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Credit FAQ: How Our Definition Of Default Takes Account Of Sanctions And Other Types Of Payment Restrictions

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International sanctions increase operating and financial risks, and therefore the likelihood of a default, of entities affected, as do judicial actions, capital controls, and other payment restrictions. Failure to pay on time and in full can lead to a default even if the obligor's inability to pay stems from sanctions or other actions taken by governments outside the obligor's home jurisdiction. Investors have been asking how S&P Global Ratings determines whether a default has occurred under such scenarios. In this article, sanctions refer to restrictive measures imposed by governments on other countries, and/or companies and individuals in other countries.

Here, we present questions in the context of scenarios commonly discussed when sanctions or other restrictions are in place and explain how we determine--in line with our criteria and ratings definitions--whether a default has occurred for our rating purposes, given any relevant conditions. These include grace periods that affect the date on which an overdue obligation must be paid, debt restructuring, or payment in a different currency to that specified in the terms of the obligation, particularly if the investor has not received value equivalent to the original promise. We may determine that a default has occurred even when an event of default has not occurred under the terms of an obligation. Our determination can also differ from the potential determination under the governing law for the obligation.

The first three questions are general questions regarding our definition of default. The other questions address specific hypothetical situations involving sanctions or restrictions.

Frequently Asked Questions

How do you define a default in the context of your ratings?

We consider a default to be a failure to pay a financial obligation on a full and timely basis. In that case, we would lower our issue rating on the debt instrument to 'D' (default), or our rating on the issuer of the debt to 'SD' selective default or 'D'.

That said, there may be various interpretations of what words like "full," "timely," or "failure to pay" mean. Our ratings definitions and criteria address these factors (see "S&P Global Ratings Definitions," Nov. 10, 2021, and "Principles Of Credit Ratings," Feb. 16, 2011, for more information).

Under what circumstances would you rate a financial obligation 'D'?

We consider a financial obligation that is not a hybrid capital instrument to be in default, and therefore we assign it a rating of 'D', when it is not paid according to its terms on a full and timely basis, unless we believe that such payments will be made within our timeliness standards.

We would also assign a 'D' rating if the issuer files a bankruptcy petition or takes a similar action, and the default on an obligation is a virtual certainty, for example due to automatic stay provisions.

A rating on an obligation is also lowered to 'D' if the obligation is subject to what we consider to be a distressed debt restructuring.

When would you consider an entity that has issued debt to be in default?

An obligor is rated 'SD' (selective default) or 'D' if we consider there to be a default on one or more of its financial obligations, whether long or short term, including rated and unrated obligations but excluding hybrid instruments classified as regulatory capital or in nonpayment according to its terms.

A 'D' rating is assigned when we believe that the default will be a general default and that the obligor will fail to pay all, or substantially all, of its obligations as they come due. An 'SD' rating is assigned when we believe that the obligor has selectively defaulted on a specific debt issue or class of obligations, but will continue to meet its payment obligations on other issues or classes of obligations in a timely manner.

A rating on an obligor is lowered to 'D' or 'SD' if it is conducting a distressed debt restructuring.

What happens if a failure to pay in accordance with a debt's terms is due to the impact of sanctions imposed on the issuer?

If an issuer can't make a payment because it is subject to sanctions, then we lower the rating on the debt to 'D' once the payment hasn't been made in accordance with the terms, unless we believe that such payments will be made within our timeliness standards. This also applies when the issuer pays a paying agent on a timely basis but actions such as a government sanction or judicial order against the issuer interfere in payment being made to the investor.

When would the ratings on an issuer be suspended or withdrawn if the issuer is subject to sanctions?

We would withdraw our ratings on an issuer if we believe sanctions or similar judicial or regulatory actions mean that ratings can no longer be assigned to an entity or if we determine that we are unable to assign ratings based on our policies and procedures (for example, because we have not received sufficient information to enable us to maintain a rating and do not view this as temporary).

A ratings suspension may occur when an entity is placed under sanctions that temporarily affect its operations, for example if the entity's assets are frozen. We might reinstate a suspended rating once the sanction or asset freeze has been lifted. We may also suspend a rating on an issuer subject to sanctions due to a temporary lack of information.

What factors determine whether you consider that a payment has not been made on time?

