FORTUNE -- Just months before the toppling of its government, Russia cut a loan deal with Ukraine that would make even an ace structured finance dealmaker envious. One expert on sovereign debt has called the transaction "clever." And the deal could come back to haunt Ukraine's economy.
Back in December, Russia lent Ukraine $3 billion as part of an assistance package that was supposed to reach $15 billion. But Russia didn't just hand over money directly to Ukraine. Instead, Russian had the Ukrainian government issue $3 billion in bonds. The bonds were denominated in euros. And then Russia bought all of the bonds.
That may have seemed like a straightforward way to do the deal. Ukraine already had billions of eurobonds outstanding. So issuing more may have appeared easier than writing up a new loan agreement. Plus, the deal would give a lift to the prices of Ukraine's other eurobonds, which were already suffering from the growing political turmoil in the country.
But the roundabout loan deal had more advantages for Russia than it first appeared. Here's where things get interesting.
It turns out that Russia didn't just have Ukraine do a straight debt offering like the ones it had done before. Instead, Russia wrote into the new bond offering a provision. As part of the bond deal, Ukraine had to promise that it would keep its debt-to-GDP level below 60%. If it rose above that level, Russia had the right to demand the bonds be repaid immediately in full.
That kind of qualification in government bond deals is unusual. Mitu Gulati, a sovereign bond expert, says he has never seen a government bond with a similar debt-to-GDP provision. Most sovereign debt is "covenant-lite."
It would be hard to prove this was premeditated, but including that provision gives Russia a lot of economic leverage. At the time, Ukraine's debt-to-GDP was near 40%. But with Russian looking likely to hive off Crimea, and taking that portion of the Ukraine's economic activity with it, along with the slowdown the political unrest has caused, it's likely that by the next reading or two Ukraine's debt will be in the 60% range or beyond it.
That means Russia can ask for its money back, and at the same time add more economic hardship to Ukraine as it struggles to rebuild.
If this was a straight loan, Ukraine could just say to Vladimir Putin, "Hey you just invaded us. Debt's off. We're not paying." But since it's a bond deal, it won't be that easy. To invalidate the eurobond debt, Ukraine has to argue that Russia knew that part of the money it agreed to give to Ukraine's past government was at least in part going to line the pockets of a corrupt ruler. The Ukrainians certainly believe that, but that might be hard to prove to an international court.
There are a lot of other Ukrainian eurobonds out there that look similar to the ones Russia is holding, so not paying the ones Russia is holding will have larger implications for all of Ukraine's debt, causing prices to fall and interest rates to rise. What's more, Russia could sell its bonds to the market, likely at a premium because of the special provision. That may make a court less likely to invalidate the debt, and Ukraine less willing to do so, if it is held by a private investor, especially a non-Russian one.
That being said, the United States and Europe will likely offer generous loan guarantees and have already pledged aid to Ukraine. That should help it with its near-term debt problems should Russia call its debt. And it probably won't, given that the debt offers Russia another piece of leverage, and another reason for Ukraine to negotiate.
Of course, there is still a chance that Ukraine would just say it's not paying the debt, and for it all to work out okay. The unusual debt deal probably works opposite from what you would expect on Wall Street. Most bond holders don't want to swap their debt for equity. Neighboring nations looking to rebuild old empires may be more willing to make that trade.
You would think that the trades that busted MF Global and Long-Term Capital Management would be barred under Volcker. Think again.
FORTUNE -- On Tuesday, regulators approved the long-awaited Volcker Rule. The final rule, which was also unveiled on Tuesday, was widely expected to be stricter than originally proposed. And in some ways it was. Bank CEOs will be required to certify that their firms are not violating the rule, which MOREStephen Gandel, senior editor - Dec 10, 2013 3:02 PM ET
Elite money manager Paul Singer is a passionate defender of the 1% and a rising Republican power broker. He's determined to put a candidate who shares his views back in the White House.
By Michelle Celarier, contributor
FORTUNE -- As he gears up for the final stretch in the marathon that is the Republican nomination campaign, Mitt Romney has no shortage of eminent financiers to call on -- for advice or money. MOREMar 26, 2012 5:00 AM ET
While attention is focused on the Middle East, Euroland's financial troubles are worsening.
By Chris Redman, contributor
FORTUNE -- The rot was exposed in May 2010 when recession-hit Greece came clean about its shaky finances and received a $159 billion bailout. Then came Ireland. The erstwhile Celtic Tiger received a $113 billion aid package in November 2010. Then, in April 2011, Portugal became the third country to request a rescue. That could MOREMay 20, 2011 5:00 AM ET
As Japan reels in the aftermath of the most powerful earthquake in its history and worries grow about a nuclear reactor meltdown, some economists wonder whether the disaster will push the country closer to a sovereign debt crisis, too.
There's a tug of war happening right now between investors who are buying Japanese government bonds (JGBs) as a safer alternative to the sinking stock market, and investors who are buying credit default swaps MOREKatie Benner - Mar 15, 2011 10:38 AM ET
What a downgrade of Japanese debt by S&P could mean for the country's future and for the rest of the world.
The timing of the downgrade of Japan's sovereign bonds by Standard & Poor's on Thursday came as a bit of a surprise to some. After all, Japanese government bond yields have been relatively stable recently, the yen fairly strong, and, as Citigroup points out, the government has vowed to address MOREKatie Benner - Jan 27, 2011 2:39 PM ET
With all the troubles developing around parts of debt-ridden Europe, could it possibly get worse? Some are actually thinking the unthinkable: A breakup of the 17-member euro zone.
The European Union just celebrated its seventeenth birthday, and it's clearly hit its awkward phase. Though the value of the euro has strengthened some against the US dollar in recent weeks, it has undergone a very bumpy ride on signs that Europe's sovereign-debt MORENin-Hai Tseng, Writer - Jan 26, 2011 1:39 PM ET
Most analysts are looking forward to a strengthening economic recovery in 2011, but slowing growth and rising inflation around the globe suggest the opposite will prove true.
by Daryl Jones, Hedgeye
For the stock market, 2010 was a solid year by many standards. Despite some unfettered volatility, most major U.S. stock markets ended the year comfortably in the positive. Leading the way were small cap stocks with the Russell 2000 up more MOREDec 31, 2010 5:00 AM ET
Contrary to what you might have thought over the past week or two, every country in Europe isn't in danger of an imminent downgrade.
So says Standard & Poor's, which affirmed France's triple-A rating Thursday. The rating agency cited French belt-tightening progress and a political environment that it says is "stable and oriented toward prudent economic policies."
The rating agency said it expects the economy to grow slowly but surely in 2010 MOREColin Barr - Dec 23, 2010 2:47 PM ET
Bank regulators pushed back at a press report that roiled financial markets Tuesday.
The Committee of European Bank Supervisors, the group that conducted and publicized the stress tests on 91 big European banks in July, issued a statement Wednesday defending its handling of data on banks' exposure to sovereign debt issued by stressed governments.
CEBS said the tests sought to provide "a meaningful and consistent view of banks exposures to sovereign debt." MOREColin Barr - Sep 8, 2010 11:26 AM ET
|Michaels hack hit 3 million|
|Wealthy investors flock to fine art funds|
|GM's recalled Cobalt was a failure from the start|
|Obama would cut deficits by another $1 trillion|
|Judge won't force GM owners to 'park' cars|