Has OFAC scored an own goal?
So after much uncertainty it appears that Russia has indeed been allowed to pay $117m in coupon payments on foreign Eurobond debts falling due this week. Thereby it avoided default, for the time-being.
The US Treasury Office for Financial Asset Control (OFAC) had issued a general licence allowing such payments until at least May 25, 2022, and the assumption is thereafter it will adopt an ad hoc approach depending on the course of the war in Ukraine and peace talks therein.
Moscow had initially complained that it could not make the payment as it’s FX reserve in the CBR had been blocked. It called on OFAC to unfreeze these assets to enable payment and thereby avoid default. It appeared as though the Russian MOF was trying to use bondholders to lobby OFAC to ease sanctions.
There had been an assumption that Russia would need to use funds still at its disposal which OFAC had not yet been able to block - the assumption is still that the CBR might still have access to at least one third of its USD640bn in FX reserves. Forcing Russia to pay debt service out of unblocked FX resources would have the impact of putting yet more of these resources out of reach of the Russian authorities. But it appears as though that these latest debt service payments were paid out of blocked funds.
If the latter is true, this would represent a significant win for Russia and for those bondholders who were still invested in Russia, long Russian assets in the run up to the invasion despite the best advice of their own governments.
Russia has in effect managed to avoid a default, and will have proven able to use funds blocked by OFAC for debt service.
OFAC has yet to comfirm whether blocked funds were allowed to be used to facilitate debt service.
Indeed , if OFAC made the decision to allow Russia to use blocked funds to make such debt service payments, it is not only a win for Russia, as it eases the sanctions regime around Russia, eases risks of default, and thereby loosens financial conditions, and also brings asset price gains to Russian investors (still the largest holders of this debt) but it represents a slap in the face for Ukraine. Let’s not forget here that Russia’s invasion of Ukraine has wrought devastating destruction on Ukraine, perhaps of the order of hundreds of billions of dollars. Who will pay the reparations and reconstruction costs? One idea is for blocked Russian assets to cover some of this cost, but if OFAC is allowing payment to bondholders now from blocked funds, that means fewer funds available to pay reparations to Ukraine.
Let’s not forget again here that bondholders long Russia risk did so at their own risk - they ignored the striking and clarion warnings of their own governments and stayed invested. This seems to be a classic moral hazard play, with bondholders being advantaged by US government decisions which are to the detriment of Ukraine, in effect.