Unexpected Trading Dynamics of Secured Sovereign Debt – Insolvency/Bankruptcy

What do Ukraine, Sri Lanka and Ghana have in common? They have all guaranteed bonds that once traded at a significant discount to their sovereign counterparts.

In the months since Russia began “special military operations” in late February this year, much of the world has watched in horror as Russia’s large-scale invasion of eastern Ukraine. As this invasion drags on into its fifth month, financial markets and the press have been paying great attention to the impact of the Russian invasion on Ukraine’s sovereign bonds and GDP warrants. This scrutiny will no doubt intensify in the coming months as holders seek to organize ahead of an upcoming $900 million deadline in September. However, relatively less attention has been paid to Ukraine’s billions of dollars of guaranteed bonds, and a $700 million Eurobond issue in particular.

Issued last summer by Ukravtodor, Ukraine’s national road authority, the 6.25% bonds maturing in 2028 are backed primarily by tolls, fines and fees collected by the agency, as well as revenue from the excise tax allocated by law to Ukravtodor from the central government. In addition, the bonds also benefit from a sovereign guarantee; in particular, Ukraine has “irrevocably and unconditionally” guaranteed “regular and punctual payment of all amounts due” with respect to Ukravtodor obligations.1 The bond guarantee deed describes the guarantee as a “primary obligation” of Ukraine, indicating that the sovereign is the principal debtor of the bonds alongside Ukravtodor, and “not merely [a] bail.”

In an execution scenario, holders would almost certainly rely on this wording to argue that the Ukraine bond constitutes an “independent guarantee” under English law – in other words, that it does not It is not necessary to sue the issuer first before suing the guarantor (similar to a payment guarantee under US commercial law). In addition, according to the offer documents, the guarantee is past bet with all of Ukraine’s other unsubordinated and unsecured debt, which means the holders would likely argue that any recovery from Ukraine under the guarantee should be at least equal to that received by sovereign bondholders from the government in the context of a restructuring. Finally, the terms and conditions of the bonds appear to include a cross-default clause regarding Ukraine’s sovereign debt. This means that, even if Ukravtodor were to remain current on its debt service despite a sovereign default, bondholders would argue that such a default nevertheless accelerated Ukraine’s obligations under the guarantee, thereby enabling its immediate execution.

In summary, if Ukravtodor holders were successful in making these claims, then in the event of Ukraine defaulting on its sovereign debt, those holders could immediately assert against Ukraine the full amount of Ukravtodor bonds that remain outstanding. , then sue Ukravtodor to recover any remaining deficiencies. In light of the above, one would expect the market to view recoveries on Ukrainian sovereign bonds as a mere floor, to be supplemented by whatever can be recovered directly from Ukravtodor (or, as subsidiary, that the Ukravtodor obligations are cut out of the framework of a restructuring entirely). The trading prices of each respective stock seem to tell a different story. In fact, although prices have recently normalized, 6.25% Ukravtodor Eurobonds due 2028 have historically traded at a big discountsovereign bonds of Ukraine.

Based on the available data,2 as of June 30, 2022, over the previous year, Ukravtodor bonds appear to have traded on average almost 810 basis points lower than 7.75% Ukrainian bonds due 2027. There is no doubt that the higher coupon and shorter duration of the sovereign bond vis-à-vis the covered bonds were relevant to their respective market prices; however, Ukravtodor’s debt was also around 360 basis points behind the 6.876% bonds due 2029:

Source: Bloomberg Terminal as of June 30, 2022.

And in case anyone thought it was just a fluke, this pattern isn’t just limited to Ukravtodor. A similar dynamic previously existed in the relative prices of Sri Lankan sovereign debt of the same maturity and bonds issued by SriLankan Airlines backed by a sovereign guarantee: again, despite the potential for multiple sources of recovery, the latter traded for much of 2021 and early 2022 at a significant discount to the former, with the spread at one point reaching close to 700 basis points:


Source: Bloomberg Terminal as of June 30, 2022.

And in the twelve months ending June 30, 2022, bonds issued by STX Engineering and guaranteed by the central government of Ghana lagged Ghana sovereign bonds of the same date by one year.
average of more than 1,200 basis points:


Source: Bloomberg Terminal as of June 30, 2022.

Historically, the same thing happened in Puerto Rico following its default, where for a time bonds issued by the Public Buildings Authority that had a central government guarantee traded at a discount to general bonds issued directly. Investors savvy enough (or perhaps lucky) to buy PBA bonds cheaply were no doubt pleased with the end result in this case, where some PBA bonds received recoveries greater than 10% (as a percentage of face value)3than GO bonds of the same date.4

Now, as noted, in recent weeks the prices of Ukravtodor bonds and Ukrainian sovereign bonds of the same date have rapidly converged. And since a Sri Lankan default was seen by the market as almost inevitable in April 2022, airline bonds have now consistently traded above their sovereign counterparts. Similarly, as Ghana’s sovereign bonds fell following ratings downgrade, the gap between its direct and guaranteed obligations has all but evaporated as well. But even though market participants seem to have realized the arbitrage potential inherent in these specific credits, the question remains: what is causing the seemingly bizarre price dislocations relative to sovereign covered bonds in the first place?

As indicated, this phenomenon is probably partly explained by differences in content and yield. Variations in legal protections (for example, conflict of law clauses, collective action clauses) should, at least in theory, also have an impact on the price. Liquidity should also play a role, as there is often simply more sovereign debt available to change hands: Ukravtodor’s $700m issue, for example, pales in comparison to the $20bn+ external sovereign bonds issued by Ukraine that remain outstanding and available for trading. . Some have also suggested that psychology plays a role, with some investors – rightly or wrongly – simply viewing a sovereign bond as “the safest credit”.5

Whatever the reason, the fact is that sovereign-backed corporate bonds often trade at a relative discount to “true” sovereign credit risk, offering the discerning investor the opportunity to build a position at an attractive price. But, like most good things in life, those opportunities don’t seem to last too long.


1. See Offer circular for the State Roads Agency of Ukraine (Ukravtodor), US$700,000,000 6.250 percent. Amortization guaranteed notes due 2028 (June 22, 2021).

2. Ukravtodor bond trading data was not readily available for some time periods from December 2021 to May 2022.

3. See in general Information Statement for the Commonwealth of Puerto Rico’s Seventh Amended Title III Joint Adjustment Plan, et al., In re Fin. Supervision and management. comic. for public relationsNo. 17-BK-3283-LTS (DPR July 30, 2021), ECF No. 17628.

4. And even before that, holders of corporate bonds issued by Greek companies and guaranteed by the state emerged more or less unscathed from Greece’s restructuring in 2012 and escaped the severe NPV haircuts imposed to holders of Greek sovereign bonds.
See Stephen J. Choi and Mitu Gulati, “The pricing of off-price terms in sovereign bonds: the case of Greek guarantees(September 1, 2016). Journal of law, finance and accounting, flight. 1, No. 1, 2016, Duke Law School Public Law & Legal Theory Series No. 2016-52, available at SSRN.

5. Mitu Gulati & Mark Weidemaier, “This strange bond guaranteed by a Sri Lankan airline“, Credit reports (April 28, 2022).

Due to the generality of this update, the information provided here may not be applicable in all situations and should not be applied without specific legal advice based on particular situations.

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