Hedge funds hoping to make a quick profit from Russia’s default are watching their chances slip away.
(Bloomberg) — Hedge funds hoping to make a quick profit from Russia’s default are watching their chances slip away.
More than two months after international sanctions for Russia’s invasion of Ukraine pushed the government into default on its sovereign bonds, insurance contracts have yet to pay out. And the amount buyers are likely to receive has dropped by about $350 million, or around a third.
The delay stems in part from uncertainties about sanctions — specifically, how to hold a settlement auction with bonds that are banned from trading. The US Treasury lifted restrictions on July 22, but the group of banks and investors that oversees the credit derivatives market only just scheduled a settlement auction for Sept. 12.
The Credit Derivatives Determinations Committee said in a statement on Wednesday that to finalize the settlement terms and hold an auction, it “had to consider a number of overlapping potential restrictions.”
Russia’s bonds have risen to about 43% of face value from 20% in early June, when the committee ruled that the government had triggered a credit event after it missed interest payments because the sanctions blocked its ability to transfer funds to creditors.
The price change means the likely compensation from credit-default swaps covering $1.5 billion of debt has dropped to about $855 million from $1.2 billion. Swaps pay buyers face value in exchange for the bonds or a cash price set at auction.
To be sure, this mostly affects speculators because bondholders can physically deliver their notes for par. It’s not necessarily exposing a flaw in swaps contracts, such as during the sovereign debt crisis when investors weren’t compensated for actual losses.
But it has upset some noteholders who are net short, or hold more derivatives than securities.
Russia’s Foreign Bond Investors Left Caught in Sanctions Web
“The sanctions are undoubtedly uncharted waters — I wholeheartedly support them from the humanitarian and political point of view but they definitely interfere with the smooth functioning of the bond and CDS markets,” said Athanassios Diplas, a veteran derivatives trader who was at Goldman Sachs during the 1998 Russian financial crisis and advised the International Swaps and Derivatives Association’s board.
“The illiquidity they introduce widens effective bid-offer as buyers and sellers might be less willing to transact at the current price,” he said.
On the other hand, protection sellers such as Pacific Investment Management Co. stand to benefit as higher recovery values reduce the amount they’ll need to pay out. Pimco reduced its exposure in the second quarter, according to its most recent filings. Pimco officials declined to comment.
Credit-default swaps on Russia were quoted at about 200 basis points at the start of the year, or about $200,000 annually to insure $10 million of the country’s debt for five years. That jumped to $6 million upfront and $100,000 annually after the invasion in late February, according to data compiled by ICE.
Still, many investors snapped up credit protection as the web of international sanctions shut Russia out of the world’s financial system, making a default look like a sure bet.
(Updates with date of settlement auction in third paragraph)
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