"A court case is the baseline scenario now," Vadim Khramov, a strategist at Bank of America in London, said by phone. "An out-of-court restructuring is possible, but the only way to negotiate is to negotiate directly. I don’t see a simple solution coming from bilateral talks." Any hearing in the case would he held in the U.K. as the bond is structured under English law.

Ukraine Defaults on $3 Billion Bond to Russia

Ukraine said it won’t repay $3 billion in bonds due to Russia, moving a step closer to a court battle amid a new wave of economic tension between the two ex-Soviet neighbors.

Prime Minister Arseniy Yatsenyuk said Kiev is imposing a moratorium on the note due Dec. 20, which Russian President Vladimir Putin bought two years ago as part of an abortive bail-out for Ukraine’s former leader just months before he was toppled. Russia said on Friday it will wait until a 10-day grace period on the bond expires on Dec. 30 before starting legal action.

QUICKTAKEUkraine's Other War

Ukraine, its finances reeling from a two-year-old conflict with Russian-backed separatists in the east of the country, had pushed Russia to join a $18 billion restructuring with commercial creditors this year. But Russia argued the debt was sovereign, despite its unusual Eurobond form, and proposed its own repayment terms.

The default “is just confirmation of the unimproved relations between the countries," said Simon Quijano-Evans, the London-based chief emerging-market strategist at Commerzbank AG. “The hope is that backstage negotiations will succeed in finding a solution. Otherwise, a legal case would probably ensue, unnecessarily complicating the ongoing political discussions surrounding eastern Ukraine and the sanctions."

Economic Pressure

Russia has stepped up the economic pressure in recent weeks, moving to impose trade restrictions on a wide range of Ukrainian products from the first of the year, when a trade deal between Ukraine and the European Union is slated to take effect. Russia has opposed Ukraine’s efforts to build ties with the EU, a key policy goal for the current government in Kiev. The EU, meanwhile, is expected this week to extend sanctions imposed on Russia over the Ukraine crisis for another six months.

The non-payment won’t trigger cross-defaults on Ukraine’s other sovereign debt since it has all been restructured. While investors had expected the default, the yield on new dollar bonds maturing in 2025 climbed nine basis points Friday amid concern that political infighting could scupper changes to tax policy needed to pass next year’s budget and unlock the next tranche of an International Monetary Fund rescue loan.

On Wednesday, David Lipton, First Managing Director of the IMF, urged Ukraine to approve its new tax code, saying that not doing so will disrupt the aid program.

Payment Freeze

Yatsenyuk announced the payment freeze at a government meeting in Kiev, contending the step was needed after Russia refused to join the restructuring. Payments are frozen "until our proposals on restructuring are accepted or until a relevant court decision is made," he said. President Petro Poroshenko described the Russian bond as a "bribe" earlier this year, rejecting Putin’s demands for repayment.

"Our Ukrainian colleagues have no chance of winning this case," Russian Deputy Finance Minister Sergey Storchak told state television on Friday. 

The moratorium also applies to about $507 million owed to Russian banks by two state-run companies, according to Yatsenyuk.

Private Creditors

The government in Kiev is barred from paying Russia back in full under the conditions of the agreement with private creditors. That pact, in turn, is a key condition of a $17.5 billion IMF aid package secured this year to keep the country’s economy afloat. Under that deal, bondholders including Franklin Templeton accepted a 20 percent reduction to their principal holdings, something Russia refused to consider.

Earlier this month, the IMF changed its policies to allow Ukraine to continue receiving funding under the aid package even if it defaulted on the Russian bond. Ukraine is still required to negotiate in good faith on a restructuring, according to IMF rules.

Ukrainian Finance Minister Natalie Jaresko said in an interview on Friday she is "hopeful" an agreement can be reached without resorting to a legal battle. Russia and Ukraine indicated earlier this month that they’re open to negotiations to restructure the debt and have been using German officials to mediate indirect talks.

"A court case is the baseline scenario now," Vadim Khramov, a strategist at Bank of America in London, said by phone. "An out-of-court restructuring is possible, but the only way to negotiate is to negotiate directly. I don’t see a simple solution coming from bilateral talks."

Any hearing in the case would he held in the U.K. as the bond is structured under English law.

http://www.bloomberg.com/news/articles/2015-12-18/ukraine-defaults-on-3-billion-russia-bond-as-court-battle-looms