Almost 18 months since the annexation of Crimea by Russia, Melodie Michel looks at how trade insurers have been affected by the Ukraine crisis.
It’s been almost a year since the leaders of the Russian Federation, the Donetsk People’s Republic (DPR), and the Lugansk People’s Republic (LPR) signed the Minsk Protocol to end war in the Donbass region of Ukraine, and although the agreement included an immediate ceasefire, fighting is still a daily occurrence.
The reason for this status quo is that Russia and Ukraine have very different views of how the protocol should be implemented.
Alex Kokcharov, principal analyst at IHS, explains: “Ukraine says that the demilitarisation of the conflict has to be achieved first, and it needs to get access to the 400km of the border to cut any supplies of weaponry and ammunition from Russia into the separatist-controlled areas. Then, Ukraine is happy to proceed with finding a political solution after the local elections are held under Ukrainian electoral law.”
This is the approach agreed upon in Minsk, but Russia is now pushing for things to be done in a different order: “Russia wants the political solution first, and the end of the conflict second, and is not very keen on re-establishing Ukrainian control of the 400km of border. They want the separatist republic reintegrated politically in Ukraine so they would become Russian proxies and be able to block any significant policy developments in the country, in particular further integration in the EU,” adds Kokcharov.
Russia is also continuing to supply the separatists with arms and ammunition despite the sanctions imposed by the west to condemn that behaviour – sanctions that have crippled an economy already affected by the fall in oil prices.
Perception of stability
In these circumstances, while the need for political risk and trade credit cover is heightened, the drop in trade transactions has undeniably hit the insurance sector: Berne Union statistics show that investment insurance in Russia decreased by US$2bn between 2013 and 2014. And the situation is unlikely to get better as long as insurers are still coping with the incredible amounts of claims generated by the crisis: again in Russia, medium to long-term insurance claims grew from US$64mn in 2013 to a whopping US$296mn in 2014, while short-term credit insurance claims almost doubled, from US$40mn to US$76mn.
Still, the private sector remains optimistic about its biggest market. “There’s an increased perception of stability. Insurance companies and FIs are now more at ease with the sanctions regime and have worked out their internal procedures on how to deal with them. The obligors we’re seeing are the same names we were seeing 12, 24, 36 months ago. Demand is picking up again,” says Henry Mummé-Young, underwriter, specialty division, at The Channel Syndicate.
As a relatively new insurer, The Channel Syndicate doesn’t have the legacy some of its peers have in Russia. So while others are scaling back large exposures and monitoring problem cases, it is in a good position to meet new demand. But even more seasoned brokers still see the country’s appeal – particularly now that reduced supply and increased risks have pushed prices up.
David Maule, executive director of credit and political risk at Arthur J Gallagher, explains: “The exposure has dropped enormously because the deals that used to get done just can’t get done, and it’s only short-term deals that get done because of the sanctions. Because it’s viewed as risky, the insurers have been able to charge high prices for Russia exposure, even getting the same rates as what they’ve been getting in Ukraine, up to 3 to 4% per annum.
“The insurers would love to do more. If the sanctions get extended it won’t change, but if they get exacerbated, then it could get worse. Obviously so long as the sanctions are in place, the huge demand that was there before the crisis won’t come back.”
Russia’s economy has already been hit hard by both the sanctions and low oil prices – IHS analysis shows that in May 2015 Russia’s GDP contracted by 4.9%, and industrial output fell by over 6.3%, which is the highest rate since September 2009.
Russia is also dealing with massive capital outflow: US$160bn last year, and US$110bn forecast for this year. According to IHS, the worst is yet to come, with the largest contraction of GDP projected between October and December 2015.
For that reason, the country will likely do its best to prevent any further economic restrictions, keeping its actions in Ukraine on the down low while still maintaining its latent influence.
“While Russia is prepared to deal with the current level of sanctions – the central bank for instance has made its forecast up to 2018 with an assumption of the current level of sanctions being maintained – it wants to avoid further sanctions. That’s the reason we don’t think Moscow would endorse any significant offensive in Ukraine, because the cost of that to the Russian economy would be too significant, but at the same time, they can create significant destabilisation to Ukraine, with the existing level of involvement supporting the separatists to the east,” Kokcharov explains.
