About a month ago, smart folks zeroed in on a single clause in Russia's two-year $3 billion loan to Ukraine. The December 2013 loan was documented as an ordinary-looking eurobond, apart from a promise by Ukraine to keep its debt under 60% of its GDP. No other Ukrainian bond had the debt/GDP clause, which naturally looked awkward when the sole bondholder started hacking at the denominator of the debt/GDP fraction (Crimea, about 3% of GDP; east and south, about 45%).

Ukraine's Russian Bonds - A Gazprom Clause?

posted by Anna Gelpern

About a month ago, smart folks zeroed in on a single clause in Russia's two-year $3 billion loan to Ukraine. The December 2013 loan was documented as an ordinary-looking eurobond, apart from a promise by Ukraine to keep its debt under 60% of its GDP. No other Ukrainian bond had the debt/GDP clause, which naturally looked awkward when the sole bondholder started hacking at the denominator of the debt/GDP fraction (Crimea, about 3% of GDP; east and south, about 45%).

Since then, I have communed a bit with Ukrainian bond prospectuses, and stumbled on another clause only found in the Russian bond. All of Ukraine's state and state-guaranteed foreign bonds cross-default to one another: if Ukraine skips a bond payment due in 2014, holders of the bond due in 2021 can accelerate. However, the Russian bond also cross-defaults to "any indebtedness ... owed to the Noteholder or to any entity controlled or majority-owned by the Noteholder". Compare the cross-default provision in this Ukrainian bond to this one  (search "Events of Default", "Indebtedness of Ukraine" and "Relevant Indebtedness").

One wonders whether they were thinking of Gazprom, majority-owned by the Russian government, and perennially claiming billions in arrears from Ukraine's Naftogaz. If Ukraine is late with its gas bills, Russia can accelerate its $3 billion. Since, according to Russia, Ukraine was already in gas arrears at the time the $3 billion bond was issued, that bond might have been callable at will all along.

This raises additional questions, which find no good answers in Ukraine's bond prospectuses. To be sure, the disclosure is a bit of a mess throughout. For example, when it comes to Collective Action Clauses, Ukraine's prospectuses routinely specify the quorum, but not the voting thresholds for amendment (search "Meetings of Noteholders" here)--making for some law firm guesswork. To understand the new cross-default term, one would need to know from the underlying contracts whether Russia is in fact the Noteholder of record, and whether, if it sells some of the $3 billion, the new creditors would retain the right to accelerate based on Gazprom arrears.

Even if Russia has no intention of enforcing the $3 billion in English courts, it could still cause a big ruckus simply by accelerating. This could well trigger Ukrainian Credit Default Swaps, or at least give ISDA's determinations committee a tough puzzle to ponder.

April 27, 2014 at 3:46 PM in Sovereign Debt