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. Last Updated: 07/27/2016

Gazprom Veksels Seen a Safe Port in a Storm

Where do you park your cash if you're unfortunate enough to have it in Russia? With equity markets dead, access to hard currency choked off and state paper either frozen or at fixed yields set way too low, Gazprom's corporate IOUs, or veksels, have become increasingly popular.

Three months ago, yields on Gazprom veksels f corporate IOUs issued to settle debts f soared to 250 percent, recalling the crazy days of the early 1990s when Russia's financial sector was awash with soft money, fueling high inflation and attracting speculative short-term capital like bees to a honey pot.

However, once short-term expectations of high inflation and a plummeting ruble proved to be unfounded, prices on Gazprom debt rose as traders realized that the company's veksels offered a rare, relatively safe haven for their cash as the ruble dropped anchor at less than 23 to the dollar, making fixed-income slightly more appealing.

"When you choose among instruments with a quality credit risk, Gazprom's paper is one of the first things to look at," says Michael Workman, fixed-income trader with MFK Renaissance.

As a result, yields on Gazprom's veksels dropped in January, settling between 55 percent and 60 percent on paper maturing within a month of the date of trade on the secondary market.

One important motivation for buying into Gazprom IOUs is they remain fairly simple instruments in the extremely complex world of veksels.

Gazprom issues veksels and pays them to subsidiaries and suppliers in lieu of cash. Those recipients then usually resell the veksels on the secondary market. The veksels are issued at a discount to face value. The brokerage through which the recipient resells the paper adds its markup and that sets the initial offer price on the secondary market. From there, each resale inevitably drops the yield.

"This is a one-way train. There are so many intermediaries that the final price is far above the initial," says Konstantin Demchenko, head of the ruble fixed-income desk at National Reserve Bank.

Another "simple" aspect of the veksels is their reliability. Gazprom remains the only Russian issuer that redeems its veksels in cash, on time, in full.

As cash started to flow again through the economy in the early weeks of the New Year, the Central Bank's rigid restrictions on hard currency transactions forced holders of rubles to seek alternative stores of value. Gazprom's paper, thanks to prudent management of the firm's veksel issues, is one of the only instruments that can stand as a liquid and effective store.

After the Central Bank prohibited commercial banks from taking currency positions, restricting hard currency sales to purchasers who can show that they need the currency to settle foreign trade transactions, numerous commercial banks were forced to search around for any even vaguely reliable instrument available that would allow them to retain some of their cash's purchasing power.

Fueling the demand for Gazprom IOUs, many foreign financial institutions found themselves unable to repatriate funds. They started chasing Gazprom veksels for much the same reason.

Another source of demand entered the picture when the federal government began paying out cash on restructured treasury bills frozen on Aug. 17 last year. The Finance Ministry has offered holders of the 280 billion rubles of GKOs held at that time 200 billion rubles worth of new securities and an unspecified amount up front in cash.

Some, mostly Russian institutions, have accepted the deal and the government began paying out rubles in mid-January. Many of the institutions that received that cash have turned around and parked it in Gazprom veksels.

The alternatives are extremely unattractive. The government has restarted its GKO market but has limited the yields to 120 percent, a level many find unacceptably low considering both Russia's credit record and the shaky state both of the ruble and the inflation rate. And after the banking crash last fall, nobody is especially keen to put money into one of Russia's here-today-insolvent-tomorrow banks.

Gazprom veksels have the advantage on a Russian bank account both in terms of stability and in liquidity, thanks to the banks' appallingly bad record for transaction settlements.

All this has added up to a surge in demand for Gazprom veksels so strong that it has brought yields on the paper down well below what would otherwise be reasonable for ruble-denominated debt f current yields of up to 75 percent on three-month paper provide no protection against predicted levels of inflation in Russia this year.

"The fact that we had a slow start this year does not encourage us to be more optimistic. We still expect inflation of the order of 100 percent," says Chris Weafer, head of research with Troika Dialog.

Long-term paper does factor inflation in f just. Yields on this paper of 90 percent to 100 percent mean that these veksels are really more of an inflation hedge than anything else.

"Veksels are still not an investment instrument for many people. This is why their yields precisely follow inflation," says Sergei Babayan, a Troika Dialog fixed-income trader.Part of the reason such low yields compared to inflation are acceptable is the veksels can be used for settlement purposes f making them an effective money substitute.

