Gary Kleiman of Kleiman International -

Ukraine’s outline restructuring deal with its Franklin Templeton-led group of main creditors, controlling a quarter of the $15bn in external bonds, was hailed in both official and private circles. It allowed continuation of the IMF bailout programme and roughly split the difference between the respective sides’ initial positions. However, hopes that Ukraine could serve as an improved resolution model after the IMF issued proposals and conducted private sector consultations throughout 2013-14 were dashed, as relations are more acrimonious over debt sustainability and the concept of “lending into arrears”, whereby the IMF allowed the next loan installment to be released as long as the talks were active.

Under the terms of the outline deal, the distressed exchange will trigger credit default swaps and rating downgrades for a period until the operations are completed. The key features include a 20% principal reduction, four-year repayment delay with 7.75% coupons, and GDP-linked warrants to come at the end of the decade.

The preliminary agreement should avoid the legal minefields that have blighted the long-running Argentina saga, as instruments have standard collective action clauses for 75% majority voting to bind all debt holders, and the “pari-passu” definition related to equal treatment is narrower to discourage attempts by some to hold out. The IMF and global banking and fund manager associations endorsed the changes in future sovereign bond contracts for clearer language and rules on these fronts, and Kazakhstan was the first to insert them in an issue last year.

Experts have urged Kyiv to undertake other unconventional legal strategies, but so far it has refrained. They argue that English law issues can be amended to shift to local jurisdiction to ensure acceptance of revised terms, and that the $3bn Russian Eurobond extended in the waning days of the ousted government of Viktor Yakunovych should be challenged as “odious debt” under a doctrine not to honour corrupt transactions. For its part, Moscow insists the obligation is not commercial and subject to reduction, but official and should be entirely covered.  

The IMF has tried to finesse the distinction, but created a muddle almost equal to its 2014 “reprofiling” strategy just as the border conflict ignited in Crimea and the east of the country. That formulation tied “exceptional access” at a multiple of the normal borrowing quota to preliminary maturity extension short of outright restructuring, if market access is lost and analysis shows longer-term debt sustainability. The former settlement option would be less disruptive and avoid the “too little, too late” quandary with country rescheduling requests, according to IMF research. Definitions envisioned three- to five-year payment stretches without coupon or principal write-downs, as in the early 2000s Uruguay case. Ukraine’s previous exchange around the same time in the wake of the Russia crisis then carried harsher provisions, as short-dated paper was swapped for five-year bonds and coupons were slashed 5%. Reprofilings like Uruguay’s have entailed just a 5-15% net present value haircut, in contrast with” harder” alternatives ranging from 30-75%. The original creditor offer this summer with advice from BlackRock featured only extension, while Finance Minister Natalie Jaresko, under the guidance of Lazard, which also helped Greece, floated 40% reductions.

The simple delay may have been viable as of the first post-Yakunovych IMF facility in April 2014, when debt/GDP was just 40%, and economic recovery and war containment prospects were brighter. But the subsequent currency collapse and fracture of the Donbass-Luhansk region signaled the need for deeper debt relief. Consensus estimates put the deal’s recovery value at 60-70 cents to the dollar, around the level of current bond prices. The debt/output ratio is close to 100% and the IMF mandates the sustainability threshold to be met at 70% by end-decade, even though official creditors with more exposure are still to be paid in full. As in Greece’s latest bailout, the private sector argues that official creditors too should provide forgiveness. Franklin Templeton and the other firms negotiating also criticized the IMF’s delay in sharing its sustainability analysis and the assumptions, particularly on currency devaluation, which seemed understated after the document was made public. They also challenged market access projections based on historic observations and recent trends without taking into account related Ukrainian corporate activity, where foreign lines have been maintained amid defaults. In the parallel quasi-sovereign Export-Import Bank talks, creditors had agreed to stay engaged in return for loan deferrals, but Kyiv and the IMF did not consider the outcome a precedent. 

Creditors were also upset over the IMF’s decision, with US Treasury Department backing, to improvise the “lending into arrears” policy before the deal was struck to allow the next loan installment to be released as long as talks were active, instead of following the stricter “in good faith” criterion. They pointed out that parliament had passed laws setting the stage for a debt moratorium and compulsory foreign to local currency conversion, and they could remain on the books indefinitely as a cudgel inconsistent with mutual trust and voluntary participation. These principles are enshrined in codes of conduct developed by the UN and Institute for International Finance, and although both bodies welcomed the accord they are working on more detailed guidelines in light of Ukraine’s experience.

With the country’s sovereign debt twists the past year and resulting bad blood and confusion, the IMF’s 2014 reprofiling-based framework has been scuttled with no replacement in sight. Just before its successor $40bn programme was finalized in the spring, the IMF reacted to growing unease by convening a large meeting to elicit recommendations on public-private burden sharing and crisis management. Participants urged a predictable workout process generally, but also practical steps such as pooling experts for common understandings on market access and debt sustainability. These modest innovations have been missing and can begin to reframe the tarnished post-Ukraine sovereign restructuring picture.