Monday, April 23, 2012

Russia's Bond Market Grows Up

On its face, it seems tempting enough. A big country with a strong desire to become a world financial center that can one day rival Frankfurt is opening up its local government bond market to foreign investors.


And guess what? The bond’s pay around 5% interest. And there’s an upside, a stronger currency to boot. This is Russia, the country every investor loves to hate.

If all goes swimmingly well, the Russian local bond market will be easier for foreigners to access starting as early as July 1, 2012.

Under new rules for sovereign bonds called OFZ and other local debt instruments, foreigners can tap in directly through the Euroclear service, bypassing the current need to have a Russian broker on the ground somewhere in Moscow or St. Petersburg.

“This will open Russia to a lot more investors,” said Chris Osborne, chief executive officer of Troika Dialog USA, a brokerage firm working with institutional clients buying Russian securities out of New York. Behind Osborne is an obstructive new Excell Development project, a new Hilton hotel cuts his view of Central Park in two.

Ekaterina Rybolovleva, the 22 year old daughter of a big Russian oligarch owns an entire penthouse nearby in the Upper West Side, sold for a cool $88 million. That kind of conspicuous wealth haunts Russian politics. The income gap is widening.

The oligarchs command a large part of the Russian economy, but that depends on their relationship with Russia’s newly elected president Vladimir Putin, who will take the reigns yet again in May after serving four years as Prime Minister.

Putin’s United Russia Party has come under substantial political pressure from citizens who have been protesting the party for alleged voting fraud and other matters, namely corruption, since October.

Out of the big four emerging markets, Russia ranks as the most corrupt according to Transparency International.

That’s the key word when it comes to investor sentiment on Russia — transparency. There’s not much of it. But opening its bond market through Euroclear shows that even Putin knows the future of Russian democratic capitalism is pushing down on him.

Reforms, still moving at a tortoise pace, according to the assessment of former Finance Minister Alexey Kudrin, are underway.

The one investors are waiting for now is the bond market. “There is a lot of demand for rouble bonds,” Osborne said. “So long as people have a neutral view on hard commodities like oil and metals then they will be bullish on the rouble.”

Rising currencies are good for bond holders, so long as the currency rises in strength from where it was purchased. Russian officials like Konstantin Vyshkovsky, the head of public debt at the Finance Ministry, will tell you that the government wants to make local-denominated bonds a “safe” and liquid investment for conservative fund managers.

Think U.S. teachers’ pensions, for example, or private asset managers looking to preserve capital for their clients. There are not many places where investors can buy investment grade bonds that pay decent yields, or interest payments.

Russian sovereign debt is currently rated BBB by Standard & Poor’s. Brazil is also BBB and it’s dollar bonds yield around 3.3% while their local currency bonds pay at least 9% in interest to as high as 11.5% on longer dated bonds.

That’s made the Brazilian bond market the most popular local currency bond market in the world, and Russia sees that and wants in on the action. To make that happen, Russia’s liberalizing its 3 billion rouble ($100 billion) OFZ market by creating a central depositary and passing laws on purchase clearing and central counterparty.

To the lay reader, this might not make a lot of sense. But to investors, the technical and bureaucratic details about placing a trade matter and make Russian bonds a potential asset to diversify U.S. fixed income portfolios.

“There will be a wave of money coming into Russia once liberalization is complete this summer,” said Michael O’Brien, Head of Trading at Eaton Vance in Boston.

“The only reason why we’re not into Russia more is because there is a lack of options. We will need more options than just Euroclear,” he said during a VTB Capital conference panel on the bond market at the gilded New York Palace Hotel on Thursday.

VTB Capital estimates those inflows to be around $5 to $10 billion a year. Euroclear is the key at this point. “The technical barriers to buy Russian bonds are being removed,” said Philippe Learnsey, Director of Euroclear Bank.

forbes.com



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