PRINT THIS PAGE

Russian issuers return to the international capital markets

For one of the first times since the August 1998 financial crisis, Russian issuers are finding that the windows to international capital markets are opening again, say Robert Langer and Marc Gold at Akin, Gump, Strauss, Hauer & Feld. In addition, a number of Russian companies have been raising debt financing in the Russian Federation. While it is too early to forecast any trends, there are positive signs that Russia is beginning to pick itself up off the floor.

Over the last 10 years, Russia has succeeded in privatisating former state companies and the restructuring of the Russian economy to a market driven economy. This transformation has pointed to the need for vast amounts of capital. However, in the past only a few companies, as well as the Russian federal government and some municipalities and regions, were able to tap the international capital markets.

As a result of privatisation, a large number of joint stock companies were created in Russia. The vast majority of joint stock companies were historically controlled by a small group of insiders who were largely ignorant of (or indifferent to) minority shareholder rights. Today, however, a growing number of large Russian companies have been making strides to establish and better adhere to corporate governance procedures that respect minority shareholders' rights. Many companies and their major shareholders have come to realize that good corporate governance can have a direct effect on the company's share price and can improve the company's ability to receive financing.

A number of Russian entities have completed or are now looking to complete debt and convertible bond offerings as a source of capital. In addition, the domestic market has seen the emergence, albeit a slow one, of ruble-denominated bond issuances, domestic lending (including domestic syndicated lending), and an increase in leasing and vendor finance arrangements. The ability of Russian companies to raise financing at present is due primarily to the improving Russian economy and the government's fiscal position, some structural reform, more transparent information disclosure by companies and greater adherence to generally accepted corporate governance norms and the availability of US GAAP and IAS-audited financial statements.

On the equity side, in July 2000 MTS completed the first initial public offering (IPO) of a Russian company since the crisis, listing its ADRs on the New York Stock Exchange (NYSE) and joining VimpelCom as the only two Russian companies fully listed on the NYSE. However, the international stock markets remain largely closed at present to new issues, both Russian and non-Russian. A number of Russian companies that were planning IPOs in 2001 have delayed their offerings until market conditions improve. Assuming the international markets reopen to equity issuances at some point in 2002, some Russian companies should be well-poised to complete their offerings. Although a number of Russian companies established Level I ADR programmes prior to August 1998, these programmes did not involve the raising of new capital, and the ADRs are unlisted. Some of these companies may eventually seek to upgrade their ADRs to Level III listed programmes. As an alternative to the public equity markets, some Russian companies have sought financing through private equity transactions, which are still in their early stages in Russia compared to more developed economies.

Below, we discuss the ways that Russian entities are obtaining debt financing.

Sources of debt financing

In November 2001 Russia's sovereign debt rating was upgraded by Moody's to Ba3 (stable outlook). This upgrade should lower borrowing costs for Russian companies and increase the access of Russian companies to financing as foreign investors may be willing to accept more Russian risk. At the same time, the Russian government regained some investor confidence by redeeming on time its first Eurobond, which was issued in 1996. This was the first time that Russia had redeemed its bonds since the 1917 revolution. As a number of offerings have recently been completed and others are now in the pipeline, the discussion below focuses primarily on these types of financing transactions.

Eurobond offerings

Eurobond offerings are particularly attractive to Russian entities that are seeking to raise relatively large amounts of debt financing. Most notably, in the fourth quarter of 2001 the City of Moscow completed two Eurobond offerings for an aggregate of E700m ($622m), and Rosneft, one of the largest Russian oil companies, completed a $150m Eurobond offering. MTS and VimpelCom, the largest and second-largest wireless telecommunications service providers in Russia, respectively, and Gazprombank have also announced plans for Eurobond offerings. The Russian Federation has announced that it may issue up to $2bn of Eurobonds in 2002.

Eurobond offerings completed by the City of Moscow and Rosneft involved the use of an intermediary, unaffiliated, offshore bank that issued loan participation notes to investors. A similar structure was used by Yamal Nenets (an autonomous region of Russia) in April 1998 and several other issuers prior to the crisis. In these transactions, the bank uses the proceeds of the notes to finance a loan to the Russian entity. Typically, the bank is domiciled in a country that has a double taxation treaty with Russia, such as Germany or Luxembourg. In these cases, payments of interest on the loan from the Russian entity to the offshore bank are not subject to Russian withholding tax of 15 per cent (which increases to 20 per cent, effective January 1 2002).

In offerings using this structure, noteholders have limited recourse to the bank. The bank is only obligated to make principal and interest payments to noteholders to the extent that the Russian entity makes payments to the bank under the loan. In the event of a default under the loan, the trustee (acting on behalf of noteholders) may seek recourse against the Russian entity with a direct claim under the loan agreement.

In contrast, MTS's proposed offering contemplates the issuance of notes by a wholly-owned Luxembourg subsidiary of MTS. As proposed, MTS would guarantee the obligations of the issuer/subsidiary. In the event of a default by the offshore subsidiary, the trustee would be able to seek recourse against the Russian parent, but only on the guarantee and not on the underlying note obligations.

