Sun | Oct 2, 2022

Russia’s dance with debt default

Published:Wednesday | May 4, 2022 | 12:08 AM
President of Russia Vladimir Putin.
President of Russia Vladimir Putin.

Russia appeared to dodge default on its foreign debt by dipping into its scarce dollar reserves. But Moscow’s debt drama is far from over.

Russia’s finance ministry abandoned its proposal to use roubles instead of dollars to make overdue payments on two government bonds, saying Friday that it had transferred the money to an account at Citigroup: US$564.4 million for a bond due in 2022, and US$84.4 million for another due in 2042. A 30-day grace period on making the overdue payments was to expire Wednesday.

The government had claimed that United States sanctions freezing its massive currency reserves held abroad meant it couldn’t pay and that Russia wasn’t to blame for any default, the first on foreign debt since the 1917 Bolshevik Revolution.

Even if Russia is found to have made the most recent payments, others are coming due. Plus, US permission for American bondholders to accept payment on Russian bonds is set to expire May 25, so even if Russia tries to pay, investors would not legally be able to take the money.

Ratings agencies have said that if bonds specify payment in dollars, then paying in roubles amounts to a failure to pay as promised. One reason Russia would want to pay in roubles instead of its reserves of foreign currency is that a large part of them have been frozen abroad. It made Friday’s payment by dipping into scarce internal reserves that sanctions could not touch.

Russia has not definitively avoided default unless the money made its way from Citigroup through the banking system to bondholders ahead of Wednesday’s deadline.

“Bondholders don’t get paid until Citigroup processes the payments” and pass them on to clearing houses that distribute payment to bondholders, said Jay S. Auslander, a top sovereign debt lawyer at the firm of Wilk Auslander in New York.

Banks are being extremely cautious about any transactions with Russia and may want to check with US and United Kingdom authorities first. But “I think it’s likely is that the funds will make it to the bondholders, in which case, they will not be in default this time,” Auslander said.

Russia owes about US$40 billion in foreign bonds, about half of that to foreigners. Before the start of the war, Russia had around US$640 billion in foreign currency and gold reserves, much of which was held overseas and is now frozen.

Bondholders who have credit default swaps – contracts that act like insurance policies against default – can ask a committee of financial firm representatives to decide whether a failure to pay debt should trigger a payout, which still isn’t a formal declaration of default.

The Credit Default Determination Committee – an industry group of 14 banks and investors that determines whether or not to pay on these swaps – said Friday that they “continue to monitor the situation” after Russia’s payment. They were scheduled to meet Tuesday.

The formal way to declare default is if 25 per cent or more of bondholders say they didn’t get their money. Once that happens, provisions say all Russia’s other foreign bonds are also in default, and bondholders could then seek a court judgment to enforce payment.

In normal circumstances, investors and the defaulting government typically negotiate a settlement in which bondholders are given new bonds that are worth less but that at least give them some partial compensation.

But sanctions bar dealings with Russia’s finance ministry. And no one knows when the war will end or how much defaulted bonds could wind up being worth.

In this case, declaring default and suing “might not be the wisest choice”, Auslander said. “You can’t negotiate with Russia right now. You’re wading into a world where sanctions are constantly changing, where there are a lot of unknowns. So you may see creditors decide at this point to keep their intentions close to their vest and hang tight for now.”

Popular sentiment is a consideration for investors, especially any who may have bought bonds at knocked-down prices in hopes of profiting from a settlement.

“Right now is maybe not a good time to rush in and show that you were profiting off distressed debt in Russian bonds,” Auslander said. “Will that time come in the future? I suspect it will.”