Wall Street bets on Russian debt
US banks have left Russia, but that doesn’t mean they’re done making money from the Kremlin’s horrific invasion of Ukraine.
The liquidation of Russian debt associated with Russian President Vladimir Putin’s campaign against Ukraine and the sanctions that have created a window for a new type of arbitrage that some in the financial world are gobbling up, viewing it as easy money.
The idea is what’s called a negative basis trade, or the purchase of cheap Russian government or corporate bonds with credit default swaps, which act as insurance against potential default. a borrower.
Normally this kind of trade doesn’t make sense, but as institutional investors look to quickly rid their portfolios of anything Russia-related, bond prices have fallen faster than the price to hedge them has. increases.
The volume of Russian corporate debt transactions has hit a two-year high since the Russian invasion, according to Bloomberg News.
Data from the MarketAxess website shows that Russian sovereign debt traded at a volume of $7 billion between February 24 and April 7, compared to $5 billion in the same period of 2021, an increase of 35 %.
Russian bonds are trading furiously, said Philip M. Nichols, an expert on Russia and social responsibility in business and a professor at the Wharton School at the University of Pennsylvania. “There are a lot of speculators buying these bonds that have been severely downgraded and are on the verge of becoming junk,” he said.
Nichols says he receives constant calls from analysts interested in whether the potential trade makes sense. “The spread of Russian sovereign debt is amazing right now,” he said. “They are making an unusual amount of money relative to the volume.”
The cost of insuring Russian debt rose to 4,300 basis points on April 5, from 2,800 the day before.
At the same time, bond rates have fallen drastically – bonds maturing in 2028 trading at just $0.34 per dollar. That means it could cost just over $4 million to insure $10 million worth of Russian securities, The Economist reported.
Hedge funds like Aurelius Capital Management, GoldenTree Asset Management and Silver Point Capital increased their exposure to Russian markets, mainly by buying corporate bonds, the Financial Times reported in late March.
U.S. financial institutions such as JPMorgan Chase and Goldman Sachs facilitate these exchanges, connecting clients who want to exit their positions with hedge funds that have higher risk tolerance and fewer moral dilemmas about buying the Russian debt.
“It’s Wall Street,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “It doesn’t surprise me that they saw some sort of loophole that they could exploit to make money.”
JPMorgan representatives say they act as middlemen, simply seeking to help customers. “As a market maker, we help our clients reduce their risk and manage their exposures to Russia in the secondary markets. None of the exchanges violate sanctions or benefit Russia,” a spokesperson said.
If clients wanted to quickly offload their exposure to Russia, they could turn to Russian oligarchs who would gladly buy sovereign bonds, said Robert Tipp, chief investment strategist and head of global bonds at PGIM Fixed Income. Selling Russian debt to US hedge funds keeps any accrued interest out of Russian hands.
Trading is legal and lucrative, Nichols said, but highly speculative and subject to wild swings based on news of Russia’s invasion of Ukraine and new sanctions.
It also illustrates an alarming disconnect between Wall Street and the real state of the global economy: typically, investors would base their assessment of Russian debt on whether or not it will be repaid, and the likelihood that it will whether repaid would depend on the strength and sustainability of the Russian economy.
But this is not the case. New U.S. Treasury sanctions on Tuesday, which blocked Russia’s access to all dollars it held in U.S. banks, dramatically increased the odds that Russia would default on its debt and gross domestic product, primary measure of a country’s economic strength, fall.
The U.S. Congress voted this week to scrap Russia’s most favored nation trading status, a major economic downgrade that would pave the way for tougher sanctions and import controls on essential goods for Russia. such as chemicals and steel.
Removing that status, Nichols said, would break Russia’s integration into the global economy. If Wall Street were associated with the real world, he added, it wouldn’t want to be close to Russian debt.
“Russian debt is the domain of high risk takers,” Nichols said, “and institutions should probably stay away.”