Research guide to banking services in eastern Europe
FIXED-INCOME INSTRUMENTSBoth rouble and dollar-denominated fixed-income instruments have been enjoying increasing attention from Russian and foreign investors alike. The main fixed-income instruments and markets and the practical elements are outlined below.ROUBLE BONDSGKOs are rouble bonds issued by the Russian state with maturities of three and six months sold at a discount. The market for GKOs has been in existence since May 1993. Longer-term federal loan bonds with tenors of between one and three years are issued at variable rates and are called OFZs.In mid-March there were around $18 billion worth of GKOs and OFZs in circulation. The majority of rouble bonds outstanding, 63% at the end of 1995, are GKOs issued with maturities of three months, with six-month GKOs making up 21% of the market. The remaining 21% of the local currency bond market is accounted for by OFZ bonds. GKO bonds have appealed to investors because of their relatively high yields compared with the limited devaluation in the rouble over the past 12 months. A combination of the slowdown in the rate of inflation (prices rose 4% in the month of January, down from 4.1% in December) and the effective management of the rouble by the monetary authorities contributed to investor interest, though yields have shown a downward trend. Yields have fallen to 50% in mid-March from the 200% prevailing at the beginning of the year. However, GKOs are volatile and yields can swing widely. The outlook for GKOs is seen by the market as being favourable given the trust that is being placed in the maintenance of the rouble corridor by the Russian monetary authorities. The potential downside for the rouble is also limited by the fact that foreign exchange reserves are relatively buoyant. Even with the risk of rouble depreciation, investors can hedge exposure to the local currency by selling roubles forward. This possibility also exists for foreign investors via their "I" accounts. These are rouble accounts that can be opened by investors with Russian banks such as ING Bank Eurasia. "I" accounts can be used for investments in a selective number of securities. Forward rates are typically based on an interest rate differential of between 20% and 30% a year and the market is fairly liquid for tenors of up to three months. Excellent returns are still achievable for those investors with confidence in the outlook for the rouble, access to the right instrument and trust in the regions with which they are doing business. However, GKOs are typically used to finance the state budget deficit and in the run-up to June's presidential elections bigger volumes of supply are expected to come to auction as the government has decided to pay wages in arrears. This fear of increased supply and political risk from the elections is likely to remain one of the most important factors keeping a floor on yields for the next quarter. DOLLAR-DENOMINATED BONDSMinistry of Finance (MinFin) bonds are dollar-denominated bonds issued on May 14 1993 as a result of a freeze on dollar deposits placed with Vnesheconombank in 1991. Four tranches of MinFin bonds with a total value of $7 billion are outstanding. Since their issuance, an increasingly liquid market in MinFin bonds has developed because they are easy to access, they can be used as collateral or in repo transactions and forwards and options and they do have relatively attractive yields.Strategies involving straddles (selling put and calls on tranches III and IV, the most volatile tranches), spread trading (long one tranche and short another), and portfolio diversification between tranches can all be employed. While MinFin bonds carry less spectacular yields than do GKOs, yielding between 14% and 17% in mid-March 1996, MinFin bond yields have been falling because of the positive developments in Russia's economy. They are subject to similar influences on their yields as GKOs such as domestic political factors, economic factors and the fact that Russia is an emerging market. However, there is also the addition of risk from players' perceptions of the market's infrastructure, for instance, the acceptance of Vneshtorgbank as a custodian and the threat of potential dilution (the Ministry of Finance has the potential to issue a further $1.5 billion into tranche V and an equivalent sum into a sixth tranche). SECONDARY MARKETGKOs can be freely bought and sold by Russian legal entities and private individuals and any income generated from GKOs is exempt from tax. Foreign investors that are not legal entities in Russia find it difficult to participate in the GKO market, however, and