A Quirk in Russian Bonds Could Hamper Default Swaps Payout

(Bloomberg) -- What was once a minor detail of Russia's international debt terms is now fueling concern about whether insurance would pay out if the nation defaults.

Six of the government's dollar and euro bonds allow the issuer to service its debts in other currencies, including the ruble, JPMorgan Chase & Co. strategists led by Trang Nguyen wrote in a note to investors. The option of paying back in rubles is what complicates matters.

That's because, given the capital controls in Russia and the sanctions, the ruble fallback optionality “may render these bonds out of scope for CDS as ‘obligations' and ‘deliverable obligations,'” the strategists said. Credit-default swaps, which are used as insurance in case of a default, cover a gross $41 billion of Russian debt, according to the Depository Trust & Clearing Corp.

That's because, given the capital controls in Russia, the sanctions, and the fact that settlement bodies aren't processing ruble transactions, that optionality “may render these bonds out of scope for CDS as ‘obligations' and ‘deliverable obligations,'” the strategists said. Credit-default swaps, which are used as insurance in case of a default, cover a gross $41 billion of Russian debt, according to the Depository Trust & Clearing Corp.

The sanctioning of Russian government entities, counter-measures within Russia to restrict foreign payments, and disruptions of payment chains present high hurdles for Russia to make international bond payments, the bank's strategists said. Foreign holders of Russia's local-currency government bonds still haven't received coupon payments three days after they were due, financial data provider CBonds and five investors at American and European firms said on Friday.

S&P Global Ratings slashed Russia's credit rating to CCC-, one of the lowest credit ratings a company can be given, while bond prices signal distress and swaps imply a record 65% chance of default. The nation has $117 million worth of coupons on dollar bonds coming due on March 16. Most eurobonds have a 30-day grace period.