The EU is under intense pressure to seize Russia’s frozen $300bn of reserves, as crises in funding the war in Ukraine and finding the funds to pay for reconstruction loom.

The US has made it clear that it doesn’t want to pay for the Ukraine war anymore. It ran out of money for Ukraine completely at the start of 2023, then struggled to get an emergence $61bn aid package through in April, but according to Ukrainian President Volodymyr Zelenskiy only 10% of these funds and supplies have actually arrived in Ukraine since, with the rest caught up in committee in the US – a problem confirmed last week by US National Security Advisor of Jake Sullivan.

Washington has already passed laws making seizing the $5bn of Russian assets still on American territory legal. Now it wants Europe to do the same.

The confiscation would be unprecedented. Central bank reserves have been frozen many times, and indeed, the US continues to hold the reserves of Iraq and Afghanistan, but technically they remain the property of the country’s central bank and should eventually be returned after the wars are over. Central bank reserves of another country have never been confiscated before.

In May, the EU approved the use of profits from the frozen assets—approximately €3bn annually—with 90% allocated to military aid for Ukraine and the rest reserved for humanitarian purposes. This compromise ensured the participation of neutral EU countries.

What is driving the renewed debate to seize the principal assets as well is Western officials are increasingly unable to fund Ukraine. At the same time as US funding dries up, the EU has also been slacking on fulfilling its commitments. Europe has pledged a total of €241bn in support of Ukraine since the start of the war in 2022, but it has only delivered half of this amount (€125bn), according to monitoring agencies, and there are no concrete plans to send the rest.

With Europe sinking into recession it has reached the point where EU governments have run out of money to pay for an expensive war that is consuming some $100bn a year, according to Timothy Ash, the senior sovereign strategist at BlueBay Asset Management in London.

Germany has been in a budget crisis all year, and cut its allocation for Ukraine in half from €8bn to €4bn in 2024, with commitments falling to €500mn in the following two years. Likewise, France, which is also suffering from a government debt crisis, cut its allocation for Ukraine from €4bn to €3bn in October and will struggle even to meet that. Finally, the G7 $50bn loan to Ukraine, approved on June 13 at a G7 summit in Italy, has also got snarled up in red tape and was supposed to be distributed this month, but now it has been split into three tranches paid out over three years, with the first tranche of $22bn due in the first quarter of next year.

Ukraine needs about $40bn a year in international funding to make the budget work and keep the Armed Forces of Ukraine (AFU) supplied, but even the Ministry of Finance (MinFin) anticipates this halving to some $22bn a year over the next two years, according to the most recent version of the three-year budget.

And all these problems are made worse by the anticipation that President-elect Donald Trump will cut US funding for Ukraine entirely. In a precursor to the new Trump policy, US Speaker of the House Mike Johnson just shot down a US President Joe Biden proposal to add a fresh $24bn of funding for Ukraine to a congressional spending bill for 2025.

With the sources of funding for Ukraine rapidly evaporating the calculus is changing.

Brussels remains committed to supporting Ukraine, even if several member states are more hesitant. One of the big changes in recent months is the appointment of former Estonian Prime Minister Kaja Kallas as the EU foreign policy chief, who is an outspoken Russia hawk. The discussion about seizing the CBR’s money was tabled at a meeting of EU foreign ministers that was chaired by Kallas, who inevitably put the issue back on the agenda. As an Estonian, that sits cheek by jowl with Russia and was occupied by the Soviet Union for 48 years, she is fully focused on holding Russia to account and cares little about the economic or financial consequences.

The Estonians have a particular hatred of Russia following the mass deportations in 1941 and 1949 when thousands were sent to Siberia overnight. Every family in Estonia lost a family member to the deportations, which are marked by a Remembrance Day every year on June 14 that keeps the tragedy fresh in everyone’s memory.

Kallas argued that the assets could be appropriated within a legal framework. “I won’t use the word ‘confiscation’ because it’s actually using assets in a legal way,” she said at the meeting.

Kallas has little power to force the confiscations policy through. The European Commission (EC) has the mandate to set EU trade policy, but foreign policy remains the prerogative of the member states. Several EU countries are not keen on the idea, led by the conservative Germany and Belgium, which would find themselves in the front line. Given all EU decisions have to be unanimous, getting permission to confiscate the CBR’s money will be very hard.

In the meantime, many EU members remain resolutely against a confiscation. Valerie Urbain, CEO of Belgium-based Euroclear, which holds €190bn of the assets, has been particularly outspoken: “We cannot end up in a situation where assets are confiscated and then a few years later Russia comes and demands them back, when the assets are no longer there. If assets are confiscated, then liabilities must also be transferred,” she said in a recent interview with Bloomberg.

Her predecessor, Euroclear's CEO Lieve Mostrey, similarly slammed the G7 plan to use Russia’s frozen assets to fund the war in Ukraine and finance its reconstruction in an interview with The Financial Times in February.

Bankers are also not keen on the idea as they anticipate years of very expensive lawsuits from Russian entities. The problem is that the decision to seize the CBR’s funds is political, however, its assets in Europe are protected by the same strong property rights as other assets in Europe and so are vulnerable to lawsuits. They want part of the funds, if they are seized, to be put aside to fund the anticipated wave of Russian lawsuits that will tie up the courts for years.

