Greed is good for gekkos

The Thursday before the election they yielded 215%. One week later they yielded 130%. In July they breached 80%, before jumping to 94% one week later. At the time of writing, the central bank had allowed them to come down to an average in the low 80s. Welcome to the Russian government’s domestic debt market, nicknamed the gekko market after its abbrevation GKO.

Not surprisingly, foreign investors have been desperate to get a piece of this volatile, high-yield action. But so far the Russian government has not been so keen to oblige, fearing only the hottest of money will arrive.

Until president Boris Yetsin’s re-election the government’s one concession was to offer a derivative product through Paris-based Eurobank. This guaranteed dollar returns of 19%, which the government optimistically expected would bring in foreign money to ease the cost of financing the government debt, the size of which has grown from $13 billion at the beginning of the year to $36 billion in July. Understandably, risk-hungry investors saw this as a little tame compared with the real thing.

The government’s latest concession, post-election, will hardly whet their enthusiasm either. The Russian authorities have set up a new investment account called the “S” account. This means that investors can buy gekkos direct from a Russian commercial bank ­ rather than go through a derivative structure in Paris. But it will still mean that while rouble gains will approach 80%, this yield will be quartered after the central bank has stepped in. Gekko profits made by foreigners will have to be converted into dollars using a three-month forward rate which is set by the central bank. This will reduce the dollar return to 19% ­ so no change there.

The next step, says Andrei Kozlov, the deputy governor of the central bank, is to allow large foreign commercial banks to become official dealers using remote terminals in Frankfurt, London, Paris and New York. He adds that with the planned launch of a Eurobond this autumn, it is not in the interest of the government to allow foreigners in on equal terms with domestic players. Otherwise, many foreign investors will just buy gekkos rather than the Eurobond.

But the full-scale opening of the gekko market is less likely to be frustrated by this sideshow in the international capital markets than by the Russian banking system’s need to keep it closed. Russia’s debt market is constructed as a means of supporting the profitability of Russia’s 2,000 banks, many of them spurious, by offering them tremendous yields of around 80%, at a time when the monthly inflation rate was 1.2% in June.

To foreign investors the legal purchase of pure gekkos with full dollar convertibility represents something of a holy grail, especially now that Yeltsin’s new term has been confirmed. Investors know that the default risk on gekkos is non-existent.

There is also very little chance of mass devaluations sapping yield gains (Kozlov’s forward rate aside). The currency showed itself to be remarkably resilient, even through the elections, and the government has set a target of devaluing by only 1.5% per month.

So it should come as no surprise that investors have paid rapt attention every time a western bank has mentioned a scheme to get around the rules and let them invest directly. Unfortunately very few of these schemes obey the letter of the law and even those that are cleverly structured contravene its spirit.

“The structures are grey at best,” confesses a Moscow-based trader. Typically, an investment company will be set up in Cyprus, which has a double-taxation treaty with Russia. Cyprus does not, however, make you any less foreign, just very tax-efficient. A standard tax rate of 4.25% is paid to the Cypriot authorities on monies channelled tax-free from investments in Russia.

The first thing is to get the dollars into Russia. This tends to be done with the help of a Russian financial intermediary which has a subsidiary branch abroad and at which you deposit the dollars. This bank then brings the funds onshore and buys the gekkos (for a fee). The problem arises, however, when the investment company’s auditors discover it has no physical ownership of the gekkos. Kozlov says he wants to encourage intermediaries to push their clients into legal schemes and he says he knows on which doors to knock. “We may punish intermediaries in the autumn. But we will not punish foreign investors, only the intermediary,” warns Kozlov.

The only apparent alternative to the illegal schemes is offered by Regent and ANZ bank which set up a closed-end gekko fund of $106 million in July. They had the foresight to start setting up a Russian company in April, long before the result of the election was a foregone conclusion and nearly four months later, the company is operational. As a result, it can invest as a domestic investor. Steven Irvine

THAILAND

Bumper money from Thai traffic

More than 600 new cars hit the traffic-choked streets of Bangkok every day. And ING Barings is banking on the fact that there is very little the Thai government can do to stall the onslaught.

