Russia hits credit event tripwire

IFR 2436 - 04 Jun 2022 - 10 Jun 2022
5 min read
EMEA, Emerging Markets
Robert Hogg, Christopher Spink

Russia has once more found itself on the wrong side of a decision by a derivatives industry body that should this time trigger payouts on credit default swap contracts. The EMEA Credit Derivatives Determinations Committee ruled on Wednesday that a "failure to pay credit event" had occurred in relation to just US$1.9m of accrued interest. The sovereign has more than US$40bn of international bonds outstanding.

The ruling had been sought following a question being put to the 14-member committee arguing that bondholders were owed the US$1.9m in accrued interest on the sovereign's 4.5% April 2022s. The committee voted 12-1 in favour of the ruling.

Principal and coupon payments were due on April 4. But because Russia was unable to service the debt through its offshore reserves following further US government restrictions, it didn't make the payments until May 2 after Moscow decided to use its onshore assets. It made US$564.8m of principal and coupon payments on its April 2022s and US$84.4m of coupon payments on its April 2042s.

Holders of the 2022s argued that Russia had not paid the interest accrued beyond April 4, "putting it in default under the bonds", according to a statement on the DC website.

The bondholders said they "submitted a default notice via Euroclear" on May 11 "demanding the payment". They added that despite the demand, "Russia has not paid the interest owed".

The DC first met on May 27 but, with the question still undecided, it reconvened on May 31 to continue discussions. A decision was finally reached on June 1 to confirm that the question had been answered, with the tally of votes and a full statement expected to follow.

"There's been no real market reaction to the decision other than in the short-dated CDS market, which was basically with the June CDS contract where people were betting on the exact timing of when this would happen," said a source.

Although the ruling that a credit event has occurred is not a formal declaration that Russia has defaulted, it should now lead to the CDS being triggered.

There is currently US$2.54bn of net notional CDS in Russia CDS to be settled, according to JP Morgan.

Second time unlucky

The question was the second time that the DC has fielded a potential Russian credit event since the country's invasion of Ukraine in February.

The committee ruled unanimously in April that "a potential failure to pay" had occurred after Russia threatened to make payments due on two US dollar bond issues in roubles. The triggering of CDS contracts was eventually averted after Russia paid its international bondholders in US dollars before the two bonds' grace period had expired.

A special waiver, General License 9C, issued by the US Treasury's Office of Foreign Assets Control that had let US citizens receive Russian bond payments was allowed to expire on May 25. Analysts said the decision had set the stage for Russia to default on its foreign currency bonds.

On May 20, Russia's finance ministry brought forward coupon payments on its US$3bn of 4.75% 2026s and €1bn of 2.65% 2036s, even though they were not due until May 27. By making the payments to its National Settlement Depository, Russia said it had fulfilled its current obligations on the notes.

The source said that US firms are no longer able to accept the payments following the expiration of the licence, so are rejecting the funds.

"The bonds are priced at 20 cents on the dollar, so if Russia ever trades sanctions relief for a de-escalation in the conflict, then these bonds can be redeemed at par," said the source. "You are looking at 80 points upside or 20 points downside, so there will be pretty decent buying interest. It's only US holders who can't receive the coupons, although I expect the Europeans and UK to follow."

Russia, meanwhile, is considering paying Eurobond holders by applying the mechanism it uses to process payments for its gas in roubles, Reuters reported. The scheme, according to the Kremlin and Russia's finance minister, would allow Moscow to pay bondholders while bypassing Western payment infrastructure.

For foreign Eurobond holders to receive payments in foreign currencies as per Russia's obligations, they would have to open rouble and hard currency accounts at a Russian bank, finance minister Anton Siluanov told the Vedomosti newspaper.

Corrected story: Corrects voting tally