After years of hesitation, Europe and the UK are poised to seize Russian assets and hand them to Ukraine.
Since the Kremlin launched its full-scale invasion of Ukraine three and a half years ago, Europe has been dithering on what to do with more than $300bn of frozen Russian assets. Faced with deteriorating finances, many countries now finally accept it’s time to act, even if in the short-term this may offer some help to Russia.
The main fear has been that seizing accounts and assets would sacrifice the sacred cow of private property and banking reliability, prompting other major clients — both private and sovereign — to seek safe havens for their billions outside Europe, thereby damaging both the currency and financial sector.
Legal action was also a worry (and is near-inevitable — a lawless Russia loves the delays and difficulties imposed by legal action in the West.) Now it seems the European Union and the UK seem to have decided that rather than slaughter the sacred cow, they will milk it instead.
Western Europe has frightened itself into inaction, but there was never much chance that Russia would be able to unblock its billions. After all, there is both an urgent need and a moral imperative to make the aggressor pay by using Russia’s money for Ukraine’s cause. Quite apart from the need to fight on, Russia has done perhaps $1.16 trillion in damage to its neighbor.
The frozen funds are primarily owned by Russia’s Central Bank. The majority of the Russian funds are held in the EU, with more than half deposited at Euroclear, the Belgian depository and clearing house. With no precedent to follow, European governments have been hesitant to seize assets from a country they are not officially at war with.
It has however, used some of the money to aid Ukraine. As interest-bearing Russian assets mature, Euroclear accumulates cash balances on its books. The clearing house uses these funds to generate interest income, similar to any commercial bank. This income is then seized for Ukraine’s benefit through a special tax. Last year, this interest income amounted to €6.9bn ($8.1bn).
This approach was legally sound. The ownership rights and nature of the assets remain unchanged, and Moscow’s only legal recourse would be claiming lost revenue, which is difficult to prove. The main risk would be a sharp drop in European interest rates, which has not happened.
Now that the US has ended direct aid to finance Ukraine, the need for more cash over a longer period has become urgent. This prompted the EU to present a new plan, details of which remain sketchy, as reported by the Financial Times, which suggested Ukraine might receive about $200bn. The UK holds about $30bn in Russian assets and looks set to mimic the EU program.
The plan would use cash balances in Russia-owned accounts as collateral for new bonds, or use them directly to purchase these bonds. In broad terms, it works as follows: the EU, or a group of participating countries, issues non-interest-bearing bonds. Russian cash balances serve as collateral, and the bonds are sold in tranches to private investment banks.
Alternatively, the cash is used to purchase these bonds in tranches. Ukraine is thought to become the ultimate party liable for the debt, but will only be obliged to pay if the reparation issue is settled. Alternatively, Russian cash is used for the repayment. Both schemes ensure a steady cash flow to Ukraine.
Bond redemption will depend on peace conditions and Russia’s agreement to pay reparations. This fully corresponds to the G7 and EU political position formulated in 2022: Russia will not recover its reserves until there is peace and an agreement on compensating Ukraine for damages.
Formally, Russia would remain the owner of its accounts, but Moscow will be unable to manage these assets, as before. Since the bonds are interest-free, Russia will lose money to inflation annually.
Nevertheless, Russia has grounds to challenge this approach, as such “replacement” would change the composition of its accounts — much like a private individual discovering their cash has become loan collateral or transformed into securities. The EU would need legally solid grounding for its plans.