Russia and China are forging the financial infrastructure needed for greater cross-border investment and inking some landmark deals, but slowing growth is dragging out negotiations on some projects.
The milestones passed in recent months include the first equity investment by a Russian state-owned entity, Rosneft in a Chinese state-owned enterprise, ChinaChem, and the first Chinese bank loan to a Russian company, MTS, in renminbi.
“There are lots of promising projects in the pipeline with China – such as in the power sector, which is quite natural,” Russia’s president Vladimir Putin told the audience at an investment forum organised by VTB Capital in Moscow in October.
Putin’s pivot to Asia comes after the West imposed sanctions on Russia for its role in the Ukrainian crisis.
Chinese direct investment into Russia swelled to about $8.4 billion in 2014, up over 10% from 2013.
Russia China Investment Fund (RCIF) on Thursday said it had invested in mainland China online English language learning platform TutorGroup as part of a $200 million Series C equity financing which also involved GIC, Goldman Sachs, and Silverlink Capital and Temasek. Debevoise & Plimpton advised RCIF.
Established in 2012, RCIF is a government-backed private equity fund which invests in projects that advance bilateral economic cooperation between Russia and China.
Progress is coming in spurts, generally around high-profile summits between Putin and China’s president Xi Jinping.
In one such case on September 3, in the presence of Putin and Xi, Russian state oil producer Rosneft and China National Chemical Corporation (ChemChina) agreed to a series of cross-border deals.
The heads of agreement contract outlines Rosneft’s purchase of a 30% stake in ChinaChem’s unit ChemChina Petrochemical Company and the Chinese company’s purchase of a majority stake in Rosneft’s Far-East Petrochemical, which is developing an integrated oil refining and petrochemical complex near Nakhodka.
“The greatly improved relationship and regular bilateral meetings between the two presidents act as a powerful catalyst,” Riccardo Orcel, deputy chief executive officer of VTB Group and head of global banking at VTB Capital, told FinanceAsia. VTB Capital acted as sole financial adviser to ChemChina on its deal with Rosneft.
The hope is that landmark government-related deals such as between Rosneft and ChinaChem will lead to others.
“The sovereign or state-related bodies are moving first with a few landmark deals. Then we will see first and second-tier firms following in time,” said Andrey Yakunin, co-founder of Russian investment firm VIYM, who also happens to be the son of Vladimir Yakunin, president of Russian Railroads.
However, all is not smooth sailing; falling oil prices, volatile currencies, and cultural misunderstandings are delaying some deals and the infrastructure still has holes. Russian hopes of a flood of Chinese capital into the country remain unfulfilled.
“I would not count on investment in commodities … Commodities are affected by the Chinese factor among others,” Oleg Deripaska, president of Rusal, said at VTB Capital’s conference talking about the impact of China’s economic slowdown on investment in Russia.
Some projects have hit snags. Russian natural gas producer Novatek first trumpeted $20 billion in Chinese capital to help it build the $27 billion Yamal LNG project which it is working on with China’s CNPC; a sum which has quietly been cut to $15 billion.
China has also been cautious in the wake of US and EU sanctions. Most Chinese banks will not execute interbank transactions with Russian peers. In addition, Chinese banks have significantly curtailed involvement in interbank foreign trade deals, such as providing trade finance.
While Russia remains keen to embrace China as the West maintains sanctions. Chinese companies are also looking further afield for higher returns on their investments.
China is Russia’s number one export partner but Russia only ranks tenth on China’s list of export partners.
One area where some progress is happening is around the Sino-Russian border that runs for more than 4,000km.
“There are great resources in the east of Russia and they need to develop Chinese territories adjacent to Russia. It would not be surprising that we increase the supply of these resources, oil and gas, to these large-scale projects,” said Putin at the conference.
Tricky mechanics
Russia and China are gradually building the financial infrastructure to facilitate more bilateral trade and while companies are starting to use these building blocks they still find the process problematic.
VTB Bank, for one, is looking at ways of helping Russian companies to invest and grow in China, and vice versa.
“We are currently putting together our ‘Go East’ strategy,” VTB Bank’s Mikhail Yakunin, a senior vice president in charge of the group’s financial subsidiaries division, told FinanceAsia.
