Wall Street Banks Are Leaving Russia

The baseball lockout is over. MLB and the players’ union struck a new collective bargaining agreement that includes higher pay for younger players. That means opening day will be April 7.

International sanctions are raising the possibility that Russia’s government, for the first time since the Bolsheviks disavowed the Czar’s debts in 1917, will default on a foreign bond. That presents another major test for the credit default swap, an insurance-like derivative that played a starring role in the 2008 financial crisis. Amid Russia’s financial turmoil, some warned that CDS contracts could amplify losses and disrupt markets.

A quick primer on the CDS market: Credit default swaps are like insurance but for bonds. Unlike typical insurance, there are no underwriters, and prices are set by buyers and sellers. Buyers get protection for their bonds, and sellers get money upfront but are on the hook to pay if there is default. What’s more, in most CDS markets the buyers don’t have to own the bonds to buy the insurance. Supporters say the swaps lower borrowing costs and hedge risks, but critics say they have created a market of side bets, multiplying losses in times of distress.

How much does Russia owe? International investors hold roughly $20 billion in Russian government bonds. As of mid-February, the latest available data from the clearing house DTCC, there was $40 billion in swaps tied to Russian debt.

What are the chances Russia could default? Russia has $117 million in foreign-currency coupon payments due Wednesday, and if it misses that or future payments, there is a 30-day grace period before default is declared. As of last week, insurance on $100,000 of five-year Russian bonds cost about $45,000, ten times more than a month ago. “It looks almost inevitable they will have to miss a payment now given the restrictions,” Richard Briggs, an investment manager at GAM in London, told DealBook.

If Russia defaults, will the swaps pay out? The $40 billion in insurance implied by CDS contracts might not actually cover bondholders’ losses. Russia has suggested it may pay its foreign bondholders in rubles instead of dollars, which could avoid triggering a default, even though sanctions make it impossible for foreigners to handle rubles. Concerns that the contracts won’t pay out have “reduced significantly over the past few days,” Briggs said, “though it is still a risk.”

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