In the meantime, tighter credit conditions have led to an improvement in deal structures, and an uptick in demand for investment insurance for both existing and new deals. Still, the combination of sanctions and lack of transparency makes Russia difficult to navigate from a legal standpoint. Mummé-Young tells GTR about a recent case when his firm asked for information on the shared ownership of a company and received a two-year-old document, despite the fact that a simple Google search could confirm that ownership had changed after that (without specifying who the new owners were).
When it comes to the list of specially designated nationals (SDNs) included in the sanctions, the involvement in companies both inside and outside Russia, combined with the country’s lack of transparency, creates challenges for underwrites. “You have situations where SDNs have actually changed the ownership structure of their companies, like when Gennady Timchenko sold his share in Gunvor – that causes a big reputational risk as well as sanctions risk.
“Something that might be within the letter of the law is not really something that underwriters necessarily want to be involved in if the rationale for the change of ownership is just to beat sanctions. And that is a real concern for our market – it’s really a lack of information,” Mummé-Young says.
While the mood remains optimistic in Russia, the situation in Ukraine is much more dire. Political risk remains severe due to the war situation in the east, which, though very localised, is destabilising the whole country. There are elevated terrorism risks in large cities in the east and south, and possibly even in Kiev. According to IHS predictions, GDP contraction is likely to be in the area of 9% this year, inflation is on the rise and incomes are 23% lower than they were a year ago. And while so far Ukrainians have accepted the sacrifices that have derived from the conflict, further economic deterioration could lead to protests.
Ukraine is in extreme need of foreign funds to keep afloat, and although there appears to be political will from western governments to provide help, the private sector is lagging behind. The IMF approved a US$17.5bn loan last February, US$5bn of which has already been disbursed. The country now needs to pass banking and energy reform laws to receive the next, US$1.7bn, tranche in August, which doesn’t look like it will be a problem. But foreign direct investment is dropping, and it’s unclear whether US-born finance minister Natalie Jaresko’s negotiation skills will prove successful with private investors demanding full payment on the US$15bn worth of high-yielding bonds they bought at a discount after Crimea’s annexation last year. As this supplement went to press, the government had extended its deadline for talks to restructure its US$70bn sovereign debt, with default fears becoming more and more present.
“There is a possibility of Ukrainian default, at least a technical default, and this would clearly change a lot including state contract observation risk. There are problems for the government stability there, so the situation is really complicated. The combination of both economic risk and political risk make policy choices for the government very difficult,” explains Kokcharov.
The little investment that does flow into Ukraine goes mainly to the agricultural sector: Kernel received a US$65mn credit facility from a syndicate of European banks in June, and fellow sunflower oil producer ViOil recently scored a US$40mn syndicated loan from the EBRD and ING.
“There has been quite a lot of demand but very little supply of insurance,” Maule says. “Any deals that are getting done are small renewals, short-term PXF possibly of grain purchases. You can still get insurance on them but it’s very tough, and anything new is declined.”
Because the economy was already in bad shape before the conflict, most insurers have not had large exposures to Ukraine for a while, but those that were still present in the country are likely to get burned. “We expect there to be a whole lot of claims coming in pretty soon if they haven’t come in already. We have one ourselves in the steel sector which is going to cost the market US$25mn, so it’s not looking good,” Maule adds.
In his opinion, insurance pricing, even the renewal of agricultural PXFs, has gone up to around 4% per year, and he doesn’t expect things to improve until at least the end of 2016. “Insurers don’t want to cover any risks — it’s pretty basic.”
As a younger insurer, The Channel Syndicate has no exposure in Ukraine at all, and though Mummé-Young says the firm is “happy to look at prospects”, he believes demand has been reactive rather than proactive: “There are sporadic requests on the political violence side but they look to be a case of ‘the house is already on fire and then they’re coming to buy insurance’, and that’s obviously very difficult for underwriters.”
Even ECAs traditionally present in the market, despite keeping their offering open in principle, have done little to no business in the country since the conflict began, mainly because of banks’ reluctance to finance Ukrainian deals. “We in principle remain open on Ukraine but the reality is that there is very little activity in the market right now. The few deals we have written of late typically represented legacy transactions from our pre-crises pipeline or were associated with hard currency generating export projects, for example in the agri sector which has traditionally been strong in Ukraine and continues to operate reasonably well,” says Philipp Rossberg, chief operating officer at the German ECA, Euler Hermes.
While western governments have largely taken Ukraine’s side in the conflict that opposes it to its eastern neighbour, from a commercial standpoint, it looks like Russia is still largely winning Europe’s favours.