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Transneft vs Sberbank Ruling Threatens to Derail Russia’s Derivatives Market

The court’s decision to award the oil pipeline monopoly RUB67bn in compensation for an options trade originating in 2014 could take a trillion-rouble toll on the country’s secondary markets.

Jul 4, 2017 // 4:22PM

A Russian court ruling in an ongoing derivatives trade lawsuit brought by Transneft against one of the country’s biggest lenders, Sberbank, could set a dangerous precedent and send shockwaves through the country’s financial markets.

In its complaint, Transneft, an oil pipe producer, was trying to challenge the loss of more than RUB75bn on options contracts dating from 2014. On 11 January, according to Bloomberg, Transneft filed a lawsuit in the Moscow Arbitration Court against Sberbank to recognize the transaction as “null and void,” allegedly claiming that the bank did not fully reveal details and potential consequences of the trade to the company.

According to an IFRS 2014 report, Transneft entered into a US$2.727bn put and call options deal in order to reduce risks of a dollar devaluation and to temporarily free additional FX funds. However, after the rouble collapsed following the drop in oil prices, from ~35 per US dollar in 2014 to the minimum of 81 per USD dollar in January 2016, Transneft saw losses of RUB75.3bn from the trade.

In its defence, Transneft insisted that the purpose of the transaction was not currency hedging, but rather for refinancing its debt obligations.

“Sberbank pitched the options deal to us at the start of 2013, they initiated the talks,” said Transneft vice-president Mikhail Grishanin in an interview with Russia’s RBC Channel. “It was pitched as a way of reducing the cost of debt servicing, it was never intended to be a hedging instrument.”

“Typically, exporters hedge their expenses by buying currency options. What we are talking about here is a completely different type of product. Calling it a currency hedging instrument is like looking at Paris from a satellite and calling it a suburb of Moscow.”

In the lawsuit filed against Sberbank, the company claimed that its representatives were misled by the bank about the possible consequences of the options trade and that it was not made aware of the risks associated with it.

In response, Sberbank argued that Transneft was fully aware of the potential losses from the transaction, as it confirmed in the agreement signed with Sberbank ahead of the deal, which included a “declaration of risks.”

Last week, the Moscow court ruled in favour of the plaintiff, ordering Sberbank to compensate the company for RUB67bn it lost through the trade – a decision that Sberbank claims could cost the Russian banking sector as much RUB600-1,000bn. The lender has already launched an appeal against the decision.

“If the court rules in favour of Transneft, it will create a dangerous precedent that could lead to an avalanche of similar lawsuits from other companies,” Sberbank global markets head Andrey Shemetov said, quoted by RBC.

He noted that the derivatives market is currently worth around US$200bn, but this decision could completely halt trading, as investors won’t be able to hedge themselves against currency volatility or other types of risks.

The Central Bank of Russia (CBR) also expressed concern at the ruling.

"The Bank of Russia is concerned with the legal precedent on the financial derivatives market, which threatens almost all deals of Russian banks with non-financial organisations," the regulator told Reuters on June 23.

Sergey Dergachev, Senior Portfolio Manager and Lead Manager for Union Investment Privatfonds, likewise sees cause for concern for Sberbank and Russia’s derivatives market if the ruling stands. According to the portfolio manager, such contracts are never riskless and professional investors and companies like Transneft, which operate internationally and in volatile commodity markets, have to be knowledgeable about the risks in using derivatives.

“The sole case where derivative sale could be questioned more massively is if the sale was fraudulent, but it does not seem to me here to be the case,” Dergachev noted. “Of course, if this precedent will be set, my fear is that this might not only lead to more lawsuits within Russia and stress on banking sector, but, it could also quickly spill-over to other markets as well.”

“Derivatives markets are hugely popular globally, and are several times bigger than physical financial markets, so there is substantial risk that this precedent can in the worst-case lead to a contagion to other regions and a re-thinking of derivatives contracts.”

While the analyst conceded that the case is unlikely to lead to such far ranging repercussions, he did warn that the lawsuit poses many questions regarding the rationale and what are key details behind the deal that triggered such a harsh reaction.

In a note published on JDSupra online journal, legal experts from Morrison & Foerster LLP concluded that while for now it is unclear how this decision will impact the derivatives market in Russia, "there will certainly be even more focus on any communications with counterparties prior to entering into any derivative contracts and on thorough risk disclosure and disclaimer statements coupled with robust representations and acknowledgements from the counterparties."

The Russian bank already confirmed that it will now take its appeal to the Appeals court, with the first hearing set for 21 July, and the case could potentially go all the way up to Russia’s Supreme Court.

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