Ongoing geopolitical tensions between Russia and Ukraine have resulted in sanctions which are threatening the stability of trade finance within the Black Sea Region (BSR), writes Jason McGee-Abe.


The Black Sea Region (BSR) is facing one of its toughest battles to date: with Russia’s annexation of Crimea and support for separatist rebels being met with heavy trade sanctions, financial conditions have severely tightened.

Recent events have had a significant impact on what have up to now been two very important markets for trade finance – Russia and Ukraine. “Initially the conflict in Ukraine triggered a level of uncertainty in the market amongst both financiers and those trading with Ukraine, which effectively stopped many new transactions from proceeding,” explains Simon Cook, partner at Sullivan & Worcester to GTR. “Banks also spent much of their time looking at existing deals on their books to see how they were affected and what their rights were – could they be called in, did they need to be restructured or were they proceeding as normal?”

Sanctions have caused great concern to many within the industry, with a Clyde & Co poll showing that 80% of commodity traders, financiers and their insurers are all worried about the increasing impact of sanctions on their business.

Unpredictability, the impact on the bottom line of business and the speed of implementation, are aspects singled out in the poll, which found that a lack of clarity over how to comply with sanctions on Russia is causing 62% of businesses to shy away from transactions, with 53% of participants agreeing that sanctions are impeding their ability to conduct legitimate trade.

John Whittaker, a partner at Clyde & Co, says: “Lack of predictability is a real issue for traders who will have multiple trades at various stages of completion when sanctions bite.

“Goods will be crossing borders and stored in the warehouses of third parties sometimes of uncertain ownership. Rule changes are typically enacted with no notice and have instant effect so they create significant contract and compliance uncertainty for everyone involved in the value chain.”

US sanctions prohibit credit that encourages exports to Russia and financing for economic development projects in Russia, while EU sanctions have been targeted at Russia’s oil, finance, defence and technology industries. Russia’s largest lender Sberbank and the Russian Agricultural Bank are among the banks that have been put on the sanctions list.

In mid-July, the European Council also agreed to suspend the financing of new projects in Russia by the European Investment Bank and agreed to look at suspending the European Bank for Reconstruction and Development’s (EBRD) financing of new projects in Russia. Certain EU bilateral and regional co-operation programmes with Russia have also been suspended.

Sanctions have frozen foreign operations of banks such as Vnesheconombank, Rosselkhozbank and Gazprombank, including trade finance lending, and they are already having an impact on the yields of the bonds of other sanction-listed banks such as Sberbank and VTB Bank.

With a pessimistic view of the situation, Panayotis Gavras, co-head of the policy and strategy department at the Black Sea Trade and Development Bank (BSTDB), tells GTR: “We’ll have to see how things play out with the sanctions, which is a completely unpredictable wildcard. Under some scenarios things could be absolutely awful, under very optimistic scenarios things could stabilise; I’m not however an optimist in this case.”

Wider sanctions could further restrict access to financing for both the private and public sectors and also reduce export market access. The ability of European banks to finance vanilla transactions to Russian banks and corporates would almost certainly dry up.

The sanctions imposed are threatening the bilateral trade links within the region and the heavily-exposed international banks are retracting from entering new transactions. “Between them, these two markets represent a huge part of the trade finance market for banks, particularly the European banks, and we are now at a stage where business is being badly affected,” says Cook.

According to recent research by Moody’s Analytics, French banks are the most exposed to Russia, followed by those in the US and Italy: “EU banks’ exposure, US$184bn to Russia and US$23bn to Ukraine as of Q3 of 2013, is likely to raise asset quality concerns and restrain lending if tensions intensify,” says the report.

Statistics from the World Bank show that syndicated bank lending in Europe and Central Asia halved to US$8bn in the first five months of the year, with the drop in banking flows to Turkey accounting for a big bulk of the reduction.

The whole region is tightening up because of the capital outflows, and banks have to now navigate a very complicated scenario of tightening of liquidity, which in turn will affect all financial operations: trade finance, investments, and corporate lending.

