Can Kazakhstan live up to expectations
Trade hotspots come and go and there’s always one destination that sets bankers drooling. For the last couple of years, Kazakhstan has been up there with the big boys. Helen Castell reports.
Seemingly unstoppable economic growth, Central Asia’s best regulators and delightfully deep oil reserves have sent bankers scurrying onto Kazakhstan-bound planes for several years. Trade deals have come along thick and fast, high oil prices are sending dollars pouring into the country’s coffers, and trade financiers just can’t get enough.
But how long can a nation of just 15mn keep up this momentum – are bankers making quick cash while they can or is Kazakhstan with us for the long haul?
“The market’s been growing and growing, and the deal sizes are getting larger; banks are coming to market usually two, sometimes three, times a year,” says Ben Dobson, director, structured trade and export finance, at Deutsche Bank in London. “If you were doing a chart over the last four or five years, each year there are more deals and larger deals and at lower margins.”
In 2001 Deutsche arranged a US$100mn syndicated loan deal for Kazkommertzbank “and at the time both they and we were very excited about this deal,” he says. In December 2005, Kazkommertsbank was raising US$1.3bn (this deal was a GTR Best Deal of 2005).
Regulatory reform combined with an energy boom that began in 2000 can be credited for much of Kazakhstan’s growth – and the signs of success keep coming, says Larissa Orlova, a lawyer at Michael Wilson & Partners in Almaty.
Kazakh banks, already considered some of the best across the CIS, are now expanding rapidly across the ex-Soviet region, and in 2006 KazMunaiGas E&P and copper producer Kazakhmys both listed on the London Stock Exchange.
Favourable energy prices and a widening web of oil pipelines are driving Kazakhstan’s growth, says Zhanna Umarova, head of transaction banking, Kazakhstan, at ABN Amro in Almaty.
“I would describe Kazakhstan as a real success story, because we have capitalism but with oriental features,” she says. “Yes, we still have corruption, but overall the growth is quite obvious.”
“The volume of this business is growing rapidly,” but remains very linked to oil prices and the export of commodities, says Valentina Nagay, director of the international department at Texakabank in Almaty.
Kazakhstan’s biggest trade partners are Russia and China, while Western European countries such as Italy, France and Germany are big exporters of garments, shoes and printing and construction equipment, she says.
Trade with Asia, and particularly China, is behind much of Kazakhstan’s trade finance growth, says Gilles Sayer, head of Asia and Central Asia, structured finance, at Calyon in London. While Chinese demand for commodities such as oil and copper soars, so its investment in Kazakhstan’s energy and mining sector continues to deepen.
“We see more and more trade, or flow of commodities, between Central Asia and Asia,” he says.
China has indeed invested billions in oil companies and pipelines. China National Petroleum Corporation (CNPC) bought PetroKazakhstan, one of the country’s largest energy producers, in October 2005 and is now funding the Atasu-Alashankou pipeline, notes Muhammad Farooq Saleem, executive vice-president, Central Asian republics, at National Bank of Pakistan in Almaty.
Chinese conglomerate Citic Group meanwhile paid US$1.9bn in December for the Kazakh oil assets of Canada-based Nations Energy, giving it the mineral rights to develop Kazakhstan’s Karazhanbas oil and gasfield in Mangistau Oblast until 2020.
The country however with which Kazakhstan retains some of its strongest trading links – and against which it is increasingly measured – is Russia. And the comparisons are increasingly kind to Kazakhstan.
As well as reaching investment grade status ahead of Russia, Kazakhstan’s trade finance sector has been the ultimate beneficiary of plummeting pricing there, says Eric Van de Peer, director, trade finance, at Citibank Global Transaction Services in London. Low margins and high commodity prices on structured transactions across most ex-Soviet Union countries have fallen to the extent that deals are no longer of such interest, he says.
“Trade finance banks are rearranging their mindset – they’re looking for other countries within the CIS.” And investment grade Kazakhstan gives them the best trade assets around, he notes.
“Kazakhstan is considered a model transition economy in overcoming the legacy of the Soviet centralised command economy,” says Elena Lee, a lawyer at Michael Wilson & Partners in Almaty. Of all post-communist economies, Kazakhstan is ranked first in foreign direct investment and is now poised to join the WTO, she says.
Where Kazakhstan can really afford to be smug is in its swiftness to build a legal and regulatory framework that keeps investors and financiers coming back for business, observers say.
Kazakhstan has certainly developed better than most CIS countries, but this is partly to necessity, argues Gerg Vojack, managing partner, Central Asia, at law firm Bracewell & Giuliania in Almaty. “When Russia broke up the Soviet Union it had oil and gas production companies, grain companies, steel companies operating, and they had a degree of cashflow. So it could be less sensitive to rules and regulations that permit international flow.”
