Wall Street banks leave Russia

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The baseball lockout is over. MLB and the players’ union have reached a new collective agreement that provides higher pay for young players. This means that the opening day will be April 7.

The international sanctions raise the possibility that the Russian government, for the first time since the Bolsheviks repudiated the czar’s debts in 1917, is defaulting on a foreign bond. This presents another major test for the credit default swap, an insurance-like derivative that played a prominent role in the 2008 financial crisis. Amid Russia’s financial turmoil, some are warning that CDS contracts could amplify losses and disrupt markets.

A quick introduction to 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 obligations, and sellers receive money up front, but are obligated to pay in the event of default. Also, in most CDS markets, buyers do not need to own the bonds to buy the insurance. Proponents say swaps reduce borrowing costs and hedge risk, but critics say they have created a sideline betting market, multiplying losses in times of distress.

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

What are the chances that Russia will 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. Last week, insuring $100,000 of five-year Russian bonds cost about $45,000, ten times more than a month ago. “It seems almost inevitable that 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 Swaps Pay? The $40 billion of insurance implied by the CDS contracts might not cover bondholders’ losses. Russia has suggested it could pay its foreign bondholders in rubles instead of dollars, which could avoid triggering a default, even if sanctions prevent foreigners from handling rubles. Concerns about non-payment of contracts have “significantly diminished over the past few days,” Briggs said, “although it remains a risk.”

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