If a coupon or principal payment is not made on the due date specified in the terms of the obligation, we consider that the payment is not on time. We would lower the rating on the obligation to 'D' soon after the due date, unless we believe the amount will be paid within the applicable grace period. We often wait until the end of the grace period before determining that a default has occurred, but we can lower the issue credit rating to 'D' before the grace period has expired if we believe that the amount will not be paid within the grace period. A grace period can be stated in the terms and conditions of an obligation or in applicable regulations.

We use the following approaches to determining the applicable grace period, which in some cases mean that we apply a grace period that is different to that stated in the terms of the obligation:

What if a delay is because an issuer needs to find a new payment channel?

If the issuer is subject to sanctions or judicial action, and the ratings have not been withdrawn or suspended, we would still apply our timeliness standards as indicated in our response to the previous question. For all issuers, if we expect a missed payment would be made a few business days after the applicable grace period ends (see the chart above), we may not lower the rating to 'D' in the case of a noncredit extraordinary event. One example of such an event is where, due to a natural catastrophe or other force majeure, an issuer cannot access payment systems for a few business days.

We use this approach only if the situation that resulted in the payment delay is not a credit event. This means we would not apply it in situations where the issuer doesn't have sufficient funds to pay in accordance with the terms or is unable to pay due to a difficult operating environment. We also use this approach only for short-lived situations where we expect the payment to be made in accordance with the terms in a few business days. We could also use this approach where we expect the issuer to establish an alternative payment channel that would enable payment according to the terms in that short timeframe.

What if an issuer makes a payment in a different currency or with modified terms because of the existence of sanctions or other restrictions?

The first thing we would consider is whether the terms of the obligation allow for payment in a different currency, different place or in a different manner. If the issuer makes the payment in accordance with flexibility allowed under the original terms, then the obligation is not in default, assuming that our timeliness standard is met. This could apply for example if an issuer uses flexibility provided under the terms in the debt documentation to make a payment in a different currency. Nevertheless, we would continue to assess whether the alternative payment was consistent with the stated terms as per value and any other aspects laid out in the terms. If the original terms state that the obligor has fulfilled its obligation only once creditors convert the payment into the original currency denomination, then we assess whether the creditors will be able to do so within the applicable timeliness standards.

If the issuer decides to modify or amend the terms of an obligation, then we assess whether it has followed the stated process for amendment. Sometimes the terms of an obligation allow for certain types of amendment without investors' approval, in which case we consider that these types of modifications represent permitted flexibility.

Other types of modification may require the issuer to enter a process or negotiation with creditors. We consider these to be restructurings of the obligation. We also regard a debt exchange or repurchase as effectively a type of restructuring. We assess any such restructuring to establish whether we could consider it to be distressed, in which case we determine that a default has occurred. We don't consider a default to have occurred if we regard the restructuring as opportunistic, such as when we believe the issuer would have been able to pay the obligation in accordance with the original terms if the restructuring hadn't taken place.

How do you determine whether a debt restructuring is distressed?

We consider a debt restructuring such as an exchange, repurchase, or term amendment to be distressed if both of the following conditions apply:

  • We believe that the debt restructuring implies the creditor will receive less value than promised when the original debt was issued; and
  • We believe that if the debt restructuring does not take place, there is a realistic possibility of a conventional default on the instrument subject to the debt restructuring over the near to medium term.

Paying in a different currency than allowed under the original terms can therefore lead to a default, even if creditors agree to the modification. We determine that a default has occurred if creditors get less than the value of the original promise in a situation where there's a realistic possibility that, otherwise, the issuer would not have been able to pay in accordance with the original terms.

A modification of terms (including where and how a payment is made) is not a default if creditors agree and receive the value of the original promise.

We consider situations where creditors receive less than the value of the original promise to be a default, unless there is a realistic possibility that the issuer would otherwise have been able to make the payment in accordance with the terms.

We may determine that a distressed restructuring (and therefore a default) has occurred even if it does not apply to all creditors of a particular obligation, for example if modified terms are imposed on nonresident creditors but not on domestic creditors.

What if an issuer can't make a payment to a financial counterparty or creditor because of sanctions or judicial actions applied to that counterparty or creditor?

In such a scenario, we don't consider the issuer to have defaulted, since the willingness and financial capacity of the issuer to honor its obligation has not changed.

