So much is happening on the immobilized Russian asset front and I have written so much on the subject over the past 3.5 year I thought it useful to update and put everything in one place on the issue in a Q&A format.
A kind of fool’s guide - apologies to readers therein.
Question: So why are we having this debate, why is the issue of immobilized CBR assets now center stage?
Answer: The crux of the issue is Western support for Ukraine in its defense against Russia is costing at least $100 billion a year, and that is a huge burden for European taxpayers to bear.
The best source of data here is the Kiel Institute, with data back from February 2022.
Now I would argue that $100 billion a year is just to keep up the Ukrainian defense, and if we wanted to give Ukraine a perspective to win the war then perhaps the West would need to provide closer to $150 billion per year.
The problem for Europe is that under the Biden presidency, 40% of the funding for Ukraine was provided by the US, but under Trump that has dropped off a cliff, and Europe (with help from Japan and Canada), will near enough have to fund the full nine yards on its own. That is a big ticket for Europe when budget deficits are already large, debt burdens high and with populism on the rise and when populations want their tax euros or pounds spent nearer to home.
This comes as the security threat from Russia seems accentuated with Russian drone, air and naval incursions against Europe now rising by the day. Meanwhile, the US security backstop for Europe has significantly weakened under the Trump presidency. Europe is extremely worried about its own security, understands that it needs to increase its own defense capability but after years of neglect this will take time.
That time could be provided by a) the US continuing to be willing to sell weapons to Europe, in the interim and b) Ukraine holding the line against Russia long enough for Europe to get its act together. Adequately funding Ukraine helps both the above as the assumption is that monies provided to Ukraine can also be used to buy US military kit - playing to Trump’s considerable ego.
The added complication for Europe is that there was some complacency that the war in Ukraine will come to a close this year, so when the G7 was thinking about its funding plan it only really planned big money provision for this year. Financing provision programmed fell off a cliff after this year - this is now reflected in messaging from the IMF that their existing $15 billion program for Ukraine is now underfunded to the tune of $65 billion - that excludes the military cost of supporting Ukraine - on the now base case of an indefinite war.
So, the message is that the West, and Europe, needs to plan for a longer war, and much higher funding needs over that period than has currently been planned for - likely hundreds of billions of euros. So, more money needs to be found by Europe, and quick, and there is an assumption that European taxpayers will just not meet the tab.
Question - why have immobilized CBR assets not been seized already?
Answer - Long story. I would cite a fundamental lack of political leadership in the West and a failure there to understand and plan for the existential threat that exists from Russia. And then a failure to properly explain that threat to their populations - if they did then maybe Ukraine would have been properly financed and armed earlier to win this war. The other point is that bureaucracies in the West - national treasuries, central banks, and business and banking communities have put up lots of excuses as to why this should not be done. In doing this they have not though provided alternative and sustainable funding strategies. Decisions here have been taken by national treasuries, and central banks, and not national security types. Proponents of seizing CBR assets, like me, have met and convinced politicians to act, but then have been met by “the computer says no” kind of approach. It’s been classic kicking the can from bureaucracies who just do not like thinking outside the box and doing things that are slightly challenging.
But as I wrote a few weeks back:
“The problem so far is this whole debate has been driven by the legal complexities, not the economics. The legal complexities have given the politicians cover not to do the right thing. Now the economics is driving the politics and the legal has to follow. In the EU laws change when need be - in crisis/emergencies. We are now at that point. The bureaucracy will be told to go away and get this done. And they will because the funding numbers for Ukraine do not add up without resort to using the underlying assets - CBR reserves.”
Question - what about the arguments against?
Answer - Well I always start my response here by saying, sure, seizing immobilized CBR assets would not be plan A in an ideal world, and there are risks, but what is the alternative? And the reality is that after 3.5 years of this war, what we have been doing, as the collective West has been failing. We have not funded and armed Ukraine to win. I would also make the point that taking the lazy approach of just reaching to spend Western taxpayers’ money is surely immoral but also political suicide, when we have Russian taxpayer money sitting in bank accounts, doing nothing, in Western jurisdictions. What has been happening is that Western politicians have in effect been prioritizing the defense of Russian taxpayer assets at the expense of their own taxpayer dollars, euros or pounds. This should be an absolute scandal.
Question - What about the risks to G7 reserve currency status from this?
Answer - This has been the argument used by the ECB and G7 central banks. The argument is that using CBR assets to fund the war in Ukraine will undermine confidence in the sanctity of property rights in Western jurisdictions and see flight from G7 currencies as trust in their reserve currency status will erode.
The data does not really support this argument. CBR assets were immobilized in April 2022 and since then there is no evidence of reserve assets being moved from say dollars, Sterling, euros to other jurisdictions. Partly this reflects the lack of alternatives. If you think of the reserve stocks of the like of China, India, the Gulf states, they have close to $7 trillion in FX reserves.
