Russia Defaults for the First Time in a Century (and it’s no surprise)

In this buzz: Why did Russia default on its debt; who will be most impacted by this and why it matters?

On Sunday, after the grace period ended on $100 million worth of Russian external sovereign debt. This first default in over a century is the result of increasingly tough Western sanctions that shut down payment routes to creditors. Russia, benefitting from high energy price exports, certainly has the means to service its debt but payment has been blocked by sanctions.

This default comes as no surprise to bond investors as Russia’s debt has been trading at distressed levels since March. Given that the country has the means to pay, some investors view this event as a “technical default” and are prepared to wait it out, hoping to recoup their investment in time.

Despite the technical nature of this default, it’s not a good look thus Russia has been pushing back on the designation; pointing out that it can fulfill its obligation but has been blocked from doing so. In fact, Russia is trying to work around this default. Last week it announced that it would restructure $40 billion dollars of debt into rubles.

This default likely means very little to the average Russian citizen who has been dealing with runaway inflation and the impact of Western sanctions for months. However, the default may have a bigger impact on one large institutional investor.

It was reported in early March that a U.S. asset manager had $1bn in credit default swap exposure (CDS) on Russian debt. In a nutshell, a bet that Russia would not default. In addition, there were reports that they also held over $1 billion in Russian sovereign debt. In a nutshell:

Owning a CDS provides investors with insurance against default. In contrast, selling a CDS is going long credit risk allowing the short to collect a premium if there is no default. As Russia defaulted, a bet of this size could run as high as hundreds of millions of dollars.