Washington Ends Bond Payment Exemption for Russia, Leading to Fears of Default

Washington Ends Bond Payment Exemption for Russia, Leading to Fears of Default
The U.S. Treasury Department in Washington on Aug. 30, 2020. (Andrew Kelly/Reuters)
Naveen Athrappully
5/25/2022
Updated:
5/25/2022

Following Washington’s decision to end a key sanctions exemption, Russia’s chances of defaulting on its debts have increased.

Back in February 2022, the U.S. Treasury had stated that it would allow Russia to make sovereign bond payments to American investors despite strong financial sanctions imposed on Moscow for its aggressive incursion into Ukraine. But on May 24, the department’s Office of Foreign Assets Control (OFAC) announced that it will not be renewing this exemption.

The sanction exemptions ended at 12:01 a.m. Eastern time on May 25. This means that U.S. individuals and entities will no longer be able to receive bond payments from Russia without breaching government sanctions.

“If the bondholders don’t get their money when the money is due, factoring in any grace periods that apply, Russia will be in default on a sovereign debt,” Jay Auslander, a partner at law firm Wilk Auslander, said to Reuters. “With the waiver gone, there seems to be no way for bondholders to get paid.”

Though the exemption-lapse only applies to American citizens, it is expected to make things tougher for Russia as it seeks to pay other debt holders, owing to the critical role U.S. financial institutions play in the global financial system.

Moscow is due to make bond coupon payments worth $71 million and 29 million euros ($31 million) on May 27. Russia has already transferred a part of the money, anticipating the end of the U.S. exemption, according to Business Insider.

Russia can still avoid an official default despite Washington’s action, according to Olga Nikolaeva and Iskander Lutsko of Russian broker ITI Capital. The majority of Russian bondholders are now European entities, while the Treasury decision only applies to U.S. entities, the analysts point out.

“Russia will proceed with coupon payments, while those blocked from getting money from the Russian sovereign will not be able to meet a quorum requirement to initiate litigation as part of default procedure,” ITI Capital said in a recent note, according to Insider.

Moscow will likely argue that it has not committed a default since the United States has made it impossible for Russia to make those payments  despite Russia having the necessary funds, said Adam Solowsky, a partner in the Financial Industry Group at global law firm Reed Smith, in an interview with CNBC.

Russia’s situation is an abnormality when compared to the regular process for sovereign defaults. In such a situation, a country restructures its bonds with investors as it nears default.

“That’s not going to be feasible for Russia at this time because basically under the sanctions, nobody can do any business with them, so the normal scenario that we would see play out is not what we would expect in this case,” Solowsky said.