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. Last Updated: 07/27/2016

Investors Take Fresh Look at GKOs

LONDON -- Some of London's more cunning financial minds believe there may still be value in one of the darker corners of international finance - defaulted Russian domestic debt.

Foreign investors who bought into the ruble-denominated GKO bond market, once worth some $40 billion, were livid when Moscow defaulted on the debt last year and offered a deal that gave them only five cents on the dollar.

But bankers and traders said Friday the GKOs have found fresh buying interest in secondary markets from new London-based funds which believe they may now be able to extract more value than Russia's original offer.

"There's definitely growing interest among brokers and boutique funds in the GKO market," Santander analyst Barbara Peitsch said. "There are a lot of people trying to be creative, as hard as that is where Russia is concerned."

Two traders said they had been asked by a new fund they declined to name to search out potential sellers of GKOs - both those that had been tendered under Russia's deal and those still held by investors who refused to sell at such a discount.

"The tendered GKOs have been trading fairly happily but now someone is setting up a fund to buy both types - the untendered as well. What they will do with it after is not clear," one of the traders, who deals at a brokerage that specializes in distressed debt, said.

The renewed interest in GKOs comes as Russian officials said this week that foreigners stuck with the frozen debt would be allowed to invest them in any infrastructure or industrial project approved by the government.

It also comes ahead of talks next week between Russia and its London Club creditors to try to restructure $32 billion of different Soviet-era debt, which is also in default.

Russia has not yet released details of what projects GKO holders will be able to swap their debt into, nor at what price. Bankers complain that is typical of the thin news flow the government provided during the GKO default which threatened to push the global financial system over the edge last summer. For creditors another key question remains unanswered: Will they ever be allowed to freely repatriate funds?

All of the known investment options currently available to creditors who took Russia's offer of swapping the GKOs for a part cash payment and new bonds face stiff restrictions on repatriating funds.

Current options include investing swapped GKO proceeds into OFZ bonds, dollar-hedged Russian corporate bonds or shares traded on Micex. Making the best of a bad lot, ING Barings' chief economist Philip Poole favors staying in OFZs.

"The yields are high, at around 95 percent in ruble terms, the exchange rate is relatively stable, and if your funds are trapped in Russia anyway, you're probably better off there than most other places," he said.

When the deal was offered last April, several banks such as Credit Suisse First Boston, Santander, Nomura and Bank of America were so furious they refused to participate. They still hold some 14 billion rubles ($530 million) of paper.

To try and generate a better return, CSFB subsequently set up the Nikitsky Recovery Fund that would allow bond holders to swap the debt into direct investments in the economy.

Bankers say the latest twists to the GKO saga are: first, that other funds may now be trying to muscle in on CSFB's act and the management-fee income CSFB hoped the fund would generate and, secondly, GKO holders that did not swap first time round will be allowed a second chance to do so on Dec. 16.