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Wall Street banks are leaving Russia

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Wall Street banks are leaving Russia

The baseball lockout is over. MLB and the players’ union struck a new collective bargaining agreement that includes higher salaries for young players. That is, the opening day will be 7 April.

International sanctions are increasing the likelihood that Russia’s government will default on foreign bonds for the first time since the Bolsheviks rejected the Tsar’s loans in 1917. This presents another major test for credit default swaps, an insurance-like derivative that played an important role in the 2008 financial crisis. Amid Russia’s financial turmoil, some have warned that CDS contracts could widen losses and disrupt markets.

A Quick Primer on the CDS Market: Credit default swaps are like insurance but for bonds. Unlike typical insurance, there is no underwriter, and prices are set by buyers and sellers. Buyers get security for their bonds, and sellers get money upfront, but are prepared to pay if there is a default. In addition, most CDS markets do not have bonds with buyers to buy insurance. Proponents say swaps lower borrowing costs and hedge risk, but critics say they have created a market for side bets, multiplying losses in times of crisis.

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

What are the chances of Russia missing? Russia has $117 million in foreign currency coupon payments due on Wednesday, and a 30-day grace period before default is declared if it or she misses future payments. As of last week, the cost of insurance on $100,000 of five-year Russian bonds is about $45,000, ten times higher than a month ago. Richard Briggs, an investment manager at GAM in London, told DealBook: “It seems almost inevitable that they will have to pay now given the restrictions.”

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If Russia defaults, will the swap pay off? The $40 billion in insurance implied by CDS contracts may not actually 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 make it impossible for foreigners to handle the ruble. Briggs said the concerns about contracts not being paid “have subsided significantly over the past few days, although it is still a risk.”

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