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Burenin: the court’s Decision on the deal “savings&Transneft” is killing the real sector

Буренин: Решение суда по сделке "Сбербанк&Транснефть" убивает реальный сектор

Professor, doctor of Economics, Professor of International Finance MGIMO(U) MFA of Russia Alexei Burenin said “Arguments of the week” that the court’s decision on the deal “savings&Transneft” is killing the real sector. Market securities and derivative financial instruments.” The deal Transneft Sberbank interesting and instructive in many ways, however, draws attention to the paradox. The transaction, which according to “plan” Sberbank was to provide Transneft additional funding to service the coupon payments on its bonds, led to the fact that Transneft has suffered astronomical losses in the amount of 1 billion dollars, which was Sberbank. Losses incurred by Transneft, is able to bankrupt any company of a smaller size than Transneft. Financial instruments, which with persistence of the savings Bank has imposed Transneft, can be called, to quote Warren Buffett, weapons of mass destruction. Refer to the text of the Decision of the court of Appeal.

The first landmark judicial approval of the terms of the transaction “was symmetrical and did not violate the balance of the parties.” I would disagree with that. At the conclusion of the call option the buyer of the option bears the risk of losses in the amount of premium paid, and the seller assumes the risk of unlimited losses. If the transaction is parties for speculative purposes, the symmetry and balance of the positions is achieved by the value of the premiums, paid by the buyer. In the transaction Transneft was the seller of the call option, however, unlike the savings Bank, she wasn’t a speculative purpose, and sought to solve the problem of obtaining additional financing to service the payments on its bonds, and this idea suggested itself to her Sberbank. This is evidenced by the presentation title of the savings Bank for Transneft: “Liability Cheapening Ideas for Transneft and NSCP” or “Ideas to reduce the cost of debt Transneft”. In the transaction Transneft was not going to play the role of speculator, and the savings Bank, as we have seen, introduced it in a completely different light, initially disoriented Transneft. Really, what kind of cheaper debt can be a speech if you impose a position with unlimited risk? In turn, the risk of loss of Sberbank was reduced to only the amount of premium paid. But even this risk is reduced due to the fact that persuaded Transneft to buy from him is absolutely unnecessary Transneft put option. To persuade Transneft to buy the put option, the Bank referred to the fact that in such a combination, i.e. simultaneous sale of a call option and buying put option (risk-reversal), “…the deal was consistent with the Standard documentation for forward transactions on financial markets (RISDA)”. (Review of Sberbank in the statement of Transneft, p. 40) However, even under a microscope, we do not find such statement in RISDA. Here, the savings Bank has explained that “use in conjunction with the call option the put option is allowed to reach the exact amount of money that the Company needed to reduce the cost of service of bonds…” . (Review of Sberbank in the statement of Transneft, p. 40). Whether so it actually?

If the task was to get the exact amount needed by the company to reduce the cost of service of bonds, it was possible to achieve by merely reducing the value of the call option. Calculations show that in this case the value of the call option would decrease by 260 million dollars, and, consequently, would decrease the risk of Transneft, but notice, and speculative winnings of the savings Bank. Only due to the fact that Sberbank Transneft has imposed a put option and increased in this connection, the value of call option on 260 million dollars, Transneft additionally lost 8.5 billion. Thus, the savings Bank imposed Transneft frankly speculative transaction.

Why Transneft after repeated persuasion of the savings Bank has agreed to make a deal? This can be explained by the fact that the Bank had acted as adviser to Transneft and is not acted against the interests of the company, so Transneft’s no reason not to trust the savings Bank in its quest to really offer Transneft a tool to reduce the cost of its debt.

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Further, in assessing the balance of positions court on formal grounds assessed the qualification of the parties as the same. In particular, the Resolution noted that Transneft “…there are specialized units that provide assessment and management of risks, including foreign exchange,…therefore the plaintiff could adequately assess their risks from entering into the disputed transactions prior to their conclusion” (p. 10). Even on formal grounds not to agree with this statement. Sberbank specializiruetsya on operations with various derivative instruments. For Transneft’s the deal with barrier options was first experience. Why Transneft to have a specialist in barrier options, if it has never engaged in similar transactions, and if they could occur as a single episode. No company in the production sector does not hold in the state the whole set of experts in all existing state-of highly complex derivatives. This directly contradicts the logic of the efficient forms of doing business. To do this, and there are just banks-consultants.

In the game with currency options which the Bank had led in 2014-2015, the victims were not alone Transneft. Among the victims of this game the leaders of the Russian industry, which received billions in losses – “Rosneft” – 122 billion rubles, “Uralkali” – 36, “Aeroflot” – 27,4, “NOVATEK” – 20, AKH “Dry” – 13.5 billion. A settlement agreement was proposed only AKHK “Sukhoi”. Under the terms of the settlement agreement, the savings Bank may reimburse the “Dry” half of the losses amount to 7.8 billion rubles out of 13.5. Other partners of the savings Bank …was not so lucky. As you can see, not one Transneft has suffered losses in transactions with the savings Bank. Is this a coincidence or a pattern? Maybe these companies do not have departments of the financial sector, analysts and risk managers? We believe that it is not. Then why companies have suffered such losses? It appears that the answer will be the same as in the case of Transneft: the fact that the presence in the structure of the leading Russian companies have financial departments is not to say that the level of training of personnel is comparable to the level of training of specialists of banks. Losses eloquently prove that it is impossible to put on the same level of knowledge and experience of staff in financial departments of companies and the experience and knowledge of Bank employees. Their huge losses, companies say that in such transactions and litigation, banks and manufacturing companies can not be considered as equivalent parties.

