There will be no doubt that Russia will have defaulted if it chooses to make forthcoming coupon payments in roubles rather than US dollars, according to legal expert on sovereign debt restructuring Lee Buchheit.
Coupon payments of US$117m are due from the sovereign on Wednesday to holders of two US dollar bonds maturing in 2023 and 2043 but they could be paid in local currency, if they are paid at all.
"That will certainly be a default," said Buchheit, who advised on the restructuring of Iraq’s debts after the fall of Saddam Hussein in 2003 as well as Russia’s restructuring after a default on local currency bonds in 1998 during Boris Yeltsin’s presidency.
Cash prices suggest the market is expecting a default, with both bonds bid at 20 cents on the dollar, according to MarketAxess. And a default on Wednesday's coupons might also have implications for the rest of Russia's foreign currency bonds.
“All of the bonds have a cross-acceleration trigger, not a pure cross-default," said Buchheit. "So it would take one of the two bond syndicates that have coupon payments due this Wednesday to vote to accelerate sometime after April 16 [when the 30-day grace period ends]."
If they did so, it would mean that investors across all Russian sovereign debt could demand their money back immediately.
Get-out clause
Though the coupon payments on Wednesday have to be paid in US dollars, that is not the case for all of Russia's sovereign bonds. Six notes issued since 2018 have fallback language that allow for rouble payments if Russia is unable to use foreign currency for "reasons beyond its control". A coupon is due to be paid on one of those notes on March 21. But Buchheit said that did not give Russia the right to simply pay back in roubles with no questions asked.
"When the first payments come due under the more recently issued Russian Federation bonds [the bonds issued post-2018], it won’t be a question of Russia 'changing the currency of payment'," said Buchheit. "The payments will still be due in US dollars or euros. It will rather be a question of whether Russia can discharge the payment by invoking the clause allowing the payment to be made in roubles."
Buchheit said Russia will need to clear two hurdles in order to invoke the clause, and ultimately have it recognised by courts in England as the bonds are written under English law.
"First, is the cause of this difficulty a reason 'beyond Russia’s control'?" said Buchheit. "Second, Russia has announced that half its reserves have not been frozen. Will an English judge find that Russia is financially 'unable' to make the payment?"
Can't pay, won't pay?
Russia insists that it is planning to pay the coupons due on Wednesday in US dollars but may not be able to. If it can't, it will make the payments in roubles.
“This week, on Wednesday, we are due to repay another Eurobond coupon," the country’s finance minister Anton Siluanov told state TV on Monday, according to Reuters. "And today, on Monday, we prepared a payment document in foreign currency and will give an order to foreign banks to execute this payment. We will keep an eye on this payment document and monitor how banks will execute our orders."
The finance ministry added that if sanctions mean that those foreign banks – the paying agents – are unable to transact with the Central Bank of Russia, money owed will be transferred in roubles to the National Security Depository and the payment will then be made at some point in the future via so-called “S” accounts.
Whether it repays the bonds in the currency of issue or in roubles, Siluanov said Russia will have fulfilled its side of the bargain. “Is that a default? ... From Russia's point of view, we are fulfilling our obligations," he said on Monday.
Rating ban
The ability of the major ratings agencies to opine on whether a default has occurred was thrown into doubt on Tuesday when the EU banned top firms from rating Russia's sovereign debt and the country's companies as part of its latest sanctions package.
S&P had said in a note on March 4 that "if payment is made in a currency not stipulated in the terms of the obligation, and we believe that the investor does not agree to the alternative payment, we could deem this a default".
Local investors
Russian holders of Eurobonds are also struggling to receive money they are due. Last week, the Russian Union of Industrialists and Entrepreneurs asked the central bank to facilitate fund transfers that would normally come via Euroclear to Russian investors, reported Interfax. Euroclear has halted its interaction with the National Settlement Depository in the wake of Russia's invasion of Ukraine.
While on one hand it makes sense for Russia not to pay in US dollars and preserve its hard currency, any Russian default would have big consequences. Conversely, it also makes sense for Western policymakers to try and ease any US dollar transfer to deplete Russia’s hard currency reserves.
"A default would see Russian ratings cut to default status, and given likely difficulties in ensuring speedy debt restructuring, this status could remain for a very long time," said Tim Ash, senior EM sovereign strategist at BlueBay Asset Management.
"This would keep Russian borrowing costs very high, limiting financing options even from so-called allies, such as the Chinese. Even should the war end quickly, and peace be resolved, markets and ratings agencies will remember this crisis for some time and ratings will be slow to recover and Russian borrowing costs slow to moderate. This will crimp Russian economic development for years to come."
Even if Russia pays in US dollars on Wednesday and default is avoided on these payments, there will be further tests in the weeks to come. For example, the sovereign has a US$2bn maturity on April 4.
After May 25, US and EU sanctions stipulate that Russia can no longer wire US dollars or euros to service debt. "[In that case] Russia might be able to invoke the 'rouble discharge' exception on that basis," said Buchheit.