The U.S. is considering closing a sanctions carve-out that currently allows Moscow to make payments on $40 billion of sovereign debt, potentially forcing Russia into its first default on foreign-held debt since 1918.
U.S. entities have been barred from transacting with Russia’s central bank since Feb. 26, but the sanctions regime contains a waiver allowing Americans to process and accept sovereign debt payments. The waiver expires on May 25.
At a press conference on Wednesday, U.S. Treasury Secretary Janet Yellen said it was “unlikely” the waiver would be renewed, though she noted that no final decision had been made. Yellen’s comments confirmed earlier reports by Bloomberg and Reuters that the Biden Administration is considering ending the waiver.
If the waiver is not renewed, U.S. entities will be barred from accepting Russian debt payments. Russia would be “a debtor seemingly desperate to make payments, but not allowed to do so,” Matthew Vogel, head of sovereign research at FIM Partners, told Bloomberg.
Russia has come close to defaulting before, but was able to get funds to its creditors in time.
On March 18, Russia made its first bond payment to creditors since it invaded Ukraine, with a $117 million payment handled by JPMorgan Chase and Citibank. Russia made the payment from its foreign reserves held overseas—nominally frozen by Western sanctions, but with an exception for debt payments.
The U.S. ended that exemption on April 4, declaring that Russia could no longer use its frozen foreign reserves for debt payments and blocking a payment due that day. The current waiver that Yellen says the U.S. might not renew allows Russia to make payments using its domestic reserves.
When the U.S. blocked Russia from tapping its foreign reserves in order to service debt, Russia threatened to pay in rubles instead. Yet international watchdogs said that a payment in rubles would constitute a “failure-to-pay” event, and thus a default. Finally, days before the country would be officially declared in default, Russia chose to pay using dollars from its domestic reserves, again avoiding default.
On Wednesday, Russian Finance Minister Anton Siluanov again affirmed that Russia would try to pay debt in rubles if it was unable to pay in dollars, which an end to the U.S. sanctions waiver would ensure is the case.
Governments normally try to avoid defaulting on their debt, as a failure to pay could lock countries out of international capital markets for years. But Yellen noted that Russia already “has no access to capital markets,” and so a default wouldn’t be “a significant change in Russia’s situation.”
Western financial institutions do not have large exposure to Russian sovereign debt, but a Russian default might still have unintended consequences for the financial system.
For one, a Russian default would trigger about $6 billion worth of credit-default swaps (CDS). A CDS is a promise to buy the debt from a bondholder in the event of a default, in exchange for a regular premium.
A formal default might also start a long legal battle by bondholders to recover funds. Assets frozen by sanctions overseas—like the billions in Russia’s foreign reserves held in overseas banks—could become a target for creditors.
Politicians in the U.S. and Germany have suggested confiscating Russia’s frozen foreign reserves and using it to fund Ukraine’s reconstruction. Yet Yellen on Wednesday noted that “it would not be legal now in the United States for the government to seize” these assets.
Russia’s next bond deadline is a $100 million payment due May 27, which could potentially be paid in currencies other than the dollar, notes Bloomberg. If Russia doesn’t—or can’t—pay, the country has an additional 30 days to transfer the money; if the money still isn’t received by then, the country will be in default.
Sign up for the Fortune Features email list so you don’t miss our biggest features, exclusive interviews, and investigations.