2. Brooklin Bridge

      And I’m disappointed that Naked Capitalism- the best economics blog on the Web- would lend credence to this misguided view. – Olaf Lukk (no relation to Lucky Luke, I imagine)

      That formula is no longer accepted currency as others have upped the ante. Now in addition to insisting that your point of view must prevail if NC is to continue to be the best this-or-that on the web, you must add that when and if Yves and Lambert ever come to their senses (on what ever topic you fantasize about disagree with) and agree with you – as God and Nature no doubt intended, you would also be willing to consider a contribution…

  8. beene

    Yves, you fail to understand American exceptionalism; we make our own laws to fit the circumstances of the moment, regardless of present USA law.

    It is a shame we do not have leaders that lead the French revolution. Where the national traitors were tried then beheaded.

    Yves, still a great answer to some sort of troll.

  9. Patrick

    After the Argentina default it seems like this type of debt restructuring has been effectively ruled out. There is always an incentive for someone to hold out. Even without Russia, the idea that Ukraine’s restructuring could proceed always seemed unrealistic to me.

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