The following important point. The structure of the deal was to limit risk to acceptable Transneft level. This provision is Central to such presentations as “Ideas to reduce the cost of debt”, otherwise to “reduce” from the very beginning is questionable. And obviously the deal to reduce the cost of obligations without limiting risk is absurd. Why Sberbank has not offered Transneft to structure the transaction so as to limit the risk of the company? The answer is obvious: Sberbank acted as a speculator, and the source of his profit in the transaction is the loss of Transneft, and the greater the loss of Transneft, the higher the profits of the savings Bank.

In the judgment of the court of Appeals noted that “other transactions with derivative instruments, which were concluded with PJSC “Transneft”, no different from the disputed transactions, except for the presence of barrier terms” (p. 11). It appears that this phrase must stress that if you’ve made simple options, and barrier is almost the same. However, the judges apparently do not sufficiently familiar with derivative financial instruments and are unaware that changing a technical parameter of a financial instrument changes its qualitative characteristics and, therefore, the strategy of risk management. Therefore, a good command of a simple call option does not mean that this investor will automatically be able to perform and cope with barrier options. For clarity, we present comparison. In fact, the court says that if we take the glider and jet plane, the aircraft differs from the airframe only with stock motor. Therefore, if an experienced glider pilot to land an aircraft, it must also skillfully dealing with it as a glider. Of course, this is misleading.

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It appears from the Decision, the appellate court did not sufficiently good command of the essence of the transactions in barrier options. The fact that in comparison with conventional call option barrier option with a suspensive condition, when the barrier price is significantly above the strike price, the seller is “mine” waiting to happen. The high level of prices creates a barrier for the inexperienced investor a false sense of security, because the probability of a significant growth rate of the underlying asset is perceived as not high. Otherwise the seller would not participate in the transaction. However, when the barrier rate, then the seller is immediately bombarded by an avalanche of accumulated losses that are impossible to avoid.

The judgment read that the inclusion of Sberbank barrier “..the conditions were aimed at protecting the interests of the plaintiff and reduced the risks of costs and losses” (p. 11). Thus, the savings Bank, which had a speculative purpose in the transaction, and profit is directly dependent on the loss of Transneft, took care to protect her interests and to reduce losses? Isn’t it, sounds at least strange. In addition, the court did not consider that in the transaction the savings Bank has positioned itself as the counterparty of Transneft, therefore, had no reason to care about her interests to the detriment of their own.

The resolution read: “Even after the exercise of the option (21.09.2015) and to sue (December 2016), i.e., for more than a year, the plaintiff believed the disputed transaction is valid and no claims were presented” (p. 6). This fact only says that Transneft has taken a year to fully understand the financial instrument, which was imposed on Sberbank, resulting in astronomical losses. Losses the likelihood of which, according to Sberbank, was extremely small.

The court writes: “…the legislation does not contain special requirements to the qualification and experience of the person for transactions similar to the contested” (p. 11). In our my opinion, this phrase, the court tries to justify the savings Bank that it has imposed a complex financial instrument to the counterparty, taking advantage of his inexperience. But this sentence is talking about the fact that so far in the country’s financial market was only used simple financial instruments and legislators were not even aware that under the financial instruments there is also a narrow specialization, as in other industries. After all, if we require that the physician optometrist acted as the dentist and filled tooth, it probably will get a poor result based on your medical diploma.

If it was not obvious to legislators until recently, the transaction Transneft Sberbank, as well as the above, such transactions of the savings Bank with other companies in which all partners of the savings Bank suffered record losses, illustrates the problem. All of a sudden are the words of the court of appeal that “… the court of first instance has not established that the contested transactions lead to the violation of such public interests as the interests of an indefinite circle of persons,…of defense and state security” (p. 14). As you know, Transneft is a state backbone of the Russian economy company. Following the transaction, it suffered astronomical losses. If the dollar rose even higher, and the free floating of the ruble theoretically suggested the possibility of any rate, the state would have to save Transneft.

At the same time received from Transneft 1 billion dollars in public money was in Cypriot accounts. Financial transactions that undermine the functioning of the backbone companies threaten the security of the economy and the country’s defense. If you leave the case unattended and to allow banks to continue with impunity to carry out such operations, in a “beautiful moment” we will see a prosperous banks but ruined the economy.

Alexey Burenin

Professor, doctor of Economics, Professor of International Finance MGIMO(U) MFA of Russia, head of the magistracy of the University “Financial Economics. Market securities and derivative financial instruments.”

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