MTS's offering contemplates that MTS will complete an SEC-registered exchange offer within 210 days of the initial note issuance. Although at present only a limited number of Russian corporates are SEC-reporting companies and fully listed on a US exchange (including VimpelCom and MTS), if the relevant SEC rules and regulations can be met, it is possible in the future that a Russian company could go public by registering its debt securities with the SEC.

Shareholder or board approval may be required under Russian law for these transactions, depending on the size of the loan/offering in relation to the book value of the Russian company's assets (calculated according to Russian accounting standards). In addition, interested party transaction approval may be required under Russian law depending on the structure of the transaction.

Recent changes to Central Bank of Russia regulations, including Order No 1030-U, dated September 10 2001, have arguably obviated the need for a licence from the Central Bank for a Russian entity or sub-sovereign to receive and repay loans denominated in hard currency in connection with a bond offering. However, Russian entities still need to comply with other Central Bank requirements, such as registration of the loan with a licensed Russian bank.

Covenants contained in recent Eurobond transactions have been akin to those often found in traditional Eurobond offerings. Recently issued Eurobonds have been offered and sold in reliance upon Rule 144A and Regulation S, and have been listed on the Luxembourg Stock Exchange. To date, all completed Eurobond offerings involving Russian entities have been unsecured, and transactions using the loan participation note structure have been governed by English law. However, New York law is contemplated for MTS's proposed offering.

Covertible bond offerings

In July 2000 VimpelCom completed a convertible bond offering. This offering was conducted using a wholly-owned offshore subsidiary of the Russian parent. The notes may be converted at a set exercise price into shares of common stock of the Russian parent. In this offering, VimpelCom unconditionally guaranteed the subsidiary's obligations under the notes, including the conversion obligation. Convertible bonds offer potential investors the opportunity to have some of the equity upside while retaining some of the protections of a fixed return.

Ruble bonds

The ruble bond market is limited in the sense that it cannot absorb large volumes compared to international capital markets. Prior to the August 1998 crisis, the domestic markets were for the most part unwilling or unable to provide any significant sources of capital. Most ruble bonds are short term (less than one-year maturity), and often interest rates are benchmarked to government bond yields. A number of Russian corporate ruble bonds have market makers, which provides additional liquidity and narrows bid and ask spreads. Usually, these bonds are traded in Russia on the Russian Trading System (RTS) and the Moscow Interbank Currency Exchange (MICEX). Considering the annual rate of inflation in Russia (approximately 13.9 per cent for the first nine months of 2001), the dollar equivalent yield on ruble bonds is low and these instruments are primarily purchased and traded by domestic investors. In March 2001 Tyumen Oil Company (TNK) completed the largest ruble bond offering to date, raising R3 billion ($100 million) with a yield of 18 per cent annual interest and a maturity of six months.

Bank loans

Russia's banking and other financial systems continue to remain less well-developed or regulated. There are a limited number of creditworthy Russian banks with whom Russian corporates can conduct banking transactions. The August 1998 financial crisis resulted in the bankruptcy and liquidation of many Russian banks and almost entirely eliminated the developing market for commercial bank loans. Russian banks typically require security for loans. Most recently, Russian banks have been offering loans through the use of syndicates that help spread the risks among the banks participating in the syndicates. In addition, some Russian companies have received loans from foreign banks. In August and September 2001 Dutch bank ABN Amro arranged and underwrote a $300m export-backed loan to Sibneft, a large Russian oil company.

Shareholder loans

Russian entities may also be able to turn to shareholders as a source of debt financing. In the past, when all hard currency loans required a Central Bank licence, shareholder loans were more difficult to arrange. Given the general preference for debt in the event of bankruptcy, some strategic equity investors may be more amenable to making additional investments through demand or convertible loans, especially if the valuation of the company has fallen since completion of the last equity round. Investors should note, however, that traditional loans (as opposed to convertible securities) cannot easily be converted into equity of Russian companies.

Conclusion

The ability of Russian companies to obtain financing is affected by both the global and Russian economies. As has happened in the past, financial problems or an increase in the perceived risks associated with investing in emerging economies could dampen foreign investment in Russia and adversely affect the Russian economy. In addition, a steep decline in the world price of oil could slow or disrupt the Russian economy because Russia produces and exports large amounts of oil. These developments could severely limit access to financing by Russian companies.

Russia's president, Vladimir Putin, has restored a level of political and economic stability. Russia's GDP has been growing at one of the fastest rates in Europe, and the Russian government has been focused on implementing a budget and other structural reforms that reflect principles found in more developed economies. Primarily as a result of these factors, together with recent regulatory changes, as well as an increased willingness by Russian companies to adhere to corporate governance principles, the prospects for Russian companies to obtain financing are at their brightest in years. Even in these heady times, though, investors should remain cautiously optimistic.

Akin, Gump, Strauss, Hauer & Feld LLP, Ducat Place II, 7 Gasheka Street, Moscow 123056, Russia, 7-095-974-2411, www.akingump.com

© IFLR 2002

With kind permission of the IFLR. To subscribe to IFLR, or for further information, please contact Simon Oliver, Associate Publisher on 44 (0) 207 779 8496 or fax 44 (0) 207 779 8665 or email soliver@iflr.com