Russia engages in ‘payment theater’ as bondholders prepare for a default

Russia has vowed to sue if sanctions force it to default on its bonds, but academics and lawyers have dismissed the threat as “payment theatre” aimed at projecting the state’s financial strength.

Over the weekend, Finance Minister Anton Siluanov said Western sanctions are an attempt to “artificially create a man-made default” – Moscow’s first since 1998. Siluanov, who has already attempted to convert some dollar repayments into rubles, did not say who the government sues are could or in which country.

However, bondholders and rating agencies believe a bankruptcy process is underway, and academics argue that the country’s efforts to be seen as solvent are more political than practical.

“Paying contrary to expectations is a bullish policy move that’s pretty cheap,” said Anna Gelpern, a law professor at Georgetown University and a senior fellow at the Peterson Institute for International Economics. “When it comes to [the invasion of Ukraine] Partly it’s about projecting that “we’re a global power, respect us,” then that kind of payment theater is pretty important [President Vladimir] Putin.”

According to the US authorities, Moscow has already missed payments on two of its dollar bonds clogged American banks are barred from processing cash as part of measures to punish the country for its invasion of Ukraine. It is unclear how a Russian lawsuit might affect the default process.

“If we don’t get our dollars after 30 days, that’s a default,” said a Europe-based investor who holds Russian dollar bonds, referring to the grace period following last week’s scheduled coupon and principal payments.

S&P Global has already downgraded Russia’s credit rating to “selective default” and said it does not expect investors to receive dollar payments within the 30-day window. Meanwhile, a panel that sets payouts for derivatives contracts on Monday ruled that state-owned Russian Railways had defaulted on its debt after an interest payment failed to reach investors within a 10-day grace period, despite the company’s attempt for the past month to pay the money.

Line chart of bond price, cents per dollar, showing Russia's debt collapse

Like many government borrowers, Russia’s foreign currency bonds are governed by English law. Unusually, however, about the terms under which the bonds were issued, Russia said it would not submit to the jurisdiction of a foreign court.

The legal ambiguity surrounding the bonds means the Kremlin could potentially take legal action at home, according to Mitu Gulati, a law professor at the University of Virginia, who substantiated Russia’s argument that it was blocked by US authorities from making payments , referred to as “not crazy”.

“To the extent that they sue, they’re going to say, ‘Look, we want to pay, we just can’t, someone’s stopping us,'” Gulati said. “But here’s the rub: Normally, it’s supposed to be some kind of exogenous event for both parties [that is preventing payment] while investors would argue that’s not true. You caused this, they might say. If you don’t invade countries, you don’t get this situation. Leave Ukraine and you can pay.”

In any case, it is highly unlikely that a UK court would follow a Russian court’s ruling on whether the bonds are in default, Gulati added.

Both Gulati and Gelpern compared Russia’s situation to Argentina in 2014, when a New York judge prevented Buenos Aires from making payments to holders of new debt until it settled older creditors, effectively forcing the country into default.

Countries typically seek to avoid defaulting to facilitate the sale of new debt once the strain on government finances has eased, perhaps through a restructuring arrangement with creditors. However, the severe sanctions against Russia leave little prospect of negotiations with bondholders or of Moscow regaining access to bond markets any time soon.

“This is not a normal default,” said one investor. “As far as I know, nobody is talking about forming bondholder groups and talking to the Russians. I don’t even think that would be legal.”

Siluanov also said Russia has no plans to borrow in 2022. “We do not plan to enter the domestic or foreign market this year. It doesn’t make sense because the cost of such borrowing would be cosmic.”

Russian bond prices have plummeted since the invasion of Ukraine, with bonds currently trading at around 22 cents per dollar, a level that implies a default is priced in.

After the 30-day grace period, bondholders can “speed up” repayment and request immediate cash back if 25 percent of a particular bond’s holders vote in favor. Such a decision will likely depend on whether investors believe they can seize Russian overseas assets to enforce their claims — an exercise complicated by the fact that sanctions largely freeze Russian assets, Gelpern said.

“The current environment is so incredibly messed up that bondholders may not want to play their one big card without a clear game plan,” Gelpern said.

“But then it is a bit optimistic to count on civil negotiations [between bondholders and Moscow] be in the foreseeable future,” she added, “so some might want to accelerate if they think they can hit some assets.” Russia engages in ‘payment theater’ as bondholders prepare for a default

Adam Bradshaw

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