Russia sanctions global financial system in legal wrangling
Sanctions on Russia are disrupting the flow of payments between bond issuers and investors as lawyers for banks and other intermediaries assess the risk of acting on behalf of companies with ties to Moscow.
Fund managers generally assume that payments on the bonds they own, or regular interest payments, will reach their accounts.
But the unprecedented sanctions imposed on Russia since its invasion of Ukraine have upended global finance, harassing the companies that shuffle these payments around the world into legal discussions about what obligations they can meet without breaching restrictions.
Lawyers and compliance departments at Western institutions must assess the risk of violating sanctions as well as the risk of being sued by clients for forcing them to default. Payouts are judged on a case-by-case basis, meaning previous actions are not necessarily a guide to the future.
Major investment banks are blocking cash flows out of Russia while they determine whether they can handle it and, in some cases, have blocked interest payments altogether.
“As a portfolio manager, it’s usually not your job to understand the nuances of payment systems. But now we all have to be careful,” said Andrea DiCenso, bond portfolio manager at Loomis Sayles in Boston.
Russian borrowers generally have the funds to pay investors, and not all companies in the country are sanctioned. However, this does not mean that their payments can reach their creditors and investors.
As a result, it can be difficult to know whether a payment has been made or not, because non-payment of debts does not necessarily mean non-payment, according to Steven Burrows, director of financial markets and products at Fieldfisher lawyers at London. “It depends on which side of the fence the problem is.”
A growing number of Russian-linked companies are struggling to close deals.
Severstal, which was not named in the Western sanctions, could become the first major Russian company to default on debt after Citigroup froze a $12.6 million interest payment to the funds. A grace period expired 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 prevented 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 transactions are tracked and settled, said its account with international securities depositories Euroclear and Clearstream had been blocked. The NSD said the duo were awaiting decisions from their regulators in Brussels and Luxembourg respectively.
The Russian government surprised some investors earlier this month by paying $117 million in interest owed on two-dollar bonds, but Andy Sparks, head of portfolio management research at MSCI, said the High prices of Russian credit default swaps – similar to insurance against non-payment – indicated that the probability of it defaulting on its sovereign debt was around 70%. The country is due to make a $2 billion payment in early April.
Investors and debt issuers are increasingly frustrated with the disputes. Severstal urged its noteholders to contact Citi’s trustee to process payment, even releasing the phone number. The steelmaker said it remained committed to fulfilling its obligations.
The snags are a consequence of the long chain of transactions involved in the global financial system, which in many cases is now controlled by lawyers at every link.
Typically, a bond issuer sends 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, who is appointed by the issuer to distribute the money in the market. The money then passes through the correspondent bank of a securities depository. Arriving at the latter allows transactions to be reconciled and recorded, and assets are then transferred between customer accounts.
Custodians like Euroclear and Clearstream are a vital part of the financial markets as they hold €50 billion in assets on behalf of investors.
“People don’t appreciate the amount of infrastructure behind these payments. It’s a convoluted system to figure out,” Burrows said.
Some hedge fund managers have had to seek legal approvals to confirm that their banks can exchange certain assets or names, or receive payments. This has forced fund managers to bear the risk that payments will be blocked, potentially indefinitely, in the global financial system, even if they hold the debt of companies that are not sanctioned.
“The sanctions business is that you can buy this stuff and then all the [interest payments] will be frozen for a long time,” said a hedge fund manager. In the long run an investor would probably make money” but the practical reality is that if you do [through a bank] it’s going to be difficult because they’re going to have a really different vision.