‘Hostile Activities’ (Who Wants Rubles?)

Vladimir Putin has an idea.

A week after making the transfer of hard currency illegal by decree, Putin signed a new order permitting debtors, both sovereign and corporate, to pay creditors in rubles. A debtor can establish, on behalf of a creditor, a specially designated account at a Russian bank, through which ruble-denominated payments are carried out at the official exchange rate. At that point, the payments are considered executed. Or at least by the Kremlin they are.

The problem, of course, is that not all obligations allow payments in rubles. And, although this is technically irrelevant, I’d be remiss not to note that holders of local currency debt aren’t likely to be enamored with their predicament right now, considering the very real possibility that Russia is on the brink of an existential economic meltdown which could eventually entail some kind of currency rethink, whatever that might mean.

This is very difficult to sort out even when you have all the numbers and legalese in front of you. The snapshot (below, from JPMorgan) suggests Russia needs to service around $5 billion in hard currency debt from March through year-end.

As the bank’s Saad Siddiqui, Anezka Christovova and Trang Nguyen noted, “bonds issued post-2014 sanctions contain alternative currency payment provisions.” But it looks as though Russia needs to come up with $117 million for dollar-bond coupons in 10 days (red square in the table). For those payments, at least, rubles won’t work.

As you can see, there are a number of key dates associated with bonds that don’t have a ruble option, and it’s also worth asking whether the alternative currency payment provisions are even relevant for any securities where the ruble isn’t specifically listed. Russia presumably can’t (or won’t) pay in euros, pounds or francs.

On the corporate side, Rosneft and Gazprom both have dollar-bonds coming due. According to Bloomberg, Gazprom already wired the funds to settle a $1.3 billion obligation and will also make a franc coupon payment. So that’s good news.

“Russia’s corporate FX bond stock has declined significantly over the past decade,” JPMorgan remarked, noting that maturities are front-loaded. About half is due over the next three years, and $17 billion in 2022 alone.

As you can imagine, the breakdown is heavily weighted towards quasis, and particularly energy issuers.

Another thorny issue involves CDS. “Only Russian hard currency government bonds are relevant for CDS, local currency are not, with alternative settlement currency bonds also likely out of scope,” JPMorgan wrote.

In short, it’s not obvious what the ramifications of Putin’s new ruble-payment scheme are for CDS holders, nor is it clear how payments stuck in limbo at Russia’s National Settlement Depository (due to Putin’s ban on foreign payments) should be considered.

On Sunday, Moody’s downgraded Russia again, referencing the NSD payment purgatory. “The downgrade of Russia’s ratings was triggered by Moody’s expectation that capital controls by the Central Bank of Russia will restrict cross border payments including for debt service on government bonds,” the ratings agency said, adding that its view “is supported by a statement from the National Settlement Depository that coupon payments on OFZ government bonds due on Wednesday 2 March have only been paid to local holders of the papers, citing the CBR order prohibiting payments to non-residents.”

Apparently, Putin’s weekend decree didn’t do much to bolster confidence. The Moody’s rationale was very foreboding. To wit, from Sunday’s downgrade:

The reported statement from the NSD on the non-payment of coupons on domestic government debt to nonresident investors, citing the CBR order prohibiting payments to nonresidents, materially increases Moody’s concerns around Russia’s willingness and ability to pay. The escalating military invasion, the acceleration in the imposition of sanctions on Russia to include the most severe forms that Moody’s had outlined previously, as well as the unpredictable actions that the government has undertaken in response to those sanctions have, in Moody’s view, significantly increased the risk of a default occurring. The rating of Ca is consistent with Moody’s expectation that the recovery for investors will be in line with the historical average for sovereigns in default.

The high degree of coordination among Western countries to impose wide-ranging sanctions on Russia in response to the invasion of Ukraine has materially impaired Russia’s ability to ensure timely repayment of its sovereign debt obligations. Restrictions on some Russian banks’ access to the financial messaging system SWIFT coupled with the direct sanctioning of large state-owned banks and the CBR will effectively block these institutions from participating in the global financial system and make it exceptionally difficult for them to engage in international transactions. Given compliance risks, non-Russian institutions will be very reluctant to deal with sanctioned and likely also non-sanctioned entities within Russia.

These restrictions on Russia’s ability to execute its sovereign debt payments compound already significant concerns around Russia’s willingness to service its debt. The decision to not pay coupons on domestic government debt to non-resident investors, which is also likely intended to help contain liquidity within the Russian domestic market, further weakens Moody’s already very low assessment of Russia’s institutional strength and leaves debt repayment flows highly vulnerable to default. This reported statement by the NSD is the latest in a series of negative signals on Russia’s willingness to repay, compounding the uncertainty around how the government’s actions will impact on investors given the absence of clarification by the authorities. In Moody’s view, an increasing unpredictability of government actions is a reflection of a lack of checks and balances around the executive.

If you didn’t read that all the way through, do yourself a favor and try again. There are a number of important points, including multiple references to an increasingly mercurial “executive,” and the apparent inability of anyone at the Kremlin to exert any kind of check on what now looks like absolute power.

Clearstream and Euroclear both said they’ll no longer accept rubles for settlements. “With immediate effect, the Russian Ruble is no longer an eligible settlement currency,” Clearstream announced, in an update on “Russia-related measures.” “Domestic, Bridge and internal against payment settlement in RUB is no longer possible.”

Putin said the new ruble payment plan can include creditors from “countries that engage in hostile activities” against Russia. As Bloomberg dryly noted, “the government will prepare a list of such countries within two days.”