If you don’t know how a private equity, venture capital, or hedge fund works I will give you a very very quick thumbnail.
Fund managers put together fundraising documents and go pitch their fund idea to various pools of capital. These can be but aren’t limited to pension funds, private investment funds, family offices, high net worth people, and sovereign wealth funds.
Now, suppose you raised a fund and you raised from Russian oligarchs.
What do you do with their money now that a war has broken out and the Western Democracies have decided to divest themselves from Russia?
It’s a sticky situation for a fund manager, isn’t it?
Suppose you raised a $1B investment fund and 10% of the money came from the Oligarch Network. You have been operating it for a few years, but you aren’t at the end of the investment period. You have an investment on the table and want to do a capital call.
What do you do?
You could not call from the Russian oligarchs, and let your other LPs know. But, some LPs have fund check size limits. Does a $100MM drop in your fund size affect their legal requirements?
Can you commit to companies you are already invested in with the smaller fund size? Can you pursue the same strategy with smaller fund size?
A first-world problem for a fund manager with Russian investment would be an exit. You’d simply custody the money in a separate bank account that would normally be transferred to the Russian investors. When legal clarification happened then you would treat the money according to the legal guidelines.
If the Russian investment size of your fund was a large percentage, approaching or more than 50% so they had a controlling interest, you are basically out of business right now. You can’t issue capital calls. If you have called capital for management fees, you might be able to pay yourself and the operating expenses of the fund. However, you better be ready to have all that capital clawed back.
We are seeing second and third-order financial effects from this war in Ukraine. Airlines have planes on the ground in Russia and can’t get them out. It’s not clear what the legal and accounting ramifications of the leases on those planes are. Debt payments due from Russia to debt holders are normally executed in US dollars. Russia is speculating that they will pay in rubles instead. That guarantees default since rubles are worthless.
Today, Saudi Arabia said they are exploring executing oil trades in Chinese yuan instead of US dollars. That has less to do with the war in Ukraine and very much to do with the misguided Joe Biden policy of offering many olive branches to the Iranians.
For what it is worth, oil futures are lower today easing a little pressure. By the way, when the Federal Reserve aggressively raises interest rates, commodity prices will go lower because their carrying costs will be higher. It will also strengthen the US dollar.
Fund managers that have courted and accepted investment from Russian principals are spending a lot of time behind closed doors trying to figure out what to do. Bet they are running up some nice unexpected legal bills too.
Great presentation and discussion as usual.
Fund managers have a more fundamental problem: they may be universally prohibited from acting in any manner on behalf of any beneficial interest from the banned list of oligarchs and Russia in general. The default condition, per the sanctions, is zero action, not do whatever you think is fair.
Normal self-help remedies like selling an asset and putting the proceeds in an escrow account do not appear to be allowed. In the US you would have a 30% foreign interest income tax withholding requirement anyway.
As to Russian bonds, they come in two forms: sovereign debt and corporate debt.
The bonds are universally clear on what they require as to payment, specifically the currency to be used. It is spelled out in the indenture which is written in several languages. CNN may not be sufficiently sophisticated to figure this out, but the real world can.
What you think you can pay back bonds in Monopoly Money? That none of this stuff is written down? Come on, man.
More than half of all Russian sovereign debt is in USD or EU currency. Period.
There are some indentures that provide for payment in rubles, but that is just a head fake as the payments have to be convertible and there is a huge doubt if you can convert rubles. If you can, you convert into USD or EU currency then that is the end of the story. My God that will take a shit pot of Rubles.
Full stop: Russia defaulted on all the Czar's debt in 1917 and it took 70 years to work that out. Russia went down in 1998 and it took 7 years to work that out. This is not the first time Russia has done this. The current bond indentures have this baked into the cake.
Russian company corporate debt is far more dicey as these companies routinely access the debt markets for project finance and they have assets outside of Russia plus they have assets and cash flows that are attachable outside Russia - payments from Germany for oil and natural gas.
Most of this stuff is trading at $0.10/USD. So the market has already spoken.
These bonds have a 30-day default period in which the issuer can "cure" the default. Then the power shifts completely to the holder of the bonds.
Putin's bullshit law that they can pay all obligations with rubles doesn't matter except for domestic debt. Good luck with that, Vlad.
There are also massive cross default provisions in corporate finance that are gigantic minefields. Gazprom cannot trick somebody on Bond A and expect to continue to benefit from Bond B. Default on one and the whole world is coming for you.
Expect Russian corporations that have cash flowable assets like mines, pipelines, energy to do "workouts" in which payments are made into lockboxes, or with commodities, and other typical bankruptcy or default provisions.
Big problem is that the beneficial owners are going to call the entire issuance at accelerated default rates of interest, not just haggle over payments. Much of this behavior is not within the power of the bond holders to control as they use big servicing outfits that sign contracts to do just that.
For these big bond issuers who are public companies headquartered in Russia, they have another problem. As public companies their stock is headed for the toilet and they become huge acquisition targets.
I can't imagine how any Russian company with bonds can possibly protect their bonds, their stock price, their balance sheet, their business, and, ultimately, their survival. Would five big oil companies buy up Gazprom? Maybe. Especially if they can get started buying bonds for $.05/USD and a stock price of $0.15/share.
This whole problem is made infinitely more difficult by the Moscow Exchange being closed and London based Russian stocks dropping by 98%. Every day this continues the probability of Russian stocks disappearing increases.
The Moscow Exchange is no longer affiliated with any global network. They have the same financial clout as a hot dog push cart in Central Park that has run out of hot dogs.
The biggest thing is this -- nobody with a brain in the finance racket has any goodwill toward Russia, there will be no workouts based on new money, and if there are attachable assets the lawyers will get their hooks into them before any negotiations happen.
Russia has only been integrated with the global finance racket for maybe a decade and a half. The Moscow Exchange was founded in 2011 when the MICDX and the RTS merged. The world and Russia lived without them for a long time and they will not be missed.
Russia, well-deserved, is well and goodly fucked and they have nobody to blame but that rat fuck Putin who is not a Harvard MBA.
JLM
www.themusingsofthebigredcar.com