Russia edges closer to CDS trigger
Credit-default swap contracts insuring against a default on Russian sovereign debt are expected to be triggered next month, an industry body signalled on Wednesday, absent a last-minute change of heart from Moscow following its decision in early April to offer payment in roubles to international bondholders.
The 14-member Credit Derivatives Determinations Committee, which includes Wall Street heavyweights such as Goldman Sachs and Pimco, ruled unanimously that a "potential failure to pay" had occurred with respect to Russian CDS contracts subject to ISDA’s 2014 definitions, the main legal documentation in the market.
A potential failure to pay is not a credit event and so will not trigger CDS payouts just yet because it does not take into account any grace period on the bonds in question. But it provides a signal to the market about how CDSs are likely to be affected if Russia is unable or unwilling to honour its debts to international investors before those grace periods expire in early May.
“The ruling prepares the market in terms of what potentially could be coming [if Russia fails to pay international bondholders], but the DC will still have to take into account the relevant grace periods,” said Athanassios Diplas, a CDS market veteran who helped design the auction process used to determine payouts to protection holders. “We’ll have to see how it plays out before knowing whether there is an actual credit event.”
Russia failed to make payments on two of its sovereign US dollar bonds on April 4 after the US Treasury blocked a route Moscow had previously used to pay international bondholders through US banks. That move prevented Russia from tapping frozen offshore funds to service its debt and instead forced it to choose between running down its unfrozen funds held onshore or defaulting.
Russia offered to pay investors in roubles – an option not permitted under the bonds’ legal documentation, which was swiftly rejected by its creditors. Both bond issues have 30-day grace periods, leaving the door open to an eleventh-hour reprieve. But a default now looms large unless Moscow makes a dramatic about-turn or manages to find a way to circumvent the current web of Western sanctions.
“There have been sanctioned countries before, but there is no question that this is a unique situation. Sanctions mean that the borrower is unable to pay, so at the end of the day bondholders are not going to be receiving their payments as required,” said Diplas. “Obviously, the currency of the payment is a significant factor that was contemplated in the design of the failure to pay credit event.”
The DC ruled earlier this month that CDS on Russian Railways had been triggered after the state-owned firm was unable to make a payment on a Swiss franc bond issue. A Russian sovereign CDS trigger would be a more significant affair given there are about US$3.4bn in net notional of credit derivatives positions across the market, according to a note from JP Morgan strategists published on April 11.
“CDS settlement should be fairly standard,” the strategists said, highlighting that there are several Russian government bond issues that should be eligible to be delivered into a CDS auction if there are no additional Western sanctions.
Russia’s US dollar bonds due 2026 traded at about 22% of face value on Thursday, implying a significant payout to CDS protection holders.