ANALYSIS - Dubai, Ukraine raise quasi-sovereign worries

LONDON (Reuters) - Dubai World’s debt restructuring is the latest reminder for investors that governments may prove less willing than they had hoped in covering obligations of strategically important companies.

Since Washington unleashed the financial crisis last year by letting bank Lehman Brothers go under, investors have been learning the hard way that, while governments will go a long way towards propping up firms, they won’t always pay the whole bill.

Dubai’s decision to embark on a tricky restructuring process for the conglomerate which has powered its breakneck growth has hammered stocks and markets around the world.

But it may also have a longer-term impact on how investors approach so-called “quasi-sovereign” debt issues. These are by companies, often state-owned, which appear so important to the government that investors buy into the idea of an “implied sovereign guarantee”, even though the debt does not legally carry sovereign status.

“It is obvious that some investors had relied too much on implied sovereign guarantees when it came to quasi-sovereign debt,” said TD Securities analyst Beat Siegenthaler.

“People will be taking a new look at quasi-sovereign valuations even if at the moment there isn’t that much effect on the wider market.”

On a smaller scale than Dubai, it emerged earlier this month that Ukraine’s Naftogaz and its state railway company were pushing their creditors towards a restructuring of debt rather than meeting their dues.

Other analysts said the wider fallout could roll across emerging markets, from Russian state firms such as gas giant Gazprom to Israel Electric Corp. State companies such as South African power utility Eskom could find it more difficult to borrow without explicit sovereign guarantees.

“It affects anything quasi-sovereign,” said Michael Ganske, head of emerging markets research at Commerzbank.

“In Russia, for example, a lot of people have bought the quasi-sovereign -- banks, Gazprom -- rather than the sovereign. You need to look at the fundamentals of the company and not just assume the sovereign will support.”

He said markets were too illiquid at present to respond fully to the Dubai news, but that any snap sell-off could leave good buying opportunities in quasi-sovereigns that were fundamentally sound and would not need state support.


Ultimately, many of the big shocks of the financial crisis so far have been the result of markets being taken aback when governments fail to provide the support that investors had been expecting. Lehman Brothers was the most serious example.

But as markets’ confidence has begun to revive over the past six months, investors have flooded into quasi-sovereign bonds, enjoying higher yields than they would on sovereign bonds but assuming the state treasury would step in if necessary.

Several Dubai state firms have suffered credit rating downgrades this week since the Dubai World restructuring news broke, and Royal Bank of Scotland said in a research note that it saw potential for downgrades across the quasi-sovereign sector for anything that lacked an explicit sovereign guarantee.

RBS said restructuring deals for state banks in Kazakhstan were examples of investors being caught out. If states do not give a hard guarantee for debt, that leaves companies the option to restructure or default, it said.

“It gives sovereigns the option to walk away should the going get tough,” RBS analyst Tim Ash said.

“Investors...will (now) likely demand a higher risk premium for holding assets of quasi-sovereigns, better pricing the option for sovereigns to walk away.”

No country has defaulted outright on its sovereign debt since the collapse of Lehman in September 2008; even Iceland and Ukraine have continued to pay off their national debt and instruments with explicit sovereign guarantees, with the help of the International Monetary Fund.

This concern to protect sovereign creditworthiness, and to avoid the stigma of national default, helps explain why Ukraine pledged this week it would honour a state-guaranteed $700 million credit to the state railway from Deutsche Bank. A non-guaranteed $440 million loan is being restructured, however.

Ukraine also says emphatically that it will keep repaying its sovereign Eurobonds, but state gas firm Naftogaz defaulted on a $500 million Eurobond -- again without an explicit guarantee -- in September.

Some investors tried to hedge against problems with quasi-sovereign debt such as Naftogaz or Dubai World by buying insurance in the credit default swaps market on Dubai or Ukrainian sovereign debt. But they will find the lack of true sovereign default status means their contracts will not pay out.

Those who bought CDS protection specifically for Naftogaz or Dubai World will be covered -- but the market in quasi-sovereign CDS has all but dried up since the financial crisis erupted, and such protection is now almost impossible to get.

Editing by Patrick Graham and Andrew Torchia