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Russia’s New Bond Rules Split Creditors Based on Sanctions

Russia’s New Bond Rules Split Creditors Based on Sanctions

Vladimir Putin introduced new rules for foreign creditors that will set debt payments depending on whether or not investors are based in a country that’s sanctioned Russia, dividing bondholders into two distinct categories.

Authorities said at the weekend that Russia and Russian companies will be allowed to pay creditors from “countries that engage in hostile activities” in rubles, even on securities denominated in other currencies. But they also said creditors in countries that haven’t imposed sanctions may be able to receive the payment in foreign currency with special permission.

The countries deemed “unfriendly” include the U.S., the U.K., Japan and European Union members. 

Russia is trying to show it can continue to honor its financial obligations amid uncertainty about whether the country will default on a debt payment. Foreign payments are banned under capital controls introduced to protect the economy from the sweeping sanctions imposed because of its invasion of Ukraine.

For many, the key date coming up is March 16. That’s because while some of Russia’s foreign sovereign debt allows repayments in rubles, the $117 million worth of coupons on dollar bonds due on that day don’t have that option. If Russia decides to pay in rubles, it could eventually lead to a default and trigger the credit-default swaps -- the contracts insuring against such risks.

On Monday, the cost of insuring Russia’s sovereign debt surged to signal an 80% probability of default.

Bond Slump

Russian corporate bonds denominated in foreign currencies have plunged to deeply distressed levels as investors weigh the impact of the sanctions and capital controls. The ruble has fallen to a record low and the stock exchange has been shut for more than a week.

Also over the weekend, Russia’s debt rating was cut further into junk territory by Moody’s Investors Service. It said there are “severe concerns around Russia’s willingness and ability to pay its debt obligations.”

Earlier this month, Russia made a coupon payment on sovereign bonds known as OFZs. While Russia’s National Settlement Depository received the money, foreign bondholders weren’t paid because of the ban on foreign payments. That triggered a debate over whether or not that constituted a default.

According to Saturday’s decree on servicing foreign-held debt, payments will be considered executed if they are carried out in rubles at the central bank’s official rate.

“There are still many open points there,” said Sergey Dergachev, senior portfolio manager and head of emerging market corporate debt at Union Investment Privatfonds in Frankfurt. “The question is, how will it be treated by rating agencies? How will it technically be transferred to investors?”

For Russian residents and creditors from countries that have imposed no sanctions, they “will be able to receive funds on existing debt obligations” on time in rubles or, with a permit, the denomination of the security.

But a different procedure will apply to creditors from countries that have imposed sanctions, the central bank said. Ruble payments to them will be made to special ruble-denominated accounts in the name of foreign creditors for settlement.

Rodica Glavan, head of EM corporate fixed income at Insight Investment Management in London, said the measure is a “way to go around capital controls,” but it’s not yet clear how the plan to have investors set up local accounts will work.

©2022 Bloomberg L.P.