Ukraine Bailout Will Benefit Russian Bondholders

As Western leaders prepare a bailout package for embattled Ukraine, they face a startling irony: Thanks to the almost bizarre structure of a bond deal between Ukraine and Russia, billions of those dollars are almost certain to go directly into the coffers of the Putin government.

As CNBC has reported, some aid money is bound to go into Russia as a result of energy trade and other economic factors. But the situation is actually much more acute than just that: An existing agreement between the two countries makes an immediate, direct transfer from Ukraine to Russia legally enforceable.

In December, Russian President Vladimir Putin agreed to lend Ukraine $15 billion. Few details were released at the time, except that Ukraine would issue bonds and Russia would buy them in installments through 2014.

The first and only installment occurred in late December, while then-Ukrainian President Viktor Yanukovych was still in charge in Kiev. The second installment was slated to happen in late February, but it never occurred, because the pro-Russian president had fled Ukraine and a new government was in place.
(Read more: Russia vs Ukraine: ‘No contest’ if fighting starts)
That first installment was $3 billion–in U.S. dollars, as dictated by the terms of the deal–issued on Dec. 24. It carries a lenient interest rate considering the shattered state of Ukraine’s economy: a coupon of only 5 percent, payable semiannually on June 20 and Dec. 20. It is short-term debt, maturing on Dec. 20, 2015.
Startlingly, the notes are governed by U.K. law and subject to the exclusive jurisdiction of British courts. And most crucially, there is an odd and crucial clause in the bonds that has a direct impact on European and American taxpayers, as CNBC learned through a review of the bond agreement:

via CNBC

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza