The problem of Ukraine’s Russia bond

By Felix Salmon
March 18, 2014
$3 billion it borrowed back in December.

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Now that Russia seems to have formally annexed Crimea, no one can possibly expect Ukraine to repay Russia the $3 billion it borrowed back in December. The money was given directly to kleptocratic Ukrainian president Viktor Yanukovych in order to buy his fealty; now that Yanukovych is an international pariah and Russia has seized Crimea instead, in what you might call the geopolitical equivalent of a debt-for-equity swap, Ukraine has no legitimate reason to make its payments on the loan.

But there’s a problem here: the loan was not, technically, a bilateral loan from Russia to Ukraine. Instead, it was structured as a private-sector eurobond. As Stephen Gandel says:

There are a lot of other Ukrainian eurobonds out there that look similar to the ones Russia is holding, so not paying the ones Russia is holding will have larger implications for all of Ukraine’s debt, causing prices to fall and interest rates to rise. What’s more, Russia could sell its bonds to the market… That may make a court less likely to invalidate the debt, and Ukraine less willing to do so, if it is held by a private investor, especially a non-Russian one.

This is a notorious vulture-fund move: a hedge fund buys bilateral debt from a sovereign, and then sues not as a sovereign but rather as a private-sector creditor. I can think of a few hedge funds which would be interested in Russia’s debt, if they could buy it at a discount to where the rest of Ukraine’s debt is trading. After all, to use a term you might have seen on this blog in the past, this loan is, legally, pari passu with all the rest of Ukraine’s bonded debt.

(In fact, this bond is arguably senior to the rest of Ukraine’s bonds, thanks to a very unusual provision which allows Russia to accelerate the debt if Ukraine’s GDP falls. But since there now seems to be no chance that Ukraine will pay the coupon on this bond, it’s going to be in default very soon anyhow.)

So, if Ukraine defaults on its $3 billion Russian eurobond, how can Ukraine’s allies prevent that default from having massive negative repercussions on the Ukrainian economy? Anna Gelpern has the answer: The United Kingdom, she says, should make the bonds unenforceable under English law.

Yanukovych’s good-bye bonds would not have to get bogged down in the doctrinal mess of Odious Debt precisely because they took the form of simple English-law contracts, freely tradable in the capital markets and enforceable in English courts… English courts may not have much sympathy for Russia. They may decide that invading a country, bankrupting it, and trying to collect would be too distasteful with or without Odious Debt. Supreme Court Chief Justice (and former President) William Howard Taft offered similar reasons when he refused to enforce claims by private creditors complicit in the escape of another kleptocrat in an international arbitration against Costa Rica in 1923…

To stop the debt from migrating to private hands and showing up in court, now is the time for the UK government to make the Yanukovych bonds unenforceable under English law.

If the UK parliament passes this kind of a law now, before Russia can sell its debt to a vulture fund, that would severely reduce any fund’s appetite for the bond, and therefore minimize the likelihood of the default getting litigated in London.

Gelpern adds — quite rightly — that now is also the perfect time to implement a general ban on countries selling their bilateral debt into the private markets. I’m unclear on what form such a ban would take, or how it would ever be enforced, but as a principle it’s a really good idea.

Even if the UK passes a non-enforcability law, however, the problem of the Russian bond is not going to go away for Ukraine. I’m sure there are cross-default provisions in the rest of Ukraine’s debt, which means that Ukraine’s existing bondholders are likely to be able to accelerate whenever they feel like it. Again, think vulture funds here: a small group of aggressive funds could quite easily buy up 25% of one of Ukraine’s other bond issues, and then declare the whole amount due and payable immediately. As a result, even if Russia never gets its $3 billion back, and never sells any of its bonds, the structure of the December deal could still come back to haunt Ukraine.

All of this was entirely deliberate on Russia’s part. And of course the damage that Russia caused to Ukraine by structuring its loan as a bond is pretty much nothing, compared to the damage it’s causing by seizing Crimea. But it is a reminder that wonky sovereign-debt distinctions can have real geopolitical importance. As Argentina, for one, is well aware.


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Why exactly would Western creditors be afraid of Ukraine defaulting on its debt to them just because it defaults on its debt to Russia? The excision of the Crimea would appear to make the Ukrainian state more stable and more securely in the Western sphere, not so liable to the alternating succession of East-West-favoring kleptocrat governments. Anyway Western European governments are reportedly giving Ukraine $15B to the new insurgent government – that seems to indicate some confidence.

Of course the whole thing could blow up if Russia decides to take over more of Ukraine, but that possibility seems to be receding.

Posted by skeptonomist2 | Report as abusive

And then, after stiffing Russia on the $3 billion, the UK will supply Ukraine with natural gas at 30% below market prices for … how long, exactly?

Surely someone in the EU will supply them, no? oh dear…

Posted by Trollmes | Report as abusive

If this was the summer of 1914, we’d already have a shooting war going on, so I guess letting the Russians “have” Crimea constitutes progress, if you think avoiding a land war at all costs is the best possible outcome.

Posted by Strych09 | Report as abusive

First, Ukraine was essentially bankrupt in November 2013: actually, the poor state of its finances is the main reason why it asked for the credit and for gas discount. The following three months its government was paralyzed by Occupy Kiev protests; many more Ukrainians were too busy with protests or afraid of the protests to be productive. The country either was going to ask for more help, or default on its debts even without the coup d’etat / revolution / government change.

Second, though a 22 year history of dully elected kleptocracy contributed mighty to Ukrainian woes, the main reason was different. A fragile balance between voters blocks forced all governments to avoid obvious but unpopular decisions, to kick a proverbial can down the road. Wast agricultural regions are overpopulated: modern agricultural technologies cannot use so many hands. They are subsidized by industrial regions. However, the industrial regions are nothing but a huge rust belt. Whatever coal mines and plants did not close yet, it happens mostly due to a government support.

Ironically, the capture of Crimea slightly improves Ukrainian finances, because the net subsidized region used to receive more funds from the state coffers than it contributed as taxes.

As a side note, to my understanding the discussed Ukrainian bonds were issued not in UK, but in Ireland.

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