April 11, 2018 / 12:36 PM / 3 months ago

EXPLAINER-How Russian tycoon Deripaska might try to navigate sanctions

MOSCOW, April 11 (Reuters) - Businesses controlled by Russian metals tycoon Oleg Deripaska are scrambling to find ways to keep trading after they were added to a U.S. sanctions blacklist.

The sanctions - imposed by Washington in response to what it called “malign activities” by Russia - will in effect choke off access for Deripaska’s businesses to the international financial system, forcing them to make major re-adjustments.

Among individuals and entities named on Friday’s sanctions list was Deripaska and a number of his companies, including Rusal and En+ Group, which manages his assets and owns his 48 percent stake in Rusal.

The biggest asset in Deripaska’s portfolio is Rusal , one of the world’s biggest aluminium producers. It will likely feel the impact of the sanctions in two main areas: its sales on world markets, and its borrowing.

Rusal and En+ declined to comment. Rusal has said that the sanctions may result in technical defaults in relation to some of its credit obligations but it intends to continue to fulfill its existing commitments in accordance with legal and regulatory requirements.

Here is a look at what is at stake and what some of the options Deripaska has to mitigate the sanctions impact.

SALES

What’s at stake?

Rusal is the world’s second-largest aluminium producer after China’s Hongqiao, accounting for 5.8 percent of world production of the metal last year, according to the Russian company.

The United States was Rusal’s third biggest foreign customer last year by revenues, bringing in $1.4 billion, the company’s financial report showed.

Large scale end-customers of Rusal include Glencore , Alcoa’s Samara Metallurgical Plant in Russia, Toyota, Mechem SA and Rio Tinto Alcan, the company said in a bond prospectus earlier this year.

What effect are the sanctions having?

While some customers have said they are looking at what steps to take, it is too early to determine what the full impact of sanctions will be.

The sanctions on dealing in goods with Rusal do not come fully into force until just after midnight eastern daylight time on June 5. here

Once they do take effect, U.S. customers will be prohibited from buying aluminium from Rusal because the sanctions prohibit U.S. companies and individuals from doing business with a sanctioned entity.

Non-U.S. customers could also have difficulties buying the aluminium. Their lawyers may advise them they risk being targeted for so-called “secondary sanctions” for helping a sanctioned entity.

Also, the transaction is likely to be in dollars, which means passing through correspondent accounts in the United States, and U.S. banks could refuse to handle the transaction because the beneficiary is under sanctions.

Swiss-based mining company Glencore, which is both a customer of and a stake owner in Rusal, has said it is committed to complying with sanctions and is taking steps “to mitigate any risks” to its business. It added that includes the risks from secondary sanctions, which could be imposed on firms if they are deemed to be facilitating Rusal’s business.

“Glencore is still evaluating the position under its contracts with Rusal, but notes that these contracts are not financially material to Glencore,” it said in a statement.

What might Deripaska do?

Rusal will likely divert a greater proportion of its sales to Asia, according to traders and metals market analysts.

“Supplies will be re-directed to other markets,” said Maxim Khudalov, an analyst with Russian ratings agency AKRA. “The re-focusing will be mostly to Asia and China.”

Rusal has already planned for such a scenario. When the U.S. government earlier this year raised the prospect of tariffs on some metal imports, En+ told investors Rusal had other options. In light of a “global aluminium market deficit,” Rusal “would be able to redirect volumes to other regions as may be required,” En+ said in a March presentation.

However, sending cargos to Asia would likely mean that Rusal’s margins are squeezed, according to analysts.

Rusal has activated a contingency plan asking customers to pay in euros instead of dollars to try to skirt U.S. sanctions, a source close to the matter said.

The plan follows the example of Iran, which a few years ago opted to use gold, oil and the Japanese yen to pay for goods that would typically be priced in dollars.

Another route Rusal might take is to try to enlist the Russian state as a customer. Rusal has in the past proposed the creation of a state stockpile of aluminium, which would buy the output Rusal cannot sell to the market.

Its proposal was that it would sell 1 million tonnes of aluminium to the state, stockpile the metal at its warehouses and buy it back in seven years.

But the idea was opposed by deputy prime minister Arkady Dvorkovich who said back in 2014 that the country’s budget did not have the money. Russian state development bank Vnesheconombank, or VEB, said at the time it was considering participating in the proposed project.

The government has not replied to Reuters request for comment. Rusal declined to comment on how it might mitigate impact on sales and potential help from the government.

DEBT

What’s at stake?

At the end of 2017, Rusal’s net debt was $7.6 billion and total debt was $8.5 billion. Almost all of it was U.S. dollar-denominated borrowing. Russian top state lender Sberbank and VTB, another Russian state bank, are the biggest lenders.

Rusal has three outstanding Eurobond issues, totalling $1.6 billion, with the first maturing in February 2022.

Rusal also has two yuan-denominated issues outstanding, worth 1.5 billion yuan ($238 million). The first of these matures in March 2020.

Rusal needs to repay $600 million annually in its debt in the 2018-2020 period.

What effect are the sanctions having?

Rusal’s bonds are being cut off from the infra-structure that makes bond markets function — the indices that list the prices, the “clearing” services that handle payments. That is because the companies that provide those services do not want to expose themselves to sanctions risk by association with Rusal.

MarketAxess, one of the world’s biggest multi-dealer trading systems, said it had removed Rusal debt from its platform. Investment bank Barclays has suspended Rusal ratings and estimates because of the sanctions, according to a research note sent on Friday.

Much of the sanctions risk stems from the fact that the bonds are dollar-denominated, which makes related transactions difficult because the sanctions effectively cut off the company’s access to the U.S. banking system and correspondent banks and creditors.

The issue will come to a head on May 3, when the next Eurobond coupon payment by Rusal is due. Rusal is unlikely to be able to make the payment, which is in dollars, because American banks would be expected to block that payment, investors and analysts said.

Raising new debt via Eurobond issues will also be de facto impossible for Rusal and the other sanctioned companies in Deripaska’s empire as long as the sanctions are in place.

What might Deripaska do?

One option is for the Rusal bonds to be paid off ahead of schedule, according to two Russian financial market sources.

Rusal itself cannot do that because the bond-holder that takes the money would themselves come under sanctions risk. But a third party could do it, possibly a Russian state bank, said one of the sources, who did not want to be identified.

It might work for the bond repayment, but the appetite from the Russian banks to help Rusal with other operations, including potential debt refinancing, would be limited by risks of sanctions toughening against creditors.

To reduce the cost of the operation, the redemption could be limited to foreign bond-holders, while domestic holders of the debt will have their bonds converted into domestic paper, the source said.

The Kremlin has already said it will help the sanctioned tycoons and analysts said it could prevail on a state bank to step in.

Russian banks have accumulated a large reservoir of foreign currency that they could use for the operation. In November last year, the central bank said the big Russian banks between them had $39.7 billion in available foreign currency.

VTB and Sberbank did not respond to Reuters questions about how much forex liquidity they hold.

Additional reporting by Pratima Desai in LONDON, Melanie Burton in MELBOURNE, Katya Golubkova, Gleb Stolyarov, Andrey Kuzmin and Polina Ivanova in MOSCOW and Allison Martell in TORONTO Editing by Cassell Bryan-Low

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