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Will Russian bonds default? There’s debate about that

Will Russian bonds default? There’s debate about that

A Russian flag waves next to one of the Kremlin towers in downtown Moscow on Feb 26, 2022. (File photo: AFP/Alexander Nemenov)

War, sanctions, perplexing government decrees and disrupted payment chains have left holders of about US$150 billion in Russian bonds bracing for a possible default. With about half of Russia’s foreign reserves frozen by sanctions after the invasion of Ukraine, it’s unclear if, when - and how - investors in the country’s government and corporate debt will get their money back. If Moscow fails to meet its foreign obligations it would be the first time since 1918, following the Bolshevik Revolution. 


It looks that way. A key test came Mar 16 with confusion around US$117 million in coupon payments due that day on two dollar-denominated government bonds. Russia’s finance ministry said it sent the payment to its correspondent bank, but holders of the bonds said they didn’t receive the funds. The payments have a 30-day grace period, so an official declaration of a so-called sovereign default may come as soon as Apr 15.

Russia’s last default was in 1998, when shockwaves from the Asian debt crisis and tumbling oil prices pushed Boris Yeltsin’s government to renege on about US$40 billion of domestic debt and declare a moratorium on payments for foreign-currency bonds. 


They want to honor the obligations, and say they will pay foreign debt in Russian rubles if sanctions prevent them from paying in dollars or euros. Finance Minister Anton Siluanov said on Mar 14 that freezing Russia’s accounts could be interpreted as an “artificial default”. The following day, the US Treasury Department said that restrictions don’t bar Russia from paying its dollar debt, at least until May.

Concern about a default intensified after President Vladimir Putin signed a decree early March saying creditors from “countries that engage in hostile activities” can only be paid in rubles and outlined new procedures for ruble accounts.

With the US, European Union and its allies ratcheting up sanctions, that means most investors could be paid in the Russian currency, which has lost about a third of its value this year. Creditors outside the “unfriendly” jurisdictions may be able to receive foreign-currency payments with special permission. 


Basically, yes. Paying in a different currency is widely seen as a default. If it weren’t, the world “would be awash in Venezuelan bolivars and Argentine pesos”, according to Elena L. Daly, a sovereign debt restructuring lawyer based in Paris. There’s a growing chorus of investors who say a Russian default is probably inevitable. They include Simon Waever, Morgan Stanley's head of emerging-market sovereign credit strategy, who compared Russia with Venezuela’s default in 2017 because both countries have significant oil assets that can’t come into play until sanctions are removed. The price of Russia’s dollar-denominated debt plunged in expectation of a default, with bonds due in 2023 quoted at just under half of their face value in mid-March.


Mixed messaging from Russian officials and gummed-up payment systems have left investors unclear on whether they’re going to be paid and studying the terms of their lending more closely. Six of the government’s dollar and euro-denominated bonds have what’s known as “fallback optionality”, which would allow the borrower to pay in other currencies, and in some cases, the ruble.

In the days following Putin’s decree, Russia’s biggest companies were still paying their obligations in foreign currencies, including energy giants Gazprom PJSC and Rosneft PJSC. MMC Norilsk Nickel PJSC, the mining company that dominates the palladium market, has been cleared to pay foreign debts in currencies other than the ruble, Vladimir Potanin, the company’s president and biggest shareholder, said in an interview with Russian newspaper RBC on Mar 12. 


Credit assessors including Fitch Ratings and S&P Global have said Russia will be considered in default if it doesn’t pay coupon payments in dollars within the grace period. Russia’s credit ratings were dramatically slashed after its Feb 24 attack on Ukraine in a sudden fall from so-called investment grade.

After the 1998 default on ruble-denominated debt, it took Russia about six years to gain investment-grade status, which meant it could be held by a broad pool of investors. It has been sanctioned in various ways by the US and its allies since it annexed Ukraine’s Crimean Peninsula in 2014, though it has been building foreign reserves.


Russia’s situation is unusual because companies could possibly keep servicing their debt even if the sovereign defaults. Some of them sell bonds via foreign subsidiaries and have dollars offshore. Issuers also have a responsibility to treat all bondholders fairly and must follow the “pari passu” principle (Latin for “equal footing”), meaning that they can’t treat holders of the same note differently.

That 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-running legal saga between the government and holdouts led by Paul Singer’s Elliott Investment Management.


If bondholders don’t get paid, it’s likely the start of a very long, 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 service or recognize the czar’s debts a century ago, the Soviet Union signed an agreement to settle at least some of those claims in 1986.

Any attempt to enforce an agreement now will likely involve Russian assets and Russian courts, but how foreign investors will access them is hard to know at this stage. The Russian bonds with coupon payments due Mar 16 are governed by English law, meaning that holders would have to try and sue the Russian government in a UK court to enforce after a default. 


Some investors also purchase credit-default swaps, or CDS, insurance-like instruments designed to cover losses if a country or company fails to meet its obligations. In the days following Putin’s decree, CDS prices were signaling around an 80 per cent likelihood of default.

However roughly US$13 billion of Russian government debt could be ineligible, a panel of banks and investors ruled Mar 11, because of the ruble fallback optionality in six of the Eurobonds. 


While concerns about a Russian default are rippling through other emerging markets, so far there’s no sign that it could trigger a broader global financial crisis. A Russian sovereign default is no longer an “improbable event”, International Monetary Fund managing director Kristalina Georgieva said Mar 13, though the exposure of global banks to Russia is “definitely not systemically relevant.” 

Source: Bloomberg/fh


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