less than 5% of the GKO market is held by foreigners. To date, the only way of investing in short-term bonds is via agents of the Russian central bank outside Russia.In contrast, Russian government debt with maturities in excess of one year can be bought by foreign investors if they open a rouble "I" account with a Russian bank. Primary auctions for GKOs take place every Wednesday, the amount and tenor of each auction is announced a week in advance by Micex. There are two types of bid applications within the primary auction; competitive and non-competitive. Micex reveals the limitations on non-competitive bids at the same time it announces the auction details. TRADING AND SETTLEMENTThe distinguishing feature of the GKO market is that the bonds are not traded over the counter and they are settled in roubles. Between $350 million and $500 million in GKOs are traded every day on the Moscow Interbank Currency Exchange (Micex), the only bond trading exchange. Registered investors can only trade GKOs on Micex via the system of primary dealers which includes ING Bank Eurasia.Secondary market trading is on Mondays, Tuesdays, Thursdays and Fridays between 11:00 and 13:00 local time. GKOs are in book entry form with Micex as custodian and settlement is T-1 for buying and T+1 for selling. There are no derivatives yet available on GKOs. MinFin bonds, meanwhile, are bearer bonds and cannot be taken out of Russia, though they can be traded outside Russia while a custodian bank keeps the bonds. Vneshtorgbank in Moscow is the main custodian for MinFin bonds. Between $150 million and $200 million MinFin bonds are traded OTC each day in a market that is open 24-hours. As there are no restrictions for non-resident participants, foreign players are very active in the MinFin market, making up around half of the market holdings. Settlement is T+7 calendar days. Unlike GKOs, MinFin bonds can be used in repo transactions and can be lent or borrowed on, they also have collateral value. Forwards and options can also be traded on MinFin bonds. ROUBLE PROMISSORY NOTESPromissory notes, known as Veksel in the local market, are sold by a very limited number of Russian legal entities, such as ING Bank Eurasia. They can be denominated both in roubles and dollars and can be bought freely either by foreign parties with an "I" account with a local bank or by Russian entities.Promissory notes have terms which vary between three days and one year. Although the promissory note has a similar function to a bank deposit, it has several advantages over deposits and other money market instruments, such as the fact it can be redeemed for cash roubles and there are full re-endorsement rights. Promissory notes have the advantage over GKOs in that they can be used as repo instruments or as collateral. They also mitigate the disadvantages of GKOs as gains can be repatriated and they do not have as many restrictions of refinancing, as long as proper credit risks can be found. Interest on rouble promissory notes is lower than on Russian bonds as they are subject to 15% withholding tax if bought by a non-banking institution (18% for banks). This tax on interest bearing promissory notes is substantially less than tax on interest earned through bank deposits. There is also a reserve requirement effect on promissory notes. Foreign currency promissory notes are subject to a 1.5% reserve requirement and rouble notes reserve requirements vary between 10% and 20% of principal depending on the term of maturity. MinFin bonds outstanding
ING Bank Eurasia's capabilities: * ING Bank Eurasia is one of the biggest market-makers in MinFin bonds * ING Bank Eurasia is the first, and to date the only, foreign bank that is a licensed and operational primary dealer in both Russian GKO and OFZ bonds * ING Bank Eurasia sells rouble hedging instruments * ING Bank and ING Barings have sales desks in Moscow, London and New York * ING Bank Eurasia issues its own dollar- and rouble-denominated promissory notes * ING Bank Eurasia provides the most extensive custody services available for fixed income as well as equity instruments * ING Bank Eurasia is a leader in the MinFin repo market. Contacts: Maarten L Pronk General manager Maarten van den Belt Assistant general manager/treasurer Dennis Reynard Assistant general manager/manager operations Alberto Oucinde Manager, commercial banking Cor Timmermans Manager, corporate banking Pauline van den Beck Manager, trade and commodity finance Alexander Lomakin GKO dealer Sergei Petrov MinFin bond dealer Courtney Fellowes Sales, treasury products Irina Buryanova Sales, treasury products Tel: (7095) 244 9531/32 Fax: (7095) 244 9539 |