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Russian Financial Crisis

On August 17, 1998, the Government of the Russian Federation and the Central Bank of Russia announced the gradual devaluation of the Rouble, the imposition of a repayment moratorium on certain loans to foreigners and the compulsory restructuring of approximately $40 billion of outstanding short term treasury securities. The announcements unsettled financial markets in Russia to a significant degree and led to a rapid decline in the value of the Rouble, a collapse in the value of traded equity stock in Russian companies and the virtual cessation of international fixed income securities offerings by both Russian sovereign and corporate issuers. This led President Yeltsin to remove the reform-minded Government led by Prime Minister Kiriyenko, which precipitated a further decline in confidence in the Russian financial system and further downward pressure on the value of the Rouble. Subsequent actions by the Central Bank and the acting representatives of the Russian Government have done little to generate confidence among the investment community that Russia's financial problems can be addressed rapidly.

The following is a brief summary and analysis of the August 17 Announcement, and the proposed terms of the compulsory restructuring of the short-term treasury securities.

Devaluation of Rouble

The Announcement specified a new range for the currency corridor of 6 to 9.5 Roubles per U.S. Dollar (representing a maximum potential devaluation of approximately 34%). The new range was intended to allow for an orderly devaluation of the Rouble over a period of several months. The Central Bank was expected to intervene to smooth the decline of the value of the Rouble. However, it quickly became apparent that the Central Bank would not be able to intervene on the scale necessary to avoid a rapid devaluation. The Central Bank has repeatedly suspended all foreign currency trading on the Moscow Interbank Currency Exchange amidst reports of trades well below the announced exchange rates. At the time of writing, the Rouble had decreased in value by more than 300% against the U.S. Dollar since its pre-August level.

90 Day Repayment Moratorium

Repayment of principal under financial credits (loans) received from non-residents for a term over 180 days were suspended for a period of 90 days from 17 August 1998. Payment of interest on such loans was not affected. The following entities were excluded from the suspension:

  • the Russian Federation (whether represented by the Government or the Ministry of Finance);

  • the Russian Central Bank;

  • subjects of the Russian Federation -- only to the extent of fulfillment of their obligations under external bond issues (i.e., bonds issued to holders outside the Russian Federation) but for example not under external loans; and

  • Vnesheconombank in respect of servicing external state debt of the Russian Federation.

Financial loans provided by the European Bank for Reconstruction and Development ("EBRD") were also excluded. Thus, commercial lenders holding "B" loan participations in EBRD A/B loans are not affected by the suspension.

The moratorium does not appear to apply to current currency operations of Russian residents, including remittances abroad of interest and dividends on foreign investments in the Russian Federation. The moratorium also does not appear to apply to the payment of trade credit made available by non-residents of the Russian Federation.

Compulsory Restructuring of GKOs and OFZs

Under the Announcement, Russian short-term non-coupon treasury bills ("GKOs") and variable coupon federal state loan bonds ("OFZs") with maturities of up to December 31, 1999 were to be converted into new, longer-term, securities in an effort to reduce Russia's short-term repayment burden. Trading in GKOs and OFZs was suspended until conversion.

In late August, the Government of the Russian Federation issued a term sheet setting forth the terms for the compulsory restructuring of the GKOs and the OFZs ("Redeemed Securities"). The term sheet was initially rejected by the foreign banking community as being discriminatory, as it appeared to provide for more favourable treatment to domestic holders of the Redeemed Securities. Negotiations on the terms of the compulsory restructuring are currently underway. The deadline for conversion under the term sheet (September 18, 1998) has now passed without any satisfactory resolution of the outstanding issues.

Under the term sheet issued in August, the Redeemed Securities were to be replaced by new securities of the Russian Federation, denominated in Roubles, in a face amount equal to the redemption amount. Holders were offered new securities with one of the following attributes:

  • three-year term with a coupon of 30% per annum; or

  • four-year term with a coupon of 30% per annum in the first three years and 25% per annum in the fourth year; or

  • five-year term with a coupon of 30% per annum in the first three years, 25% per annum in the fourth year and 20% in the fifth year.
Holders of Redeemed Securities wishing to redeem their Redeemed Securities earlier than this were offered an up-front, lump-sum cash payment of an amount equal to 5% of the face value of the Redeemed Securities.

Holders were also offered the right to exchange up to 20% of the Redeemed Securities for new securities with a face value in U.S. Dollars equal to the value of such Redeemed Securities as at August 14, 1998, determined in U.S. Dollars according to the average "official" Rouble:U.S. Dollar exchange rate during the period August 17-26, 1998. It was proposed that such new securities would mature in 2006 and have a coupon of 5% per annum with a bullet repayment at maturity. The term sheet provides that the conditions of such new U.S. Dollar denominated securities must be approved by the Ministry of Finance. The term sheet further provides that "standard" Russian Federation Eurobond terms and conditions will apply, and that a Luxembourg listing will be sought for the U.S. currency denominated bonds.

In its current form, the term sheet amounts to a confiscation of investors' funds for three to five years. In addition, repayment at maturity is to be in Roubles, which will likely suffer from further devaluations.

While negotiations continue, there appears be no real prospect for a short-term recovery in Russia. Adding to the current difficulties, Russia's financial collapse comes just as it is due to commence repayments on $32 billion of sovereign debt, the rescheduling of which was only completed last year (after seven years of negotiations). A default on sovereign loan obligations by the Russian Federation would further exacerbate the financial instability in Russia, which has already spilled over into other markets in Europe and Latin America.

The new government now taking shape in Moscow faces the difficult task of repairing Russia's badly damaged financial markets and rebuilding the confidence of the investment community in Russia's commitment to market reform.

The above summary is based on information available to us on October 15, 1998, and may become superseded because of the rapidly changing political and economic situation in Russia. Furthermore, the summary is necessarily general in nature and should not be construed as legal advice. Readers are accordingly encouraged to obtain up-to-date legal advice before taking any action.

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