Cutting through the fog of the Russian assets debate

A school building outside of Kharkiv destroyed by Russian missile strikes last month. There is no shortage of homes, schools, hospitals, commercial buildings and infrastructure in Ukraine to rebuild now © Valentyn Ogirenko/Reuters

This week features two international events that matter — or should matter — for Ukraine’s and therefore the democratic world’s future. One was the third instalment of the annual Ukraine Recovery Conference, which had just wrapped up in Berlin. The other is the G7 summit in Puglia, Italy, where the leaders of the world’s largest advanced economies will discuss, among other things, whether and how to give Ukraine more funding based on blocked Russian central bank reserves.

There is a lot of confusion (even in expert gatherings, and I have attended many) about the many proposals that have been aired for “mobilising” Russian assets. So in the interest of piercing through any obfuscation that may come out of the G7 summit, it’s a good time to set out the basics and highlight the technical details that can make all the difference. Read on to know what I will be looking for in the communiqué — and what Estonia’s foreign minister told me about his country’s new asset confiscation law.

Leaders understand the need to prevent Ukraine from running out of money: that would mean certain defeat. They are much less conscious of how much good could come from aiming higher than what mere “financing gaps” indicate. I don’t mean just enough to stop rationing weapons on the battlefield. I mean much larger, and predictably sustained, injections of funds into the economy itself.

Last year I wrote about the surprisingly dynamic state of the economy of the free parts of Ukraine. The numbers have borne that out, as the economy grew by 5 per cent in 2023 and 3.3 per cent last year. If a highly finance-constrained economy can grow at such rates, just think of what an amply financed economy could do in terms of investments, jobs and — just possibly — the start of a virtuous circle of returning refugees, further fuelling growth in relatively secure parts of the country. Especially if adequate war insurance for private investments and trade is finally put in place. (For the long-term prospects of Ukraine’s economy, see this recent report from the Vienna Institute.)

In addition, there are huge reconstruction needs that can be addressed immediately. That is obviously true in energy. The FT recently reported that Russian destruction had reduced Ukraine’s power generation capacity by more than half, from 55GW before 2022 to below 20GW at present; 10GW of this loss is due to bombardments just since March. The faster generation and transmission capacity can be built or rebuilt, the better (including interconnectors with the EU). And there is no shortage of homes, schools, hospitals, commercial buildings and infrastructure to rebuild now.

The upshot is that it is a severe mistake to think reconstruction and recovery funding is a lower priority than the war, or something to prepare just for when the fighting stops — the URC’s unspoken premise (at least of western participants). The right way to look at it is to realise that the more that is rebuilt immediately, and the more growth can be stimulated in the safer part of the economy, the more likely the war is to end sooner — because it would increase the resilience of Ukrainians and because it would generate more domestic resources that could in turn free up funds for the military effort.

It is in this context that we need to see the paradoxical debate over what to do with Russia’s central bank reserves. Western politicians are becoming ever more adamant that Russia must pay for its destruction. Just this week, 24 chairs of foreign affairs committees in western parliaments wrote a punchy open letter in the FT calling for the “confiscation of all €300bn in frozen Russian central bank assets”. All this money — less than what Russia has destroyed, but still a game-changing amount — sits in blocked accounts in the west. But most western governments are so far unwilling to transfer Russia’s money to Ukraine.

There are exceptions, of which a timely one is Estonia, which has just passed a law to provide for the transfer of assets linked to Russia’s war — public and private — to Ukraine according to specified criteria and procedures (sanctions must be in place, and Ukraine must make a request and document the damage to be compensated). Estonia’s foreign minister Margus Tsahkna told me the country decided a year ago to establish how “to use [frozen Russian] assets even during the war, and also give them to Ukraine”. Estonia, at least, gets the urgent need for much more money now.

At the time “no one [in Europe] wanted to listen to this question, everyone was either afraid or not listening”. So Estonia, Tsahkna said, “wanted to set an example” of a legal confiscation-and-transfer process, compatible with EU law and a constitution with strong property protections, to “take down all these excuses we have heard that we can’t use Russian assets because European law does not allow this”. The law came on the books this month.

Estonia’s foreign minister Margus Tsahkna during a visit to a memorial for fallen soldiers in Kyiv earlier this month © Efrem Lukatsky/AP

Estonia’s foreign minister Margus Tsahkna during a visit to a memorial for fallen soldiers in Kyiv earlier this month © Efrem Lukatsky/AP

There are no known Russian state assets in Estonia, however, so the example will only be set for private assets, and for the legal principle applying to sovereign ones in theory. Still, Tsahkna reported “huge interest” from other EU countries — some interested in following suit, others nervous about what this precedent does to the argument that it cannot be done. “It’s impossible to explain to your voters why we’re not using frozen assets but taxpayer money,” remarked Tsahkna. It will be interesting to see how Ukraine avails itself of the procedure Estonia has put in place and how smoothly it works.

