Delayed redemption pushes Russia closer to default

6 min read
Americas, EMEA, Emerging Markets
Christopher Spink, Robert Hogg

Russia’s options to avoid default are running out after the US Treasury told US banks that funds in accounts held by Russian entities that are subject to sanctions should not be used to make debt payments.

On Monday Russia was due to make its first redemption of a Eurobond since it invaded Ukraine on February 24. Last week the country had already bought back the bulk of the US$2bn 10-year 4.50% note but US$552m outstanding has yet to be paid to investors.

Russia’s correspondent bank JP Morgan heeded the Treasury warning and did not release the monies, presumably held in an account in the name of the Central Bank of Russia, which is subject to sanctions.

That stopped money flowing to the bond’s paying agent, which is Citigroup. “The US Treasury will not permit any dollar debt payments to be made from Russian government accounts at US financial institutions,” said a Treasury spokesperson.

JP Morgan and Citigroup declined to comment.

The country has 30 days to pay the monies before a formal default is declared. On Wednesday Russia attempted to make the payment in roubles but that breaches the terms of the bond, which state that the US dollar is “the sole currency of account and payment for all sums payable”.

Lee Buchheit, a lawyer with expertise in sovereign debt restructuring, said it was “a little mysterious” as to why the Treasury had thus far tolerated Russia tapping frozen accounts to make coupon payments on its external debt of around US$40bn.

“[Russian president Vladimir] Putin must know by now that there is a good chance that he will not get those frozen assets back – or at least not all of them – when this situation ends. From Putin’s standpoint, this policy was thus tantamount to letting him use free money to remain current,” said Buchheit.

“This is a sensible change in policy. It forces Putin to choose between two unpalatable alternatives – either default on external debt or drain some of his remaining unfrozen reserves.”

The Treasury spokesperson said: “This will further deplete the resources Putin is using to continue his war against Ukraine and will cause more uncertainty and challenges for their financial system.”

Until now Russia has received significant amounts of foreign currency through sales of oil and gas by state companies, such as Rosneft and Gazprom. But it is not clear how long this will continue, as Russia has now demanded such payments be made in roubles, partly to support the domestic currency.

A Kremlin spokesman told Reuters that Russia did not intend to default. “Russia has all necessary resources to service its debts ... If this blockade continues and payments aimed for servicing debts are blocked, [future payments] could be made in roubles.”

Artificial situation

In all US$649m was due to be paid on Monday comprising the redemption and two coupon payments. Instead payments in roubles have been made to Russia’s National Settlement Depository, according to the Russian finance ministry.

“In theory, a default situation could be created but this would be a purely artificial situation. There are no grounds for a real default,” said the Kremlin spokesman.

Investors disagreed. “Most likely this will be an event of default and funds are going to have to write down their bond ownership," said one.

A second investor doubted whether the money would now reach investors’ accounts within the 30-day grace period.

“They could use internally held US dollar reserves or energy export dollar receipts to settle and go through a non-sanctioned bank but it’s getting very complex for this money to wend its way to bondholders,” she said.

She said that the prospectus did not allow payments in roubles and that should lead to a default but said local investors could be holding some bonds and may have agreed to receive roubles. “That would not be a default.”

However, if Russia tried to force offshore investors to receive roubles without their consent then that would be a default. “I don’t think that has happened yet,” she said.

Fitch said last month that if a payment in local currency were to occur on US dollar bonds it "would constitute a sovereign default". Moody's and S&P said in recent weeks that a payment due in US dollars but made in local currency would probably be considered defaults but they would need to consider the details first.


The first investor said the payment block was “ill-conceived” since it prevented Russia from paying money owed to US investors. “It just penalises US or European investors who were due money from the Russian government,” he said. "This is hurting US and European pension funds.”

The investor called for the frozen assets to continue to be used to make payments. “The US can’t seize assets but it can freeze them. Logically it makes sense for that money to be used to pay international holders, I just don’t understand why they are going down this route,” he said.

“There will be all sorts of legal challenges – ultimately default will happen if Russia says it is not going to use oil and gas receipts to pay debt. If it will pay in roubles or nothing, then default will happen.”

Legal position

Although Buchheit agrees with the freezing of payments from US bank accounts, he warned that the Treasury’s Office of Foreign Assets Control, which implements sanctions, should tread carefully if it moves to stop payments coming from Russia's accounts that aren't frozen, even after May 25 when the current licence expires to process such payments on existing debt.

“To do so might give Putin a legal defence in an English or US court against a bondholder enforcement action,” he said. Russia could claim it was prevented from making payments from any of its accounts, rather than choosing not to pay using resources that are free of sanctions.