Financial Vultures Start to Circle Over Ukraine

Financial Vultures Start to Circle Over Ukraine

There is more and more evidence that Ukraine could declare default soon. This summer the leading rating agencies downgraded the Ukraine’s ratings. The International Monetary Fund takes an increasingly dim view of the country’s mid-term economic prospects and insists that the tariffs for companies and households should be raised. In case Ukraine signs an Association Agreement with the European Union in November in Vilnius it would need $160 billion to meet European technical standards, the sum is equal to the country’s annual GDP, a load too heavy for Ukraine to shoulder. 

According to Ukraine’s National Bank, the external debt was $134, 4 billion or 75, 7 percent of GDP in the middle of the current year. The terms for external loans are much less favorable in comparison with any European Union member-state because of low credit and investment ratings. Even in the relatively good year of 2012 Ukraine placed in eurobonds the sum equal to 2, 3 % of its GDP at annual rate of 8.8%. In some other cases the annual rate even exceeded 10%. The external debt is becoming an unbearable burden for the state, companies and banks. Some loans are mature this very year (perhaps some loan maturity dates are already behind); and getting new loans to pay off the old ones presupposes serious losses in the form of high interest rates. The external debt burden is to be shouldered by the state and the National Bank. In 2013 Ukraine is to spend $ 3, 5 billion to service the debt, the sum is equal to 15% of national gold reserves which are melting away. As of January 1, 2013 the gold reserves accounted for 24, 55 billion dollars, on October 1 the sum was only $ 21, 64 billion (about 3 billion less). This summer Bloomberg put Ukraine into the list of top ten nations at risk of bankruptcy (world riskiest nations), which means that default may be declared any time soon. 

Franklin Templeton Investments acquires Ukrainian state bonds

The Financial Times reported on November 10 that Franklin Templeton Investments, one of the US largest investment funds, acquired the bonds of Ukrainian government worth $ 5billion, accounting for 20 percent of the Ukrainian foreign debt. According to the source, the investment group snapped up Ukrainian international debt at the end of August. Serhiy Arbuzov, Ukraine's first deputy prime minister, and Yuriy Kolobov, the finance minister, earlier this year made an unofficial visit to Franklin Templeton's San Mateo headquarters to reassure the country's biggest creditor. The sum paid by Franklin Templeton for the fifth of Ukraine’s debt is a commercial secret. Before that, at the very beginning of eurozone crisis, the overseas fund bought the bonds of Ireland getting a large profit as a result. 

According to the Financial Times, the world markets expect Ukraine to crash soon. The cost of insuring against a Ukrainian default is among the highest in the world. «They face a currency and funding crunch, it's as simple as that», said Paolo Batori, a senior strategist at Morgan Stanley. «The trigger point could come tomorrow; it could come next week, or next month. But Ukraine is simply not equipped to deal with another wave of outflows. It needs the help of a third party, whether that is Russia or the IMF», he said.

Under the conditions, the American investment fund acquired Ukrainian bonds on the cheap with an eye to get a large chunk as revenue when the bonds are due for redemption (perhaps 200 or even 300%). There are two options here. 

Option one. Ukraine manages to find money and gets away from the abyss of default going back to normal payments for its obligations. The fund gets the price at the bonds’ face value. Where could such aid to Ukraine come from? Certainly not from the European Union, which itself is one step from default. It could be either Russia, or the International Monetary Fund. Signing a free-trade zone deal with the European Union will automatically cut off any aid coming from Russia. Until now Kiev has been refusing the tough conditions imposed by the International Monetary Fund, like, for instance, further budget atrocity and raising home market energy tariffs. 

The chances are 5-10% the events will unfold according to this scenario. 

Option two. Ukraine declares default on sovereign (state) debt, as Bloomberg news agency and rating agencies predict. We believe the probability is 90-95%. Franklin Templton is ready for it with its estimated revenue to be as large as in the first option scenario. 

Financial Vultures and legal colonialism

The world has recently become accustomed to managed, «civilized» defaults. It goes like this. The chief debt holders come to accord on debt restructure writing off a certain part of debt and reviewing the initial conditions for granting credits and loans (maturity dates, interest rates). Classic examples of restructuring are the reviewals of Argentina’s (2005 and 2010) and Greece’s (2012) debts by bondholders. 70 billion dollars of Argentina’s debt were written off, and it was more than 100 billion dollars in the case of Greece. 

This mechanism has started to hit snags recently. The reason is the activities of some large investment funds called «financial vultures». They acquire some bonds from a state facing bankruptcy. In case of default they refuse to restructure debts, take a tough stand and insist the bonds be redeemed at their face value. If need be, they go to US or British courts to make their debtor kneel. In the case of Argentina, they bought some certificates on the cheap during the second debt swap and then started to demand the bonds be 100% redeemed. NML Capital и Elliott Management, the two main US vulture funds, went to the court of New York that handed down a verdict in November 2012 saying Buenos Aires had to pay 1, 33 billion dollars to the «holdouts». All other debt payments had to be stopped till the «holdouts» were repaid. The Argentina’s restructured bond payments sovereign debt was around 24 billion dollars (45% of GDP) at the moment the court decision was handed down. Now the country had to redeem about 3 billion dollars till December 15, 2012. The New York court’s decision hit Argentina badly; its investment and credit ratings abruptly went down. 

It became clear that aircraft carriers and missiles are not the only instruments of US hegemony; the US courts had their role to play spreading their jurisdiction across the whole world. 

In Argentina the court’s decision was called judicial colonialism. Buenos Aires refused to comply and appealed the verdict. If the appeal is rejected, then Argentina will have to pay according to the court’s decision creating a very dangerous precedent. Then all the holders of Argentinian debt, who gave their agreement on restructuring (they account for 97% of the debt), will demand to get it all back as it was initially. Argentina will find itself returning to the situation it found itself in 2001 before the default set in. 

Conclusions

Franklin Templeton possesses all the makings of a financial vulture. The acquisition of 20% of the debt proves Ukraine is at the threshold of plunging into default. The financial vultures have bulldog grip. They will not let Ukraine, their new victim, go. The recent decision handed down by New York court in favor of financial vultures and to the detriment of Argentina has inspired them in their endeavor to achieve more victories. Another and the most famous case as yet may be the victory to be held over Ukraine…

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