Against the backdrop of the shocking and tragic events of 2022, tectonic shifts occurred on the Russian bond market, including in the sphere of its regulation.
The main drivers of change were:
All this largely overshadowed for the Russian market the large-scale changes that occurred on global financial platforms due to a wave of inflation and rising rates in reserve currencies, which provoked sell-offs on Western bond markets.
Moreover, Russian financial institutions and regulators generally withstood the unprecedented external pressure with dignity. Given the combination of external and internal factors, Russian ruble bonds turned out to be one of the best-performing classes of debt assets in 2022.
In this article, we will briefly recap the changes in regulation and deal structuring that occurred in 2022 and also share our vision of the prospects for 2023.
BLOCKING OF NSD ACCOUNTS
2022
As a result of the blocking of Russian infrastructure, particularly the accounts of the NRD in Euroclear and Clearstream, a powerful barrier arose between the Russian and foreign depository systems.
Foreign securities, including Eurobonds of Russian borrowers, that ended up on the blocked accounts of Russian depositaries, can now only move within Russia; it became impossible to withdraw them abroad.
Russian securities that were in accounts at foreign depositaries became impossible to return to Russia. Payments and ballots for such Russian and foreign securities are not being passed through by Euroclear and Clearstream.
Although there were isolated cases in LECAP's practice of successfully obtaining sanctions licenses to unblock assets in Euroclear, until December 2022 such licenses were granted extremely rarely.
At the end of December, it was announced that the authorities of Belgium and Luxembourg had issued general licenses to unblock assets of non-sanctioned persons in the NSD's accounts in Euroclear and Clearstream. However, in practice, the unblocking conditions turned out to be too harsh, and most market participants could not use them. By the time sanctions were imposed, the NSD, through its accounts in Euroclear and Clearstream, was the main channel connecting Russian infrastructure with foreign markets. By the end of the year, the possibility of executing transactions through the settlement bank of the SPB Exchange, "Best Efforts Bank," and a number of other non-sanctioned depositaries with accounts in Euroclear remains.
2023
The possibility of a "general" unblocking of the NSD's accounts in 2023 will depend primarily on geopolitics. At the same time, we express cautious hope for the unblocking of at least some assets of non-sanctioned persons. This could be achieved through private, general licenses, or court decisions. However, litigating in the EU for Russian companies is now very difficult due to the ban on providing them with legal services, introduced by the EU's 8th sanctions package. We foresee in 2023 the establishment of new connections between Russian depositaries and depositaries in "friendly" countries and are advising on several such projects.
COUNTER-SANCTIONS BLOCKING OF ASSETS OF "UNFRIENDLY NON-RESIDENTS" IN RUSSIA
2022
Russia responded to the sanctions by blocking the financial assets of all non-residents from "unfriendly" countries and companies controlled by them. Such assets are to be credited to type "C" accounts and, as a general rule, cannot be debited from them without the approval of the Government Commission for Control over Foreign Investment.
Without the permission of the Government Commission, unfriendly non-residents and persons controlled by them also became unable to sell securities, issue loans and credits, pay interest and principal, including on bonds, other than to type "C" accounts.
If the first months after the start of the special operation were marked by a strengthening of counter-sanction measures, in the second half of 2022 the counter-sanctions regulation was somewhat liberalized. Thus, assets of residents from "friendly" countries that initially ended up in type "C" accounts were released, and such persons received the opportunity to conduct transactions on the Russian exchange.
2023
Following the introduction of counter-sanctions, many commentators discussed the idea of a "great set-off," as a result of which the assets of unfriendly non-residents in Russia would be unblocked in exchange for the unblocking of Russian assets abroad. For now, geopolitical conditions do not offer much hope for such a development.
Further liberalization of the counter-sanctions regime is more likely. In particular, one could expect that the criteria for approving certain transactions with non-residents, which have developed in the practice of the Government Commission, will be enshrined in a regulatory act. This will allow deals to proceed without waiting for the commission's approval for each transaction. The unblocking of small portfolios of citizens of unfriendly countries would also seem logical.
"BUILDING BRIDGES" FOR EUROBOND PAYMENTS
2022
Due to sanctions and counter-sanctions blockages, it turned out that payments from Russian borrowers in many cases could not reach the holders of their Eurobonds.
