No Compromise Met in Ukraine Debt Talks While Deadline Is Looming

Ukraine’s government failed to reach a compromise with Eurobond holders during the first round of negotiations, but it’s also not interested in default – especially during a wartime economy.

For half a year at least, news from debt restructuring negotiations was a subject of intense curiosity. The news from negotiations and preparations for them were confidential until June, 17, when the Ministry of Finance of Ukraine published a press release about the first round of negotiations.

An unsuccessful resolution so far

Since Russia’s full-scale invasion in 2022, Ukraine’s Eurobond holders agreed to a two-year moratorium and haven’t received any payments. The outcomes of Russia’s advance in the first half of 2022 were too uncertain – Russia was rumored to have planned to attack Kyiv for the second time after its first attempt in February 2022. 

The needs to finance military kept rising after 2022 – Ukraine’s debt-to-GDP ratio rose from 81.6 percent to 90.4 percent in the end of 2023, according to Ukraine’s central bank.

All debt cannot be repaid now since Ukraine will have nothing in its pocket to finance the military – and the country’s survival. When companies, countries or individuals lack money to repay their debts, they talk about easing debt conditions. That is called restructuring and is normal for the corporate world.

Ukraine needs to repay Eurobonds worth almost $20 billion. All of them were issued during 2015-2021, according to the Ministry of Finance website.

“I know we are asking private creditors for a substantial effort on their part, but without a restructuring, Ukraine will not be able to sufficiently finance our defense and embark on our bold recovery and reconstruction agenda,” Sergii Marchenko, Ukraine’s Finance Minister, said in a press release.

Two Options for Restructuring

After two years of standstill, first repayments are scheduled to start in August 2024, unless Ukraine’s government agrees to new conditions. 

Ukraine’s government has been negotiating debt restructuring over a twelve-day period from 3 to 14 June 2024. The other party is Ad Hoc Creditor Committee – several major institutional asset managers and other long-term investors in Ukraine representing around 20 percent of the outstanding amount of Ukraine’s Eurobonds, and other holders of Eurobonds.

The group includes Amundi, BlackRock and Amia Capital, according to Bloomberg. PJT Partners Ltd. and Weil, Gotshal & Manges LLP are their financial and legal advisors respectively. Meanwhile, the government retained Rothschild & Co. and White & Case LLP as financial and legal advisers.

Ukraine presented two restructuring strategies to bondholders. The first one is to exchange Eurobonds for a package of fixed income instruments, so-called Vanilla Bonds (Option 1).

There’s another option – exchange Eurobonds to Vanilla Bonds and state-contingent instruments (SCDIs) named as “the Ukraine Recovery Instruments”,  which value is dependent upon Ukraine’s performance on tax revenues and real GDP levels (Option 2).

These conditions would act during the IMF program period until 2027. In Option 1, the SCDIs would be converted into Vanilla Bonds in 2027. 

In Option 2, holders would receive $475 principal amount of Vanilla Bonds for each $1,000 in the principal amount of Eurobonds exchanged with accrued interest.

The Ukraine Recovery Instruments would become another type of instrument in Option 1. It is not a debt obligation and would not entitle its holders to any principal or interest payments.

URIs depend on conditions anchored in economic growth – if they are met, bondholders could get up to $1,000 per bond in exchange to the previous $1,000 invested before restructuring. If the conditions are not met, the bondholders would not receive payments.

“It’s as if one issues 35 fake coins to exchange for 35 real coins if the stars align,” Oleksandr Parashchii, Head of Research at Concorde Capital, told Kyiv Post.

Option 2 includes issuing Vanilla Bonds only, with $475 principal amount of Vanilla Bonds for each $1,000 in the amount of principal in Eurobonds exchanged, and the interest accrued.

Summary of Sovereign Proposal. Graphics provided to Kyiv Post from the Ministry of Finance.

Both strategies have been designed to deliver holders cash flows during the IMF program period. The securities would mature in 2034, 2035, 2036, 2038, and 2040. For now, the bonds would mature in 2024-2032, 2034 and 2035.

Interest rates for Vanilla Bonds in both Options are estimated at 1 percent in the second quarter of 2024 and throughout 2025, 3 percent during 2026-2027, and 6 percent from 2028 to maturity. In both options, the nominal trimming of the Eurobond ranged between 25 and 60 percent. These was one major disagreements between Ukraine and the creditors. 

A Compromise Among the Differences

“I have seldom seen so great a difference in initial views of conditions as here,” Andrii Nesteruk, Strategy chief at Finteum, wrote in his Facebook post. He said that the current government strategy may work as an anchor for investor’s expectations.

The “access to capital markets in the near future” is unavailable for Ukraine soon, and bondholders aren’t considering that Ukraine would be unable to pay significant interest payments, Nesteruk wrote.

The Creditor Committee suggested a nominal cut of 22.5 percent – just 2.5 percent less than the minimum cut in the government’s proposal.

Over the 2024-2027 period, bondholders want a 7.75 percent cash coupon and 0.5 percent as paid-in-kind (PIK) – meaning Ukraine would repay with goods or services. 

After 2027, a full cash coupon of 7.75 percent would be required.

Adjusted Committee Proposal Summary. Graphics provided to Kyiv Post from the Ministry of Finance.

Agreement not reached this time – is this the end?

Definitely not. “Both sides have shown their maximum of what they want to receive. The conditions may undergo significant adjustments already at the next stage of negotiations”, senior financial analyst at ICU group Taras Kotovych told Kyiv Post.

Ukraine did not develop its two-option-strategy on its own. Previously, Ukraine had discussed its proposal with staff of the IMF and the Secretariat of the Group of Creditors of Ukraine (GCU).

These proposals remain consistent with the debt sustainability objective of Ukraine’s IMF Extended Fund Facility (EFF). That is, Ukraine should reach 60 percent of its debt-to-GDP ratio in 2033, according to the third IMF Memorandum.

The IMF agreements gave Ukraine no room for compromise

“The IMF actually did not ‘let’ us pay anything with bonds for the duration of the program (until March 2027) but demanded a partial write-off of the debt,” Parashchii told Kyiv Post.

Bondholders, on the other hand, demand at least some payments in the coming years in exchange for the write-off, he added. The government proposed some payments, but the bondholders decided to demand repayment in full according to February 2022 price tag – 40 percent of the Eurobond.

The long-term debt trajectory, which assumes that the debt restructuring targets are delivered by 2033. Graph taken from IMF’s Memorandum after the Third Review of Extended Fund Facility Program. 

Though the first round did not bring good news, Ukraine still has other options rather than default

Bondholders don’t want to write off debt unconditionally – the Ministry of Finance needs to propose some conditions under which the entire debt will be restored, Parashchii said. The finance ministry would have to reduce the nominal cut.

But bondholders need to be aware Ukraine is unlikely to promise any payments during 2024-2027 – the IMF limitations are too tight.

The restructuring could have been postponed for another year if there had been such a possibility, Kotovysh said.

“However, investors want to receive interest payments on this debt, and this is unlikely to be agreed upon without a full restructuring”, he added.

Negotiations are happening in a situation of high uncertainty – and Parashchii is worried about it.

The discussions are based on macroeconomic forecasts of Ukraine from the IMF, and they “have very poor predictive power,” the Parashchii told Kyiv Post.

If he were in minister’s shoes, he would negotiate to postpone any bond payments “until the moment when it is possible to adequately forecast something in Ukraine.”

The question remains: Will the time ever come, with Russia as Ukraine’s neighbor constantly destabilizing world peace and Kyiv’s state budget?