Karin Strohecker & Sujata Ro

LONDON (Reuters – Russia’s lapsed license allowing it to make payments to U.S. holders on sovereign debt has brought the risk of default on the sovereign debt into sharp focus.

Russia will pay interest of $100 million on two sovereign bonds Friday. Additional payments are expected in June.

Below are some possible next steps.

WHAT IS CHANGED

The U.S. Office of Foreign Assets Control (OFAC), issued a license on March 2. This allowed transactions between U.S. entities with Russia’s central bank, finance ministry or national wealth fund to pay debt.

This allowed Russia to continue making maturity and interest payments on sovereign debt, in spite of many restrictions on Russian dealings. Seven dollar-denominated bond payments have been made since Feb. 22.

The Treasury Department announced late Tuesday that it will not renew the license. Despite the fact that it directly impacts only U.S. bondholders (the Treasury Department), holders from other countries will be unable to accept Russian payments as a result of U.S. dominance over the global financial market.

HOW MUCH DEBT IS AFFECTED

Russia currently has approximately $40 billion worth of international bonds, and just over $2 billion left for external debt servicing until the end.

There are two types of debt: legacy bonds, which can be settled off-shore in the normal manner, and secondly, the ones issued following Moscow’s 2014 annexed Crimea. These are settled at Russia’s national settlement depositary, (NSD), and include alternative hard currency payment provisions.

This last category includes debt that was sold after 2018, which is also settled at the NSD, but has provisions to be paid in roubles.

WHEN WILL THE DEFAULT HAPPEN

Interest payments in the amount of $71.25million and 26.5 million Euros ($28 million), are due for two bonds on May 27. Russia started the payment process last week to meet the OFAC deadline.

Russia’s NSD, the agent for payment on the bonds, announced that it had received the funds and will pay the foreign currency payments on May 27.

Both bonds’ prospectus states that the Principal and Interest (including additional amounts) of Global Bonds registered as NSD are payable to NSD, in its capacity of registered holder.

This is a sign that the payment has been made, according to some analysts and Russia’s financial ministry.

It is unlikely, however that the money will be able to make its way into bondsholders’ accounts. Russia’s Finance Minister Anton Siluanov stated Friday that the restrictions on non-Russian residents withdrawing capital from Russia will continue until Russia’s FX and gold reserves have been unfrozen.

According to many definitions, a default is when funds fail to show up in the accounts of creditors.

Russia is allowed to pay the amount within a 30 day grace period starting May 27, 2012.

WHAT IS THE NEAREST PAYMENTS?

Russia is responsible for payments to two bonds, one in June 23, and the other in June 24, if creditors receive the May 27, payments.

Like the May 27 payments, the June 23 payments are due to bonds paid at the NSD.

The $159 million payment is due for a 1998 bond. Analysts believe Russia won’t be able make the payment without the Treasury licence because this issue cannot be settled off-shore.

This bond has a grace period that lasts 15 days.

SHALL CREDIT DEFAULT SWAPS BE TIGGERED?

There is a question about whether nonpayment may trigger payouts on credit default Swaps (CDS). These are instruments that investors use to protect themselves from specific risks. This would be Russia’s default on its sovereign debt.

The task of determining whether there has been a credit event is the responsibility of a committee made up major asset managers and banks. A payout can be triggered by this.

JPMorgan (NYSE 🙂 believes that CDS holders will not be able to settle bonds in Russia that are non-redeemable and get payment at NSD.

JPMorgan analysts stated in a note that they sent to clients, “Even though this payment isn’t subsequently transferred to bondholders. This may be sufficient to avoid a CDS trigger.”

If Russia does not pay the June 24 payment, CDS may be activated once the grace period ends.

But a trigger can happen sooner than this.

On Friday, a credit derivatives committee meets to determine if a “credit incident” has occurred following Russia’s payment of its sovereign debt. However, it failed to pay $1.9million in interest during the grace period.

JPMorgan estimated that there are $2.54 trillion in net notional CDS currently outstanding relative to Russia. This includes $1.68 billion for the country and the rest on the CDX.EM Index.