For many borrowers, both sanctioned and non-sanctioned, foreign paying agents and payment infrastructure began blocking payments on Eurobonds. Even if payments went through, Russian holders of Eurobonds held at the NSD could not receive them due to the blocking of the NSD's accounts in Euroclear. Decree of the President of the Russian Federation dated 05.03.2022 No. 95 provided for the possibility of direct payments in favor of holders of Eurobonds in Russian depositaries, bypassing foreign banks. According to the decree, obligations under Eurobonds are considered fulfilled from the point of view of Russian law in this case. However, from the point of view of English law, which governs Eurobonds, performance according to the decree without making changes to the bond documentation usually means a default on the Eurobonds. Making changes to the documentation, even for non-sanctioned issuers, initially proved impossible. This was due to the refusal to cooperate from the issuers' management companies, trustees, and legal advisors on organizing meetings of Eurobond holders.
As a result, some Russian borrowers were forced to pay on Eurobonds into blocked accounts in Euroclear. This money, in most cases, never reached the bondholders.
At the same time, overall, Russian borrowers demonstrated resilience and a commitment to high standards of investor relations, continuing to seek ways to get money to investors in Eurobonds despite all obstacles. At least one issuer even paid twice: once through the Eurobond paying agent, a second time to Russian bondholders through Russian depositaries.
Mechanisms for Eurobond payments were established by the end of the year. LECAP and LCPIS, a bondholders' representative accredited by the Central Bank of Russia, were among the pioneers in organizing voting on Eurobonds under the new conditions. LCPIS was the first Russian company to begin providing trustee services (Eurobond issues of MMK 2024, Evraz 2023 and 2024, MTS 2023) and information and tabulation agent services (issues of Severstal 2022 and 2024, Evraz 2023 and 2024, MTS 2023) for Eurobonds. By the end of the year, the mechanism for issuing local bonds that were exchanged for Eurobonds ("replacement bonds") was also established. This process was led by Gazprom, for whose replacement bonds LCPIS also acted as bondholders' representative.
2023
We expect that in 2023, processes to change the mechanism of Eurobond payments and the issuance of replacement bonds will continue. Some issuers may even repeat the exercise of issuing replacement bonds to cover those holders who did not have time to exchange their Eurobonds.
Furthermore, a number of issuers who do not fall under the provisions of Decree No. 95 are also next in line, including because they issued Eurobonds not through an SPV but through their foreign operating or holding companies.
BOND LOANS FOR THE BENEFIT OF CORPORATE GROUPS AND FOREIGN BORROWERS
2022
Buyback offers (put options) presented by affiliated companies in the event of an issuer's default have been a standard security instrument on the Russian market for many years. Offers were often used instead of guarantees to avoid additional disclosure requirements and net asset requirements for guarantors, especially if it concerned a foreign entity.
In 2022, it became extremely difficult to enforce offers from companies from unfriendly jurisdictions. Conducting transactions on offers with "unfriendly" companies requires the consent of the Government Commission, and "suing" for debt under an offer abroad became almost impossible due to the unwillingness of foreign lawyers to work with Russia.
2023
In view of counter-sanctions regulation, we foresee the emergence of structures alternative to offers from holding companies registered in unfriendly jurisdictions. In particular, one option could be the model of "Russian LPNs" (Local Payment Notes), which are issued by a Russian SPV to provide a loan to a Russian operating company. The loan claims are pledged against the SPV's bonds, and the loan itself, in turn, is secured by guarantees from the foreign holding company of the group or other group companies. This structure allows providing investors with a safer mechanism to protect their rights, expands the list of potential obligors under the transaction who are not subject to Russian net asset requirements for guarantors, translates the group's rating to the bond issue, and simplifies the disclosure mechanism for the borrower. We believe that such an instrument has a good chance of completely replacing the offer mechanism on the Russian market.
STRUCTURED BONDS AND SECURITIZATION – IMPORT SUBSTITUTION
2022
In 2022, structured products from foreign banks became unavailable to Russian investors. At the same time, for example, in the HNWI (High Net Worth Individuals) segment, demand for such products revived in the second half of 2022.
