European and US investors steered clear of a controversial Kremlin Eurobond sale because the organisers didn't arrange clearing in time for them to transact, bne IntelliNews can report after the $1.75bn placement of 10-year notes.
Investors required VTB Capital, the state-controlled investment bank in charge of the deal, to set up a bridge to the Russian clearing system after the two main settlement agencies, which play a key technical role in placing bonds internationally, didn't sign up to handle Russia's first issue in three years.
The bond's prospectus said that there would be "no assurance" that the issue would be eligible for clearing systems such as Euroclear and Clearstream Banking. Instead, they will be settled on Russia's own National Settlement Depository (NSD), it noted.
Most international investors, who trade in US dollars, are not set up with the NSD and therefore missed out the chance to participate, according to Paul McNamara, a London-based fund manager at GAM. with about $4.5bn of assets under management.
"They screwed up the settlement thing," McNamara told bne IntelliNews. "Most dollar investors won't have NSD accounts good to go – only local-currency investors like us and Russians," he said. "The Euroclear bridge should be perfectly feasible, but amateur hour meant they didn't have all the boxes ticked ahead of time."
Argentina, which has had far deeper problems with investors than Russia, set up trading bridges with both Clearstream and Euroclear last year after being readmitted to international capital markets.
McNamara also pointed out that federal government bonds (OFZs) are also already euroclearable via the NSD.
VTB Capital, which managed - or mismanaged - the deal, didn't immediately reply to an e-mail seeking comment.
Triumph that wasn't
Analysts and journalists alike were bamboozled by the sale as VTB Capital claimed the Eurobond was a triumph in attracting back international foreign investors.
"Foreign investors boost Russia's bond comeback," ran the FT's initial headline about the issue before some backpeddling in a subsequent story. Nomura International strategist Tim Ash said he was surprised the Kremlin had followed through with the issue "given the lack of foreign demand".
The Russian Finance Ministry claimed that $1bn of the $1.75bn raised came from foreign investors. But a senior debt capital markets banker in Moscow said it was highly unlikely that genuine foreign investors had access to the deal.
"We reckon it was friends and family of Kremlin Inc," said the banker, who helped arrange prior sovereign deals, speaking on condition of anonymity.
Andrey Kostin, the head of the state-controlled VTB flatly refused to name the investors participating in his comments to a US newswire.
However, the Finance Ministry admitted most of the "foreign" investors were indeed from Britain, whose capital, known in some circles as "Londongrad", is a mecca for Russian wealth.
Andrey Solovyev, head of VTB's debt capital markets, pointed the finger at Euroclear for their lack of participation. He said the bank had received "positive messages" from the clearing house in the lead-up to the sale and he was surprised by its decision not to state that it would settle the bond.
The FT changed its tune on the deal on May 25 in a report saying the deal was "creating discord" in debt capital markets.
Some Western banks, who did steer clear of the deal, will be delighted at how badly it fared without them. Nonetheless, there is demand for Russian sovereign and quasi-sovereign paper given the over-subscription seen late last year for Eurobonds worth $3.7bn sold by Gazprom, Norilsk Nickel and Evraz. The three blue-chips, unlike the Russian sovereign, have not been blackballed with sanctions imposed in 2014 over the Kremlin's involvement in the Ukraine conflict.
The quality of the investors is the main but not sole concern, according to privately-held Alfa Bank. "The Finance Ministry finally raised $1.75bn, while the demand was for $7bn, which suggests that a larger placement would have been more costly," the bank adds.
Despite the placement not clearly showing that investor interest in Russia is stronger than sanctions, and it failing to place the targeted $3bn in foreign borrowings originally budgeted for 2016, this still marks a first Russian return to international markets with a sovereign issue since the start of the Ukrainian conflict in 2014 and the imposition of Western sanctions.
"There wasn't any real financial need to issue bonds," the head of the Finance Ministry's debt department Konstantin Vyshkovsky told Bloomberg. He added that "we sold them to confirm our presence in the market, as a long hiatus is bad for an issuer, to feel out investor sentiment and to understand our possibilities overall".
The ministry might make an additional sale of $1.25bn by the end of 2016, Vyshkovsky said.
Earlier in the year, Russia announced its intention to place a benchmark $3bn bond issue, but Wall Street and European banks came under intense pressure from Western authorities and financial regulators not to assist.
Although Russian sovereign debt is not prohibited directly, Eurobond revenues could potentially be channelled to sanctioned companies, making Western banks wary of falling foul of the sanctions regime.
Moscow previously held back from such issuance for fear of provoking further sanctions from the West to close gaps in the embargo regime.
However, in mid-May the European Commission's foreign policy chief Federica Mogherini made it clear there would be no talk of tightening sanctions at the next EU council meeting.
Russia's last sovereign issue was $7bn worth of Eurobonds placed in 2013: $1.5bn of 5-year notes at 3.7%, $3bn of 10-year notes at 5.1%, and $1.5bn of 30-year bonds at 6.05%.
Therefore the new bond's yield of 4.7% is not seen as expensive for Moscow given the current geopolitical risks and tensions.