Will Russian bonds default? Investors watch

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1. Is Russia headed for default?

It’s unclear. A key test came on March 16 with confusion around $117 million in coupon payments due that day on two dollar-denominated government bonds; the fund managers said two days later that they had received the funds. The process has drawn attention to clearing houses, correspondent banks, paying agents and custodians who normally handle transfers out of the public eye. The March 16 payments had a 30-day grace period – a buffer that gives the payer the chance to resolve any technical issues – so there were initial fears that a so-called sovereign default could occur as early as April 15. The default took place in 1998, when shock waves from the Asian debt crisis and falling oil prices caused Boris Yeltsin’s government to write off about $40 billion in domestic debt. If Moscow fails to meet its foreign obligations, it would be the first time since 1918, after the Bolshevik Revolution.

2. What are the obstacles?

The hurdles include a freeze of around half of Russia’s foreign exchange reserves and the cautiousness of US banks as they seek to ensure they will not fall under sanctions against Russian billionaires. In the days following the invasion, Russia’s biggest companies were still paying their obligations in foreign currencies, including energy giants Gazprom PJSC and Rosneft PJSC. However, it has not been so easy for other companies. Severstal PJSC has become the first Russian company to run out of time to pay interest on its foreign currency debt since the start of the war in Ukraine, after Citigroup Inc. blocked the deal. This posed the risk that some creditors would call a default. Additionally, a US sanctions waiver that allowed financial intermediaries to process bond payments will expire in May, posing new legal hurdles.

3. What do Russian officials say?

Russian officials have said they want to honor the obligations, but also that they will pay foreign debt in Russian rubles if sanctions prevent them from paying in dollars or euros. Finance Minister Anton Siluanov said on March 14 that Russia’s freezing of accounts could be interpreted as an “artificial default”. Concern over a default intensified after President Vladimir Putin signed a decree in early March stipulating that creditors from “countries that engage in hostile activities” can only be paid in rubles and set new procedures for ruble accounts. With the United States, the European Union and its allies stepping up sanctions, that means most investors could be paid in Russian currency. Creditors outside “hostile” jurisdictions may be able to receive foreign currency payments with special authorization.

4. Wouldn’t that be a default?

Basically, yes. Paying in a different currency is widely considered a default. Otherwise, the world “would be flooded with Venezuelan bolivars and Argentine pesos,” according to Elena L. Daly, a Paris-based sovereign debt restructuring lawyer.

5. So what’s the confusion?

Mixed messages from Russian officials and gummed up payment systems have left investors uncertain about whether they’ll get paid and take a closer look at the terms of their loans. Six of the government’s dollar- and euro-denominated bonds have what’s called a “fallback option,” which would allow the borrower to pay in other currencies, and in some cases, the rouble.

6. What are the rating agencies saying?

Credit assessors, including Fitch Ratings and S&P Global, said Russia would be considered in default if it did not pay coupon payments in dollars within the grace period. Russia’s credit ratings were drastically reduced after its Feb. 24 attack on Ukraine in a sudden drop in so-called investment grade. After the 1998 default on ruble-denominated debt, it took about six years for Russia to achieve investment grade status, which meant it could be held by a wide range of investors. He has been sanctioned in various ways by the United States and its allies since he annexed Ukraine’s Crimean peninsula in 2014, although he has built up foreign exchange reserves.

7. What principles are at stake?

Russia’s situation is unusual because companies could potentially continue to service their debt even if the sovereign defaults. Some of them sell bonds through foreign subsidiaries and have dollars abroad. Issuers also have a responsibility to treat all bondholders fairly and must follow the principle of “pari passu” (Latin for “on an equal footing”), which means that they cannot treat bondholders differently. of the same ticket. This idea played a role in Argentina in 2014, when it was blocked by a US judge from paying some bondholders until it resolved a long legal saga between the government and holdouts led by Elliott Investment. Managed by Paul Singer.

8. What can investors do about it?

If bondholders don’t get paid, that’s probably the start of a very long and complicated process. History is an imperfect guide, but Russia already holds the record for the longest time between default and some form of resolution with creditors: after the Bolsheviks refused to repay or acknowledge the Tsar’s debts a century ago, the Soviet Union signed an agreement to settle at least some of these claims in 1986. Even though many of the notes are governed by English law and therefore bondholders can take the Russian government to court in England, any attempt to enforce a deal now will likely involve Russian assets and Russian courts. It is unclear at this stage how foreign investors will access it. The price of Russian dollar-denominated debt has plunged ahead of a default, with bonds maturing in 2023 trading at just under half face value in mid-March.

Some investors also buy credit default swaps, or CDS, insurance-like instruments designed to cover losses if a country or company fails to meet its obligations. However, about $13 billion of Russian government debt could be ineligible, a panel of banks and investors said March 11, due to the ruble’s fallback option on six Eurobonds. In the days following Putin’s decree, CDS prices were signaling a probability of default of around 80%. Despite coupon payments since then, CDS prices suggest that a default has only become more likely.

10. What is the wider impact?

Concerns about a Russian default are spilling over to other emerging markets. A Russian sovereign default is no longer an “unlikely event,” International Monetary Fund Managing Director Kristalina Georgieva said on March 13, though global banks’ exposure to Russia is “certainly not systemically relevant.” . Some investors have warned that a Russian default could ultimately lead to a global sovereign debt crisis if investors start to avoid risk and more countries are shut out of financial markets.

• The Odd Lots podcast looks at alternative payment clauses in Russian bonds.

• Bloomberg’s Big Take on Russia’s spiral into default, how its economy might adapt, and its strategy to avoid default.

• A 2008 National Bureau of Economic Research research paper on the history of sovereign defaults in emerging markets.

• Bloomberg’s Max Hastings Opinion on Centuries of Russian Brutality.

• Bloomberg QuickTakes on the SWIFT payment system and the history of sanctions against Russia.

• A statement from the U.S. Treasury Department on initial Russian debt sanctions and the review of global Treasury sanctions in 2021.

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