Russia relies on ‘payment theatre’ as bondholders prepare for default

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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” designed to project the state’s financial strength.

Over the weekend, finance minister Anton Siluanov said western sanctions were an attempt to “artificially create a man-made default” — Moscow’s first since 1998. Siluanov, who has already sought to flip some dollar repayments in to roubles, did not say who the government might sue or in which country.

But bondholders and rating agencies assume a default process is under way, and academics argue the country’s efforts to be seen as willing to make payments are political rather than practical.

“Paying contrary to expectations is a bullish political move that’s rather cheap,” said Anna Gelpern, a professor of law at Georgetown university and a senior fellow at the Peterson Institute for International Economics. “If the whole point of [the invasion of Ukraine] is partly about projecting that ‘we are a global power, respect us’ then this kind of payment theatre is quite important for [President Vladimir] Putin.”

Moscow has already missed payments on two of its dollar bonds, after US authorities blocked American banks from processing cash as part of measures to punish the country over its invasion of Ukraine. It is unclear what bearing any Russian legal action might have on the process of a default.

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

Already, S&P Global has downgraded Russia’s credit rating to “selective default”, saying it does not expect investors to receive payment in dollars within the 30-day window. Meanwhile a panel that determines payouts on 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 attempts to pay the cash last month.

Russia’s foreign-currency bonds — like those of many sovereign borrowers — are governed by English law. Unusually, however, in 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 launch legal proceedings at home, according to Mitu Gulati, a law professor at the University of Virginia, who described Russia’s argument that it has been thwarted from making payments by US authorities as “not crazy”.

“To the extent they litigate they will say ‘look, we want to pay, we just can’t, somebody is stopping us’,” Gulati said. “But here’s the rub: usually it’s supposed to be some kind of exogenous event to both parties [that is preventing payment] whereas investors would argue that’s not true. You have caused this, they could say. If you don’t invade countries then you don’t get this situation. Get out of Ukraine and you can pay.”

In any event, a court in the UK would be highly unlikely to defer to a Russian court’s judgment on whether the bonds were in default, Gulati added.

Both Gulati and Gelpern likened 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 had paid off older creditors, effectively forcing the country into default.

Countries typically strive to avoid default to make it easier to eventually sell new debt once the stress on government finances has eased, perhaps through a restructuring agreement with creditors. However, the severe sanctions against Russia leave little prospect of any negotiation with bondholders, or of Moscow regaining access to bond markets in the foreseeable future.

“This isn’t like a normal default,” said one investor. “As far as I’m aware no one is talking about forming bondholder groups and talking to the Russians. I don’t even think that would be legal.”

Siluanov also said Russia had no plans to borrow in 2022. “We are not planning to enter the domestic market or foreign markets this year. This makes no sense, because the cost of such borrowing would be cosmic.”

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

After the 30-day grace period has expired, bondholders are able to “accelerate” repayment, demanding they get their money back immediately if 25 per cent of the holders of a specific bond vote to do so. Such a decision is likely to depend on whether investors think they can seize any of Russia’s overseas assets in order to enforce their claims — an exercise complicated by the fact that Russian assets are largely frozen by sanctions — said Gelpern.

“The current environment is so incredibly muddled that bondholders may not want to play their one big card with no clear game plan,” Gelpern said.

“But then it’s a little bit optimistic to expect a civil negotiation [between bondholders and Moscow] to ensue any time soon,” she added, “so some may want to accelerate if they think they can reach some assets.”

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