Long lines formed outside exchange kiosks in Moscow as the Central Bank of Russia (CBR) suspended trading in dollars and euros as a result of new US sanctions targeting banks facilitating sanctions-busting trade with Russia on June 12.

The CBR unexpectedly changed the start time for the start of trading on the foreign exchange market on June 13, pushing back trading to 9.50 am, instead of the usual 6.50am.

The US expanded smart sanctions introduced in December, amongst the most successful sanctions to date, that has hurt Russia and caused leading Chinese and Turkish banks to cut ties with Russian clients to avoid being hit with secondary sanctions.

The US Office of Foreign Assets Control (OFAC) released details of the new round of sanctions targeting Russian banks that serve as intermediaries in dollar trading on the Russian foreign exchange market. The Moscow Exchange suspended trading in dollars and euros as of the start of the following day beginning June 13.

“As President Biden and Group of Seven (G7) Leaders prepare to meet this week in Italy, the U.S. Department of the Treasury is issuing sweeping new measures guided by G7 commitments to intensify the pressure on Russia for its continued cruel and unprovoked war against Ukraine,” OFAC said in a statement.

“Today’s actions ratchet up the risk of secondary sanctions for foreign financial institutions that deal with Russia’s war economy; restrict the ability of Russian military-industrial base to take advantage of certain US software and information technology (IT) services; and, together with the Department of State, target more than 300 individuals and entities both in Russia and outside its borders—including in Asia, the Middle East, Europe, Africa, Central Asia, and the Caribbean—whose products and services enable Russia to sustain its war effort and evade sanctions,” OFAC said.

Foreign financial institutions risk being sanctioned for conducting or facilitating significant transactions, or providing any service, involving any sanctioned person. OFAC specifically named VTB Bank and Sberbank, Russia’s two biggest banks, as being off limits.

The new US restrictions have also impacted the National Clearing Centre, a counterparty to all currency transactions on the Moscow Exchange; the National Settlement Depository, Russia's primary securities depository; and the insurance companies Sogaz and RNPK.

Companies, banks, and investors can no longer trade dollars or euros via the Russian exchange. However, buying and selling FX is still possible, but only on the over-the-counter (OTC) market.

Trading in dollars, euros and the Hong Kong dollar as well as trading in precious metals has been suspended on the Moscow Exchange as a result of the sanctions. Viral videos showed long lines of Russians forming at money changers, trying to buy foreign exchange while stocks last.

“Russia’s war economy is deeply isolated from the international financial system, leaving the Kremlin’s military desperate for access to the outside world,” said Secretary of the Treasury Janet L. Yellen. “Today’s actions strike at their remaining avenues for international materials and equipment, including their reliance on critical supplies from third countries. We are increasing the risk for financial institutions dealing with Russia’s war economy and eliminating paths for evasion, and diminishing Russia’s ability to benefit from access to foreign technology, equipment, software, and IT services. Every day, Russia continues to mortgage its future to sustain its unjust war of choice against Ukraine.”

The ruble was unaffected by the change, trading at RUB90.9 to the dollar as of the close of trading on June 12, slightly weaker than the RUB89.2 it was trading at the end of trading on June 11. (chart).

Most Russians hold some portion of their savings as FX as insurance against regular exchange rate volatility and banks hold billions of dollars and euros in retail deposit accounts. The CBR was quick to announce these deposits are in no danger and will be unaffected by the suspension of FX trading, in an effort to head off a possible run on bank deposits.

"Companies and individuals can continue to buy and sell US dollars and euros through Russian banks," the CBR said in a statement. "All funds in US dollars and euros in the accounts and deposits of citizens and companies remain safe."

What do the sanctions mean?

 

Adding the Moscow Exchange, the National Clearing Center (NCC) and the National Settlement Depository (NSD) to the Specially Designated Nationals and Blocked Persons (SDN) List means isolating a company from the global dollar system. It is not surprising that the sanctions forced the Moscow Exchange to immediately announce a halt to trading in dollars, euros and instruments denominated in these currencies. In fact, half of all foreign exchange trading on the exchange has been stopped.

