Europe: From Russia With FUD: Settlement of Credit Derivatives Transactions Referencing Entities Under Western Sanctions and Kremlin Capital Controls

By: Anthony R.G. Nolan and Kenneth Holston

Russia’s war against Ukraine has led in record time to the implementation of extensive anti-Russian sanctions by the United States, the European Union, and the United Kingdom, among others. Those initiatives in turn have led to the imposition of extensive capital controls within Russia. The combined effect of Western sanctions and Russian countermeasures threaten the liquidity and creditworthiness of Russian debt obligations. Although the Russian Federation avoided defaulting on a coupon payment on its dollar bonds on March 16, it subsequently announced that it will satisfy its obligations under rubles a dollar bond coming due on April 4 by making payment of principal and interest in rubles.

Meanwhile, certain Russian corporate issuers such as Petropavlosk and Severstal have experienced technical payment defaults and others such as Yandex have indicated that payment defaults might be imminent on foreign-currency obligations. This is a moment when credit default swaps are a focus of attention. However, market participants have expressed concern that credit default swaps might may not provide effective protection against default of bonds and loans of Russian issuers.

Do sanctions and countermeasures restrict the scope of credit protection provided by a CDS on Russian bonds and loans? If a loan or bond default is triggered by Western sanctions and Russian countermeasures, is the character of the default affected in a way that might impair the crystallization of a payment entitlement on the CDS? Will illiquidity for Russian bonds and loans impair a robust settlement of credit default swaps?

The linked paper dissects ISDA’S 2014 credit derivative definitions and the July 2021 ISDA physical settlement matrix to assess how these strains may affect the practical realization of benefits under credit default swaps referencing Russian and Russian-affiliated reference entities.