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Foreign holdings of Ukrainian domestic bills reached a record US$4bn at the end of September according to statistics the National Bank of Ukraine (NBU).

The NBU’s affiliation with Clearstream played an important role in increasing investor confidence in Ukraine’s capital markets as it took them more than three years to put the mechanism in place, and it appears to have paid off already.

National Bank of Ukraine Clearstream

This wasn’t the case two years ago according to Konstantin Stetsenko, founding partner of ICU, Ukraine’s leading asset manager. Mr. Stetsenko said that the holding of foreign investors in Ukrainian bonds was barely above zero. He attributes this to lack of confidence in the market for hryvnia-denominated bonds, as settlement was something of a bureaucratic nightmare. He adds that before the Clearstream link was implemented, foreigners needed a special investment account with a Ukrainian bank, and a signed agreement with a local broker. This meant extra expense and cost time as well. 

Foreign investors entered the bond market in a big way in August 2017, when they also participated in the debut issues of credit linked notes (CLN) organized by Citigroup. By using CLN, foreign investors could by-pass the bureaucratic requirements of investing in the Ukraine bond market. They could purchase CLN abroad, leaving Citigroup to comply with bureaucratic procedures. Similarly, foreign investors were able to use the same infrastructure to purchase global depository notes (GDN) according to Konstantin Stetsenko. These instruments were issued by international banks using global infrastructure with Ukrainian local-currency bills as the reference asset.

Foreign investors have slowly been testing the Ukrainian domestic-bills market. By March 2018, their portfolios rose to US$0.56bn. Mr. Stetsenko believes seasonal volatility of hryvnia also played an important role, boosted by an attractive FX profit and high interest rate.

This year started off with a new wave of investments, and in significantly larger amounts. By the end of April, foreign investor holdings rose to US$1.37bn, as Ukrainian local-currency bills offered some of the best interest rates in the world. This spring, interest rates exceeded 19%. Rates declined somewhat with the easing of monetary policy and increased demand for UAH-denominated bills, but most issues are still above 16%. 

When the Clearstream account was launched in Ukraine, foreign investors’ portfolios were US$1.57bn, having been helped by the 5% appreciation of the hryvnia since the beginning of the year. 

At the same time, other currencies are attracting investment in addition to the hryvnia. Since the beginning of 2019 until now, Ukrainian hryvnia appreciated by 13% and the Egyptian pound appreciated by 8.9%; the Nigerian naira was strong. On the other hand, while once attractive, the Argentinian peso, Brazilian real and Turkish lira are now weak.

Source: Bloomberg, ICU

In only four months since Clearstream was launched in Ukraine, foreign investor holdings more than doubled, reaching US$4bn. As a way to increase demand, the Ministry of Finance of Ukraine offered in June a new, six-year note, which was currently sold at UAH33.9bn (US$1.4bn). The NBU further easing monetary policy and cutting the key policy rate has added additional stimulus to demand for longer instruments. If all goes according to plan, the trend is likely to continue, says Konstantin Stetsenko.

Source: NBU, Bloomberg, ICU

Mr. Stetsenko commented that while the collaboration of Ukraine and Clearstream will not solve all problems connected to investments in Ukraine, it is a major achievement on the path to making Ukrainian government bonds and the Ukrainian currency even more attractive to foreigners. He believes Ukraine is moving in the right direction to open its local market to a broader range of investors and that the move also helps integrate the Ukrainian market into international trading platforms like Bloomberg and Thomson Reuters. This will enable faster and easier trading of Ukrainian bills for all investors, both Ukrainian and foreign. 

Critically important will be including Ukrainian bills in the bonds indices, e.g. EMBI+ or GBI-EM, which can happen now when total bonds outstanding of 5-year note exceeded US$1bn, depending on index rules. 

As investors see the market open, they will gradually change their strategy from looking for a quick profit in short-term investments in UAH-denominated bills, to making longer-term investments in instruments that are supported by active trading. Mr Stetsenko believes Ukraine is taking all the right steps to attract long-term foreign investment, broadening the Ukrainian market. 

Investors believe that a further benefit to building a liquid market for government debt would be to create a real yield curve that can be used to as a benchmark for corporate debt. This strategy has worked for other countries that have adopted Clearstream, and it should for Ukraine, too.