Russia edges closer to bond default

Russia edges closer to bond default
Russia's Ministry of Finance forgot to pay $1.9mn of accrued interest on a bond payment due in May, triggering a "default event" ruling. / bne IntelliNews
By bne IntelliNews June 2, 2022

After months of manoeuvring on the sanctions minefield, the Russian finance ministry seems to have slipped up for the first time after it missed a $1.9mn interest payment that has triggered the first default event on Russian sovereign debt since the one that followed the 1917 revolution.

As followed by bne IntelliNews, as of May 27 Russia is back on a 30-day countdown to default only two days after the US Treasury decided not to extend its ability to service sovereign debt in US dollars. But now there is a new problem: the ministry appears to have forgotten to add $1.9mn of interest payments to a delayed coupon payment made last month. The latest developments are likely to complicate the finance ministry’s efforts to outwit the restrictions, including the latest bonds-for-rubles proposal.

On June 1 the Credit Derivatives Determinations Committees (CDDC) of the International Swaps and Derivatives Association (ISDA) ruled that said a “failure-to-pay” event occurred on credit-default swaps because Russia didn’t include the additional interest in a late bond payment made at the start of May.

The CDDC is the committee that rules when a default event has happened that can trigger the decision to pay out on credit default swaps, a kind of insurance bond investors can take out to protect themselves against a bond’s default. The committee has declared that a default event has occurred, but will meet at the start of next week to decide if this triggers CDS payouts.

Russia has already narrowly escaped a default once this year, only hours before the May 4 deadline. But the $1.9mn interest accrued during the 30-day grace period has not reached the investors. It appears that the ministry forgot to add this sum to the payment.

“On May 11, 2022, bondholders of the 4.5% 2022 Russian sovereign bonds submitted a default notice via Euroclear demanding the payment of approximately $1.9mn in accrued interest payments in respect of the delayed principal repayment upon maturity of the bonds. The bonds matured on April 4, 2022 but the payment of principal and interest due at maturity was not made until May 2. The bond documents provide for interest to continue accruing on the principal until the principal is discharged at the 4.5% coupon on a 30/360 day count, resulting in approximately $1.9mn in additional interest being owed upon discharge of the bonds. Russia did not include accrued interest beyond April 4, 2022 in its payment, putting it in default under the bonds. Following the demand from bondholders, Russia has not paid the interest owed,” CDDC concluded.

Another CDDC meeting on the “failure-to-pay” event by the Russian Federation is scheduled for June 6, 2022.

The ruling by the CDDC could trigger all of Russia’s outstanding credit default swaps. According to Bloomberg, citing the Depository Trust & Clearing Corp data, credit default swaps covered a net $1.5bn of Russian debt as of end-May, compared with $3.2bn at end-April.

Russia has some $400mn of bond obligations to pay in June and a total of about $1bn is due by the end of this year in 14 more bond payments from the total of about $40bn in outstanding Russian debt obligations.

Investors rushed into credit default swaps after Russia’s military invasion of Ukraine amid sharply collapsing bond prices. Under the instrument two investors swap credit risk, with one party agreeing to reimburse another in the case the borrower defaults. US bond investment house Pimco is especially exposed and is said to have sold more than $100mn of such guarantees as protection to banks such as Barclays and JPMorgan & Chase.

However, notably, the failure to pay $1.9mn interest isn’t sufficient to trigger a cross-default across other sovereign instruments, as the minimum threshold for unpaid debt is at least $75mn, according to documents for other Russian Eurobonds reviewed by Bloomberg.

Still, it is likely to upset the investors and fuel resistance to the latest finance ministry’s efforts to outmanoeuvre the restrictions of the US Treasury’s Office of Foreign Assets Control (OFAC) that supervises sanctions. As followed by bne IntelliNews, similarly to the controversial “gas-for-rubles” scheme enforced by President Vladimir Putin, Russian Finance Minister Anton Siluanov recently suggested a similar “bonds-for-rubles” scheme.

Bondholders would have to open dual ruble-dollar accounts in Russian banks, transfer a ruble equivalent of their coupon payments to their accounts, and immediately convert that into US dollars on the market in the second forex account.

The gas-for-rubles scheme has proved controversial, with European Commission President Ursula von der Leyen initially saying that it breaks EU sanctions rules on Russia, but increasingly European companies have adopted the scheme which meets the sanctions requirements under the letter of the law, if not the spirit. Some countries like Hungary have agreed to meet their gas bill obligations by paying rubles directly to the Russian state and can expect to be rewarded by the Kremlin with attractive energy deals as a result.

Earlier reports suggested that the two specific issues due for payment on May 27 potentially allow for other payment options, such as using rubles as a last resort and paying in euros, Swiss francs or pound sterling for “reasons beyond the control” of the Russian Federation.

Two bonds for $183.75mn and $51.1mn due on June 23 also have provisions for payment in euros, sterling and francs, so it could be possible for the finance ministry to avoid sanctions in this instance. The first really problematic bond will be a June 24 coupon payment on a $159.4mn bond that matures in 2028 that can only be paid in dollars. Russia is likely to break the terms of the covenant in this case, as it is almost certain to offer payment in rubles and could go into a clear default after the 30-day grace period expires in July.