Explainer: The US Treasury is pushing Russia into default: what next?

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Russian ruble coins are seen in front of the US dollar banknote displayed in this illustration taken February 24, 2022. REUTERS/Dado Ruvic/Illustration

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LONDON, May 27 (Reuters) – The expiration of a key U.S. license allowing Russia to make payments on its sovereign debt to U.S. holders has brought the prospect of the country’s debt default back to the fore. sovereign.

Russia is due to pay $100 million in interest on two sovereign bonds on Friday, with further payments to come in June.

Here are some questions and answers about what could happen next:

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WHAT CHANGED?

A license issued on March 2 by the United States Office of Foreign Assets Control (OFAC) had authorized transactions between American entities and the Russian Ministry of Finance, the central bank or the national wealth fund concerning the payment of the debt.

This allowed Russia to maintain interest and maturity payments on its sovereign debt, despite sweeping restrictions on dealings with Russian entities. Since February 22, it has managed to make payments on seven dollar-denominated bonds.

But the Treasury Department said Tuesday night that it would not extend the license. Although his action only directly affects US bondholders, holders elsewhere will struggle to accept Russian payments due to US dominance of the global financial system.

SO HOW MUCH DEBT IS AFFECTED?

Russia has about $40 billion in international bonds outstanding, with just under $2 billion in external debt service through the end of the year.

Debt can be broadly divided into three tiers: firstly, legacy bonds which are settled overseas in the usual way and secondly, those issued after the annexation of Crimea by Moscow in 2014 which are settled by the national custodian of Settlement (NSD) of Russia and who have alternative rights. currency payment arrangements.

The last category includes debt sold after 2018 which also settles at the NSD but contains provisions for payment in rubles.

WHEN WILL THE DEFECT OCCUR?

On May 27, interest payments worth $71.25 million and €26.5 million ($28 million) are due on two bonds. To beat OFAC’s deadline, Russia launched the payment process last week.

Russia’s NSD – the paying agent for the two bonds – said it had received the funds and said it would make payments in foreign currencies on May 27.

The prospectus for both bonds states that “payments of principal and interest (including any additional amounts) on a global bond registered in the name of NSD will be payable to NSD in its capacity as registered holder”.

Some analysts, as well as the Russian Ministry of Finance, consider the payment to have been made.

However, it seems unlikely that the money will go further into the bondholders’ accounts. Russian Finance Minister Anton Siluanov said on Friday that restrictions on capital withdrawals from Russia for non-residents would remain in place until Russia’s gold and currency reserves are unfrozen. Read more

By many definitions, the failure of funds to appear in creditors’ accounts is a default.

Russia has a 30-day grace period after May 27 to make the payment.

WHAT ARE THE NEXT PAYMENTS?

If creditors receive the May 27 payments, Russia will have to pay two bonds on June 23 and another on June 24.

June 23 payments are – just like May 27 payments – due on bonds that are settled at the NSD.

However, the latter is $159 million owed on a bond issued in 1998. Because this problem can only be solved abroad, analysts believe that Russia will not be able to make this payment without the license from the Treasury.

This obligation is subject to a grace period of 15 working days.

WILL CREDIT DEFAULT SWAPS BE TRIGGERED?

The question is whether a potential non-payment will trigger a payment on credit default swaps (CDS) that investors use to insure their exposure to specific risks, in this case Russia defaulting on its sovereign debt.

A committee of major banks and asset managers is responsible for deciding whether a “credit event” has occurred. This in turn can trigger a payout.

JPMorgan expects that bonds that can be settled in Russia and receive payment at the NSD will not result in a payment for CDS holders.

“Even if that payment is not then passed on to bondholders, it may be enough to avoid a CDS trigger,” JPMorgan analysts said in a note to clients.

However, if Russia does not make the payment due on June 24, the CDS could be triggered once the grace period expires.

Still, a trigger could already be happening earlier than that.

A credit derivatives committee will meet on Friday to discuss whether a ‘credit event’ occurred after Russia made payments on its sovereign debt but failed to add 1.9 million dollars of accrued interest during the payment grace period. Read more

There is currently $2.54 billion in net notional CDS outstanding against Russia, including $1.68 billion on the country itself and the rest on the CDX.EM index, JPMorgan calculated. .

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Reporting by Sujata Rao and Karin Strohecker, additional reporting by Jorgelina do Rosario Editing by Tomasz Janowski and Susan Fenton

Our standards: The Thomson Reuters Trust Principles.

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