Inside Russia’s 96-Hour Cliffhanger to Sidestep Bond Default

(Bloomberg) — It was perhaps the most widely-tracked coupon payment in history.

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After the Russian Finance Ministry on Monday sent an order initiating a $117 million payment due on dollar-denominated bonds this week, traders and money managers globally watched with bated breath as the money began to snake its way through the financial system.

What should normally be a quick formality between a borrower and its investors became an excruciating wait, as JPMorgan Chase & Co. and Citigroup Inc., the banks appointed to move the money, added extra diligence to the procedural steps amid punishing Russian sanctions. The lull left the world wondering if the country would make good on its debt — and heaped attention on a part of banking rarely in the spotlight: The staid back-office mechanisms that handle trillions of dollars of payments daily.

By Friday, some bondholders said they’d received the funds, temporarily easing fears Russia would default on its borrowings. Still, with more payments on sovereign and corporate debt due in the coming weeks, the pipes behind Wall Street’s biggest operations will remain in full glare.

“Everyone ignores the plumbing of the financial markets until periods of crisis or uncertainty,” said Elisabeth de Fontenay, a professor at Duke University School of Law. “And that’s when we find out that the banks’ back-office functions are essential, but somewhat antiquated and fallible, particularly in the bond market.”

The following account of the chain of payments is based on conversations with more than a dozen people across bond markets and in regulatory agencies who asked not to be named discussing private information.

March 14th:

The Russian Finance Ministry said it first ordered the interest on its dollar bonds to be sent on Monday to a correspondent bank it didn’t identify at the time. The ministry warned it would first try to make the payments in dollars and then use rubles if that failed. It ultimately sent the payment in dollars to its correspondent bank: JPMorgan.

March 16th:

The payment was with JPMorgan’s treasury services’ business on Wednesday. The bank, which had known for weeks that unit would probably end up a de facto enforcer of U.S. sanctions in some way, got to work seeking the appropriate approvals from authorities to shepherd the funds.

For the biggest U.S. bank, a $117 million payment pales in comparison to the $8 trillion it processes each day across 52 million transactions. Most of those payments move in real time, with just 2% taking more than a day.

As JPMorgan sought the okay from regulators, the U.S. Treasury Department was also working to clarify its own stance on the payments. The agency said Wednesday its restrictions on dealings with Russia’s central bank and other Russian institutions don’t bar that country from making payments on its dollar debt. Still, that carve-out will expire: U.S. persons are only authorized to receive interest, dividend, or maturity payments on debt or equity from Russia’s central bank, national wealth fund and finance ministry until May 25.

“If these payments are received, then bondholders will be more comfortable,” said Anthony Kettle, a senior portfolio manager at BlueBay Asset Management Plc. “But once the OFAC carve out expires, the uncertainty will return.”

JPMorgan received the approvals it needed by the end of Wednesday and pushed the payment on to Citigroup.

March 17th:

Citigroup, which was acting as paying agent on the bond, had the payment on Thursday. That raised optimism that the probability of a Russian default was receding and prices on the country’s debt rose across maturities. The implied probability of a default by Russia within the year plummeted after reaching as high as 80% just last week.

In its role as paying agent, Citigroup largely performs housekeeping functions on bonds, collecting interest from issuers and helping to dole it out to investors. The business sits inside the firm’s agency and trust division, which administers a whopping $6 trillion worth of fixed income and equity investments for 2,700 clients around the world.

It’s not the first time Citigroup has found itself embroiled in national political strife through its paying agent business. In 2016, the company resigned that role on six bonds issued by Venezuelan state oil company PDVSA while the country’s finances were in shambles after a drop in oil prices.

Citigroup is the paying agent for about four dozen bonds tied to Russian companies, according to data compiled by Bloomberg. Some of those companies — including MMC Norilsk Nickel PJSC and Gazprom PJSC — have successfully made coupon payments in recent days, but others have seen such payments stall. Just this week, Citigroup blocked a $19.25 million interest payment sent by EuroChem Group AG, a Russian fertilizer maker, while the steel and mining company Severstal PJSC warned this week that Citigroup may refrain from processing a $12.6 million interest payment due on its dollar bonds.

“The company is committed to fulfill its obligations,” Severstal said in a filing. “However, given the recent developments around the company, we have grounds to believe that Citibank N.A. London Branch, acting as principal paying and transfer agent and the account bank in respect of the notes, may refrain from processing the payment.”

While Citigroup’s name appears on bond documents, paying agents don’t typically communicate with bondholders directly. Instead, they leave much of that to clearinghouses. Citigroup passed off the payments to international clearinghouses on Friday.

March 18th:

It didn’t take long for clearinghouses in Europe and the U.S. to process Russia’s bond coupon payment. From there, the money was forwarded on to custodians across Wall Street, which slowly began crediting bondholders’ accounts for the interest payments on Friday.

“Assuming the coupon payment has gone through, is being or will be received, this removes some of the worries regarding an imminent default,” said Antoine Lesne, head of ETF strategy and research for State Street’s SPDR, which holds the bonds.

Still, even with the drama of the week subsiding, traders and asset managers remained on edge.

“We have numerous more coupon payments and redemptions coming due in the rest of the year and over the next 12 to 18 months,” Cristian Maggio, head of portfolio strategy at Toronto Dominion Bank in London, said in an interview with Bloomberg Television earlier on Friday. “The market will be holding its breath for quite some time every time these payments come due.”