Jim France is based in Hong Kong, but his structured finance team at ING Barings has put together what they are claiming is the largest international securitization from an Asian issuer ­ floating-rate notes backed by Thai auto-lease receivables.

The originators of the leases are Thai companies Tru-Way, which offers hire purchase for luxury imported cars, and TISCO Leasing, which provides leasing finance for similar cars, as well as for office equipment.

After months of fine-tuning the Thai Cars structure, ING Barings finally received the nod from Moody’s and Standard & Poor’s on the triple-A rating requirements and from US specialist insurer MBIA Insurance before launching at the end of July. The deal raised $250 million on underlying leases of $310 million. The floating-rate notes were issued at par with a margin of 22 basis points over three-month US dollar Libor payable quarterly in arrears.

France says the deal was well oversubscribed, with most interest from European banks. The notes were issued by the Cayman Islands-registered Thai Cars special purpose vehicle and are being listed in Luxembourg. They have an expected average life of 1.5 years, a final maturity of six years and an expected final maturity of three to three-and-a-half years. The notes were not offered in Thailand.

The issues faced by the arrangers were numerous and complex, as would be expected in the first such international deal from the Thai jurisdiction. The tax and legal considerations had to be considered in tandem with the country’s macroeconomic issues, but on top of that, Bangkok’s horrendous traffic situation was also a factor in structuring and selling the paper.

As the congestion worsens, the Thai government is being forced to address its traffic issues. Bangkok’s deputy prime minister, Thaksin Shinawatra, dubbed the city’s “traffic tzar” for his pledge to solve the urban nightmare, has threatened to ban new cars completely on some roads during peak hours.

But future legislation should not effect the transaction because there will be no substitution in the existing pool of car loans, argues France.

“Even though the government wants to reduce vehicles on the road, it probably won’t be that successful in terms of preventing people from buying new cars,” he says. For example, drivers could switch registration plates from their old cars on to their new ones to circumvent any new restrictions.

Nevertheless, any serious clampdown on new cars, coupled with the country’s inflation worries, could put pressure on leasing companies such as TISCO Leasing and Tru-Way.

The history of the deal goes back over a year when Tru-Way was working with Bankers Trust to put together a $75 million structured loan collateralized by the hire purchase contracts. But the deal took longer than anticipated, the costs were higher than expected and Tru-Way felt the deal was not really big enough to satisfy its funding objectives.

At that point ING Barings stepped in with a proposal for a full-scale securitization and was mandated in February, initially putting in place a $75 million bridging facility using the same structure as the securitization, which has now become a public FRN issue incorporating TISCO Leasing assets as well.

Thai withholding tax of 15% led to the use of a fixed-rate yen loan to on-lend the proceeds of the dollar notes from Thai Cars to an intermediate Thai company, Tru-Lease, which is assigned rights and interest over the underlying hire purchase and lease payments, which remain on the originators’ balance sheets. The lower absolute interest rate on yen loans meant such a structure was the best way of minimizing withholding tax.

Tru-Lease will then on-lend the proceeds by buying baht-denominated notes from TISCO Leasing and Tru-Way.

After Tru-Lease has been in existence six months, in November, the baht notes will be redeemed and replaced by a baht loan. The baht notes and loan carry a fixed coupon, payable monthly and are cross-guaranteed by TISCO Leasing and Tru-Way. This mechanism avoids the baht loan incurring a 3.3% specific business tax on lending by companies which are not banks or approved finance businesses. Related parties are exempt from the tax if the affiliates have been in existence for six months.

The legal status of securitization in Thailand was also a hurdle. “The reaction we kept hearing was that it couldn’t be done,” says France. The main issue was to ensure there was clear legal transfer of the rights to the receivables underlying the hire purchase and lease contracts. ING Barings also had to structure the transaction to ensure bankruptcy of either of the originators would not prejudice payments to investors.