The exchange will continue trading in other currencies, primarily the yuan, but this will depend on how large Chinese banks behave. If they refuse to work with the sanctioned Moscow Exchange, NCC and NSD, exchange trading in the yuan will also become impossible. Then the only way to sell and buy currency (for example, within the framework of the budget rule) may be a system of authorized banks: the Central Bank sells yuan to one of the special non-sanctioned banks, and it then trades further. A similar system worked in the foreign exchange market in the 1990s.

The first time the United States spoke about restrictions on the work of NCCs and NSDs back in 2022 giving the CBR adequate time to prepare the OTC market, which means the exchange rate will now be determined not on the basis of trading, but on the basis of direct contracts between buyer and seller. 

To determine the official exchange rates of the dollar and euro against the ruble, the CBR will use bank reports and data on transaction results coming from digital over-the-counter trading platforms. Individuals and legal entities will be able, as before, to buy and sell both currencies through Russian banks. 

The purpose of the NCC clearing centre is to ensure uninterrupted exchange of non-cash instruments and currencies among trading participants. It is the guarantor of transactions and buys currencies from sellers and sells to buyers. In addition, the NCC can hold currency in accounts if clients have chosen it as a place to store their and client money. Under sanctions, the NCC will no longer be able to act as the central intermediary - it cannot hold dollar accounts in American banks. Excluded from the transaction scheme, all that remains is the possibility of over-the-counter transactions.

Stopping foreign exchange trading does not mean a complete loss of ruble convertibility. But this is another step in the opposite direction from this status, reports The Bell. For those wishing to buy and sell currencies, switching from exchange to over-the-counter trading will mean widening the spread and additional costs. 

The sanctions will also make life more difficult for exporters, who need FX to complete international trades. 

“This, apparently, is the main goal of the US Treasury sanctions - to reduce export revenues and complicate imports,” The Bell reported. 

The knock on for consumers is the cost of imports will rise in an already high inflation environment. The volatility of exchange rates and the spreads between buy and sell will also increase. 

“Only the largest banks will remain in the foreign exchange market, it will become an oligopoly, and this leads to high volatility,” a banker involved in the foreign exchange market argues in a conversation with The Bell. “It would be in the interests of everyone else to restore trading on the basis of some non-sanctioned exchange, and give clearing to banks that are not under American and European sanctions.” 

Most likely, trading in replacement bonds - securities issued under Russian law instead of Eurobonds of Russian companies - will continue. Coupons on Eurobonds traded on the stock exchange will also be paid (but in rubles). Trading in these bonds will most likely stop and investors will have to hold them until maturity.

Tech sanctions also expanded

OFAC also expanded sanctions against the Russian IT sector on June 12. The new sanctions were expected, but business is still not completely ready for it.

The sanctions banned the provision of IT consulting and design services in Russia, as well as the provision of technical support and cloud services for software in the field of management, design and production.

The ban will affect all Russian individuals, regardless of industry and personal sanctions, and will come into force on September 12. Now suppliers of industrial and business software from the United States will have to obtain export licenses to supply their software or its updates to Russia.

The press release says that the new sanctions are aimed at the Russian military-industrial complex and should not disrupt the work of civil society, for the protection of which two general licenses are provided, 25D and 6D.  

Exempted were services related to the exchange of messages via the Internet (this includes mail, social networks and instant messengers, exchange of photographs and films, web maps and much more), and also allows the supply of software , equipment or technologies designed for communication on the Internet. Another license allows software updates for medical equipment and devices.

The ban will primarily include solutions for engineering design (for example, AutoCAD) and business and production management systems (CRM, ERP) produced by SAP, Oracle, Microsoft and others, which will be hard to replace.

The government began preparing a plan for the development of domestic engineering and industrial software back in 2021. The war did not speed up the process - according to recent reports, the transition to domestic engineering systems is planned only after 2030.