Without the infrastructure in place, and with a largely extractive economy, Kazakhstan meanwhile “had no choice,” he says. It needed to import materials to develop, and to do this it needed cross-border financing, “so it created a legal base that allowed trade finance to go forward.”
Achievements so far include a deepening of the banking sector, the advancement of financial sector regulation and improvements in company law, local players say.
One development was the 2001 Law on Grain, which established a legal framework for the circulation of grain receipts, enabling commercial banks to accept them as collateral and arrange pre-export financing for Kazakh grain companies, says Alfiya Aliyeva, head of structured finance at Kazkommertsbank in Almaty. Creating a similar legal framework for cotton receipts – not yet a reality but under discussion – could similarly help the market, she suggests.
Almaty has long fancied itself as a regional financial centre – able to provide a wide range of financial services on the international level – and progress here has been good, says Orlova.
Regional finance centre status should boost the country’s sluggish stock market, provide alternative funding for businesses, and bring in more foreign players, in turn stirring up competition and introducing sophisticated products and services, she says. And the regulators in charge of it seem to be doing a good job.
Solid regulation of the country’s financial sector is one of Kazakhstan’s key strengths in trade finance, says Dobson. “The Kazakh financial institutions have always had a very good reputation and that’s partly the effect of regulations. I think the Kazakh banking sector is generally seen as being strong and that’s maybe in contrast to the situation in other CIS countries.”
Because of this, syndicated deal sizes for top-tier banks like Kazkommertsbank and Bank TuranAlem have swelled to the US$1bn-plus mark, with banks from all over the world getting in on deals, he adds.
Another advance was the abolition in January 2007 of the licensing system for export and import deals, and currency exchange liberalisation has meanwhile removed restrictions on the purchase of foreign currency by legal entities. However, most capital transactions, payments and transfers are still subject to government approval through registration or notification regimes and strict documentary requirements, says Lee.
The National Bank of Kazakhstan also recently introduced a new method for calculating reserve requirements. Coming into effect March 2007, the ratios were designed to safeguard local banks – suddenly courted from all sides and able to tap a vast pool of syndicated lending – from building up unmanageable external borrowings, says Umarova.
“The central bank was very wise,” she says. “Now local banks think twice before they go for external long-term borrowing versus short-term loans in Kazakhstan.”
However, while the reserve requirements are good for the overall economy, they may restrict growth in the trade-related syndicated loans business, says Timur Sabyrbaev, head of financial institutions and global trade finance at Bank TuranAlem in Almaty. “That’s why maybe the FSA will provide help in order to switch from syndicated loans facilities to trade finance facilities.”
Kazakhstan’s ‘progressive’s regulations have helped both levels of the country’s two-tier banking system to develop, and should be credited for much of the sector’s growth, Nagay says.
Kazakhstan’s central bank is relatively open, and maintains a two-way relationship with banks, says Umarova. Whenever it makes changes to rules, it usually first distributes a draft among banks, which have the opportunity to comment. “It does not necessarily mean that the banks can influence, but at least there is a dialogue.”
However, although most bankers interviewed say the country’s legal and regulatory system was supportive of structured deals – especially when compared with other ex-Soviet countries – it is still far from perfect.
Current legislation on promissory notes, bills of exchange and their circulation in the market remain hurdles as are legal restrictions on the issuance of financial notes, says Kayrat Kaliyev, head of the international department at Nurbank in Almaty. It is hoped that this issue might be resolved within three or four years though, he notes.
“Kazakhstan’s legal system does not provide sufficient protection for private property,” Orlova notes. “With the weak rule of law, corruption remains widespread, and the judiciary views itself more as an arm of the executive than as an independent enforcer of contracts, or guardian of property rights.”
“The government constantly challenges contractual rights and legislates to favour domestic investors over foreign ones, all of which significantly deters foreign investment,” Lee continues. Although no sector of the economy is closed to overseas investment, the process of screening foreign proposals is “often non-transparent, arbitrary and slow”.
Not that that’s putting banks off. Kazakhstan has attracted foreign banks en masse in recent years. “There is a clear rush – everybody is coming,” says Frédéric Genet, global head of export finance at SG Corporate and Investment Banking in Paris.
Amng international banks, ABN Amro and Citibank have cornered much of the market, but many major banks are now active and more are expected to enter within the year, according to Orlova.
“There has been a lot of attention from banks generally on Kazakhstan, not just on structured trade finance but debt markets in general, and capital markets, equity markets – and that’s one key reason why we opened an office in Almaty last year,” says Calyon’s Sayer.
Large structured commodity financings remain few and far between and attract a great number of banks, he says. Calyon aside, main players include BNP Paribas, SG, ABN AMRO and HSBC, he says.