2023
In 2023, we predict the appearance on the Russian market of structured products for new types of risks (e.g., insurance-linked), as well as the activation of the securitization market. Russian regulation is still not very convenient for structured products, so bringing products to market will require creative work by lawyers. Several innovative deals in these markets are currently in our pipeline.
ESG
2022
In 2022, Russia introduced its own standards for issuing sustainability bonds, sustainability-linked bonds, and climate transition bonds, analogous to international standards for such instruments. Unique Russian standards for transition bonds also appeared. However, market participants did not see the introduction of budget subsidies for the interest rate on green bonds, which was much discussed in 2021. For obvious reasons, activity in the ESG bond market was also lower than in 2021.
2023
Nevertheless, we see that a number of borrowers have not lost interest in the ESG theme, and in 2023 we will see issues of new instruments in sustainable development formats. An example of an ESG-oriented placement could be, for instance, the debut issue of secured bonds by PPK "Russian Ecological Operator," placed in January with legal support from LECAP. Although the issue did not receive a "green" or "adaptation" label, it was placed to finance a waste utilization project and, moreover, has a subsidy from the Ministry of Finance on the coupon.
EMERGENCE OF A MARKET FOR EQUITY-CONVERTIBLE DEBT INSTRUMENTS
At the beginning of 2022, we were involved in six projects for the initial public offering (IPO) of shares of Russian companies. The closure of traditional external markets and the difficulties that arose in finding company valuations led to the suspension of such projects, but not to the abandonment of plans by controlling shareholders to acquire a public status for their companies. We expect that in conditions of limited investment ideas, various forms of convertible bonds could be a compromise between potential investors and current shareholders. We see two specific industries where these instruments are in demand by companies. The main question is market readiness.
NEW OFFSHORES FOR THE RUSSIAN MARKET
Since the beginning of the year, we have been involved in two projects for the redomiciliation of European holdings of Russian companies to friendly jurisdictions. We see infrastructure (law firms; brokers) for Russian business being established in the UAE.
You can download the full PDF version of the article on the [Cbonds](http://review.cbonds.info/article/magazines/5966/) website.
The main drivers of change were:
- Unprecedented Western sanctions, the blocking of the Central Bank's foreign currency reserves, accounts of the National Settlement Depository (NSD), and other Russian assets by "unfriendly" countries;
- An extremely high degree of suspicion among foreign companies, even from conditionally "friendly" countries, towards Russian assets, including non-sanctioned ones;
- Russian counter-sanctions designed to freeze assets of residents from "unfriendly" countries in Russia.
All this largely overshadowed for the Russian market the large-scale changes that occurred on global financial platforms due to a wave of inflation and rising rates in reserve currencies, which provoked sell-offs on Western bond markets.
Moreover, Russian financial institutions and regulators generally withstood the unprecedented external pressure with dignity. Given the combination of external and internal factors, Russian ruble bonds turned out to be one of the best-performing classes of debt assets in 2022.
In this article, we will briefly recap the changes in regulation and deal structuring that occurred in 2022 and also share our vision of the prospects for 2023.
BLOCKING OF NSD ACCOUNTS
2022
As a result of the blocking of Russian infrastructure, particularly the accounts of the NRD in Euroclear and Clearstream, a powerful barrier arose between the Russian and foreign depository systems.
Foreign securities, including Eurobonds of Russian borrowers, that ended up on the blocked accounts of Russian depositaries, can now only move within Russia; it became impossible to withdraw them abroad.
Russian securities that were in accounts at foreign depositaries became impossible to return to Russia. Payments and ballots for such Russian and foreign securities are not being passed through by Euroclear and Clearstream.
Although there were isolated cases in LECAP's practice of successfully obtaining sanctions licenses to unblock assets in Euroclear, until December 2022 such licenses were granted extremely rarely.
At the end of December, it was announced that the authorities of Belgium and Luxembourg had issued general licenses to unblock assets of non-sanctioned persons in the NSD's accounts in Euroclear and Clearstream. However, in practice, the unblocking conditions turned out to be too harsh, and most market participants could not use them. By the time sanctions were imposed, the NSD, through its accounts in Euroclear and Clearstream, was the main channel connecting Russian infrastructure with foreign markets. By the end of the year, the possibility of executing transactions through the settlement bank of the SPB Exchange, "Best Efforts Bank," and a number of other non-sanctioned depositaries with accounts in Euroclear remains.
