Invest: So Russia defaulted, what’s next?

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Russia is facing troubles.

Russia has international bonds outstanding, and it has the dollars to make payments on them, but it has been blocked, by sanctions, from making those payments. Yesterday a deadline for making some of those payments expired, putting Russia officially into default on its bonds. Now what?

The Wall Street Journal has the traditional answer:

In theory, creditors could try to seize Russian assets abroad, though it is unclear what they might go after. Some investors have suggested they might claim frozen central-bank reserves or oligarchs’ assets. Bondholders of Venezuelan debt sought assets of a state-owned oil refiner after the country’s default. In 2013, Argentina hired a private jet for the then-president’s trip to Asia and the Middle East because of the risk of creditors seizing the official aircraft. 

“I suspect, remembering what happened with Argentina, that the Americans would be keen to have creditors chasing Russian assets all over the world,” said Paul McNamara, an emerging-market fund manager at GAM. “It’s basically contracting out the job of going after Russian assets.” 

Sure. If there is some stash of dollars (or yachts, houses, etc.) that belong to Russia, the bondholders could try to seize them. I will tell you where one stash of Russian dollars might be. The Journal also reports:

Russia has plenty of money from oil and gas sales to pay its foreign debts, which are relatively small compared with the size of its economy. But allied Western governments have blocked the Kremlin’s ability to tap foreign bank accounts or use cross-border payment networks to move money.

The Treasury Department last month let a prior sanctions exemption expire that had allowed U.S. banks and investors to process and receive payments on existing Russian bonds. …

One investor said clearinghouse Euroclear received funds for the May interest payments just before the Treasury’s exemption expiration. But the funds were frozen there because of sanctions, unable to be forwarded to his account. Lawyers say the bond documents are unclear over whether payments that reached the clearinghouse, but not the bondholder account, would constitute a formal default. 

A Euroclear spokesperson didn’t immediately respond to a request for comment.

Okay. Let’s not focus on the technical question of whether it counts as a default if the money gets to Euroclear but Euroclear does not (due to sanctions) pass it along to the bondholders. I just want to make a narrow point here, which is:

  • Russia supposedly transferred the $100 million for this payment to Euroclear, where it is stuck.
  • The bondholders are now, I guess, looking to seize some Russian assets abroad.
  • What about that $100 million at Euroclear?

Like, Euroclear has that money, and the bondholders want it, but Euroclear can’t pass it along to them because sanctions prohibit it from passing along interest payments on behalf of Russia. But if you utter the right incantations, you can turn that $100 million from “a Russian interest payment” into “Russian assets abroad that can be used to satisfy a default judgment.” And then Euroclear could give it to the bondholders. Maybe? Boy is that not legal advice.

This does not quite work as a matter of arithmetic. Russia has transferred a little bit of money to foreign banks and clearinghouses to make interest payments on its bonds, and those payments have gotten stuck, and that has led to a default, and in theory that default allows the holders of all of Russia’s billions of dollars of international bonds to accelerate those bonds and demand immediate repayment. So there could be a rush of all of the bondholders to seize money, and the $100 million that might or might not be at Euroclear won’t come close to satisfying all of their claims.

Still it is a strange sort of default. You could imagine a financial-engineering approach:

  1. Get all the bondholders together to agree to accelerate the debt and try to seize Russian assets abroad.
  2. The bondholders also agree to a payment waterfall: Holders of Bond A get the first $X seized, and then holders of Bond B get the next $Y, and then holders of Bonds C and D share equally in the next $Z, etc. And $X happens to be the interest payment due on Bond A next month, and $Y happens to be the amount due on repayment of Bond B at maturity next year, etc.
  3. On the next interest payment date for Bond A, Russia transfers $X to a foreign account at some international bank and says “hey bondholders come seize our money.”[4]
  4. The bondholders apply to the bank to seize the money and give it to the holders of Bond A under the payment waterfall.
  5. The bank is like “sure whatever here you go, seizing Russian money isn’t sanctioned, in fact it is encouraged.”
  6. Then Russia pays Bond B the same way.
  7. Etc.

Basically you pass the bond payments along to the holders as normal, except that instead of calling them “bond payments” you call them “assets seized due to acceleration of the bonds in default.” The bondholders get paid as normal, but you get to say that Russia is getting punished for default instead of paying its debts in the ordinary course. You get to call it a default, but the bondholders get to keep getting paid.