Streetwise Professor

• Limited liability structure fully ring-fenced and non-recourse to Glencore apart from its €300 million equity contribution and the provision of margin guarantees of up to €1.4 billion, for which Glencore has obtained full indemnification from appropriate Russian banks.

My interpretation of this is term is that the loan funding the bulk of the purchase includes a margining feature, as in a stock margin loan. That is, the borrower is obligated to put up additional cash if the collateral value of the shares declines. In this case, Glencore has apparently promised to pay up to €1.4 billion. But apparently Glencore has passed this risk to “appropriate Russian banks.” (What’s an “appropriate bank”, anyways?) That is, the Russian banks will stump up the cash in the event of a stock price decline. Sounds to me like the banks have written a put on Rosneft shares (which is one of the structures that I had originally guessed at).

Well, puts aren’t free. Neither of the documents indicates the price of the put, or who is paying the premium.

If Glencore’s downside is limited to €300 million, certainly it doesn’t have a claim to 50 percent of the upside. One possibility is that it is paying for the put by writing a call. If so, the deal basically embeds a swap between Glencore and “appropriate banks” via which the risk of Rosneft shares are essentially transferred to the banks (with Glencore being short the swap and the banks long). If so, this would be a backdoor way for the Russian banks to buy Rosneft shares. To a first approximation their exposure is on the order of 9 percent (19.5 x .5 minus a little to reflect Glencore’s exposure).

This interpretation would square with Glencore’s assertion that “Glencore will not have any economic exposure to its interests in the Shares.” That means neither upside nor downside exposure. Where did the upside exposure go? Most likely to the Russian banks.

The QIA has been totally silent on the deal. It has not issued a press release. (Its web page looks like it was designed by a 15 year old in 1999, and is remarkably uninformative. Go figure.) Therefore, it is unknown if Qatar also has posted “margin guarantees.” If so, it would make calling the debt “non-recourse” highly misleading. It’s not as if QIA could put the keys in the mail and walk away with no additional liability in the event of a large decline in the value of Rosneft stock. Such a margin guarantee feature would effectively make a good portion of the debt recourse, rather than non-recourse, and convert its position into a conventional leveraged equity purchase. (This is because the lenders would have a claim on QIA assets beyond the initial investment.)

Another way to look at this is to ask: where does the risk go? The candidates are: QIA, Glencore, Intesa Sanpaolo and other funding banks, Russian banks “providing financing and credit support,” and even Rosneft (there would be Enronesque ways of passing the risk of an SPV back to Rosneft). Even with the additional disclosure, we only have a limited understanding of where the risk is going. Glencore is insisting its downside risk is very limited: €300 million. Its upside potential is unclear, but it is highly likely that has been transferred elsewhere, mainly to pay for Glencore’s limiting its downside exposure. We know some of the downside exposure has gone to Russian banks. The exact division is unclear.

If I had to guess, I would surmise that the exposure of Intesa and other banks providing funding is limited: margin guarantees limit their risk to a stock price decline. Due to the indemnification, Intesa et al have a rather complex exposure to the credit of Russian banks and Glencore, where this credit exposure also depends on the price of Rosneft stock. Good luck modeling that correlation risk and (implicit) tranching!

As I noted earlier, my guess is that Qatar has a fairly standard leveraged long position in Rosneft.

The Russian banks have a long position too, through the indemnification feature, and likely through the way that is paid for (e.g., a call). If this is the case, and if the “appropriate banks” are state banks like VTB, that makes the privatization something of a sham, or at least only half of what Sechin and Putin are trumpeting, because Russian state entities would have an long equity exposure to Rosneft.

A couple of asides on how this story evolved–or should I say is evolving. First, Rosneft evidently made its initial announcement without clearing it with Glencore. I have been told that the first Glencore’s corporate affairs people heard of the news was when reporters contacted them. Glencore then made a rather bizarre statement, the first sentence of which was: “Glencore notes the announcement released by the Russian government regarding the privatization of shares in Rosneft.” (Emphasis added.) Notes the announcement. Doesn’t confirm the truth of it, just notes it. Glencore then proceeded to say that negotiations were still ongoing and that no deal was finalized, though it anticipated such a result. Methinks that Rosneft made the announcement to pressure Glencore into finalizing the transaction.

Second, just how the official announcement would read was a  matter of contention up to the last minute. Rosneft told several wire services that they would receive a briefing at 11PM Moscow time on Friday (!). But that was delayed hours, apparently because Glencore and Rosneft (and their lawyers) were fighting over how Glencore’s participation would be described. My conjecture is that Rosneft wanted it to appear that Glencore was a full equity participant, thereby putting its imprimatur on Rosneft as a great investment: this would also conceal the risk being passed onto Russian banks. Glencore, as we’ve already seen, is intent on conveying that its exposure to Rosneft is minimal. This would no doubt allay its creditors concerns–but it would also undermine Sechin’s narrative. Hence the battle. Reading the releases, it looks like Glencore won. The sense I get is that Glencore is signaling that it gained significant trading benefits (a big offtake agreement, and potential for future commercial ventures with Rosneft) without having to expose itself all that much to Rosneft’s embedded price, operational, and political risks.

Perhaps some additional details will come out. But I doubt much more will. If I’m right, Rosneft and the Russian banks have little interest in disclosing how much risk Glencore is passing along to them. Glencore will be happy as long as it is convinced its creditors and investors believe that it has little exposure to Rosneft but has gained significant commercial advantages. And QIA don’t need to tell nobody nothing.

So as it stands, things are clearer than mud, but not much. Like the Brazos River or somesuch.