Kazakhstan central bank grapples with CDS headache

Astana, the capital of Kazakhstan, lies thousands of miles from London’s trading rooms – let alone the political lobbyists in Washington. This summer, however, Grigori Marchenko, the Kazakh central bank governor, has reason to follow the US and UK debate about the future of credit derivatives with particular interest.


By the end of this month, Kazakhstan is supposed to restructure two of its highest profile banks, BTA and Alliance, which have all but collapsed in recent months. This reorganisation would be emotive and challenging in any circumstances, given the complexity of Kazakhstan’s domestic political scene.

But the saga also has an element of international controversy because of the presence of credit derivatives. Back in the heady days of the credit boom, from 2004 to 2007, numerous western banks rushed to provide finance to Kazakh banks – and some, such as Morgan Stanley, also hedged their exposure using credit derivatives.

That trade may have left some players with a net “short” position in the banks (meaning they stand to benefit if the company goes into default). What Mr Marchenko is trying to understand is how these incentives are affecting credit behaviour.

“This is a whole new ball game – I don’t think anyone was prepared for what has happened here,” says Mr Marchenko. “There is a new class of financial institutions now who are speculating that BTA [and others] go into a default ... rather than in keeping the bank as a going concern. There is an underlying principle of restructuring that all investors should be treated equally. But what if everyone [in the creditor group] accelerated [the process of default]?”

This question of “acceleration” is crucial because of the behaviour of some BTA creditors. This spring, when it became clear that BTA was hovering near collapse, the government tried to organise a restructuring. But before it was completed, Morgan Stanley and another large international creditor demanded repayment of thier loans, which BTA refused to do.

Soon afterwards, Morgan Stanley asked a committee linked to the International Swaps and Derivatives Association in New York to rule whether CDS contracts linked to BTA could be activated. The ISDA committee ruled there was a default, ensuring that Morgan Stanley (and others) could duly claim on the CDS.

Morgan Stanley has declined comment. But traders with good knowledge of the Western banks’ market strategy believe that the foreign groups were mostly using CDS to protect themselves against potential losses on loans, not to short BTA. In practice it is impossible to tell the real motive because while the DTCC in New York collects some overall data on CDS trading – which suggests there are $700m contracts outstanding – the banks do not need to disclose who is short, or not. “The problem is that the CDS market is not transparent,” says Mr Marchenko.

Thus far, the Kazakhs are not seeking to ban CDSs. “Abolishing [CDS contracts] might be a bit radical – it is easier to regulate CDSs than prohibit them entirely. They grow like mushrooms in the dark,” says Mr Marchenko. The central banks wants to see “a middle-of-the-road approach – only those companies and institutions that own underlying securities should be allowed to buy CDS. There should be better disclosure and central clearing”.

Such calls are not limited to Kazakhstan. In the US, there is concern that credit derivatives might be creating perverse incentives, after the bankruptcy of some American groups. Western regulators are actively promoting measures to introduce more transparency and place CDS in a clearing house. Some US politicians also want to limit the use of these contracts to hedging, although this is a minority view.

Western bankers, for their part, retort that the CDS is simply a red herring in the case of the Kazakhs. They point out, irrespective of CDS, the state of Kazakh banks is pretty opaque.

On paper, the government has set a deadline of the end of the month for restructuring the banks. However, this is proving “extremely complicated”, says Michael Carter, chief executive of Visor Capital, a Kazakh investment bank.

BTA, for example, has foreign debts of $9bn (more than half of all borrowing) – but it also has “assets throughout the CIS [Commonwealth of Independent States] that the government is slowly finding that it does not control”, Mr Carter says. Several billion dollars of these assets have apparently vanished into a black hole – to the surprise of the Kazakh government and western creditors.

The government has now appointed Lovell, the law firm, to hunt for the missing assets. Goldman Sachs, which was acting as an adviser to the government, has resigned for reasons that – like much else – are unclear.

Lazard Freres has replaced Goldman and is trying to organise a creditors’ committee. “We believe there should be a market-based solution, and it should be resolved in an amicable way,” Mr Marchenko says.

It is far from clear whether Lazard Freres will find a way to resolve these conflicting interests – or what the long-term impact will be. Last month, Nursultan Nazarbayev, Kazakhstan’s president, told parliament that the Kazakh banking system had “failed the test”. He called on local regulators to develop a new model for banks that would prevent them from borrowing too much from western banks in future.

“The key point that everyone is forgetting is that [bankers] would not have lent as much money to Kazakhstan if they had not been able to hedge their exposure with CDS – there was just too much risk,” says one western banker. “Now everyone fingers CDS. But these events also show why hedging is so important.”

Copyright The Financial Times Limited 2009


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