Will Russian Bonds Default? Investors Keep Watch

1. Is Russia headed for a default?

It’s unclear. A key test came March 16 with confusion around $117 million in coupon payments due that day on two dollar-denominated government bonds; money managers said two days later that they had received the funds. The process has trained a spotlight on the clearing companies, correspondent banks, paying agents and custodians that normally handle the transfers away from the public eye. The March 16 payments had a 30-day grace period — a buffer that gives the payer room to work out any technical glitches — so there were initial fears that a so-called sovereign default could come as soon as April 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 $40 billion of domestic debt. If Moscow fails to meet its foreign obligations it would be the first time since 1918, following the Bolshevik Revolution.

2. What are the obstacles?

The hurdles include a freeze on about half of Russia’s foreign reserves and the caution of US banks as they seek assurances they won’t fall foul of sanctions on Russia’s 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 hasn’t been as easy for other companies. Severstal PJSC has become the first Russian company to run out of time to pay interest on foreign-currency debt since the war in Ukraine began, after Citigroup Inc. blocked the transaction. That posed the risk that some creditors could call a default. Moreover, a carve-out in US sanctions that allowed financial intermediaries to process the bond payments is set to expire in May, posing new legal obstacles.

3. What are Russian officials saying?

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 March 14 that freezing Russia’s accounts could be interpreted as an “artificial default.” Concern about a default intensified after President Vladimir Putin signed a decree in 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. Creditors outside the “unfriendly” jurisdictions may be able to receive foreign-currency payments with special permission.

4. Wouldn’t that be a default?

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.

5. So what’s the confusion?

Mixed messaging from Russian officials and gummed-up payment 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.

6. What do the ratings agencies say?

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 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.

7. What principles are at stake?

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.

8. What can investors do about it?

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. Even if many of the notes are governed by English law and hence bondholders can take the Russian government to court in England, any attempt to enforce an agreement now will likely involve Russian assets and Russian courts. How foreign investors will access them is hard to know at this stage. 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.

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. However roughly $13 billion of Russian government debt could be inligible, a panel of banks and investors ruled March 11, because of the ruble fallback optionality in six of the Eurobonds. In the days following Putin’s decree, CDS prices were signaling around an 80% probability of default. Despite the coupon payments since then, CDS prices suggest that a default has only become more likely.

10. What’s the broader impact?

Concerns about a Russian default are rippling through other emerging markets. A Russian sovereign default is no longer an “improbable event,” International Monetary Fund Managing Director Kristalina Georgieva said March 13, though the exposure of global banks to Russia is “definitely not systemically relevant.” Some investors have warned that a Russian default could ultimately lead to a global sovereign debt crisis if investors start shunning risk and more countries are locked out of financial markets.

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

• Bloomberg’s Big Take on how Russia is spiraling toward default, how its economy might adapt and its high-wire act to avoid default.

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

• Bloomberg Opinion’s Max Hastings on centuries of Russian brutality.

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

• A statement by the US Treasury Department on initial sanctions concerning Russian debt and the Treasury’s 2021 global sanctions review.

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