‘Banditry and theft’: The delicate plan to unlock a $350 billion Russian safe

The European Union has taken a major step toward using the near-$350 billion of Russian central bank assets frozen within Europe to help Ukraine fund its defence.

Last week, the EU, after intense debates over the past six months over whether to access the Russian funds – the larger part of the $430 billion of Russia’s central bank assets frozen by the West at the onset of the war two years ago – announced that it would proceed with a plan to pass most of the interest being generated on the assets held by the Belgium-based clearing house Euroclear to Ukraine.

The Kremlin has labelled the plan as “banditry and theft”.Credit: AP

It said the first payment of about €3 billion (almost $5 billion) to Ukraine could occur as soon as July 1, with, depending on the prevailing interest rates, two payments a year totalling €2.5 billion to €3 billion in future. Last year, Euroclear generated €3.25 billion of after-tax profits on the Russian funds.

Where the original discussion about accessing Russia’s assets centred on using the funds for the reconstruction of Ukraine, the new plan, which has been agreed in principle, is to funnel the interest through a special EU budget allocation known as the European Peace Facility, which is dedicated to funding Ukraine’s military.

The unwillingness of the Republican majority in the US House of Representatives to even consider more funding for Ukraine is hampering Ukraine’s ability to defend itself. Access to the earnings on Russia’s assets is no substitute for the massive amounts that the US has previously provided – Republicans have blocked a proposed new $US60 billion ($92 billion) of aid – but along with the start of funding from the EU’s new €50 billion financing mechanism, it will help.

Ukraine and the US have previously argued (as Ukraine still does) that the corpus of the Russian funds, and not just the interest on them, should be seized and handed over to Ukraine as reparations for the invasion and the trillion-dollar-plus damage to its infrastructure.

However, Euroclear, the Europeans more broadly and Western banks have argued that seizure is a big step beyond freezing of the assets, one that would be in breach of international laws that generally prohibit expropriation of foreign private property assets without fair compensation.

There are precedents for seizing foreign governments’ assets, most notably the expropriation of Iraqi assets held offshore during the Gulf War, but that was during a direct military conflict between the US and Iraq and the funds were used for the postwar reconstruction of Iraq.

The fact these are central bank assets amplifies the concerns, given the centrality of central banks to the global financial system.

The Europeans have been concerned that targeting the underlying assets, rather than the income they generate, could jeopardise the euro’s status as a reserve currency, leading to an exodus of foreign capital from Europe and impacting European interest rates and inflation. It could also undermine Euroclear’s credibility and trust as a major clearing house – and a key component of the infrastructure of Europe’s financial system – for international securities transactions.

Ukraine desperately needs funds to halt Russia’s advances.Credit: AP

US Treasury Secretary Janet Yellen has played down those risks by making the point that there are no real alternatives as reserve currencies to the US dollar, the euro and Japan’s yen.

No rational Middle Eastern or developing economy central bank would be comfortable holding its reserves in China or Russia, although there is little doubt that, having experienced the weaponisation of the dollar and euro in response to the invasion, plenty of countries in the “Global South” and Middle East would like to have a viable alternative.

It is notable that, despite murmurs of discontent when the G7 responded to the invasion with the freezing of Russian assets held offshore, there has been no discernible shift of any consequence in global capital flows.

The Europeans are also worried, with good reason, that Russia will launch a blizzard of litigation in response and also target not just the €33 billion of assets Euroclear holds within Russia, which are already frozen, but funds in its securities depositaries in other jurisdictions. Euroclear has about €37 trillion of international assets on its platforms.

Euroclear doesn’t pay interest on those assets, so siphoning off the interest on Russia’s funds while leaving the underlying assets frozen but without any further threat to their ownership – they remain Russia’s property – is arguably a less vulnerable and less precedent-setting course.

Euroclear, which has generated more than €4.4 billion of profits on the Russian assets since the invasion, has kept that income at arm’s length from its normal operations.

Under the EU’s plan, Euroclear would retain about 3 per cent of the annual income from those assets to cover its operating costs and another 10 per cent to provide for the cost of the inevitable litigation. The rest – and the amounts would depend on the interest rates prevailing at the time – would go to Ukraine.

While the Kremlin has described the plan as “banditry and theft” and warned that those making the decisions would become the objects of prosecutions for decades, the EU is effectively taxing earnings that, because of the G7 (and Australia’s) decision to freeze Russia’s central bank reserves, would otherwise flow as windfall profits to the clearing house.

It’s a tax, albeit an extremely targeted one, rather than a confiscation. Euroclear itself has been wary of other plans to use Russia’s assets to help Ukraine, like using them as collateral for loans, but is broadly supportive of the current plan because the earnings on assets held by the clearing house legally belong to it.

The €3 billion or so a year that the EU envisages handing over to Ukraine might be a paltry amount when set against the €210 billion sitting on the Euroclear platform that the Ukrainians would love to get their hands on. Every little bit, however, will help in the desperate circumstances Ukraine finds itself in.

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