Russia could be headed for its first default on foreign-currency debt in more than a century if its attempt to pay the interest on bonds in dollars fails.

While the $117 million coupon payments on two dollar securities due Wednesday are being processed, Finance Minister Anton Siluanov reiterated that there’s a risk the transfer in greenbacks won’t go through. Russia has sent the instruction for the payment to the U.S. bank that normally handles the transactions, but the ministry hasn’t received either a rejection or a confirmation, he was cited as saying by the RIA Novosti news service.

If the transfer fails, then the payment will be made in rubles, he said earlier this week. Fitch Ratings said on Tuesday that making a settlement in any currency other than the dollar within the 30-day grace period would be considered a default. S&P Global Ratings made a similar statement earlier this month.

The coupon payment could prove to be yet another turning point for Russia, which in the weeks since its invasion of Ukraine, lost its investment-grade ratings and has become the world’s most-sanctioned nation. Russia’s finance minister has repeatedly warned that without access to its foreign reserves, it’ll make the payment in rubles, outlining a process that involves transferring the cash into local accounts.

“The situation remains fluid for now, as has been the case since sanctions have been coming through,” said Antoine Lesne, head of ETF strategy and research for State Street’s SPDR, which holds the bonds.

Sudden Bounce
To be clear, U.S. sanctions don’t prohibit Russia from servicing dollar bonds, at least until May, according to a Treasury spokesperson.

The Treasury’s guidance said that U.S. persons were authorized “to receive interest, dividend, or maturity payments on debt or equity of the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, and the Ministry of Finance of the Russian Federation through 12:01 a.m. eastern daylight time on May 25, 2022.”

It’s unclear if or when a payment in dollars would be blocked. If it is, and Russia settles the coupons in rubles, that would be particularly problematic for these two securities, because neither of them have ruble fallback options that would’ve allowed settlements in the local currency. Some of Russia’s Eurobonds have that option.

All of the dollar bonds, including those with coupons due on Wednesday, rallied across maturities and the cost of insuring the debt fell on optimism that talks between Moscow and Kyiv to end the war are progressing.

If Russia doesn’t pay the coupon in dollars before the 30-day grace period expires, then creditors would have the right to declare default. It would be the nation’s first default on foreign-currency bonds since the Bolsheviks refused to service or recognize the czar’s debts a century ago. In 1998, Russia defaulted on local-currency debt and declared a moratorium on payments for its foreign-currency bonds.

“We think Russia will be in the isolated wilderness for a long time to come,” said Mark Dowding, the chief investment officer at BlueBay Asset Management. “A regime change in Russia is probably a pre-requisite for re-investment for many, along with lifting of sanctions.”

The drama with Russia’s bonds, however, has an impact on emerging markets as a whole. The Bloomberg Emerging Markets Hard Currency Aggregate Index dropped 5% since the start of the war, almost double the decline in global junk bonds.

Type C Accounts
The new procedure for debt settlements involve opening so-called Type C accounts, which can be done automatically without the consent or involvement of a foreign creditor, Morgan Lewis partner Grigory Marinichev said. The limited actions that holders of the accounts can perform include transactions with securities registered in Type C accounts and tax payments.

Even if the accounts were more flexible, moving the cash is going to be tricky because neither Euroclear nor Clearstream, the world’s biggest settlement systems, work with Russian assets anymore.

It’s even more complicated for holders of the accounts from nations the Kremlin designated as ‘unfriendly’ -- effectively any country that has imposed sanctions. They aren’t allowed to receive payments in dollars unless issuers get special permission. But also, they need approval to move rubles out of Type C accounts after the transfer has been made, according to Marinichev.

In other words, for investors based in so-called unfriendly nations, receiving transfers into Type Cs is “equivalent to paying into a blocked account,” Marinichev said. “You can’t repatriate those rubles.”

Either way, the finance ministry has warned that so long as its foreign reserves are frozen, there may be no payment in dollars. Russia’s total reserves are about $640 billion, but it can’t access about $300 billion, according to Finance Minister Siluanov. Data published in January shows that $100 billion of the reserves were held in U.S. dollars as of June, which was 16.4% of the total cash pile at that time. Holdings in euros were 32.2% and those in yuan were at 13.1% at the end of June 2021.

-With assistance from Anchalee Worrachate, William Shaw, Jenny Surane, Irene García Pérez, Selcuk Gokoluk and Daniel Flatley.

This article was provided by Bloomberg News.