Explainer: US Treasury Pushes Russia to Default: What’s Next?

In this illustration taken on February 24, 2022, Russian ruble coins are seen in front of dollar bills on display. REUTERS/Dado Ruvic/Illustration

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LONDON, May 27 (Reuters) – The lapse in a key U.S. license allowing Russia to pay its sovereign debt to U.S. holders has brought back the prospect of a default on the country’s sovereign debt.

Russia is due to pay $100 million in interest on two sovereign bonds on Friday, with more due in June.

Here are some questions and answers about what might happen next:

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What has changed?

A license issued on March 2 by the U.S. Office of Foreign Assets Control (OFAC) allows U.S. entities to trade with Russia’s Treasury Department, central bank or state wealth fund in relation to debt payments.

This has allowed Russia to maintain interest and payments on its sovereign debt despite extensive restrictions on dealing with Russian entities. It has successfully paid seven dollar-denominated bonds since February 22.

But the Treasury Department said late Tuesday that it would not extend the license. While its actions only directly affect U.S. bondholders, holders elsewhere will find it challenging to accept Russian payments because of the U.S.’s dominance of the global financial system.

So how much debt is affected?

Russia has about $40 billion in international debt outstanding and has less than $2 billion in external debt left at the end of the year.

Debt can be roughly divided into three tiers: first, legacy bonds that are settled offshore in a conventional manner; Settlement and have provisions for alternative hard currency payments.

The last category includes debts sold after 2018, which are also settled in NSD, but include provisions to be paid in rubles.

When will a default occur?

Two bonds worth $71.25 million and 26.5 million euros ($28 million) were due to pay interest on May 27. To meet the OFAC deadline, Russia launched the payment process last week.

Russia’s State Security Service — the disbursement agent for the two bonds — said it had received the funds and announced that payments would be made in foreign currency on May 27.

The prospectuses for both bonds state that “payments of principal and interest (including any additional amounts) on the Global Bonds registered in the name of NSD will be made to NSD in the capacity of its registered holder.”

Some analysts, as well as the Russian Ministry of Finance, believe the money has already been paid.

However, it seems unlikely that the money will go any further into bondholders’ accounts. Restrictions on non-resident withdrawals from Russia will remain in place until Russia’s gold and foreign exchange reserves are unfrozen, Russian Finance Minister Anton Siluanov said on Friday.read more

By many definitions, the absence of funds in the creditor’s account does constitute a default.

Russia has a 30-day grace period after May 27 to make payments.

What is the next payment?

If creditors do receive the May 27 payment, Russia will pay two bonds on June 23 and the other on June 24.

The June 23 payment – very similar to the May 27 payment – is due on NSD-settled bonds.

However, the latter is a bond issued in 1998 with a maturity of $159 million. Since the issue can only be resolved abroad, analysts believe that Russia will not be able to make the payments without permission from the Treasury Department.

The bond has a grace period of 15 working days.

Will credit default swaps be triggered?

The question is whether a potential non-payment would trigger the payment of credit default swaps (CDS), which investors use to ensure they are exposed to specific risks, in this case Russia defaulting on its sovereign debt.

A committee of major banks and asset managers decides whether a “credit event” has occurred. This in turn can trigger payments.

JPMorgan expects that bonds that can be settled in Russia and receive payments at NSD will not result in CDS holders being paid.

“Even if the payment is not subsequently passed on to bondholders, it may be enough to avoid a CDS trigger,” JPMorgan analysts said in a note to clients.

However, if Russia fails to make repayments due on June 24, CDS could be triggered once the grace period expires.

However, the trigger may have occurred before that.

The Credit Derivatives Committee will meet on Friday to discuss whether a “credit event” occurred after Russia paid its sovereign debt but failed to add $1.9 million in accrued interest within the payment grace period.read more

JPMorgan calculated that the current net balance of notional CDS related to Russia is $2.54 billion, of which $1.68 billion is from Russia and the rest is from the CDX.EM index.

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Reporting by Sujata Rao and Karin Strohecker, Additional reporting by Jorgelina do Rosario Editing by Tomasz Janowski and Susan Fenton

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