Sanctions against Russia are disrupting the flow of payments between bond issuers and investors as lawyers at banks and other intermediaries assess the risk of acting on behalf of companies with links to Moscow.
Fund managers typically take it for granted that payments on the bonds they own, or regular interest payments, will reach their accounts.
But the unprecedented sanctions levelled on Russia since its invasion of Ukraine have upended global finance, snarling the firms that shuffle these payments around the world in legal discussions about what obligations they can meet without falling foul of the restrictions.
Lawyers and compliance departments in western institutions must assess the risk of breaking sanctions as well as the risk of being sued by clients for forcing them in to defaults. Payments are being judged on a case-by-case basis, meaning that previous actions are not necessarily a guide to the future.
Big investment banks are holding up cash flowing out of Russia while they work out whether they can handle it, and in some cases have blocked interest payments altogether.
“As a portfolio manager it’s not generally your job to understand the nuances of payments systems. But now we all have to pay attention,” said Andrea DiCenso, a bond portfolio manager at Loomis Sayles in Boston.
Russian borrowers generally have the funds available to pay investors, and not all companies in the country are sanctioned. However that does not mean their payments can reach their creditors and investors.
As a result, it can be unclear whether a payment has been made or not because failure to receive debt payments does not necessarily mean failure to pay according to Steven Burrows, director of financial markets and products at lawyers Fieldfisher in London. “It depends on whose side of the fence the issue lies.”
A growing number of Russia-linked companies are struggling to complete transactions.
Severstal, which has not been named in western sanctions, could become the first major Russian company to default on its debt after Citigroup froze a $12.6mn interest payment to funds. A grace period lapsed last week. The steelmaker’s majority owner Alexei Mordashov has been sanctioned by the UK and EU but not the US.
Gold producer Petropavlovsk was also blocked from making a $560,000 interest payment due on Friday after the UK froze the assets of its main lender Gazprombank.
Russia’s National Settlement Depository, where securities deals are tracked and settled, said its account at international securities depositories Euroclear and Clearstream had been blocked. The NSD said the duo were waiting for decisions from their regulators in Brussels and Luxembourg respectively.
The Russian government surprised some investors earlier this month by paying $117mn of interest due for two dollar bonds but Andy Sparks, head of portfolio management research at MSCI, said that elevated prices of Russian credit default swaps — akin to insurance against non-payment — indicated the chance that it would default on its sovereign debt was around 70 per cent. The country is due to make a $2bn payment in early April.
Investors and debt issuers are becoming increasingly frustrated with the wrangles. Severstal urged its noteholders to contact the trustee at Citi to get them to process the payment, even publishing the phone number. The steelmaker said it remained committed to fulfilling its obligations.
The snarl-ups are the consequence of the long chain of transactions involved in the global financial system, which in many cases is now being checked by lawyers at every link.
Typically, a bond issuer sends the money to a correspondent bank or common depository, which is set up to receive deposits and make payments for a parent bank in a foreign country. The funds then go to a payment agent, which is appointed by the issuer to distribute the money around the market. The money then passes through the correspondent bank of a securities depository. Arrival at the latter allows deals to be reconciled and recorded, and assets are then transferred between customer accounts.
Depositories like Euroclear and Clearstream are a vital part of the financial markets as they hold €50tn of assets on behalf of investors.
“People don’t appreciate how much infrastructure sits behind these payments. It’s a convoluted system to get your head around,” said Burrows.
Some hedge fund managers have had to seek legal endorsements to confirm that their banks could trade certain assets or names, or receive payments. This has left fund managers having to take on the risk that payments will be stuck, potentially indefinitely, in the global financial system even if they hold the debt of firms that are not sanctioned.
“The trade on sanctions is that you can buy this stuff and then all the [interest payments] will be frozen for a long time,” one hedge fund manager said. Over the long term an investor would likely make money “but the practical reality is if you’re doing it [through a bank] that’s going to be difficult because they’re going to have a really different view.”