Citibank is building up its own activity in Kazakhstan, says Van de Peer. Local banks are also starting to get more involved, not only as syndicated borrowers but as trade finance product providers, he notes.
Of the country’s 10 biggest local banks, only two or three are active in pure trade finance though, says Umarova.
Bank TuranAlem, which says it has already captured more than 37% of the local trade finance market, plans to grow its trade finance portfolio by 20-25% in 2007, as well as continuing to expand throughout the CIS, according to Sabyrbaev.
While Almaty’s development as a regional financial centre will no doubt facilitate this growth, there is however one downside, he says. The rush of foreign banks to Kazakhstan is slowly eroding margins. The margin on a typical one-year letter of credit (LC) for example has fallen from around 14% two years ago to 12-13% now, he notes.
Too much competition
Other than that, foreign banks do not pose much direct competition to local banks, says Kaliyev. Instead they tend to focus on the more profitable retail banking sector, he notes.
As international banks crowd into Kazakhstan, pricing has come under sometimes unsustainable pressure, says Umarova. “There are always rumours about banks that are looking at the market – some even participate in deals without having any official representation in the country. And they really influence our margins,” she says. “Some international competitors will even go below Libor, which is something we would never do.”
“I’m afraid there are too many bankers for the size of the economy,” notes Genet.
Competition is certainly stiff. Whereas in 2000, an arranger bank might find itself up against another two or three banks for a mandate, now there are commonly 10-15 in any bid, says Dobson.
Syndicate banks also have much more appetite for Kazakhstan risk. “If you looked at the deals that were done last year, I think almost 95% of them would be oversubscribed.”
“When we started off doing these deals five years ago, the response was ‘we like the pricing but we don’t like the risk’. Now it’s the other way around – ‘we like the risk, but not so keen on the pricing’”, he adds.
Meanwhile, as large corporates become able to tap a variety of financing, the opportunities for structured commodity finance in Kazakhstan are becoming fewer, says Sayer.
It has become increasingly popular for some Kazakh companies to raise capital in Europe, especially London, through Eurobonds, medium-term note programmes and initial public offerings, Lee says.
Kazakhmys and KazMunaiGas have already raised US$1.16bn and US$2.03bn respectively on the London FTSE and Kazkommertsbank recently completed an IPO of its American Depository Receipts, raising US$5.3bn, she notes.
Back in trade finance land, the instruments most typically used differ according to sector. In grain, it’s mostly LCs and LGs, while in telecommunications, food processing and mining, cash finance and ECA finance dominate, says Aliyeva. Post-finance and deferred-payment LCs are often used in the auto dealer sector, whereas in construction, oil and gas, bid bonds and performance bonds are becoming more common.
Local currency deals have also remained popular since the currency depreciations of 2004, as have post-financings, whereby local banks issue LCs, which are afterwards funded by international banks, notes Umarova
Trade finance structures in Kazakhstan are mostly plain vanilla, although this is in some ways a credit to the country, says Van de Peer. “Why do you not see innovative new structures like ownership-based structures
- ” Because they’re not needed, he concludes.
“Kazakhstan has been a good pupil of the EBRD? a lot of CIS countries are miles apart from them, so in that respect structuring can be pretty traditional. As a matter of fact you’ll now see loosening of structures due to the increasing demand for Kazakh trade assets.”
Within syndicated loans, the purpose of funding is getting looser for the top two local banks “and I think that will probably be a trend that continues,” agrees Dobson. However, whereas trade-related loans – where funds are for general purposes, including but not limited to trade finance – are now the norm for top-tier banks, loans for second-tier banks are still mostly financing specific trade contracts, he notes.
There is also a drive towards increasingly sophisticated instruments.
“Leasing contracts are common for the procurement of expensive capital equipment, which are normally purchased by Kazakh or foreign financial institutions and subsequently leased to the end operator,” Orlova says. And “more complex deals involving a combination of leasing and securitisation are not uncommon these days.”
Kazakhstan’s trade finance market has already reached the level where it can be dubbed sophisticated, says Vojack. “I think trade finance progresses when it goes to the next level of structured finance? . and we’re beginning to see more of that.”
Local banks are under pressure to replicate. “I’m talking about project finance, ECA finance, I’m talking about securitisation, synthetic structures,” says Sabyrbaev. “If we do not provide those kinds of services, we will lose our position in the market.”
Banks are also accepting longer tenors on trade finance transactions, says Aliyeva. “There’s a good opportunity for the bank to substitute cash financing by documentary credit operations and as a result gain considerable capital relief.”
Kazkommertsbank last year arranged a forfaiting deal, for a customer that was buying equipment, with a discounted deferred payment LC issued for four years.