This is one of the objections to the confiscations: either Euroclear will lose in court and be on the hook to repay €190bn it no longer has, or the courts will be pushed to uphold a political decision and massively undermine trust in Europe’s financial system that could lead to massive capital flight. The share of the US dollar in sovereign reserve funds has already fallen to a 40 year low, thanks to the White House’s decision to weaponize its currency via sanctions that has undermined trust in the dollar.

Another problem is the Kremlin is threatening to launch cases in Russian courts and seize billions of dollars in Russian accounts that belong to Western firms. As bne IntelliNews reported, only 9% of western companies have left the Russian market and they still owned significant assets in Russia.

A decree signed by Vladimir Putin in May enables the use of foreign-owned assets in Russia to compensate for damages caused by Western sanctions. Finance Minister Anton Siluanov announced in October that Russia has initiated “mirror responses” against the West.

Reconstruction elephant

But the elephant in the room is where the money will come from to rebuild Ukraine after the fighting stops. Trump has famously promised to stop the war “in 24 hours” after taking over. With the Ukrainian defence in the Donbas slowly crumbling – military analysts predict the fall of the key logistics hub at Pokrovsk in the next 2-5 months that could lead to the collapse of Ukraine’s resistance – the war appears to be in its end game.

Estimates of the damage caused by Russia’s campaign start at just under $200bn for the physical damage and run up to between $500bn to $1 trillion, depending on what is included in the calculation. The Centre for European Policy Analysis released a detailed report analysing the damage sector by sector in April this year.

All the talk and funding plans so far have focused on funding the budget to keep the government and the AFU working, but as the end of the war looms thoughts are slowly turning to how to pay for reconstruction. Currently, there is no plan.

At the Ukraine Recovery Conference in London last year it was suggested that the private sector pays for the rebuild. However, fund managers told bne IntelliNews that was going to be a tough sell.

“Of course, Ukraine is a fantastic opportunity, but I would want to wait for at least a few years,” one famous veteran of Eastern Europe investment told bne IntelliNews. “We need to see the domestic political turmoil that will follow a ceasefire die down first and Bankova prove its commitment to a stable and predictable investment climate. And then there is the threat of a second Russian invasion that also needs to be abated.”

It’s a Catch-22 situation: the investment won’t come until the investment has already come and the post-war bounce-back-boom is well underway.

In the first year it will be up to the EU to prime the pump, however without the CBR’s $300bn budgets will be tight. According to another study by Elina Ribakova, non-resident senior fellow at the Peterson Institute for International Economics, counting out the CBR money there is a total of some $75bn committed in the form of the EU’s Ukraine Facility and other International Financial Institutions (IFIs) commitments. That may or may not be enough. And even getting old of that money will be hard: pre-war Ukraine typically received about $3bn a year from the IMF – half of its three-year Extended Fund Facility commitments, reduced due to Kyiv’s foot-dragging on promised reforms and eventually downgraded to a one-year Stand By Facility.

All these problems are likely to resurface after the war is open as Ukraine remains one of the most corrupt countries in Europe. Ironically, Georgia is much further down the road to complying with the EU accession criteria thanks to the Saakashvili administration and the work of the late former-oligarch and reform major domo Kakha Bendukidze.

Damage is already done

In this context, confiscating the CBR’s money starts to look a lot more appealing. There is no other way to fund the investment needed to kick start Ukraine’s recovery and start that bounce-back-boom. And the investors are interested. In a long-forgotten story, there was a banking gold rush in 2006, when foreign investors rushed to Kyiv to snap up banks at crazy six-times book multiples after it appeared that Ukraine’s economy had finally turned the corner. But it all went wrong again in 2008 during the Great Financial Crisis and those same investors have been left licking their burnt fingers.

The biggest question left is what damage will seizing the CBR’s money do? The lawsuits are inevitable, but that problem can be coped with. However, in my personal opinion the damage to the EU’s reputation and the euro has already been done.

In the first week of the war European Commission President Ursula von der Leyen held a press conference where she announced both the seizure of the CBR’s reserves and the introduction of the SWIFT sanctions that effectively cut Russia off from using the dollar. Both sanctions were unprecedented. The SWIFT sanctions had been mentioned in the run up to the war, but ruled out by Berlin in particular. The CBR sanctions came completely out of left field.

Underlying the objections to confiscating the CBR’s money is the assumption that once the war ends things will go back to normal and so preserving the trust in the euro and European banks is paramount. But thanks to the sanctions that trust has already been undermined in the eyes of the Global South bankers and central banks. The dollar is so deeply ingrained as the currency of choice to settle international trade deals that it can probably cope with the dent in its reputation it has taken from its weaponization, but the euro is a lot more vulnerable. Moreover, the reputational damage the EU has taken from its unabridged support of Israel’s campaign in Gaza, versus its backing of a de facto proxy war against Russia in Ukraine has been significant.

Confiscating the CBR’s money will do a lot less damage than feared as the damage has already been done. Bottom line, there is no other way of funding Ukraine’s recovery other than seizing the CBR’s money.

 

 

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