Strategies for dealing with the Russian crisis
9 January 1998
Russia's debt problems and the general global financial crisis are set to tax the skills of firms specialising in providing restructuring advice, says Rita Lowe. Rita Lowe is a partner in Cameron McKenna's corporate recovery and restructuring department.
The corporate recovery and restructuring groups in legal and accountancy practices throughout the City have spent the past 12 months supporting clients with exposure in the Far East.
One of the major lessons learned is that, for political and/or cultural reasons, corporate entities and financial institutions which develop financial problems are often kept alive in the same form.
Familiarity with the political environment and culture, as well as with the legal structure within which banks and companies operate, has thus been important in enabling international law firms to service their clients in the Far East. Now, once again, clients' attention is focused on the East - but this time on Russia.
The recent devaluation of the rouble came as no surprise to those close to the Russian economy. More surprising, however, was the declaration by the Russian government of a 90-day moratorium on currency transactions under commercial or financial contracts.
The devaluation of the rouble is the cumulative effect of three factors:
the requirement to service the federal government's enormous burden of short-term borrowings;
the collapse of the price of oil in what is a petro-chemical economy, which has meant that much-needed income to service sovereign debt has largely dried up; and
the problems in Asia have led to a loss of confidence in emerging markets, including Russia.
No one knows what the impact of the moratorium will be. However, it is suspected that it is designed principally to affect foreign investors, while giving the Russian government some headroom to enable it to pay public employees, some of whom have not been paid for up to two years.
A number of foreign banks which have lent to the Russian government and to Russian corporate borrowers will be affected by the moratorium and some may suffer substantial losses.
The government has met a large proportion of its financing requirements with short-term rouble-denominated treasury bills (GKOs) and eurobond issues, as well as other more common lending instruments.
Of the $40bn GKO market, foreign investors own about $17bn. Moreover, there are a number of domestic banks whose sole business is based on the trading of GKOs. A number of analysts find it difficult to see how some of these banks will avoid conglomeration or going out of business.
As with the Far East, the question will be whether the Russian government will allow domestic banks and businesses to be placed into formal insolvency proceedings. No doubt some insolvent banks and other entities will avoid such proceedings by virtue of their political connections. But some members of the government have expressed the view that, although depositors should be protected, there are certain banks in Russia which should be allowed to fail.
The question now is whether the country's insolvency legislation can cope with the problems. The new Russian Federation Bankruptcy Law came into effect on 1 March. It replaces the much-maligned Law on Insolvency (Bankruptcy) of Enterprises 1992. The principal features of the new law, which has been largely untested, are:
if a debtor fails to repay its obligations within three months of their due date, a creditor has the right to file an application to court requesting the appointment of an examiner. If the court appoints an examiner, the management of the debtor remains in place, although certain transactions cannot be undertaken without the consent of the examiner.
at any time following appointment, the examiner has the right to recommend to the creditors and the court that an external administrator should be appointed to the debtor company. This means that existing management will be displaced and the debtor will be run by the external administrator. This recommendation is likely to be made if the examiner is concerned about the management of the debtor and its ability to preserve or maximise the debtor's property.
if an external administrator is appointed, a moratorium will be imposed on creditors pursuing monetary claims against the company.
in those cases where an external administrator has been appointed, he must (within two months) produce a plan for the economic recovery of the debtor company.
if either the external administrator (if appointed) or the examiner concludes that it is impossible to recover the debt owed to the creditor or, in the case of the external administrator, it is impossible to return the debtor to profitability, the final process of formal bankruptcy is commenced.
The new bankruptcy legislation does not directly apply to banks and other credit institutions. They are covered by a different code, the Law on Insolvency of Credit Institutions. This is presently in draft form awaiting formal parliamentary approval. One of the principal differences between this legislation and the law that applies to corporates, is that commencement of the bankruptcy proceedings must be initiated by Russia's Central Bank and cannot be initiated by a creditor.
Russia and the foreign banking community is unsure what the effect of the 90-day moratorium will be and whether formal insolvency (in conjunction with the rescheduling of foreign debt) is inevitable. The only certainties are that a number of Russian banks were, prior to the crisis, severely undercapitalised and that the devaluation has exposed weaknesses in the domestic banking system and the fragility of Russia's market economy.
Various lenders and investors in Russia may take very different attitudes to the present problem. The financial institutions expecting repayments under loans and GKOs and other instruments will be concerned about the restructuring package which is yet to be presented to them.
Those financial institutions dealing in futures contracts are likewise concerned, because the Moscow foreign exchange market has apparently used the confusion to avoid paying up margin calls on contracts.
In the oil and gas sector, where there are large, ongoing projects, investors are likely to take the view that this is a short-term crisis and that it will not affect their long-term interests in the region or the viability of their projects.
Because there are concerns about a global financial crisis, those firms best placed - regionally and internationally - to offer restructuring advice are likely to be taxed with finding inventive solutions to what may otherwise be intractable problems.