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Russia Should Foment a Bond Market Revolution

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Russia would like to tap the international capital markets for funds by issuing new bonds. Investment banks jockeying to manage the sale, though, have been warned off by the authorities in the U.S. and Europe because Russia is still subject to economic sanctions. This raises an interesting question: What if Russia, or any borrower, just bypassed the middlemen and sold its securities directly to investors?

Governments and companies still sell international bonds the same way they have since the 1963 deal worth $15 million for the Italian highways authority Autostrade, which many people regard as the first true Eurobond issue: A borrower needing money hires a gang of investment banks to handle the fundraising; that syndicate handles the paperwork, finds investors willing to buy the debt, and underwrites the issue ensuring that the borrower gets its money even if the sale falters.

The model is almost identical to how young companies list on an exchange in an initial public offering. But there’s a key difference: Investors can already find out everything they need to know (or at least anything Russia will allow them to know) in publicly available information. They can see how its existing securities are valued and traded in the market. Unlike a new, unknown company selling shares for the first time, there’s no added value in having a syndicate banker explain Russia’s finances as part of the sales pitch.

Russia hasn’t offered international debt since 2013, and Deputy Finance Minister Maxim Oreshkin said last week that money managers are clamoring for fresh securities:

The story here is that it’s actually investors asking us to do an issue because Russia wasn’t issuing for several years. Russian risk is doing really well in the past years and those funds on the sidelines are underperforming the benchmarks. They were coming and asking us to issue a new debt, to do a new supply on the market.

Oreshkin cited the example of Argentina, which last month raised $70 billion in bids for its first new bond sale in 15 years, raising $16.5 billion. A Russian bond, he said, would be “even easier than to place the Argentinian Eurobond.”

There’s every reason to think that a new bond from a country that still enjoys an investment grade rating from at least one of the three major rating agencies would meet huge demand in this yield-starved world. So if Oreshkin is right, what does he need a syndicate of banks for? Why not go directly to the global investor community for money?

So far this year, the 156 banks involved in syndicated government bond sales have earned average fees of about 0.8%, according to Bloomberg data. As well as doing the necessary paperwork such as getting official codes assigned to bonds so they can trade efficiently, the banks gauge market demand to work out at what price the bonds will sell. If an issue is particularly hot, they also choose to which investors to allocate bonds (trying to ensure post-sale price stability, as well as rewarding buyers who are likely to bid again in future), and guarantee a liquid secondary trading market in the weeks and months after launch.

Except that in the current environment, the huge demand for Argentina’s issue suggests everything but the paperwork is less dependent on an intermediary (and even the paperwork is probably not so hard to do independently). Determining the price at which investors will lend to Russiaby looking at yields of similar bonds isn’t difficult — asking some of the biggest emerging-market players what interest rate they’d accept is no harder than sending a couple of e-mails And with yields so low — Russia’s $1.5 billion of bonds repayable in 2019 yield about 3% — the cost of getting the pricing wrong by a handful of basis points is negligible.

With banks reining in the amount of capital they allocate to their trading desks, secondary-market liquidity is largely an illusion these days. While no borrower wants to risk the stigma of a failed bond auction, Russia would seem to be on fairly stable ground if it appealed directly to fixed-income buyers.

It puzzles me — and has done for more than a decade — why technology hasn’t transformed the way bonds are sold by providing an electronic bond marketplace to connect borrowers directly with lenders. “There’s a big fat moat around banking,” former Deutsche Bank Chief Executive Officer Anshu Jain said in October. “That’s kept tech at bay.”

It once made sense to have a syndicate of banks hunt down investors, unearthing pockets of demand and leveraging existing client relationships to ensure successful bond sales at the best possible price. But today? Half a century is a long time for a market to resist the forces of change.

I’m not for sanctions-busting. But if Russia decided to go it alone by raising capital without paying investment banks to hold its hand, it may start a bond market revolution in the process.