* Banks slashing inventories of Russian assets
* Actions reflect fears of wider sanctions over Ukraine
* Institutions fear being left holding Russian debt
By Sujata Rao
LONDON, June 2 Banks fearful of wide-ranging
Iran-style U.S. sanctions in retaliation for Moscow's actions in
Ukraine are slashing their inventories of Russian assets to the
minimum, effectively freezing up the trade in its bonds.
In the short-term, that is an inconvenience for the funds
that may be seeking to dip back into Russian bonds after a huge
sell-off in March and April. But if the drought persists it
could threaten the ability of Russian borrowers to raise money
by issuing new securities in primary markets.
What institutions fear above all is to be left holding
Russian debt in event of more sanctions. The result? Many
investment banks, the so-called market makers that usually
provide liquidity and hold stocks of securities to trade, have
wound down their holdings of Russian bonds.
The situation has continued even as the market improved in
May, investors say, and that has made it tough to buy debt. So
the sell-off as well as the subsequent market rebound in May
both happened in ultra-thin market volumes, markets players say.
"We have seen a real drying up of liquidity when it comes to
trading Russia, it's been difficult to adjust positioning
because of the lack of depth in the market," said Aaron Grehan,
senior portfolio manager at Aviva Investors.
"We are aware that some banks have applied fairly
restrictive caps on Russian risk ... as a result there is a
lower ability to facilitate trading," he added.
The world's biggest asset manager, Blackrock, last month
told the Financial Times it had dumped all its Russian bonds
because the secondary market was "freezing up" on fear of
True, the Kremlin appears to have averted the immediate
threat of crippling Western sanctions. But the fear is that
Russian assets - like in the case of Iran some years ago - may
suddenly become toxic, meaning banks may not immediately change
Aside from the reputational risks attached to Russia, banks
also fear Eurobond coupon payments may be jeopardised if
sanctions are imposed on paying agents - entities that take cash
from bond issuers and disburse them to bondholders.
Reports of a $10 billion fine on BNP Paribas for breaking
Iran sanctions will have done little to soothe fears.
One trader in Moscow, speaking on condition of anonymity,
said he had been ordered by U.S. bank clients to close all
Russian bond positions soon after the first sanctions round hit.
Another bond trader, based in London, said the cost of
access to the Russian market had increased "because of wider
bid/offer spreads caused by scarce liquidity". This was
inevitable, he added, given the political volatility.
The Russian liquidity collapse highlights a longer-term
structural issue: thinning volumes across emerging bond markets.
That is partly down to post-crisis regulatory changes which
forced many banks to cut back or shut down proprietary trading -
the practice of trading securities with their own money. They
are also now required to hold higher capital buffers against the
asset inventories they hold on their books.
Many see this as having crimped banks' risk-taking ability,
especially in junk-rated or lower quality assets.
"The way things work is that when someone sells, banks would
build inventory and when demand appeared they would sell the
inventory. That was the normal liquidity provision," said Okan
Akin, emerging debt analyst at asset manager AllianceBernstein.
But he said very few banks were now buying or selling
Russian inventory, with institutional investors and private
banks the main foreign players left in the market.
"So if you want to sell $50 million worth of Gazprom (bonds)
there might be no one to buy, and if you want to buy, there
might be no one to sell it to you," Akin added.
The shift is reflected in wider bid/offer spreads on Russian
dollar bonds, which industry body EMTA says are among the
sector's most traded instruments. The bid/offer spread is a
simple measure of market liquidity.
Data from Tradeweb, an electronic trading platform, shows
for instance that the spread between bids and offers on the 2022
bond of state oil firm Rosneft have blown out to around 450
basis points, doubling from early-January levels.
While Rosneft itself is not under sanction, its CEO Igor
Sechin is on a U.S. list of sanctioned individuals.
Similarly, bid/offer spreads Russia's sovereign 2030 dollar
issue have more than doubled from year-ago levels, Tradeweb says
while Gazprom debt displays a similar pattern.
On Russian domestic bonds, among investors' favourite assets
in 2012 and 2013, stock exchange data shows bond turnover halved
from year-ago levels in April to 759 billion roubles ($22
billion) while daily turnover also halved.
Of late, Moscow's more conciliatory tone has helped Russian
stocks, bonds and currency recover from recent lows. Rosneft's
2022 dollar bond for instance is up 9 cents on the dollar since
mid-April while the 2030 sovereign issue has risen 6 cents.
But that has not translated into a re-opening of the primary
market for Russian firms, which remain locked out of the new
issuance market. Josef Dayan, managing director of brokerage BCS
Financial Group, says the prices don't imply surging volumes.
"(Lack of liquidity) is part of the reason why we have seen
the rally being so large, both on the fixed income side and in
the equity market," Dayan said.
He blamed Western banks' slow reaction, noting they had cut
Russia inventories just as sentiment started to improve, leaving
prospective buyers unable to find anything to buy.
"The Russian banks were very quick to pull the bids - they
were the first to know the situation was dire," Dayan said.
"(Western) banks have to go to credit committees and they step
back when the situation is already past."
In fact, gains may be met with further selling from banks
seeking to purge portfolios of any remaining Russian risk,
predicts Luis Costa, Citi's head of CEEMEA debt and FX strategy.
"The headline action of recent weeks has not really changed
the dynamics," Costa said. "Most banks are still looking to
reduce the inventory of Russian securities in their portfolios."
(Additional reporting by Carolyn Cohn in London; Kira
Zaslavskaya and Jason Bush in Moscow; Editing by Giles Elgood)