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Forced sovereign debt defaults | Financial Times

Lee C. Buchheit is a professor of law (with honors) at the University of Edinburgh; Mito Goulatti is a law professor at the University of Virginia.

Some countries are unable to pay their debts because they do not have the dough. Others have the money but are just not willing to pay. To this taxonomy we can now add a third category – a solvent sovereign who is willing, indeed eager, to pay creditors, but cannot do so because he is prevented from sending the money through the international payment system.

As a result of ma a decision By the US Treasury Department on May 24, the Russian Federation finds itself in this third category. Under a previous policy that expired on May 25, U.S. holders of Russian bonds Debt payments were allowed on those securities as long as the source of the money was an account that was not frozen by the sanctions imposed after Russia’s invasion of Ukraine. The U.S. Treasury Department has now allowed this permission to expire.

The result? Russia may in fact be forced to do so The default of its international bondsNot because it is not willing or financially willing to pay the debt service for the repayment of the instruments, but because the payments will be blocked by the financial intermediaries through whom they must pass in order to reach the accounts of the bondholders.

“See you in court.” © AP

On the face of it, this new policy seems counterintuitive. It simultaneously enriches Vladimir Putin’s regime (because it allows him to keep his foreign exchange balance), impoverishes Western bondholders who expected to receive these payments, and in a distorted way could give Russia legal protection in an English or US court in any A lawsuit filed by a bondholder to enforce the instruments.

In contrast, the continuation of the previous policy (which allowed Russia to pay by debiting non-frozen accounts) would have increased the impact of sanctions by draining some of Russia’s remaining foreign exchange reserves.

The motive for changing this policy is opaque. We can think of four possible explanations.

One interpretation holds that once Russia has demonstrated its eagerness to continue in full service of its external debt, the U.S. Treasury Department smelled a rat and took steps to thwart these payments. If so, it could be that Putin just brought out the most successful Berr rabbit. “Do not throw me into this lip patchStrategy in history. By showing himself eager to pay, he made the Treasury prevent him from paying, thus saving himself some money and giving him something he would otherwise have lacked – legal protection in court.

An alternative explanation is that by preventing payments from US holders of Russian bonds, the US Treasury Department will gain control over any future debt management activities that Russia may carry out. These holders could not, for example, participate in the reorganization of the devices without a license from the US Treasury Department. Venezuelan public sector bondholders have been in exactly this situation since the US imposed sanctions on the Maduro regime in Venezuela in 2019.

But it is not at all clear to us that Russia will want or need debt restructuring when this situation is over. The amount of the country’s external debt is manageable and Russia may try to simply pay off all the arrears caused by the sanctions when the smoke dissipates, verbally and figuratively.

Perhaps the Treasury is betting that repayment of Russian bonds – even one engineered through sanctions policies – will inevitably tarnish Russia’s credit reputation and cause long-term damage to the country in the form of limited market access and higher interest rates?

Russian Rolling Bond Yield in 2042 © Refinitiv

We offer two observations. First, it is likely that the memory of this state of the market is that default has been imposed on Russia despite its efforts to pay. From a creditor’s point of view, this may actually increase the reputation. Indeed, the Russians have already labeled it by default “artificial” or “technical”.

Second, it is not the default of the bonds that the financial markets are likely to remember and punish; it is precisely the memory of a cruel and unprovoked invasion of a neighbor that will affect it.

A final explanation may lie in the US Treasury Department’s desire to mobilize the commercial investor community to put pressure on Russia to stop its aggression in Ukraine.

If Russia’s bonds do slip into default, bondholders may have a shorter-than-usual period of time – just 36 months – in which they can file their claims in court or lose their claim altogether. Three years, unless “served”.

From documents for Russia’s 2017, 2022 and 2042 bonds.

The Treasury Department’s decision to refrain from renewing the license that allows U.S. bondholders to receive payments originating from non-frozen Russian assets may, therefore, prevent a willingness to force Russia to deal with multiple lawsuits filed by holders of those instruments.

This will not be the first time the U.S. Treasury Department has attempted this maneuver in the context of sanctions.

At 8:15 a.m. EST on November 14, 1979, the Treasury Department froze Iranian deposits in U.S. banks in retaliation for taking hostages at the U.S. Embassy in Tehran. Since its US dollar deposits are unattainable, Iran has been unable to make payments on bank loans denominated in US dollars. Some of these loans were quickly accelerated by American syndicate agents. Offsets, legal proceedings and seizure of Iranian assets soon came.

Bankers gather outside Chase Manhattan’s London branch to vote on Iran’s syndicated loan © Euromoney, January 1980, courtesy of Mito Gulati

It has been remarkably effective by the US sanctions authorities in their power over the US financial system to force a foreign sovereign to cease its commercial debt instruments. The result was the recruitment of lenders from the private sector to put additional pressure on the wandering sovereign.

But if that’s the US Treasury Department’s motive to impose a Russian default, there may be a flaw in that.

By preventing Russia from making payments through bond-bound payment procedures, the U.S. Treasury Department may have unintentionally given the Russian Federation legal protection in any bondholder enforcement action.

Both British and American law are recognized as a defense in a situation where it has become impossible or illegal to perform the contract. It is difficult to predict whether the courts will recognize the Russian situation as a real case of the impossible. The rule is that the party claiming for defense could not himself have been the cause of the difficulty.

In this case, is the inability to pay the bonds a result of the sanctions or is it rather the result of an illegal invasion of Russia that caused the sanctions?

Forced sovereign debt defaults | Financial Times Source link Forced sovereign debt defaults | Financial Times

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