Russia faces new urgency to avoid default, sidestep Wall Street

NEW YORK (BLOOMBERG) - Russia's race to avoid default just escalated.

The country has been inching closer after JPMorgan Chase & Co, under orders from the United States Department of the Treasury, halted interest payments the country owed on two US dollar-denominated bonds in recent weeks. The move forced the Russian central bank to make the payments in roubles instead and left it scrambling for ways to sidestep JPMorgan and rival Citigroup to make good on its debt.

The situation got more serious on Wednesday (April 20). The Credit Derivatives Determinations Committee (CDDC) said the rouble payment was a potential default, fuelling growing consensus that Russia may have reneged on its debt obligations.

The CDDC's ruling, which does not directly impact the debt, could trigger payment of credit-default swaps if Russia does not pay bond holders in US dollars before the debt's grace period ends on May 4. The nation could still avert a default if it pays bond holders in dollars before that period ends.

Russia is exploring ways to reroute payments through domestic institutions as well as its own clearing agent. But it remains unclear if the efforts stand any chance of success and whether the moves would even help the country avoid default.

There is "no clarity about any of this in the language" of the bond documents, Professor Mitu Gulati of the University of Virginia School of Law said in an interview. "Some judge would presumably have to decide all of this."

One option being considered is replacing the foreign banks acting as correspondent banks and paying agents on foreign debt deals with the Central Bank of Russia, according to the Russian newspaper Vedomosti. A correspondent bank performs basic treasury services and manages foreign exchange for clients, while a paying-agent bank handles housekeeping on bonds, collecting interest from issuers and helping distribute it to investors.

Under this scenario, payments to bond holders would progress to the Central Bank of Russia instead of the foreign correspondent bank and paying agent. These would then move to Russia's domestic clearing agent, the National Settlement Depository. From there, the money would end up with local bond holders or in specially created accounts for bond holders from so-called hostile nations, like the US.

For Russia, relying on its own domestic clearing agent would also allow it to sidestep foreign rivals that have held up payments to Russian investors. Euroclear and Clearstream, which process payments as central securities depositories, have blocked accounts that the national Russian depository has with them, leaving payments to local bond holders in limbo.

Russia's big-business lobby, the Union of Industrialists and Entrepreneurs, pitched a similar proposal for corporate borrowers as part of the group's plan to avoid a wave of cross-defaults and foreign asset freezes. In its pitch, non-residents would receive payments for the bonds in special foreign currency accounts with Russian banks, along with the right to sell the notes to the Finance Ministry or its agent.

The move seeks to help a bevy of Russian companies that have been forced into technical default as their interest payments get held up in the web of foreign banks' due-diligence processes. Even Russian entities not subject to US penalties have run into delays: Citigroup, for instance, ordered Severstal to seek a special waiver from the Treasury Department before it would process the steelmaker's interest payment.

State-controlled lender VTB gave investors a glimpse into how these scenarios could work when it paid coupons on a dollar-denominated euro bond in roubles, Vedomosti reported on Wednesday. Investors from Russia and "friendly" nations received funds in their rouble accounts, while Russian currency was transferred to special accounts for residents of hostile countries, the newspaper said.

Still, switching paying agents likely will not be easy. It requires agreement from a majority of creditors and, in some cases, bond documents require borrowers to give investors months of notice before they can make such a change.