Everything you need to know about Russia’s dance with default

Russia seemed to be able to avoid defaulting on its foreign debts by drawing from its limited dollar reserves. But Moscow‘s debt drama is far from over.

Russia’s finance ministry abandoned its proposal to use rubles instead of dollars to make overdue payments on two government bonds, saying Friday that it had transferred the money to an account at Citigroup: $564.4 million for a bond due in 2022, and $84.4 million for another due in 2042. Wednesday’s deadline for paying overdue amounts was set at 30 days.

The government had claimed that U.S. sanctions freezing its massive currency reserves held abroad meant it couldn’t pay and that Russia wasn’t to blame for any default, the first on foreign debt since the 1917 Bolshevik Revolution.

Even if Russia has made the latest payments, there are still others due. American bondholders will no longer be allowed to accept Russian bonds payments. The May 25 deadline means that investors won’t legally be able take money from Russia even if Russia pays.

Here are some facts about Russian debt

Rating agencies are available. saidBonds that require payment in dollars are considered to be bonds. Therefore, payments in rubles would amount to non-payment. Russia may prefer to pay in rubles over its foreign currency reserves, as a large amount of the Russian currency’s reserve has been frozen overseas. It made Friday’s payment by dipping into scarce internal reserves that sanctions could not touch.

Russia has not definitively avoided default unless the money made its way from Citigroup through the banking system to bondholders ahead of Wednesday’s deadline.

“Bondholders don’t get paid until Citigroup processes the payments” and pass them on to clearinghouses that distribute payment to bondholders, saidJay S. Auslander, a leading lawyer in sovereign debt at Wilk Auslander, New York.

Russia transactions are being closely monitored by banks. Banks may be hesitant to do business with Russia. But “I think it’s likely is that the funds will make it to the bondholders, in which case, they will not be in default this time,” Auslander said.

Around $40 billion worth of foreign bonds was available to foreigners, roughly half the amount. Russia had $640 billion worth of foreign currency and gold reserves before the conflict. Much of this was kept overseas, and is now frozen.

Rating agencies have the power to lower the rating to default, or a court may decide the matter. Bondholders who have credit default swaps – contracts that act like insurance policies against default _ can ask a committee of financial firm representatives to decide whether a failure to pay debt should trigger a payout, which still isn’t a formal declaration of default.

The Credit Default Determination Committee – an industry group of 14 banks and investors that determines whether or not to pay on these swaps – said Friday that they “continue to monitor the situation” after Russia’s payment. The committee met again Tuesday. said it would continue to monitor the situation and “defer publication of an Initial List of Deliverable Obligations.”

The formal way to declare default is if 25% or more of bondholders say they didn’t get their money. Once that happens, provisions say all Russia’s other foreign bonds are also in default, and bondholders could then seek a court judgment to enforce payment.

Normal circumstances are that investors and defaulting governments negotiate a settlement where bondholders receive new bonds with a lower value but at least partial compensation.

But sanctions bar dealings with Russia’s finance ministry. No one knows when or what the value of defaulted bonds will be.

In this case, declaring default and suing “might not be the wisest choice,” Auslander said. “You can’t negotiate with Russia right now. You’re wading into a world where sanctions are constantly changing, where there are a lot of unknowns. So you may see creditors decide at this point to keep their intentions close to their vest and hang tight for now.”

Investors need to take into consideration popular sentiment, especially if they bought bonds at discounted prices in the hopes of making a claim on a settlement.

“Right now is maybe not a good time to rush in and show that you were profiting off distressed debt in Russian bonds,” Auslander said. “Will that time come in the future? I suspect it will.”

Once a country defaults, it can be cut off from bond-market borrowing until the default is sorted out and investors regain confidence in the government’s ability and willingness to pay. Russia has been cut off access to Western capital markets so any return of borrowing is likely to be delayed.

While the Kremlin is able to borrow rubles from home, it mainly relies on Russian banks for its bonds.

The country already feels the economic effects of Western sanctions. Foreign companies have fled the country, disrupting trade and financial ties. One more sign of the isolation and disruption is default.

Analysts are cautiously assuming that a Russia default will not have the same impact on global financial markets or institutions as a 1998 default. Back then, Russia’s default on domestic ruble bonds led the U.S. government to step in and get banks to bail out Long-Term Capital Management, a large U.S. hedge fund whose collapse, it was feared, could have shaken the wider financial and banking system.

Holders of the bonds – for instance, funds that invest in emerging market bonds – could take serious losses. Russia played a limited role in the emerging market bond indexes which helped to limit losses for fund investors.

While the war itself is having devastating consequences in terms of human suffering and higher food and energy prices worldwide, default on government bonds would be “definitely not systemically relevant,” Kristalina Georgieva, head of the International Monetary Fund, has said.