What if an issuer can't make a payment in accordance with the terms because of capital controls or other systemwide restrictions on certain types of payments?

If an issuer is not under sanctions but is unable to make a payment because of systemwide restrictions, we can determine that the issuer is in default. Examples of such systemwide restrictions include capital controls and restrictions on transactions--imposed at the national level--by the government of the jurisdiction in which the issuer operates. If the issuer can't make a payment because capital controls restrict its access to foreign currency or its ability to transfer funds outside the country (or to nonresidents) in accordance with the terms of the obligation, then this leads to a 'D' rating on the obligation unless the entity finds an alternative way to make the payment in full and on time. An example of an alternative payment route is the use of funds held outside the jurisdiction, or obtaining agreement from creditors to pay in a different currency or manner while ensuring that creditors receive the value of the original promise. In addition to a default occurring when no investors are paid in full and on time, we would also lower our rating on the financial obligation to 'D' if some but not all investors are paid.

Failure to make a payment due to systemwide restrictions leads to a default even if the issuer is not at fault. Such restrictions are examples of negative government intervention, which we factor into our ratings. Although such government actions may serve broader government policy objectives, they can still reduce an entity's ability to meet its obligations in full and in a timely manner.

What if an issuer makes a payment into an account for the benefit of a creditor but that account is not accessible to the creditor?

If the account is not accessible because the creditor is on a sanctions list, this situation doesn't lead to a 'D' rating on the issuer.

However, if the creditor can't access the account due to systemwide restrictions in the country where the account is located (such as on nonresident withdrawals from such accounts), then this can lead to a default on the obligation. We assess the nature of the access that creditors have to such accounts and whether this enables them to access the full payment in accordance with our timeliness standards (which includes considering any applicable grace periods as shown in the chart above).

If the payment to the account represents a modification of the original terms of the obligation, then we also assess whether this amounts to a distressed restructuring, as described in our answer above to the question on how we determine whether a debt restructuring is distressed.

What if a court rules that a nonpayment is not a default under the terms of the obligation or if a change in the governing law means that a nonpayment is no longer an event of default?

To make our determination, we apply our ratings definitions, and these can differ from the description of an event of default in the terms of an obligation. We may therefore assign a 'D' issue credit rating to debt even if the issuer is no longer legally obliged to pay due to a change in governing law or a court ruling.

Does a guarantor still need to make payments under a guarantee if sanctions or other payment restrictions apply?

We assess the guarantor's obligations under the terms of the guarantee, and assess whether it has met these obligations, using the same principles we apply for a direct obligor. Our issuer credit rating on a guarantor may therefore move to 'SD' if the guarantor does not meet its obligations under the guarantee in full and on time, but not if the guarantor doesn't pay to a creditor because the creditor is on a sanctions list.

How do you apply your timeliness standards to payments by insurers in respect of insurance policies?

If an insurer cannot make a payment on an insurance policy because the policyholder is on a sanctions list, then we do not consider this to be a default of the insurer.

If, however, an insurer has difficulty making such payment because of disruptions to payment mechanisms or payment routes, and the policyholder is not on a sanctions list, then we assess whether the payment is being made according to the policy's terms. If the insurer doesn't make the payment in accordance with timeliness standards set out in the specific policy contract or according to applicable insurance law (for example, that the payment must be made within a specific number of days of the claim being agreed), then this could lead to an 'SD' rating on the insurer. This is even if the bank that the insurance company typically uses is under sanction and therefore no longer able to make the payment on the insurer's behalf. In that case, the insurer may explore alternative payment routes, such as using another bank or making the payment into an account held by the policyholder in a different country (if the policyholder agrees to this). We would assess any modifications to the payment terms in the same way as for debt instruments.

Many insurance claims do not have to be paid within a specific time period or while they are subject to any bona fide dispute or investigation by the insurer. If this is the case, then a slow or delayed payment would not lead to an 'SD' rating on the insurer, as long as the insurer is otherwise compliant with the policy's features.

Related Criteria

Related Research

Methodology Contacts:Michelle M Brennan, London + 44 20 7176 7205;
Lapo Guadagnuolo, London + 44 20 7176 3507;
Takamasa Yamaoka, Tokyo + 81 3 4550 8719;
Analytical Contact:Olga I Kalinina, CFA, New York + 1 (212) 438 7350;

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