2023
The possibility of a "general" unblocking of the NSD's accounts in 2023 will depend primarily on geopolitics. At the same time, we express cautious hope for the unblocking of at least some assets of non-sanctioned persons. This could be achieved through private, general licenses, or court decisions. However, litigating in the EU for Russian companies is now very difficult due to the ban on providing them with legal services, introduced by the EU's 8th sanctions package. We foresee in 2023 the establishment of new connections between Russian depositaries and depositaries in "friendly" countries and are advising on several such projects.
COUNTER-SANCTIONS BLOCKING OF ASSETS OF "UNFRIENDLY NON-RESIDENTS" IN RUSSIA
2022
Russia responded to the sanctions by blocking the financial assets of all non-residents from "unfriendly" countries and companies controlled by them. Such assets are to be credited to type "C" accounts and, as a general rule, cannot be debited from them without the approval of the Government Commission for Control over Foreign Investment.
Without the permission of the Government Commission, unfriendly non-residents and persons controlled by them also became unable to sell securities, issue loans and credits, pay interest and principal, including on bonds, other than to type "C" accounts.
If the first months after the start of the special operation were marked by a strengthening of counter-sanction measures, in the second half of 2022 the counter-sanctions regulation was somewhat liberalized. Thus, assets of residents from "friendly" countries that initially ended up in type "C" accounts were released, and such persons received the opportunity to conduct transactions on the Russian exchange.
2023
Following the introduction of counter-sanctions, many commentators discussed the idea of a "great set-off," as a result of which the assets of unfriendly non-residents in Russia would be unblocked in exchange for the unblocking of Russian assets abroad. For now, geopolitical conditions do not offer much hope for such a development.
Further liberalization of the counter-sanctions regime is more likely. In particular, one could expect that the criteria for approving certain transactions with non-residents, which have developed in the practice of the Government Commission, will be enshrined in a regulatory act. This will allow deals to proceed without waiting for the commission's approval for each transaction. The unblocking of small portfolios of citizens of unfriendly countries would also seem logical.
"BUILDING BRIDGES" FOR EUROBOND PAYMENTS
2022
Due to sanctions and counter-sanctions blockages, it turned out that payments from Russian borrowers in many cases could not reach the holders of their Eurobonds.
For many borrowers, both sanctioned and non-sanctioned, foreign paying agents and payment infrastructure began blocking payments on Eurobonds. Even if payments went through, Russian holders of Eurobonds held at the NSD could not receive them due to the blocking of the NSD's accounts in Euroclear. Decree of the President of the Russian Federation dated 05.03.2022 No. 95 provided for the possibility of direct payments in favor of holders of Eurobonds in Russian depositaries, bypassing foreign banks. According to the decree, obligations under Eurobonds are considered fulfilled from the point of view of Russian law in this case. However, from the point of view of English law, which governs Eurobonds, performance according to the decree without making changes to the bond documentation usually means a default on the Eurobonds. Making changes to the documentation, even for non-sanctioned issuers, initially proved impossible. This was due to the refusal to cooperate from the issuers' management companies, trustees, and legal advisors on organizing meetings of Eurobond holders.
As a result, some Russian borrowers were forced to pay on Eurobonds into blocked accounts in Euroclear. This money, in most cases, never reached the bondholders.
At the same time, overall, Russian borrowers demonstrated resilience and a commitment to high standards of investor relations, continuing to seek ways to get money to investors in Eurobonds despite all obstacles. At least one issuer even paid twice: once through the Eurobond paying agent, a second time to Russian bondholders through Russian depositaries.
Mechanisms for Eurobond payments were established by the end of the year. LECAP and LCPIS, a bondholders' representative accredited by the Central Bank of Russia, were among the pioneers in organizing voting on Eurobonds under the new conditions. LCPIS was the first Russian company to begin providing trustee services (Eurobond issues of MMK 2024, Evraz 2023 and 2024, MTS 2023) and information and tabulation agent services (issues of Severstal 2022 and 2024, Evraz 2023 and 2024, MTS 2023) for Eurobonds. By the end of the year, the mechanism for issuing local bonds that were exchanged for Eurobonds ("replacement bonds") was also established. This process was led by Gazprom, for whose replacement bonds LCPIS also acted as bondholders' representative.