Reaping reserves riches
One big change in Kazakhstan is the level of risk lenders are prepared to take. “While before lenders generally relied on existing, established production of commodities, now they may lend against proven reserves, that are not yet producing,” says Sayer.
As reserve-based lending takes off it has meanwhile become more common to find banks hiring reservoir specialists or reservoir engineers into their teams, he notes.
The kinds of companies being financed has meanwhile evolved from purely national oil companies to independent producers who have access to a finite quantity of oil in reserves but still need the capital to develop those fields or increase production there, he adds.
And it’s not just within energy that the kinds of companies being financed are changing. Kazakhstan is on overdrive to diversify into different industries and this is filtering through into trade finance.
On top of its large oil and gas reserves, Kazakhstan is a major copper producer and has big reserves of uranium, coal, iron ore, chromium and zinc, while in the north of the country it has a significant grain harvest, notes Vojack.
However, with oil accounting for 60% of Kazakhstan’s exports, the country is still very energy dependent, says Umarova. Concerned about the potential effects of an oil price crash, it is working hard to diversify, with the creation of state-run enterprises dedicated to developing manufacturing and other industries.
“The Kazakh government and financial institutions like the IMF have been concerned about the dangers of ‘Dutch Disease’, the economic phenomenon that occurs when large influxes of foreign currency distort exchange rates and ultimately hinder growth in the non-energy sector,” notes Lee. “In its latest report, however, the IMF cites “impressive” growth in the non-oil sector.”
Not all oil
Diversification is well under way in Kazakhstan, says Van de Peer. “Energy of course gets all the attention because the amounts are so big, so banks tend to pitch for it aggressively,” but there are in fact a flurry of secondary deals for everything from metal to socks, he says.
Citibank is now in its second year of a wheat inventory finance programme that it launched for privately-owned Kazakh wheat aggregators.
One of SG’s key deals in Kazakhstan includes a US$59mn US Ex-Im-backed loan last year to Kazkommertsbank, says Genet. It was to finance Winncom Technologies’s Astana Next Generation multi-service telecom network.
Local banks perhaps have most to gain from diversification. “[Oil and gas] companies are really rich in terms of funds? so they don’t need support from Kazakh banks,” says Sabyrbaev. “It’s difficult for us to discuss potential business with them.”
First, they have often already forged relationships with foreign banks, which are able to provide cheaper financing, and second, energy majors tend to do business with long-term partners, reducing the need to use LCs or guarantees to cut risk, he explains.
Diversification is also changing Kazakhstan’s political standing in the region, adding a new dimension to its dealing with Russia, argues Saleem. “Astana’s growing influence has already strengthened its position in negotiations with Russia’s Gazprom, both over transit fees for gas, originating in Turkmenistan and Uzbekistan, and in efforts to use the Russian monopoly’s pipelines to ship its own gas supplies.” Gas could become just as important for the country as oil in the long-term, he predicts.
So what does the future hold for Kazakhstan and how long can the good times last
- President Nazarbayev has bold plans to achieve 350% GDP growth in the 15 years up to 2015, and the target is not that unrealistic claims law firm Michael Wilson.
Assuming annual GDP growth rates of 7-8% continue, this should be enough to keep the trade finance on track. And Kazakhstan’s plans to join the WTO will give local producers, suddenly faced with more foreign competition, an added incentive to modernise their facilities, says Aliyeva.
Unforeseen political calamities aside, Kazakhstan’s continued growth seems assured, says Van de Peer. Its strong economic and regulatory health could see it graduate beyond structured transactional business towards more corporate banking style deals and, if oil prices remain high, new structures such as oil-based finance, may make their debut, he predicts.
“It’s almost certain there will be quite a high volume of deals this year,” agrees Dobson. By January Deutsche had already been mandated with RZB and Unicredit for a two-year Nurbank facility, he notes.
However, although there should be a constant supply of transactions in the loan market, a lot depends on where the margins move, he says. Some Kazakh banks are close to reaching saturation point in terms of how much they can borrow, while some regular deal participants have dropped out because of low pricing.
Indeed, Kazakhstan’s size may turn out to be its biggest stumbling block. With only around 20 large corporates and a population of just 15mn people, however much it grows, some observers fear it will never feed everyone’s appetite.
“So far so good – trade volumes are growing proportionately to the growth in the economy,” says Umarova. “But if we have big deals, it will be just one or two in a year.”
The country is just too small for the level of growth some are expecting, Genet concludes. Even if expansion is strong, and diversification achieves some success, the economy will for a long while remain oil based. “Most of the projects are paid for by the oil sponsors – they don’t need that much financing for the oil industry.” And that could leave some bankers out in the cold.