In mainland China it has an operating branch in Shanghai and a representative office in Beijing. However, expansion in China can be time consuming.
“There is some difference in business cultures – in Russia it must be done tomorrow; while in China it takes longer and companies have to submit a five-year business-plan and strictly follow it. That is the cultural difference we have to manage,” VTB’s Yakunin said, who is no relation to Andrey Yakunin.
Russian companies are looking to banks to help them make cross border investments. Russian mobile operator Mobile TeleSystems (MTS) signed a bilateral loan facility with Chinese state-owned China Development Bank in May to support the purchase of Huawei Technologies’s equipment. The loan comprises a $100 million tranche and a Rmb620 million ($100 million) tranche with a tenor of seven years.
It marked the first loan to a Russian company by a Chinese bank with a long-term renminbi tranche, according to MTS.
“The infrastructure wasn’t there a couple of years ago but Russian commercial banks are now starting to offer direct settlement after the central banks agreed a swap line,” Joshua Tulgan, MTS’s director of corporate finance and investor relations, told FinanceAsia.
The Bank of Russia and People’s Bank of China also agreed a currency swap line worth Rmb150 billion in October last year to help bolster trade between the two countries. The three-year deal provides a backstop by enabling Russia to borrow the renminbi and lend the rouble, as required.
CDB’s credit facility was also the first competitively priced facility from a Chinese bank offered to MTS. The terms were comparable to loans European banks have provided the Russian company for, say, purchases from Nokia, according to Tulgan.
That is likely to have something to do with the growing familiarity of Chinese banks with Russian credits as well as a political desire to boost trade between the two countries. Huawei also helped CDB to get comfortable with the loan as its sales to MTS have grown in recent years.
The loan agreement was signed during an official visit of president Xi to Moscow in May.
“It is incredibly difficult to develop companies without credit – if we saw bank financing and guarantees on a wider scale that would make life much easier structuring equity deals,” VIYM’s Yakunin said in a telephone interview with FinanceAsia.
To be sure, the CDB facility was not the first loan MTS has taken from a Chinese bank – it has previously borrowed from the Bank of China but its loan was denominated in US dollars.
“We try to minimise non-rouble financing as the rouble is very volatile and we don’t want the extra [foreign exchange] risk; however a lot of our equipment is manufactured in China so we have an interest in renminbi-based transactions,” MTS’s Tulgan said. MTS spends hundreds of millions of dollars with Huawei every year.
“Direct settlement enables us to simplify the process and match our currency obligations,” Tulgan said.
The mechanism is still somewhat cumbersome though. MTS has to pay Huawei and then take the receipt to CDB, which then releases the renminbi to MTS.
The real conundrum then is what should MTS do with the renminbi. Right now there are few attractive options.
MTS would like to invest in, say, renminbi-denominated loan instruments issued by Russian companies. Gazprom was rumoured to be looking at issuing a panda bond but no deal has yet materialised.
FX fast forward
Another area of promise is in the direct exchange of China’s and Russia’s currencies.
VTB Capital is a major market maker for onshore renminbi/rouble cross-currency pair trading with over 80% of the market as of last year, according to Igor Golutvin, co-head of complex transactions at VTB Capital.
“It has to make sense to companies to settle in renminbi or roubles. That is, the process needs to be faster and more cost-effective,” said Golutvin.
As more and more bilateral trade is gradually being settled in renminbi, to reduce the need for intermediary currencies such as the US dollar, the infrastructure is slowly building up.
The Moscow Exchange launched spot trading in the renminbi against the rouble in 2010.
However, volumes are limited as China still limits the circulation of the renminbi offshore. “Even though the trade balance between Russia and China will probably keep growing – the percentage of contracts settled in renminbi or roubles is still very small,” said Golutvin. “I would love to see a faster pace of growth but there needs to be economic incentives. There is still a lot that needs to be done.”
Even if the infrastructure fell into place faster, delays to cross-border projects would still be likely due to Russia’s economic slowdown, rouble slide, and volatile oil prices, say dealmakers and analysts.
“There was a bit of misperception on the Russian side that the mega deals would be immediately followed by [small- and medium-sized enterprise]-led transactions and obviously this is not happening yet,” said VIYM’s Yakunin.
