First things first: in last week’s Free Lunch I unforgivably got my European royal houses mixed up; my apologies. It was of course the Bourbons and not the Habsburgs of whom Talleyrand supposedly said they had learnt nothing and forgotten nothing. It may still be that our financial regulators are worse than the Bourbons, as I meant to say. But the only one who has learnt nothing and forgotten everything is clearly me. Thanks to all our erudite readers who pointed out the error, not least because it proved they read last week’s very long column to the end.
Last month, I wrote a series of pieces on the western sanctions against Russian financial assets (the whole list is here). Since sanctions-related news keeps flowing in, it is time for an update.
Sanctions are a cat-and-mouse game, where any new restriction gives rise to evasion efforts. Two cracking stories from the FT illustrate this. Our energy reports document that Switzerland-based commodities trader Paramount Energy & Commodities SA has given up shipping Russian oil, but the new Dubai-based company Paramount Energy and Commodities DMCC has picked up the business. And our Vienna and Moscow reporters revealed that Raiffeisen Bank, whose Russian operations made huge profits last year, is thinking about a “prisoner exchange” of money trapped in Russia’s frozen assets that the sanctioned Russian bank Sberbank holds in Europe.
It would be extremely surprising if the Russian state were not also trying to sanctions-proof its assets (those assets that aren’t already immobilised in the west). Examples such as the ones above, even if they relate to other sanctions than those on foreign exchange reserves, are part of the reason why I think Russia may be trying to put the dollars and euros accumulated from unsanctioned energy sales beyond the reach of the western sanctioning coalition — but without converting them (all) out of hard currency. I described how they might plausibly be doing this in the last piece of my series.
But it is also clear that the shift of Russian cross-border finance out of western currencies altogether is accelerating. The FT’s Anastasia Stognei shows that in the past year, renminbi-denominated activity in Russian trade invoicing and currency exchange has soared. This is, however, a rise from a very low base, and there is little sign that western currencies are being abandoned. Russia’s sovereign wealth fund holds Rmb300bn ($44bn), according to Russia’s finance ministry. But this number has been constant for many months; indeed, total Russian foreign exchange reserves are on a downward trend. Wherever Russia is saving its surpluses, it is not in the official numbers, even the renminbi-denominated ones.
Stognei reports that the renminbi’s share of currency trading activity on the Moscow Exchange has jumped to 40 per cent, reflecting a sudden need to buy and sell renminbi because trade patterns have shifted to China. No doubt Beijing would be delighted to see a redenomination into renminbi of all China-Russia trade and even Russia’s trade with third countries. Beijing can, to some extent (but not fully), force the former. It cannot force the latter. In any case, doing more and more transactions in China’s currency is not the same as keeping more and more of one’s savings in it. It is not clear why Russia, let alone third countries, would make themselves overly dependent on a non-convertible renminbi and put all their savings in it unless they were content to source all their imports from China forever.
So the rise in renminbi exchange activity is consistent with Russians keeping their wealth (public and private) in western currencies much as before. To the extent they are accumulating renminbi balances, the hard currency with which the renminbi were bought — Russia’s energy exports are still overwhelmingly sold for euros and dollars — may remain in the German and US correspondent accounts of the Moscow Exchange’s National Clearing Centre. If so, western governments could still seize this money, as I have argued before.
That shows the relevance of another recent piece of news, namely that Russia is going to require payments for grains to be converted into roubles on the NCC, just like it has already done for gas sales (hat tip: Maria Shagina). Here, too, the motivation is surely to make it awkward for the west to freeze the NCC’s hard currency accounts, which would expose them to accusations of causing a hunger crisis by frustrating the grains trade. That motivation itself, however, is a sign that Moscow does wish to keep “shadow reserves” of western currencies at its disposal.
