The Russian government’s decision on April 29 to pay holders of two dollar-denominated Russian sovereign bonds led to a major rally, encouraging some investors that Russia may avoid default. There are, however, more challenges ahead. 

Sanctions on Russia have not affected credit-default swaps directly, but the settlement process following a default would rely on delivering and auctioning the sanctioned bonds. We examine this new form of recovery risk.

The U.S. Treasury Dept. decided this week to effectively block payments to holders of two USD Russian sovereign bonds. These payments had been initiated by the Russian Ministry of Finance, but would have required the Russian government to access its reserves held at U.S. banks.

Despite uncertainty around whether sanctions will bar creditors from receiving payments, Russia paid USD 117 million of interest due for two Russian hard-currency bonds, on March 16.

As credit spreads have gradually declined, investors have increasingly been focusing their attention on more complex instruments including synthetic Collateralized Debt Obligations in the search for yield. However, the risks of these investments — including the senior tranches — should not be overlooked.