Pimco bets on recovering Russian debt in CDS auction

Pimco appeared to be betting that Russian sovereign bond prices could continue to recover, when the investment giant placed a large order to buy Russian debt in an auction used to settle swaps on credit default on the country, according to sources familiar with the matter.

In Monday’s historic CDS auction, which many feared would never happen due to US sanctions on Moscow, Goldman Sachs placed about $1.3 billion worth of orders to buy Russian bonds at the Russian CDS protection sellers name. Banks act as brokers in CDS auctions to place buy and sell requests on behalf of clients, who are not publicly named, and also to enter orders for their own account if necessary. This process allows firms to physically settle their derivative contracts.

Filings show that Pimco has been one of the largest sellers of Russian CDS protection and would therefore be eligible to buy large amounts of bonds at the auction to settle that exposure – and two sources have confirmed that the manager of investment was heavily involved. Spokespeople for Pimco and Goldman Sachs declined to comment.

Experts said the strong demand from CDS protection sellers to take physical delivery of bonds to settle their CDS contracts – and effectively switch their exposure to Russian CDS for exposure to Russian bonds – suggests that investors like Pimco may well see a further increase in the value of these securities. .

“It is not surprising to see a group of CDS holders asking for physical settlement at the auction, as they may think that one day they will get a much higher recovery rate on the bonds,” John said. Williams, a partner at the Milbank law firm. .

“In a normal distress event, there may be differing opinions on the underlying recovery value of the debt, but it’s more of a range of outcomes. It’s essentially bimodal: Russia has a lot money and wanted to pay the bondholders, but Western sanctions prevented them from doing so.

Pimco’s large buy order contributed to a further resurgence in the value of Russian sovereign bond prices, which had traded near zero earlier this year following Moscow’s invasion of Ukraine. After taking into account offsetting demands for bond sales at the auction, there was a net demand of just over US$500 million to buy Russian debt, which helped drive up the Russian CDS recovery rate at 56 cents.

That was several points higher than the level banks had indicated in the first round of the auction when asked to rate Russian bonds. That means CDS holders who settle in cash will get back 44 cents for every dollar of default protection they bought on Russian hard-currency debt.

welcome relief

Financial professionals hailed the successful resolution of the Russian CDS auction after months of uncertainty in what turned out to be a cumbersome and complex process to settle these derivative contracts. The Russian CDS triggered in early June, after Moscow was deemed to have missed some small interest payments to investors.

A US Treasury ban on US companies buying Russian on secondary markets had threatened to completely derail the process because the auction mechanism requires banks’ trading desks to be able to buy and sell Russian debt in order to establish a fair payment for CDS holders. In the end, the derivatives industry managed to secure a temporary ban from the sanctions that allowed trading in Russian bonds two business days before and eight business days after the auction.

The Russian CDS auction gave investors their best opportunity in months to buy or sell large blocks of Russian bonds. JP Morgan strategists said in a recent report that there was about $2.4 billion worth of Russian CDS to settle on both single-signature contracts and credit indices.

Russian debt prices, meanwhile, have rallied from their nadir earlier this year as it has become more evident that Moscow plans to continue paying bondholders who are not prevented by sanctions. western countries to receive payments. These may be Russian investors or other institutions, such as family offices, for example, based in the Middle East or Asia. As a result, many see another upside for Russian debt from here.

“In March and April, [Russian] the bonds were in the hands of investors who could not be paid and the clearing price was very low,” said a credit analyst.

“Over time, these mechanisms and these buyer bases realized that they could buy bonds in the 1950s and be paid at par. Perhaps international investors who want to hold them for the long term will say, “I have bonds in the 50s; who knows?…they might be worth it. So buying at 50 cents…seems like a reasonable option to own.”

purchasing power

The CDS auction has two parts. First, bank traders provide indicative offers on Russian debt, while accepting orders from clients who wish to physically settle their CDS contracts. These requests are then offset to see if there is more demand to buy or sell bonds.

In the second round, this net demand is met by a “Dutch auction”, where anyone can offer to buy or sell bonds through a broker at a price they have determined at the advance. The price at which the request to buy or sell the bonds is ultimately satisfied becomes the final CDS settlement price for those who choose to settle their contracts in cash.

The average indicative price for Russian bonds was 48 cents in the first round, while the net interest of US$502 million to buy bonds was eventually filled at 56 cents in the second round.

Protection sellers such as Pimco who have chosen to physically settle their CDS will receive delivery of Russian bonds in return for payment to protection holders at par. Such a transaction leaves Pimco exposed to future fluctuations in Russian bond prices, suggesting that the investment manager believes the market is currently undervaluing Russian debt.

“Protection sellers who asked to take physical delivery of bonds will now have to bear bond risk going forward,” said Athanassios Diplas, a former Deutsche Bank trader who helped design the auction process.

“I think the CDS market will be relieved that the auction has worked consistently with the way it is designed to work. The outcome really depends on the direction the risk takes. This time, the demand for physical settlement was large and the imbalance between bond buyers and sellers was enough to push the final CDS settlement price several points away from the initial midpoint and reduce the payout somewhat. »