A Solution to the Ukraine-Russia Bond Stand-Off
Adam Lerrick
Ukraine and Russia are at a stalemate over the US$ 3 billion bonds due in December 2015 that were
purchased by the Russian government in 2013. Russia believes the bonds are an official concessional
loan that should receive preferential treatment in any debt restructuring. Ukraine claims the bonds are
a commercial investment that should receive the same treatment as bonds held by private sector
investors.
There is a fair and simple solution to the impasse:
First, compensate Russia for the concession granted to Ukraine in the original bond purchase.
Second, after compensation for the original concession, treat Russia the same as private sector
investors in the debt restructuring.
The solution will have minimal impact on the sustainability of Ukraine’s debt.
For Russia, the net effect is no write-down in nominal amount, an increase in the interest rate from 5%
to 6.50% and an extension of maturity of 4-12 years from 2015 to 2019-2027.
The Most Favored Creditor clause under the Ukraine debt exchange will not be triggered.
The solution is fair for Ukraine, fair for Russia and fair for the private sector investors. It recognizes
the subsidy that Russia provided to Ukraine when Russia purchased the bonds in 2013 and it
recognizes Ukraine's need for a debt restructuring.
I. Positions of Russia and Ukraine
Russia considers the bonds that it purchased from Ukraine in December 2013 an official loan that was
made on highly concessional terms. The interest rate on the bonds is 5% compared to market yields of
12% on 2-year maturity Ukraine US$ bonds in December 2013. Therefore, the bonds should receive
preferential treatment in any restructuring.
Ukraine states that the bonds are a commercial investment identical to the bonds held by private sector
investors and should therefore receive the same treatment in the debt restructuring.
II. Solution: Compensation for Original Concession then Equal Treatment
There is a fair and simple solution to the stalemate based upon a two-step process:
A. Step 1: Compensate Russia for the Concession in the Original Bond Purchase
Russia should be placed on an equal basis with private sector investors at the time of the Russian bond
purchase in 2013.
Russia will swap its existing bonds for new bonds. The new bonds will reflect the market discount of
a 5% coupon 2-year maturity Ukraine US$ bond held by private sector investors at the time Russia
bought its bonds in December 2013. The December 2013 market value of a 5% bond due in 2 years
was approximately 88% of nominal amount (12% yield).
Russia will therefore exchange its US$ 3 billion of existing bonds for new bonds with a December
2015 maturity in a nominal amount of US$ 3.46 billion.
Alternatively, Ukraine could issue to Russia US$ 0.46 billion of additional bonds that would equal the
value of the December 2013 market discount.
B. Step 2: Russia Treated like Private Sector Investors in the Exchange
Russia will tender the US$ 3.46 billion of new bonds into the debt exchange on the same terms as
private sector investors.
There is minimal impact on the sustainability of Ukraine’s debt. The compensation of the concession
in Russia’s original bond purchase will only raise Ukraine’s post-exchange debt by US$ 0.37 billion
((3.46 – 3.00) x 0.80 exchange ratio) or 0.5% of GDP.
III. Net Result for Russia
The net result of the solution for Russia is:
A. 7.7% write-down in nominal amount.
Russia will receive US$ 2.77 billion nominal amount of new bonds under the exchange
(3.46 x 0.80 exchange ratio) or 92.3% of the original US$ 3 billion bond nominal amount;
B. Increase in interest rate from 5% to 7.75%.
The new bonds issued in the exchange carry a 7.75% coupon. The increase in the interest rate will
fully compensate for the 7.7% nominal write-down in 3.5 years (7.7/((7.75 x 0.923 ) – 5))). From then
on, Russia receives a profit from the higher interest; and
C. Extension of maturity of 4-12 years from 2015 to 2019-2027.
The result does not include any value for the GDP-linked Securities that Russia will receive in the
exchange.
IV. Solution with No Write-Down of Nominal Value
Russia has objected to any write-down in the nominal amount of its bonds. Debts to official lenders
are traditionally only written down in the case of very poor countries (HIPC Initiative). Even when
private sector lenders take write-offs, official lenders maintain the nominal value of their claims and
provide debt relief through maturity extensions (Greece, Argentina).
Under the Ukraine exchange, Ukraine can offer bondholders that do not accept the exchange other
bonds as long as their net present value is equal to the net present value of the bonds offered in the
exchange. A 10% discount rate is specified for the valuation process.