There are simply no liquid alternative markets of this size for them to invest, given typically they don’t trust each other. Saudi Arabia is not going to sell US Treasuries and buy Chinese bonds. It does not trust China and the CNY that much and recognizes that any such move would be seen as an incredibly aggressive move by G7 states and they would likely change their security support for Saudi Arabia et al as a result.
There has been a move into gold in recent years, but that seems like a trend reflecting broader concerns around geopolitics, macro policy in the West, tariffs, et al, rather than specially related to the move to immobilize CBR assets. This seems like a long-term trend and I don’t think that even if the West gave CBR assets back to Russia tomorrow that the bid for gold would suddenly collapse.
Note here also that I don’t see a huge difference here between immobilization and full seizure of these assets. The West has made clear that immobilized CBR assets have been put beyond Russia’s use and they will not be remobilized for Russia until Russia pays reparations to Ukraine. If you are an authoritarian regime you already got the message that if you act against international law, invade another country, commit war crimes and genocide then your assets in the West will be at risk. That’s a good reason then not to take part in all that bad behavior.
So, I don’t think a move to full seizure will suddenly see other countries wake up and say wow this is signficantly new news and we now need to move our assets. They would surely have already changed asset allocation behavior on immobilization, but they have not, so I don’t see a move on full seizure.
It is also perhaps worth highlighting here that the current plans being worked up by Europe and the G7 do not suggest full seizure, rather under the reparation loan idea CBR assets will be invested in new instruments which could be repaid in full - assuming reparations are agreed. Russian ownership rights have not been taken away, they still own the underlying assets. But instead of being held in Bunds, Gilts or USTs, they will now be held in EU 30-year zero coupon instruments used to fund Ukraine.
Back to the risk of reserving currency status and particularly the risk to the euro, I think for me the bigger risk is if we do not do this. If we do not fund Ukraine adequately it is at risk of losing this war and the consequences of that would be catastrophic to Europe, the European project and the Euro.
Imagine tens of millions of Ukrainians moving West, think then of the social, economic and political impact of that. Think then of the two biggest military industrial complexes in Europe - Russia and Ukraine - combined and the need then for Europe to massively increase defense spending and quickly. That would mean increasing defense spending from 2% to 5% not over 5-10 years as currently planned, but immediately. Europe would need to go straight to war footings and spending. Much higher defense spending would mean more debt, higher interest rates, lower growth and a weaker euro.
Question: What about the French line that the Saudis threatened to sell euro assets in response to CBR assets being seized?
Answer - Scaremongering, plain and simple. Let’s just think through that. If Saudi Arabia sold its huge holdings of Bunds, OATs, GILTS, USTs, et al, what would that do from a market perspective? Well, it would collapse these bond prices, increase global interest rates, and subdue global growth and oil and commodity prices with it. That would be disastrous for Saudi Arabia and MBS trying to fund an ambitious Vision 2030 program at a $90 oil breakeven price - currently planning a much-enlarged budget deficit and increased financing needs. If oil prices drop $20 a barrel, MBS can rip up its Vision 2030. And actually, such a globally systemic event would see a flight back to quality, back to G7 reserve currencies, back to UST, Gilts, OATS et al. Saudi is just not going to do this, and neither is China. MBS and Xi would be better off calling their mate Putin and telling him to halt the war in Ukraine.
Question: What about the risk of Russian retaliation?
Answer - Bullshit, excuse my French.
First, the fact that Russia is even bringing it up suggests that it is rattled. Moscow understands that the provision of $330 billion of CBR assets for Ukraine would be a game changer - it would assure Ukraine’s financing for two to three years to come and enable Ukraine to buy the full range of Western conventional military kit to enable its to defend itself and win the war. It would raise the stakes for Moscow - is Moscow actually prepared to continue this war for another 2-3 years and match Ukraine dollar for dollar, actually $330 billion of Russia’s own money?
Second, and note here that the West has found an asymmetrical lever to use against Moscow as Russian assets stranded in the West - state assets stranded in the West are close to $400 billion, compared to little or no Western state assets stuck in Russia. Moscow often cites a figure of close to $289 billion of Western assets - derivatives and other assets at risk in Russia. However, a weight of this comprises private sector debt, already written down close to zero or sold out to other investors. And it leaves the question on what basis Russia would go after these fully private sector assets - with no basis for seizure.
There is clearly a case for Russian state assets to be seized because of its actions in Ukraine - and countermeasures provides the legal basis - but what have Western private sector investors done to justify the Kremlin going after them?
Rather with zero basis in morality, or law, this would be the biggest attack on private property rights in Russia since the collapse of the USSR, and it would ensure zero investment into Russia for decades to come.
It would also leave the multiples more in Russian private sector assets offshore vulnerable to retaliatory seizure - looking at capital flight data, Russian private sector offshore assets are likely closer to $2 trillion. How would ordinary Russian feel if their offshore bank account was left at risk because of the actions of the Kremlin?
Third, the threat of retaliatory confiscation is rich when Russia has already confiscated numerous Western assets within its jurisdiction. Often these assets have been confiscated by the Russian state and transferred at peppercorn rates to Putin’s buddies in the White House.
