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Russian corporates face up to increased sanctions threat

TXF: The Week That Was

Commodity producers and other corporates in Russia are closely watching the possibility of increased sanctions being imposed by the US. But while the prospect of these is still unclear, there is confidence that lessons learned over the past five years of sanctions will provide a good degree of protection to any impact.

Last week TXF zipped into Moscow for our annual commodity and export finance conference. And, for a country that has been living with various levels of sanctions imposed by the US and the EU for the past five years, there was still plenty of healthy debate around new deals and expanding business.

While much of the debate focused on export finance activity, many of the major commodity producers reported that they had benefited from higher commodity prices and had refinanced existing debt significantly cheaper in the past year. But what was also clearly on the minds of most was the new threats from the US of a potential ramping up of sanctions and what impact that might have on their borrowings and commercial activity.

So what is the new threat coming from the US and how well-placed is Russia in dealing with this?

Last Wednesday, five bipartisan US senators announced that they had submitted a bill called the Defending American Security from Kremlin Aggression Act (DASKA). According to the Senate Foreign Policy Committee the bill’s intention is to increase economic, political and diplomatic pressure on Russia: “in response to its interference in democratic processes abroad, its disastrous influence in Syria and aggression against Ukraine”.

The new bill is effectively a tougher version of legislation – described as the ‘sanctions bill from hell’ by Republican Senator Lindsey Graham - introduced last year but which failed to pass. Many politicians in both houses are disappointed with President Trump for his failure to take a tougher line on sanctions with Russia. However, since coming to office, Trump has so far gone along with a lot of congressional activity on Russia. However, Democratic Senator Bob Menendez who sits on the Senate Foreign Relations Committee is reported to have recently stated: “President Trump’s wilful paralysis in the face of Kremlin aggression has reached a boiling point in Congress.”

Of course, Trump would have to sign any bill on increased sanctions against Russia before it could become law. It is quite likely that some of the proposed items within the bill will have to be watered down before it could be signed by Trump. This is particularly the case on energy where Western oil majors have a lot at stake.

But there are arguably more important issues that the Trump administration is currently focused on right now. After all, it’s not as though the Trump administration has necessarily been dragging its feet over sanctions globally – his office is just so busy dealing with tariffs and the trade war with China, opposition to the proposed new NAFTA agreement, trade disputes and increasing trade tension with the EU, the aluminium and steel tariffs, and of course the renewed US sanctions and total economic attack on Iran. What a busy office that must be!

DASKA is designed to be used to deliver a major blow to the Russian economy via the blacklisting of large Russian state banks or energy firms, and the blocking of future Russian sovereign debt issuance. Some of the specific points, among many, mentioned in the proposed bill are sanctions:

  • against Russian banks supporting Russian actions to undermine democratic institutions in other countries;
  • in relation to investments in Russian LNG projects outside Russia;
  • in relation to the Russian cyber industry;
  • against Russian government debt;
  • against politicians, oligarchs, family members and other individuals who directly or indirectly contribute to illegal and corrupt activities in the interests of Putin;
  • in relation to supporting the development of oil resources in Russia;
  • against state-owned energy projects outside of Russia.

In the Weekly blog last week, I made reference to the efforts that Washington had already employed in its opposition to the Nord Stream 2 gas pipeline from Russia to Germany. The pipeline construction is moving ahead at pace – but future financing could be at risk.

But what is also clear is that where politics and sanctions, particularly bilateral activity, tries to bash ahead regardless of commercial and financial interests there will always be a significant degree of opposition from the business and financing communities. These are realms currently completely out of synch with each other.

In an interesting example of how sanctions don’t always work the way the legislators want them to, last year the upped sanctions against aluminium producer Rusal and energy holding company EN+, designed to target Kremlin insider Oleg Deripaska, backfired in a way not foreseen by the politicians. As one market commentator says: “Those sanctions caused chaos in financial and metal markets as both the company securities and its business are both deeply integrated into the global economy”.

On the commodity production front as a whole, Russian corporates had a very good 2018, and in many cases managed to refinance their international bank borrowings at reduced rates. So successful was this that some of those companies will have limited fund raising programmes over the course of this year. Some corporates last year also managed to refinance bonds at significantly lower cost.

While US sanctions have clearly slowed the market, business of course goes on. But adjustments have had to be made. Part of that adjustment is in finding new, or expanded, export markets – China in particular. This has led to an increased involvement of Chinese banks in the commodity financing landscape in Russia. In addition, de- dollarisation has been significant where trades are paid for with currencies other than the US dollar – specifically euros and the Chinese yuan. For more on the activity of Russian natural resource producers and their activity under sanctions see the recent excellent TXF article here.

Russia has proved to be highly capable of adjusting to a sanctions environment, both on a national (last year the Central Bank of Russia, for example, sold off two thirds of its US treasury bond holds to put the bulk of Russia’s currency reserves out of the reach of the US authorities) and a corporate level. There is no doubt that Russia will be able to cope with an increase in sanctions activity from the US. What is also certain though is that any such action will be met with anger from companies and financiers and many others both inside and outside of the country, and will ultimately lead to a hostile reaction from Moscow. Another route needs to be found.

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