To eliminate any nominal write-down of the Russian bonds, Ukraine could exchange the postcompensation US$ 3.46 billion of bonds for US$ 3 billion of new bonds with maturities matching the
7.75% coupon bonds issued in the exchange but with a coupon of 6.50%. At the 10% valuation
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discount rate, the 7.75% coupon bonds with a 7.7% nominal write-down and the 6.50% coupon bonds
with no write-down in the nominal amount have the same net present value. (See Appendix below).
Under the no nominal write-down option, the net result of the solution for Russia is:
A. No write-down in nominal amount.
Russia will receive US$ 3 billion nominal amount of new bonds matching the original US$ 3 billion
bond nominal amount;
B. Increase in interest rate from 5% to 6.50%; and
C. Extension of maturity of 4-12 years from 2015 to 2019-2027.
V. No Trigger of Most Favored Creditor Clause
The Ukraine debt exchange contains a Most Favored Creditor clause. This clause prohibits the
government from offering better terms to bondholders who refuse the exchange (hold-outs) than those
received by bondholders who accepted the exchange.
The Most Favored Creditor clause will not be triggered by the solution because Russia will receive its
compensation for the concession in the original bond purchase before the exchange is completed (Step
1 in Section II above). Russia will then receive the exact same treatment as the private sector
bondholders under the exchange (Step 2 in Section II above).
VI. Private Sector Bondholders Should Accept the Solution
Ukraine's private sector bondholders should accept the solution to the Russian bonds. Russia is simply
placed on an equal basis with private sector investors at the time of the Russian bond purchase in
December 2013. Russia then receives the same terms as the private sector bondholders under the debt
exchange.
The compensation of the concession in Russia’s original bond purchase will have little effect on the
value of the proceeds received by investors. Ukraine would publish a short supplemental exchange
offer memorandum outlining the resolution of the Russian bonds to comply with securities regulations.
The solution eliminates the risks for bondholders who accept the exchange if a resolution is not
achieved and Russia pursues legal action to enforce its rights. The history of Argentina’s debt
exchange shows that hold-out bondholders can use the courts to disrupt payments to investors who
accept debt restructurings.
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Appendix
Equivalence of Nominal Write-Down and No Write-Down Structures (1)
7.7% Nominal Write-Down
7.75% Coupon
No Nominal Write-Down
6.50% Coupon
(as % of original nominal amount)
3/2016
9/2016
3/2017
9/2017
3/2018
9/2018
3/2019
9/2019
3/2020
9/2020
3/2021
9/2021
3/2022
9/2022
3/2023
9/2023
3/2024
9/2024
3/2025
9/2025
3/2026
9/2026
3/2027
9/2027
Total
Net Present
Value at 10%
Discount Rate (2)
Interest
Principal
Total
Interest
Principal
Total
3.577
3.577
3.577
3.577
3.577
3.577
3.577
3.577
3.398
3.398
2.973
2.973
2.548
2.548
2.124
2.124
1.699
1.699
1.274
1.274
0.849
0.849
0.425
0.425
4.615
10.961
10.961
10.961
10.961
10.961
10.961
10.961
10.961
3.577
3.577
3.577
3.577
3.577
3.577
3.577
8.192
3.398
14.359
2.973
13.934
2.548
13.509
2.124
13.085
1.699
12.660
1.274
12.235
0.849
11.810
0.425
11.386
3.250
3.250
3.250
3.250
3.250
3.250
3.250
3.250
3.088
3.088
2.702
2.702
2.316
2.316
1.930
1.930
1.544
1.544
1.158
1.158
0.772
0.772
0.386
0.386
5.000
11.875
11.875
11.875
11.875
11.875
11.875
11.875
11.875
3.250
3.250
3.250
3.250
3.250
3.250
3.250
8.250
3.088
14.963
2.702
14.577
2.316
14.191
1.930
13.805
1.544
13.419
1.158
13.033
0.772
12.647
0.386
12.261
92.30
100.00
81.06
81.06
(1) Both structures include the compensation for the December 2013 market discount on Ukraine bonds
at the time of the Russian purchase.
(2) The net present value of the bonds received in the exchange without compensation for the December
2013 market discount is 70.26% of original nominal amount.
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