2023
We expect that in 2023, processes to change the mechanism of Eurobond payments and the issuance of replacement bonds will continue. Some issuers may even repeat the exercise of issuing replacement bonds to cover those holders who did not have time to exchange their Eurobonds.
Furthermore, a number of issuers who do not fall under the provisions of Decree No. 95 are also next in line, including because they issued Eurobonds not through an SPV but through their foreign operating or holding companies.
BOND LOANS FOR THE BENEFIT OF CORPORATE GROUPS AND FOREIGN BORROWERS
2022
Buyback offers (put options) presented by affiliated companies in the event of an issuer's default have been a standard security instrument on the Russian market for many years. Offers were often used instead of guarantees to avoid additional disclosure requirements and net asset requirements for guarantors, especially if it concerned a foreign entity.
In 2022, it became extremely difficult to enforce offers from companies from unfriendly jurisdictions. Conducting transactions on offers with "unfriendly" companies requires the consent of the Government Commission, and "suing" for debt under an offer abroad became almost impossible due to the unwillingness of foreign lawyers to work with Russia.
2023
In view of counter-sanctions regulation, we foresee the emergence of structures alternative to offers from holding companies registered in unfriendly jurisdictions. In particular, one option could be the model of "Russian LPNs" (Local Payment Notes), which are issued by a Russian SPV to provide a loan to a Russian operating company. The loan claims are pledged against the SPV's bonds, and the loan itself, in turn, is secured by guarantees from the foreign holding company of the group or other group companies. This structure allows providing investors with a safer mechanism to protect their rights, expands the list of potential obligors under the transaction who are not subject to Russian net asset requirements for guarantors, translates the group's rating to the bond issue, and simplifies the disclosure mechanism for the borrower. We believe that such an instrument has a good chance of completely replacing the offer mechanism on the Russian market.
STRUCTURED BONDS AND SECURITIZATION – IMPORT SUBSTITUTION
2022
In 2022, structured products from foreign banks became unavailable to Russian investors. At the same time, for example, in the HNWI (High Net Worth Individuals) segment, demand for such products revived in the second half of 2022.
2023
In 2023, we predict the appearance on the Russian market of structured products for new types of risks (e.g., insurance-linked), as well as the activation of the securitization market. Russian regulation is still not very convenient for structured products, so bringing products to market will require creative work by lawyers. Several innovative deals in these markets are currently in our pipeline.
ESG
2022
In 2022, Russia introduced its own standards for issuing sustainability bonds, sustainability-linked bonds, and climate transition bonds, analogous to international standards for such instruments. Unique Russian standards for transition bonds also appeared. However, market participants did not see the introduction of budget subsidies for the interest rate on green bonds, which was much discussed in 2021. For obvious reasons, activity in the ESG bond market was also lower than in 2021.
2023
Nevertheless, we see that a number of borrowers have not lost interest in the ESG theme, and in 2023 we will see issues of new instruments in sustainable development formats. An example of an ESG-oriented placement could be, for instance, the debut issue of secured bonds by PPK "Russian Ecological Operator," placed in January with legal support from LECAP. Although the issue did not receive a "green" or "adaptation" label, it was placed to finance a waste utilization project and, moreover, has a subsidy from the Ministry of Finance on the coupon.
EMERGENCE OF A MARKET FOR EQUITY-CONVERTIBLE DEBT INSTRUMENTS
At the beginning of 2022, we were involved in six projects for the initial public offering (IPO) of shares of Russian companies. The closure of traditional external markets and the difficulties that arose in finding company valuations led to the suspension of such projects, but not to the abandonment of plans by controlling shareholders to acquire a public status for their companies. We expect that in conditions of limited investment ideas, various forms of convertible bonds could be a compromise between potential investors and current shareholders. We see two specific industries where these instruments are in demand by companies. The main question is market readiness.
NEW OFFSHORES FOR THE RUSSIAN MARKET
Since the beginning of the year, we have been involved in two projects for the redomiciliation of European holdings of Russian companies to friendly jurisdictions. We see infrastructure (law firms; brokers) for Russian business being established in the UAE.
You can download the full PDF version of the article on the [Cbonds](http://review.cbonds.info/article/magazines/5966/) website.