“Russia has demonstrated support to its banks,” Gavras says to GTR. He continues: “I imagine if things really get difficult, the State will certainly step in because they want to maintain the level of confidence in the lending within its banking system and they also want to show that they can go it alone despite
the sanctions.”

It’s a mixed message when looking at the BSR as a whole, but the EBRD’s latest Regional Economic Prospects report foresees economic growth in the region slowing to 1.4% in 2014 from 2.3% in 2013.

The BSR’s economic orientation has shifted towards the European Union (EU). A number of countries have become EU members and increased trade in the region, which has helped to lower country risk levels, improve sovereign credit ratings and encourage foreign direct investment.

The level of integration of the flows of financing and trade within the region have grown over the past decade. “Intra-regional trade and the importance of trade are much more unpredictable now than it used to be,” says Gavras. “Turkey has now become a top five trade partner within the region, whereas 15 years ago it wasn’t even in the top 20. Turkey has had a notable reorientation of trade towards the region and the Middle East in the last few years, but its outlook has deteriorated in light of tighter global financial conditions and reduced emerging market capital flows.”

Turkey has seen an expansion of credit as a result of increasing dependence on foreign funding. However, in many cases, “this has involved short-term syndicated lending, which will lead to significant refinancing risks,” says Antonio Timoner-Salva, senior economist of Eastern Europe, at IHS Global Insight.

Bulgaria is exceedingly exposed to the weakening activity in Russia: the country imports all its natural gas from Russia, and as such may become the hardest-hit in the region from the domino effect of sanctions.

Bulgaria is also going through a banking crisis with the nationalisation of Corpbank, the country’s fourth largest lender, reigniting lingering concerns over the banking sector’s stability. “The Bulgarian banking sector is still dominated by foreign-owned banking groups,” adds Timoner-Salva, so liquidity should still be accessible to corporates in the country. “However, an increasing unease with the local banks in the country could affect the lending strategy of healthy foreign-owned banks.”

European Banking Union membership has been requested, which will mean the European Central Bank will start to monitor the Bulgarian banking crisis, but this may not take place until next year.

“The star this year in the region is clearly Romania. They’re estimated to grow between 3 and 4%,” Gavras says. Romania’s manufacturing and exporting sectors have continued to strengthen and are in a strong position at present. “It’s probably the only country that we have on positive outlook, coming from a very high risk cartulary,” says Timoner-Salva.

Conversely, Ukraine’s banking system is experiencing a very fragile situation and is on the brink of a banking crisis. Timoner-Salva says: “The impairment of the validity of banks to serve clients has caused great damage to loan portfolios and the asset holdings of Ukrainian banks. There has been a grade devaluation of the currency, because of the increased perception of risk in the Ukraine, which has exacerbated the situation for Ukrainian banks.”

“Ukraine will be lucky if it’s at -6% this year,” says Gavras, but he believes that it could possibly be looking at a “double digit contraction on the current trend”. “I hate to speculate in that direction, but things aren’t getting much better.”

The BSTDB will continue to look at projects in Ukraine and Russia, but the risk considerations have changed. “Nobody’s off cover for us at the moment; it would have to be something extreme for us if we didn’t, but we don’t envisage that,” reveals Gavras of BSTDB.

A key concern for the BSR is whether the events in Russia and Ukraine have or will affect other markets in the region. Cook at Sullivan & Worcester believes that there hasn’t been too much of a reduction in business elsewhere in the region, though he tells GTR: “Historically, the volumes are much lower than in Russia and Ukraine to begin with so any impact would not be of the same sort of magnitude. However, it will be interesting to see whether banks’ and underwriters’ perception of the political risk in those countries is increased by virtue of events on Russia and Ukraine – if you like, the ‘will Putin look further afield?’ question.”

The overall trade and wider economic forecast within the BSR will be swayed heavily on this question. However, the biggest unanswered question for the industry to address is how will existing projects be refinanced when tenors come to a close?