For now, the European G7 countries have fiercely resisted touching Russia’s central bank reserves. The US, Canada and UK, in contrast, have all warmed to at least contemplating confiscation; the first two have legislated for it (but not the UK). This fundamental disagreement is coming to a head at the G7 summit starting today, after two years of contortions to find some other way of “mobilising” the blocked central bank reserves for Ukraine’s benefit.

A goal of the summit is to find a compromise that gets a significant sum of money, somehow based on Russia’s reserves, to Ukraine soon. But a compromise between what and what? Here are three relatively simple scenarios, in order of political boldness and significance:

A. Do nothing beyond simply blocking Russia’s access to its reserves. This has been the reality until very recently.

B. Tax the bulk of extraordinary profits made by western securities depositories (primarily Euroclear) because they pay Moscow zero interest on cash that accumulates from Russia’s assets. This is what the EU has very recently resolved to do, after two years of humming and hawing. Policymakers have operated with a number of €3bn or so per year. This is timid in the extreme. As Brad Setser and Michael Weilandt show, the maximum amount could easily exceed €10bn a year.

D. (Yes, D, just wait.) Seize the full $300bn or so of Russian reserves and transfer them to a fund for compensating and rebuilding Ukraine.

The compromise to be found is something between B and D. The current candidate for option C is often referred to as the US “collateralisation” or “securitisation” plan, which would raise a loan (either on financial markets or directly from western Treasuries) whose security would be based on the Russian reserves. The idea is to leverage the future stream of profits from Euroclear into a larger upfront transfer to Ukraine — the number talked about is $50bn — rather than the drip-feed of a few billion a year.

The devil is in the detail here, however, and it’s often unclear what is supposed to be collateralised or securitised. Much of the commentary fails to distinguish between three or four superficially related but really quite different financial constructions. One is to use the reserves themselves as formal security for the loan. This is not going to happen at this summit because it requires the same legal claim as policy D.

The second is to formally collateralise the future profit stream at Euroclear, but with no claim on the actual reserves. This, like A and B, does not lay legal claim to Russia’s state assets. But it’s completely uncertain how long these profits will flow however, as it depends on market conditions and above all how long the underlying assets will remain blocked. The third adds to the second policies that would ensure profits would continue to flow for long enough. The fourth is to devote the future profit streams, such as they are, to servicing the loan, but provide some other ultimate formal security should those profits be insufficient — presumably some government guarantees.

This should make clear the difficulty of reaching an agreement. The second is a poor idea because you can’t get anyone to put up $50bn against a £3bn annual stream that could dry up next year. The third — which I understand Washington is pushing for — requires the EU to decide today to impose restrictions on Russia’s central bank in place for a long time into the future (say 10 years) rather than six months at a time as at present. Those decisions require unanimity. Good luck with that. The fourth, meanwhile, is straightforward but begs the question why you are linking things to Russian blocked assets at all, since if you are going to finance Ukraine through a government-secured loan, you can just go ahead and do so. The assets play no role in that version.

These contradictions are abundantly clear to the G7 officials who have to prepare something for their political masters. But there is no “compromise” available between these. Given the Eurozone G7’s hard anti-confiscation line — which presupposes that Russia could and should be given access to its reserves again when its behaviour changes — all but the last, pointless, option would require a European about-turn.

That would, of course, be a good choice. Estonia’s Tsahkna points out that a decision to legally keep Russia’s reserves blocked for the long term would protect against any temptation by some countries to go soft on Russia and give the reserves back. “It would be a huge deal to [commit to] keep things frozen for a long time — it would be very useful to ensure that we can’t go back to business as usual before Russia pays. If we can use [the profits from the blocked assets] as guarantee for long-term loans, that’s good enough.” Indeed, it would blur the distinction between blocking and confiscating.

But I would not expect this outcome from Puglia. Expect, instead, a political promise to “mobilise” $50bn in some unspecified way to be resolved by further technical work. But that will be a fudge, because a solution requires a political change.

I could be wrong. And I do think that political change will eventually come. The Eurozone G7 could warm to confiscation in the end. They could realise that bank regulation presents ways to direct the resources to Ukraine without confiscating anything at all. Belgium (where Euroclear is) could even learn, from Estonia, that it is possible to act at the national level. The possibilities are many. As Tsahkna says: “We need to talk loudly, honestly, and finally people will be asking: why are we not using the Russia assets? This is the right question.”

Source: Financial Times