Default question hangs over frozen Russian bond market

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(Bloomberg) — The big question facing Russian creditors is whether they will ever get their money back.

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The government is paying its bond coupons at the moment, but with the war in Ukraine raging and foreign exchange reserves frozen, it’s unclear how or when investors will get their money. Even though the central bank has called the ban on transferring coupon payments temporary, the financial crisis has been so severe that no one knows how it will be fixed or if Russia would even be motivated to repay its debt.

With decades of integration into the global financial system snuffed out in days, Russia now faces its first default since 1998. Then shockwaves from the Asian debt crisis and falling oil prices forced Boris Yeltsin’s government to give up around $40 billion in local ties.

“All bets are off now,” said Guido Chamorro, co-head of emerging markets hard currency debt at Pictet Asset Management Ltd. in London. “The conflict with Ukraine changed everything,” he said, putting the risk of default above 50%.

On Wednesday, Fitch Ratings downgraded Russia’s sovereign credit rating by six levels to a single B – deep into junk status. Moody’s Investors Service followed on Thursday, with a similar downgrade to a B3 junk rating. Meanwhile, MSCI Inc. and FTSE Russell are removing Russian stocks from their widely followed indexes.

“We assume that US sanctions prohibiting transactions with the Department of Finance will not prevent Russia’s sovereign debt from being serviced,” Fitch said in its statement. “But it’s not clear and the risk of such a harsh measure has increased significantly.”

Read more: A $9 billion bond problem is brewing for Russian issuers

Russia’s access to reserves, its willingness to pay and coupon payment mechanisms will all come into play. called OFZ.

Barring a central bank or government announcement, it may be weeks before investors or rating agencies can say with certainty that Russia has defaulted. Most bond deals come with a 30-day grace period to give borrowers some breathing room. It is unclear where OFZ bonds feature the same provision.

Several analysts, lawyers and bond investors polled by Bloomberg said they were unsure whether the Russia case — when a coupon is paid into accounts investors can’t access — would count as a default.

Others speculated that ratings agencies might call it a technical default, meaning Russia failed to meet the terms of the bond deal. Moody’s and S&P declined to comment when contacted by Bloomberg.

Read more: How sanctions are creating a risky tangle for Russian bonds: QuickTake

The world’s largest clearinghouses – Euroclear and Clearstream – no longer settle Russian assets and some of the country’s largest banks are cut off from the global banking system. Capital controls imposed by the central bank mean that even though the Ministry of Finance transferred a scheduled bond payment on Wednesday, investors cannot access the money.

“A default is a default – whether technical or official, you don’t get paid,” said Edwin Gutierrez, head of emerging market sovereign debt at abrdn in London.

Russia is not entirely cut off from world markets, but Moscow’s ties with China may be scary for holders of its sovereign debt.

Russia may be able to use its yuan-held assets in combination with China’s own cross-border payments system to counter the impact of Western sanctions, analysts at Australia & New Zealand Banking Group say. Russia’s central bank and sovereign wealth fund likely hold $140 billion in Chinese bonds, they estimated.

China’s central bank has a multi-billion dollar currency swap with its Russian counterpart, allowing both countries to provide liquidity to businesses. The country has also signed up Russian banks to its in-house payment settlement system, seen as an alternative to SWIFT.

(Adds more details on OFZ Bonds)

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