The 7 Big Questions Russia’s Likely Default Raises
#3: Who holds the Russian debt?
The sanctions taken by America and the European Union against Russia following its attack on Ukraine have made Vladimir Putin's country a real pariah of the financial system. The assets of the Russian central bank have also been frozen. Now, investors fear a default on Russia's sovereign debt.
On the markets, Russia's sovereign debt is now worth less than its face value. For the rating agencies, default is almost inevitable. In reality, the situation is complex and many questions arise. Here are the 7 main ones with an attempt to answer each one.
1. Why are we talking about default when the Russian government has already said that the debt will be repaid?
Russian Finance Minister Anton Siluanov said that Russia had issued an order to pay the $117 million in coupons due on March 16, without specifying whether this payment would be made in dollars or rubles. The second option is the most likely. Following the freezing of its central bank's assets located in Western countries, Russia has imposed capital controls to limit currency outflows.
Payment in rubles would characterize a default. The contracts for the bonds in question (maturing in 2023 and 2043) do not provide for the possibility of payments in currencies other than the US dollar.
According to Anton Siluanov, it is now up to the United States to authorize or not the payment of the two coupons:
“The payment has been received by the corresponding American bank. We do not have any information yet on whether it has passed or not. It hasn't cleared yet. But we know that the bank is in discussion with the Office of Foreign Assets Control (OFAC) and has asked us for detailed information about the purpose of the payment.”
In fact, clearinghouses such as Clearstream and Euroclear no longer accept the ruble as a settlement currency and no longer want to deal with Russian counterparties. By late Wednesday afternoon, London-based investors said they still had not received anything.
2. When will Russia's default be effective?
If Russia does not respect its obligations, there is a period of 30 days called the “grace period”. This leaves it in theory until April 15, 2022, to honor its obligations. It is the ISDA (International Swaps and Derivatives Association) that will decide on the default.
This is a completely new situation for ISDA, as there is no precedent for a bond loan repaid in a currency other than that stipulated in the contract. An official declaration of default would trigger credit default swaps (CDS), derivatives used by investors as insurance against the risk of default.
3. Who holds the Russian debt?
Before the war in Ukraine, asset management companies were the main holders of Russian sovereign bonds on behalf of their investor clients. These securities represented up to 6% of JPMorgan's emerging market debt indices. U.S.-based BlackRock, the world's largest asset manager, and its compatriot Pimco held the largest exposures, each with about $1.5 billion of Russian government bonds, according to Bloomberg.
This exposure is minimal compared to their respective $10.0 trillion and $2.2 trillion in outstanding assets, but it does not necessarily reflect their total commitments. By the end of December 2021, Pimco had also placed bets on the country's default risk (CDS or credit default swap) to the tune of nearly $1 billion, the “Financial Times” revealed.
4. Do investors have a chance to recover their stake?
Even before the prospect of a Russian default, managers have recognized the loss in value of their local bonds and equities, trapped by international sanctions and the closure of Russian markets. BlackRock has reduced the value of its $18 billion of total Russian holdings (as of the end of January 2022) to just $1 billion as of the end of February 2022. In Amundi's funds, locally tradable Russian bonds are worth only 8% of their face value when denominated in foreign currencies, and those in rubles only 5%.
Some European asset managers are thinking about keeping their Russian assets in specific side pockets. The British market supervisor, the FCA, announced on Wednesday, March 16, 2022, the opening of a consultation on the subject. It is also under discussion in Luxembourg, the first place of domiciliation of European funds, with the CSSF, the local regulator.
5. What leverage do Russia's creditors have?
The investors who bought the Kremlin's debt will find themselves quite helpless legally. The legal documentation governing the bonds contains several clauses, making legal recourse an obstacle course. Thus, even if the contracts were drafted under the aegis of American or English law, Moscow was careful not to waive its state immunity.
In other words, Russia will not recognize any court decision ordering it to repay its creditors. This leaves the only option open to creditors is to negotiate a restructuring of the debt. This seems very unlikely in the current circumstances. Bondholders can, however, assert their rights in the courts of their country and ask for the seizure of Russian assets located abroad, whether they are funds placed with central banks or various other assets. But these are long and extremely expensive procedures.
The Elliott fund, which fought hard for more than ten years with Argentina to be paid for the bonds it held, knows something about this. In particular, it targeted the presidential plane, a Navy training frigate, or even the royalties of French companies operating on Argentine soil. Often in vain, despite court decisions sometimes favorable.
6. Is there a risk that Russian companies will also default?
Russian companies that finance themselves on the international debt markets will also find themselves in difficulty. They are not exempt from the capital controls put in place by the Kremlin and are subject to sanctions. For the time being, large companies with strong foreign operations and relationships, such as Gazprom and Rosneft, have paid the amounts due on time. And in dollars. The real test should come at the end of the month. The gold mining group Polyus has to repay $483 million in bonds, the Russian railway company $625 million, and the oil group Boret International $156 million. Unless sanctions are relaxed, the default seems inevitable.
7. What damage did Russia's 1998 default cause?
In 1998, Russia defaulted on its short-term ruble debt, not on its dollar-denominated external debt. Combined with a devaluation of the ruble and a flight of foreign capital, the 1998 crisis hit a highly indebted country hard. It was facing many economic, political, and social problems. It experienced a recession and a surge in inflation that year.
Unlike the current situation, it could not count on high oil prices to bring in money. However, it experienced a strong rebound in activity with a growth of 5% to 10% between 1999 and 2001.
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