Why Russia's reported default is so tricky

Moody's ratings agency has confirmed that Russia defaulted on foreign debt after bondholders did not receive $100 million (€94.9 million) in interest payments.

"Missed coupon payment constitutes a default," the international ratings agency said in a statement late on Monday, adding that further defaults on future coupon payments "are likely."

Russia has a total of about $40 billion outstanding in foreign currency denominated bonds, and the legal picture is unclear as to the status of default.

What is default?

The way government debt works is that investors globally buy so-called government bonds — basically legal documents. The government gets to use the proceeds from the purchase for its expenses and agrees to periodically pay interest payments to the investor. After maturity of the bond, the government returns the initial sale price — the principal investment — to creditors and the debt dissolves.

What counts as default is stipulated in the legal fine print. Each government bond comes as a long legal document, in the case of one of the Russian bonds in question 143 pages of text. This document, seen by DW, defines seven events of default. Most pressing: Nonpayment.

Did Russia default?

Even though Moody's declared Russia in default, the legal documents present a messy picture. Speaking on the condition of anonymity, a capital markets lawyer in London told DW that at the very least Russia hasn’t "complied with their obligations under the contract."

With regard to what "nonpayment" means in the legal documents, the lawyer said: "Can someone fail to pay if they have actually done all there is to do within their control to make the payment ... and ensure the relevant funds leave the relevant account?"

Legally, courts will decide whether the country defaulted. But how can money be paid but not received?

Did Russia pay its creditors?

The inner workings of international finance are intricate. At least one investor had knowledge of a payment sent but not received, US business newspaper The Wall Street Journal reported this week. And Russian Finance Minister Anton Siluanov told reporters in Moscow last week that Russia has done everything "to lead the horse to water. But it's not up to us whether it wants to drink or not."

Because of the US-led sanctions regime, the international channels of sending payments aren't open for Russia anymore. In such a transaction multiple agents are involved like paying agents, who send the funds to clearing institutions which handle interest payments for debtors and creditors.

The lapsed Russian bonds were to be cleared through Euroclear or Clearstream — two private companies that offer such services but which are currently barred from clearing Russian payments as a result of sanctions.

Instead, Russia's Finance Ministry said it had transferred interest payments to a Euroclear account in the Russian settlement system, the National Settlement Depository (NSD). Under normal circumstances, Euroclear would have then transferred the money into its own system and then to the depository banks that have accounts with Euroclear and finally to the bondholders. But Euroclear is not allowed to process any further.

"So technically speaking the money is no longer in an account of the Russian Federation, but it's already in an account that doesn't belong to the Russian Federation, and the Russian Federation cannot take the money back," the capital markets lawyer said, assuming the money "is somewhere stuck in the plumbing."

Russia has precautions against seizure of assets

Countries have defaulted in the past. Argentina defaulted nine times in the past 200 years. During a period of default in December 2013, the Latin American country was unsure about its assets.

Bond holders can seize a defaulted debtor's assets, which was why Argentina's government chartered a British plane for then President Cristina Fernandez de Kirchner to visit Asia and the Middle East. This way the government's jet wasn't on the line.

"I suspect, remembering what happened with Argentina, that the Americans would be keen to have creditors chasing Russian assets all over the world," Paul McNamara, an emerging-market fund manager at GAM, told the Wall Street Journal.

But Russia's default is different. Not only is there a willingness to service the debt. The two bonds breached on Sunday lack one feature usually present in such documents: a waiver of immunity. 

Usually, governments grant creditors the ability to sue them. The Russian bonds issued in 2016 and 2021 have no such clause. An investigation posted to Harvard Law School Bankruptcy Roundtable found, there are legal ways around this hurdle. It concludes, investors in Russian bonds should organize themselves and force legal action.

What's at stake for Russia with default?

As of now, Moscow's coffers are filled with euros and dollars from commodities exports and funding isn't an issue. But in the future Russia may want to borrow from outside of its borders again, for example from China.

Being declared in default is a problem because investors aren't keen on lending to defaulters. As of now, international lenders are mostly scared away from lending to Russia as they fear to entangle themselves in the Western sanctions regime.

But, even if Russia were to find allies to the east, it would come at a cost, Timothy Ash, an economist at BlueBay Asset Management, told DW. "I think Chinese entities will look at Russia very differently if it's in default. ... If they want to still lend to Russia, they will charge a high premium for that," he said.

Edited by: Uwe Hessler

The original piece was updated in paragraph 3 to clarify Russia has $ 40 billion in foreign currency denominated bonds outstanding.