But that amounts to a vulnerability that can be targeted by harsher sanctions, albeit a vulnerability that Russia is doing its best to conceal. As sanctioning authorities are trying to make their sanctions less leaky — both the US and Europe say they are going to boost enforcement — they should read a terrific new academic study that applies network analysis to the intermediation of offshore finance based on previously leaked information. Their findings are striking:
“Our ‘knock-out’ experiments pinpoint this vulnerability to the small group of wealth managers themselves, suggesting that sanctioning these professional intermediaries may be more effective and efficient in disrupting dark finance flows than sanctions on their wealthy clients. This vulnerability is especially pronounced amongst Russian oligarchs, who concentrate their offshore business in a handful of boutique wealth management firms.”
Or as Brooke Harrington, one of the authors, puts it in an accompanying New York Times op-ed: “Break the chain between Russian oligarchs and managers, and you break everything.” For state assets (and oil trade) too, there is no doubt that particularly important “nodes” (financial professionals or entities that are expert intermediaries) can be found which can be targeted to disable the sanctions circumventions.
And what about the immobilised official reserves? Western governments can access those if they want, but even “access” is a misleading term, since these reserves do not consist of some locked-up treasure chest where we are discussing who has the right to a key. Instead, they consist of the promises to pay Moscow defined amounts of money, made by western governments themselves (in the case of bonds) or their central banks (in the case of deposits with them).
The debate on whether to confiscate keeps evolving. One unedifying is how the EU keeps exploring the very acrobatic idea of temporarily “investing” Russia’s reserves and capturing the returns. The European Commission has now prepared a detailed “non-paper” on the idea for member states. It’s a mess, resulting from too much legal contortion with too little economic understanding.
For example, the paper suggests there is no problematic interference with Russia’s property so long as the principal and contractually agreed payments are not touched. This creates a senseless difference between a low-coupon bond with a high rate of appreciation to maturity and a high-coupon bond with regular interest payments but little appreciation.
The paper also suggests that because any transaction to do with managing Russia’s reserves is prohibited, and eurozone central banks therefore may not add interest to Moscow’s accounts, there is no accumulated interest owed and no confiscation would be involved in not compensating that lost interest if sanctions are one day lifted. To be consistent with this logic, one must surely say that since the principal of a maturing bond also cannot be paid out, there is no confiscation involved in never paying that either. But then the whole alleged legal problem of confiscation dissolves into a hopeless muddle.
Then there is the plain economic illiteracy of the initial idea. If all you are going to do is to “work the assets”, why do you need to take control of the reserves even temporarily? You could just as well have the central bank print the same amount of money, invest it as proposed, keep the returns and then withdraw the money: a “quantitative easing for Ukraine” programme. The economic effects would be identical, and you would avoid the risk of serious embarrassment if you invest badly and have to compensate Moscow for losses. To be clear, I am not proposing this solution — I just offer it as an illustration of how misguided this way of thinking is.
(I have seen one even crazier idea, floated by Russian arch-propagandist Margarita Simonyan: that Moscow could give up its immobilised official reserves in payment to Ukraine for keeping the Donbas.)
Much more coherent are the calls for outright confiscations, which some state leaders make. The weightiest recent contribution to this view is the op-ed by Lawrence Summers, Philip Zelikow and Robert Zoellick, who between them have legal and economic understanding in spades. They argue that the moral (obviously) and legal (less obviously) case for seizing Russia’s reserves to pay for Ukraine’s reconstruction is clear-cut. Their piece is mostly directed at a Washington audience, trying to sway the US position, and rightly so. I think they may be right that the US faces few domestic legal hurdles; it could, if necessary, legislate to explicitly allow confiscation like Canada has done, but may not even need to do that.
Invoking the precedent of Iraq is unhelpful, however, as they neglect to mention the key difference that today’s coalition has gone out of its way to define itself as non-belligerent. And most importantly, there is no doubt that Russia will mount serious legal challenges to confiscation in Europe’s courts, and it is crucial to think ahead about the repercussions of any legal victory for Moscow and not rush in without laying the groundwork.
But I agree with them that the political goal must be clear and ambitious, and the work must be done to find a way. The best conclusion to draw from the legal debate, I think, is simply to say that international law is undefined in this case, and that the task is to develop it in a way that promotes the purpose of freedom, self-determination and the protection of rights. Making new law that removes the property protection of rogue states is clearly the right thing to do.
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