The veksels are also an extremely opaque market, something Gazprom has no intention of changing. It is extremely difficult to estimate the total market volume of Gazprom's veksels. As of Jan. 1 last year, Gazprom's balance sheet showed 3.6 billion rubles ($600 million) of veksels outstanding with maturities of less than one year.

Adjusting for issues with longer maturities, the increase in the use of veksels in 1998 and the devaluation of the ruble, one can make a rough estimate that Gazprom's veksel market does not exceed $300 million to $400 million at current rates of exchange.

Company officials were less than open about the extent of their veksel program.

"The fact that Gazprom does not give away information on veksel issues means that we are simply not interested in doing that," said an officer from Gazprom's treasury.

The market is also fragmented and quirky. Prices on veksels are set by traders through mutual agreement reached through telephone negotiations f an individual trader's sales-talk skills can therefore play a major role in setting prices.

"Often a crowd of people is talking about an issue none of them have ever seen, just heard of," says Demchenko at NRB. "This spoils the market to the extent that buyers often turn away from it."

The market is also overcrowded by a massive number of small operators. Small brokerage houses account for the bulk of the turnover, although they are rarely among the end buyers.

The daily volume of bids in Moscow rarely exceeds 250 million rubles ($10 million). The market is shallow and liquidity dries up when large volumes are offered for sale. Lots rarely exceed 15 million rubles when Gazprom's veksels exchange hands.

"I had a client who wanted to sell veksels worth 100 million ($4.5 million) in one lot. But it was impossible to find a buyer," said one trader, who declined to be named.

Offsetting these difficulties is Gazprom's careful management of its veksel program. The natural gas monopoly's credit history is immaculate f Gazprom continued to promptly service its obligations even as the government defaulted on its own debts. The firm's veksels are also vastly superior to most other corporate veksels. As a result, Gazprom's veksels were slightly less volatile than GKOs even back in the days before the state defaulted on its domestic debt.

"Gazprom's veksel program must be the most detailed and elaborate among the Russian corporates. Gazprom issues veksels very carefully," says Simon Vine, head of fixed income at Alfa Bank.

Gazprom officials take pride in making sure the company is never caught short on its paper.

"We always plan cash expenditures so that the total of interest on loans to be paid, salaries, volume of veksels maturing and other cash expenditures does not exceed planned revenues on a certain date," says Vladislav Vetchinkin, an official at Gazprom's veksel department.

The company is also very careful about when it issues new veksels, and for what purpose. New IOUs are only issued in order to settle debts with subsidiaries and suppliers.

This attitude contrasts with the behavior of numerous Russian corporations, many of whom seemed to issue veksels simply on the basis of how much debt the market could swallow. When the market finally started to hiccup, many issuers then refused to service maturing obligations under various pretexts. Gazprom held back, helped by the gas giant's access to overseas capital. "Before the crash we could afford to borrow at lower interest rates abroad," says Vetchinkin.

Although there has been talk of issuing veksels to raise capital on the domestic and foreign markets in recent months, there has been little follow-up.

But Gazprom dismissed such rumors.

"I think somebody has been testing Gazprom's mettle. A 40 percent yield in rubles with unhedged currency risk sounds like a ridiculous offer for any investor," commented one Gazprom official who spoke on condition of anonymity.

In January, Gazprom announced plans to raise 700 million rubles from placement of bonds on the domestic market. Gazprom deputy chairman, Sergei Dubinin, the former Central Bank chief, floated the idea of issuing Gazprom bonds. Dubinin suggested allowing foreigners to invest the proceeds from GKO restructuring in Gazprom's debt instead of keeping them in on-call accounts that bear no interest. But the idea faded for lack of interest.

The future of Gazprom's veksels market as an investment instrument is murky. In the short term it will depend on the ruble-to-dollar exchange rate, which is expected to fall sharply by end of the first quarter when the government releases payments under the 1999 draft budget.

The budget has made its way through the State Duma and must still be passed by the Federation Council before President Boris Yeltsin can sign it into law.

The 32.7 billion rubles of monetary emissions countenanced by the budget are likely to be funneled straight into the hard currency markets, despite the Central Bank's restrictions, sending the dollar sky-high.