Friday, June 28, 2024

"How to harvest the windfall profits from Russian assets in Europe"

Though international thinking on odious debt is pretty much hammered out and agreed upon—at least in principle if not in principal, depending on who has to take the write-off—the construct of odious assets is much newer and obviously more fun.

From the Bruegel think tank, June 24:

The challenge still remains of crafting a syndicated loan for Ukraine backed by G7 members that strikes a fair deal on burden sharing  

After months of bickering over whether and how to confiscate Russian sovereign assets, G7 members on 14 June agreed to use future profits from frozen funds held by Euroclear in Belgium to prop up a loan for Ukraine of up to €50 billion 1 . That makes sense, as a full-blown confiscation policy would be plagued with legal pitfalls. Yet, the challenge still remains of crafting a syndicated loan backed by G7 members that strikes a fair deal on burden sharing.

Three issues must be dealt with. First, the European Union will be at the centre of confiscation efforts and as such will have more to lose than the United States. Fair burden-sharing therefore suggests that the US should take on a disproportionately high share of the syndicated loan’s repayment guarantee.

Second, the EU budget must provide surety against the risk that future revenue streams from windfall profits from frozen Russian assets – approximately €3 billion annually – turn out to be insufficient to repay the loan.

Third, the uncertainty created for G7 partners by sunset dates in EU asset-freezing decisions (and hence uncertainty over the appropriation of windfall profits) should be addressed by replacing such dates with review clauses. This will reduce the risk of unpredictable voting behaviour by certain EU members.

What belongs to whom?

In unpicking these issues, the first question is who owns the windfall profits from Russia’s assets, expected to amount to €3 billion annually (after Belgian corporate tax). One answer is that the profits are Euroclear property (differently from the principal assets owned by Russia), simply because revenue from reinvesting matured bonds does not accrue to Russia. Depositories like Euroclear usually transfer their customers’ cash balances out before the end of the day without any remuneration for the customers.

What makes this case unique however, is that the EU and Russia both deny that Euroclear is entitled to retain the profits. According to the EU, Euroclear “cannot expect to gain an undue and unintended economic benefit from” EU sanctions 2  – a claim Russia would agree with. The EU denies Euroclear’s entitlement to the profits based on the EU having the competence to impose sanctions on Russia, while Russia sees the windfall profits as unjustified enrichment following the maturing of Russian assets. In pursuit of its claim, Russia could initiate proceedings under the Belgium-Russia bilateral investment treaty, possibly claiming the violation of fair and equitable treatment, or outright expropriation. While such a lawsuit would likely fail because of the overriding public interest of sanctioning violations of international law, some legal insecurity remains on the entitlement to windfall profits.

EU vulnerability

On the delicate issue of burden-sharing among G7 members, it should be noted that about €191 billion ($205 billion) in Russian assets is held at Euroclear, while only $5 billion is held in the United States. This imbalance makes the skimming of windfall profits in the EU a much more likely target of Russian retaliation, as Russia has warned repeatedly 3 . Russia’s easiest riposte will be to confiscate assets held by European companies.

According to the Kyiv School of Economics 4 , European and US companies have pulled out approximately 40 percent of their assets in Russia since the full-scale war in Ukraine began. The rest decided to stay, but stopped operating or are still in the process of trying to sell their assets. What remains in Russia are foreign assets worth $194 billion. Of this, $90 billion is owned by European companies, nearly three times more than the amount owned by US-headquartered companies ($32 billion). If Russia’s warnings of retaliation are serious, European companies could end up footing the bill for funding Ukraine.

With the EU facing greater risks of retaliation, the US should at least accept to take on the main burden in providing guarantees to underpin the Ukraine loan. This will be pivotal in crafting the syndicated loan.

It will have to be decided whether the syndicated loan will be repaid from the proceeds of a dedicated bond backed by future windfall profits as collateral. The disadvantage of this approach is that it will lead investors to ask for a high discount, making borrowing expensive. A better option would be back-to-back lending by the G7, as is EU practice already in lending via Multilateral Financial Assistance to Ukraine. Whether G7 members provide their guarantees jointly, through a third-party institution or through bilateral loans to Ukraine is secondary. In order to ‘Trump-proof’ the loan, it could be wise to first pay the loan to a multilateral institution, such as the World Bank, where it could then be sent onwards to Ukraine. This would prevent Trump from cancelling the US share to the loan 5

Most important is to agree on the design of a ‘sharing clause’ to underpin the syndicated loan agreement, and which will define the pro-rata exposure of G7 members in case windfall profits are not enough to repay the loan....