Fourth, and really the most substantive argument is that Western companies with assets now stranded in Russia long knew what kind of regime they were dealing with and what the risks were taking when they chose to remain. They were long warned by their own governments and could themselves observe Russian malign actions way back to 2008 and the invasion of Georgia, but then Litvinenko, Salsbery, the annexation of Crimea in 2014, invasion of Donbas the same year, warnings of invasion from Western intelligence in 2021, the actual invasion in 2022, then Bucha, Mariupol et al.
Throughout this decade and a half period these companies had plenty of time to sell off their Russian operations but instead many decided to double up and reap windfall profits. They now find themselves stranded but that was because of their own bad investment decisions.
Why should they now be bailed out by Western taxpayers, in effect? Because remember here that if a decision is taken not to use immobilized CBR assets to fund Ukraine so as to protect Western business interests in Russia, then it will be Western taxpayers who then have to write the cheque to cover the financing hole to ensure Ukraine has the funds to defend itself and Europe.
It’s a clear moral hazard play of private business expecting a taxpayer bailout for their cock-ups. And note here what this would amount to – that Western national security interests would be being put behind/subservient to the personal profit-based interests of some greedy Western businesses who reaped excess windfall profits from doing business with a fascist, murderous regime for far too long.
Surely the interests of Western taxpayers, and our own security, should be put first.
Question? So, what do you make of the reparations loan idea, is it workable?
Answer - look I would prefer straight seizure, but I get the politics in Europe, and the foot dragging from Belgium et al. And there are plenty of ways to skin a cat. It will secure €140 billion for Ukraine, likely well over $200 billion with the other G7 monies brought to the table, which will be game changing for Ukraine and the war. It will send a really strong message to Putin that Ukraine now has long run financing and can better compete with Russia. Is he then up for the long war scenario against a Ukraine which likely will be better financed and armed? It is more likely to bring Putin to the negotiating table. It also buys time in terms of agreeing reparations later down the line - remember the money will only be paid back to Russia upon agreement on reparations.
It can work albeit I still worry about the institutional framework around this financing.
In terms of the means - the EC issues a loan/bond, bought using CBR assets in Euroclear, or at banks in other G7 judications, and this is used to fund an SPV which then channels funds to Ukraine.
Obviously this helps alleviate concerns about confiscation - the underlying assets remain the property of Russia, but instead of owning bunds, Gilts or USTs, they are now zero coupon 30-year instruments issued by the EU for Ukraine. The assumption is that these funds are only paid back to Russia in thirty years time after offsetting against reparations - the NPV on a zero coupon in any event significantly reduces their value, or liability, thirty years down the line.
I would assume also that funds, while parked immediately in the SPV, are then only disbursed to Ukraine, and for military needs in support of the war, over an extended period of time - say 2-3 years. And if the war ends earlier, the funds can be used for recovery and reconstruction. With this in mind I think it would be wise to shape the SPV into more of a sovereign wealth-like structure. In the short term it could be used as an asset management vehicle to maximize returns of funds held on account for Ukraine.
Think here an EM credit fund could generate 8-10% return pa, and an EM local market fund high teen digits, at least this past year. Longer term though I think this sovereign wealth fund could provide a range of advantages, particularly in terms of the period of recovery and reconstruction. It could plan or program that reconstruction, lead - drive the reform agenda in Ukraine, raise money on its own behalf and perhaps collateralized by CBR assets - leveraging up the bang (literally) for buck of these assets - act as a partner for private investment into Ukraine (GIC plus Temesek). I would imagine this entity would be jointly owned/managed by Ukraine and the G7 initially, but with ownership migrating fully to Ukraine, say upon EU accession. I have called this entity the Agency for Ukrainian Reconstruction and Accession to the EU (AURA). Three and half years into this war and after numerous Ukraine Recovery and Reconstruction conference zero progress has been made in setting the institutional framework around recovery and reconstruction. Action now on the immobilized CBR asset front and talk of creating an SPV for managing CBR assets presents a great opportunity to kick start creating such an entity, like AURA. Let’s just get it done.
Question - Just going back to the legal basis for seizure, what a it?
Answer - I always cite the work of Zyskind, Zoellick and Zelikow, who have argued that Russia’s sovereign immunity only holds in the case where Russia is in compliance with international law - when it is not, and in this case, and an illegal invasion, it is not, then its sovereign immunity lapses, and it can be subject to countermeasures, of which seizure is one such measure. Russia’s ability to challenge seizure in international courts is similarly limited as it would itself have to lift its own sovereign immunity to peruse any such case - which it simply is not going to do, as it would then leave itself vulnerable to a myriad of cases by Ukrainians seeking reparations from the estimated $1 trillion plus cost of Russia’s war on Ukraine.
Reprinted from the author’s @tashecon blog! See the original article here.
The views expressed in this opinion article are the author’s and not necessarily those of Kyiv Post.