When ING Barings started marketing to companies in Thailand, it met with the Securities and Exchange Commission and Bank of Thailand, but they are still some way off producing final guidelines for domestic securitization. However, they were keen to encourage an offshore deal.

Such offshore structures are likely to remain, even once a domestic framework is in place, because of the limited local appetite for such paper and the government restrictions on lending to such businesses. Gill Baker

ASIAN CAPITAL MARKETS

The battle for Asia

John Howland-Jackson, deputy chief executive of NatWest Markets, will be posted to Hong Kong next month. He is only the most recent (and probably the most senior) of a stream of top executives sent out to run their firms’ Asian operations in the past few months. He joins, among others, John McNiven, former head of European debt markets for Merrill Lynch, and Dan Tyree, former chairman of Lehman Europe. What’s the sudden attraction of Asia?

The truth is that a battle is raging to dominate the fast-growing Asian capital markets. The US market is dominated by, arguably, six or seven firms; the top tier in Europe probably comprises 12 to 15. But Asia is still wide open: as many as 25 firms can justifiably call themselves leading players. These range from the big US investment banks to British banks (Schroders, BZW) to European universal banks (notably Deutsche Morgan Grenfell and ING Barings) and to local firms (Jardine Fleming, Peregrine). Says Howland-Jackson: “The fact is that no investment bank owns the region. Outside Japan, there are no domestic firms which have a monopoly. And maybe nobody will ever own Asia like they own the US or Europe.”

An analysis of league tables and polls shows just how wide open the field is. The table on the previous page demonstrates the fragmented nature of the business. Jardine Fleming, for example, dominates convertible issues from Asia but hasn’t led a straight bond issue in the past 18 months. Nomura has won lots of bond mandates, but few equity ones. Perhaps only Morgan Stanley and Lehman can be said to have a stong presence across the board. Add equity research to the equation and the ranking changes again. As the Asian brokers survey in this issue shows (see page 90), institutions which invest in the region go to a different set of firms for their research: Crédit Lyonnais Securities Asia, Crosby and James Capel all figure prominently in the research poll, but come nowhere in capital markets business. Only Jardine Fleming, ING Barings and Merrill Lynch are strong in both the primary and secondary categories.

Stirring up the competition is the fact that the nature of the business in Asia is changing. Until now, it has been possible to make good profits from equity broking in Asia. Jardine Fleming and Barings built up costly Asia-wide networks of branches and equity analysts which still generate lucrative business purely from stockbroking. But some bankers believe that, as fixed commissions disappear, the margins that can be made from straight broking will narrow. The brokers will then have to develop capital markets (for example, new issues) business to make those networks pay their way.

A further problem is that both JF and Barings are going through difficult times. Baring’s merger with ING still seems to have unsettled the firm’s Asian operations. JF has been the subject of an investigation by the UK’s Investment Management Regulatory Organization for allegedly allowing unethical practices by its fund managers. Its relations with Robert Fleming, its London-based half-owner, are said to be difficult. Rumours in Asia suggest the firm (and some of the other locally founded independent houses) may be up for sale.

Investment banks in Asia planning their strategy face several dilemmas. Should they try to build a pan-Asian network or instead concentrate on two or three major centres? Goldman Sachs, after some dithering, has rooted for the second option. It concentrates on big-ticket capital markets deals, its research is focused on pan-Asian sectors and written by analysts in Hong Kong and Singapore, and it is developing niches in private banking and direct investment. For firms that decide to build a network, problems abound. In many countries ­ notably Indonesia and Thailand ­ foreign firms are by law required to bring in a local partner. Finding the right partner and maintaining that relationship is invariably difficult.

Who to hire to head your Asian operation is equally a dilemma. While NatWest and others have opted to send a senior executive from London, others have decided to find a well-connected local. Deutsche Morgan Grenfell, for example, appointed Simon Murray, former managing director of conglomerate Hutchison and a resident of Hong Kong since 1966, to run its Asian operation. BZW’s Asian chairman, John Richardson, was also formerly with Hutchison.

