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Russia’s bond default isn’t going to follow the playbook. For one thing, there’s little precedent of a debtor -- even one at war -- that says it has the money and wants to pay bondholders, but has been blocked by a web of sanctions and frozen assets. For Russia, the default at the end of June has little immediate fallout beyond cementing its status as a pariah state in the eyes of the West after its invasion of Ukraine. For the bond market, though, it’s a watershed event, even though Russia’s $40 billion of outstanding foreign debt is small by historical comparisons. Get ready for a long, twisted tale full of potential surprises.

1. Why is this default unique?

Typically when a payment is missed, investors band together to declare the debt immediately repayable in full, then enter into talks with the government to work out a plan. The restructuring might involve a so-called haircut (when bondholders agree to take less than face value), swapping the bonds for new notes or extending maturities. With Russia, it’s not even clear who would act as trustee to marshal the bondholders. Contracts for the securities in question, which are denominated in euros or U.S. dollars, don’t specify one, while sanctions block a role for western institutions and complicate interactions with the syndicate banks, which are all Russian. And should investors turn to the courts, it’s not clear what venue might have jurisdiction.

2. What does Russia say?

Russian Finance Minister Anton Siluanov has called the whole affair a “farce.” He says the blocked payments constitute “force majeure” because the sanctions were intentionally manufactured to force Russia into a default. In the months since the Feb. 24 invasion, Russian officials say the sanctions have prevented its funds from reaching the accounts of bondholders. “From Russia’s side, it is clear that they did everything, so they can say they haven’t defaulted,” said Viktor Szabo, a money manager at Aberdeen Asset Management in London, who has a small holding in Russian eurobonds. “You can start arguing whose fault that is, but the fact is that it’s not on bondholders’ accounts. Which means it’s a default no matter how you try to explain it.”

3. So what happens next?

That’s unclear. There’s also been a pile-up of defaults from Russia’s corporate borrowers, and if those are anything to go by, expect a period of limbo: Investors have yet to make a move to accelerate those liabilities. Creditor claims on the sovereign extend for three years, so any immediate efforts to take action seem unlikely. Investors may opt to hunker down in the hope that international penalties against President Vladimir Putin’s government are removed, opening the way to payment. It could be that Russia acts first. In April, Siluanov told the Izvestia newspaper that the country planned its own legal action, though he didn’t say how or where. “Of course we will sue, because we have taken all the necessary steps to ensure that investors receive their payments,” he said. “It will not be an easy process. We will have to very actively prove our case, despite all the difficulties.”

4. What does it mean for bondholders?

They can hold on for the long haul or try to offload the debt in the so-called secondary market, where it traded at about 20 cents on the dollar at the start of July. However trading has been quashed by more U.S. Treasury restrictions after banks handling Russian corporate and sovereign bonds were blasted for undermining the sanctions. US firms can hold or sell Russian debt, but can’t purchase it. That’s looking like a calculated bid to scare away so-called vulture funds from buying the cheapest, most battered assets in the hope of eventually wringing out a hefty profit. (In a parallel plot line, the Treasury’s move has also confounded the payout of credit default swaps, a type of insurance that typically uses a bond auction to establish a value for the contracts). Pacific Investment Management Co., which held the equivalent of about $1.8 billion of Russian sovereign bonds as well as exposure through credit-default swaps, warned the Treasury about the fallout on investors from the sanctions.

5. What’s the outlook for recovering the money?

Might we see some kind of replay of the dramatic seizing of the three-mast frigate, ARA Libertad, in 2012? In that famous case, Ghana temporarily impounded the Argentine naval vessel at the request of NML Capital, run by billionaire hedge fund investor Paul Singer’s Elliott Management Corp. NML and other vulture investors were seeking to recover the full value of the Argentine securities that defaulted in 2001 after refusing to participate in a government debt swap. Russia offers a big, potential target: It has hundreds of billions of dollars of foreign reserves that are frozen abroad, the biggest example of what Putin calls the West’s economic “Blitzkrieg.” But assets of the central bank have a higher level of protection, as do diplomatic ones, which are shielded under the Vienna Convention. There’s also the matter of sovereign immunity, which means that a foreign state isn’t bound to the jurisdiction of another country, making enforcement of any ruling difficult. If investors were to still pursue legal proceedings to recover at least a part of their investments, the most likely jurisdiction to do so would be England, as the Russian Eurobonds are regulated by English law. But a legal battle could also unfold elsewhere: in the U.S., home to many of the creditors and to most of the financial institutions within the payment infrastructure, or Russia itself, albeit this would likely be picked as jurisdiction only if the sovereign were to pursue legal action first.

6. What happened the last time Russia defaulted?

The last time Russia fell into direct default vis-a-vis its foreign bondholders of external debt was more than a century ago, when the Bolsheviks under Vladimir Lenin repudiated the nation’s staggering Czarist-era debt load in 1918. The Soviet Union signed an agreement to settle at least some of those claims in 1986, marking perhaps one of the longest-ever workouts. Then a balance-of-payments crisis in the late nineties triggered a default on $40 billion of local debt in 1998. The government budget was already gutted by the war in Chechnya before the Asian financial crisis of 1997 hammered oil prices, Russia’s key exporter earner. Russia also abandoned its defense of the currency, the ruble, triggering a cascade of bank failures. The biggest victim was SBS-Agro, the nation’s largest private lender, whose owner, Alexander Smolensky, famously said two years later that the bank’s foreign creditors deserved “dead donkey ears” instead of the $1 billion he owed them. Under Putin, Russia amassed one of the biggest foreign cash piles globally as oil roared back, allowing it to repay its Soviet-era debts to foreign governments and return to the Eurobond markets in 2010. It’s been a regular foreign issuer since, continuing even after the annexation of Crimea in 2014.

7. What makes this default a watershed?

An unusual combination of factors makes Russia’s default groundbreaking, according to Hassan Malik, senior sovereign analyst at Loomis Sayles & Company, who is also author of “Bankers and Bolsheviks: International Finance and the Russian Revolution.” In addition to the sanctions and the frozen central bank reserves, there are calls, including from U.K. Foreign Secretary Liz Truss and an adviser to Ukrainian President Volodymyr Zelensky, to seize assets to provide reparations to assist with the rebuilding of Ukraine. That could complicate the picture. Malik points to echoes of Iran’s 1979 default in Russia’s current predicament. Sanctions prevented Tehran from using deposits in US banks to make interest payments on its foreign loans until a waiver allowed freshly transfered funds to be tapped. It’s similar to a move by the US Treasury to force Russia to burn through its cash held locally. Ultimately, Iran simply repudiated the debt, Malik said, much like the Bolsheviks in 1918.

8. What steps is Russia taking?

Days before a June deadline on $100 million of coupon payments triggered the default, Putin signed into law new rules stating that the sovereign’s liabilities have been met if payment on foreign bonds is made in rubles. A mechanism was set up to pay rubles into local accounts instead of the currency the bonds are denominated in. However with international sanctions, there’s no proven path for foreigners to get their money out. According to the plan, the funds will be held on so-called “I” accounts at the main Russian depository until investors have proved title to the bonds, after which they can request permission to convert and repatriate the funds. No foreign investors have taken up the offer, Itar-Tass quoted Siluanov as saying June 29. And as for attempts to seize Russia’s overseas property: “If we ultimately get to the point where diplomatic assets are claimed, then this is tantamount to severing diplomatic ties and entering into direct conflict,” he said. “And this would put us in a different world with completely different rules. We would have to react differently in this case -- and not through legal channels.”

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