It’s a tiny amount for a country that is theoretically rich enough to put it on the table. Nevertheless, an interest payment of 1.9 million dollars (1.8 million euros) missed by Russia means that sellers of so-called credit default swaps (CDs) will soon have to dig into their pockets. And that for much, much larger amounts.
This insurance against default works on the same principle as fire insurance. But instead of on a house, they are taken out on a loan. If the debtor fails to fulfill his obligations, and does not repay part of it, the seller of the insurance will compensate the damage incurred. However, it must first be established that there is non-payment.
Three major rating agencies normally analyze the health of countries: Standard & Poor’s, Moody’s and Fitch. They are currently unable to label Russia as a defaulter. In mid-March, under European sanctions, they were banned from assessing the creditworthiness of both the Russian government and Russian companies.
As a result, it is up to the International Swaps and Derivatives Association to rule on default. This organization examines the functioning of the CDS market. A committee that includes both supply and demand representatives decided on Wednesday that a ‘credit event’ had occurred because Russia failed to pay sufficient interest to government bond holders in early May.
Not paid on time
Now, after maturity on April 4, the bond in question was repaid late to the lenders, but just within the 30-day grace period allowed by the contract. The problem is with the compensation that Russia had to pay for that postponement. It is this $1.9 million interest that did not reach the bondholders in time.
Russia does have the money, and the intention to pay, Finance Minister Anton Siluanov has been saying for weeks. However, international sanctions over the war in Ukraine have largely cut off Moscow from the international payment system and prevented it from getting that money from its creditors.
Although this concerns a limited amount for which there is a default, the consequences can be significant. The case shows what would happen if all outstanding CDs on Russian debt were to go into effect. According to ISDA, these are contracts that together represent about 2.5 billion dollars.
On the winning side are especially investors who, after the Russian invasion of Ukraine, pumped money into both the sharply depressed Russian government bonds and the default insurance on it. Normally this is meaningless, because a bond’s price moves in the opposite direction to that of the insurance, so they cancel each other out. But because in the first weeks after 24 February institutional investors sold their Russian bonds en masse, their prices fell faster than those of their insurance policies.
Public auction
The size of the insurance payout will depend on a public auction of the bonds. For example, suppose a $10 million debt is converted to a $3 million debt, the counterparty to the CDS contract must pay the difference of $7 million.
The next important date is June 26. Then the grace period ends for two interest payments due last week. The Kremlin is considering making those payments in rubles due to the tightening of US sanctions. However, the contracts in which the dollar loans are fixed state that this is not allowed.
The total Russian government debt in ‘hard currencies’ such as the euro and the dollar is 38 billion dollars. These bonds are now trading at 20 to 30 percent of their face value. A quick calculation suggests that the insurance sellers soon owe a total of $1.7 billion to the holders of the CDs.