Which firms are likely to emerge victorious from the battle? Much will depend on how quickly the domestic markets in the region liberalize. If they remain closed and fail to restructure, the firms with operations on the ground will be at an advantage. But if Asian governments understand the need to attract more foreign capital to fund infrastructure projects, it is more likely that the big global firms will emerge the winners. Garry Evans

KAZAKHSTAN

Gulf state on the Black Sea

Kazakhstan’s president Nursultan Nazarbayev apparently enjoys the many pleasures available during his regular trips abroad in the company of foreign government officials and businessmen. This autumn, however, it is the attractions of his own country which will be paraded in front of international investors, when ABN Amro launches Kazakhstan’s inaugural Eurobond issue.

The Dutch bank won the mandate in June against competition from 17 rivals, helped no doubt by its presence, for the last two years, in the capital Almaty, as the only fully licensed foreign bank in Kazakhstan. According to Noman Siddiqui, head of structured finance and commercial banking for ABN Amro in Almaty, the oil-rich former Soviet republic is likely to raise $100 million with a three-year maturity in November. ABN will first act as a rating adviser and coordinate presentations to the three main agencies in September or October. Other sources at the bank reckon Romania’s recent BB minus rating should provide a guide, while the market’s early talk suggests pricing between 400 basis points and 450bp over Libor, which was where Lithuania issued last year.

Investors will be encouraged by the resolution of a four-year dispute between Kazakhstan, Russia and Oman over their participation in the Caspian pipeline consortium. They now need to be convinced that the pipeline, connecting the Tengiz oilfield to the Russian port of Novorossiysk on the Black Sea, will actually be built. Its cost is estimated at $1.5 billion and will be met by eight international oil companies: the first delivery of oil is expected to be made in 1998. But, as 300 delegates heard at a conference promoting Kazakhstan, organized by London’s Adam Smith Institute at the beginning of July, the country experiences problems common to other CIS states ­ an unreliable and untrustworthy government bureaucracy, and a poorly developed infrastructure.

ABN will hope to side-step such concerns by focusing on the country’s potential as a putative “Gulf state”, containing vast oil and gas reserves ­ the Tengiz field contains 800 million tons of extractable oil reserves. Last year inward investment flows to Kazakhstan increased 38% to $2.6 billion, with nearly half directed to the mining sector (predominantly oil and gas), which has taken 90% of the total since 1991, according to figures published by the UN Economic Commission for Europe. Mobil’s intention to buy half the government’s stake in the Tengiz field for $1.1 billion and the interest shown by other US oil companies in different fields suggest the increasing trend will continue this year. Says ABN’s Siddiqui: “Kazakhstan has tremendous potential and the risk profile of the region as a whole is improving. The issue of a Eurobond will raise the country’s profile even more.”

UBS forecasts 2% growth this year, rising to 4% in 1997, and points out that a likely decline in the annualized inflation rate to 43% this year will mean that
Kazakhstan has one of the lowest inflation rates in the CIS.

Capital markets, however, are still embryonic; a stock exchange with listed shares exists but they are not actively traded. Treasury bills for three and six months are available, but that is the extent of the debt market.

But the financial sector is starting to develop. Peter Phelps moved from the Moscow office of Framlington Asset Management in August 1995 to run Kazakhstan’s first investment bank called Global Kazkommerts Securities. It is a joint venture between the country’s largest private bank, Kazkommertsbank (which holds a stake in ABN Amro in Almaty, along with the IFC) and the Turkish Global Securities investment company. Already it has advised the government on the privatization of Kazakhstan Telecom and raised finance for Coca-Cola’s Almaty bottling factory, and acted for several companies in acquisitions in the food processing and brewing sectors. Peter Phelps is enthusiastic about his move: “Kazakhstan is more centralized and considerably more stable than Russia,” he says.

Rupert Gordon-Walker