Western countries got tough on Russia after it said it would recognise the two breakaway regions in Ukraine and rolled out new sanctions on February 22.

In a surprise move German Chancellor Olaf Scholz dealt Russia the biggest blow by announcing the government would remove a crucial document from the package needed to certify Nord Stream 2 gas pipeline and effective kill the project off. Scholz said that Nord Stream 2 cannot be certified, as “the situation has fundamentally changed,” Interfax reported, adding that Germany stands behind Ukraine and believes in the need to maintain its territorial integrity.

The UK also imposed mild sanctions targeting three oligarchs and five banks; however, US President Joe Biden announced much tougher measures, hitting one of Russia’s biggest state-owned banks and banning investors from buying any new ruble-denominated treasury bonds.

Russia has been pushing hard for the pipeline to be completed but the regulator has been dragging its heels due to the mounting pressure applied by Russia to Ukraine.

Despite being an extremely important project for the Kremlin, Russia is not expected to retaliate by cutting or squeezing gas supplies to Europe. President Vladimir Putin said the same day that Russia would continue its uninterrupted supply of gas to the international market, Interfax reported.

Former Russian president and prime minister Dmitry Medvedev greeted the news with the sarcastic comment: “'Welcome to the brave new world where Europeans pay €2,000 for gas,” a reference to the recent all-time peak prices of gas during the worst of the last year’s gas crisis, caused by gas shortages and high demand.

UK sanctions oligarchs, banks

British Prime Minister Boris Johnson announced sanctions against five Russian banks and three billionaires in response to Russia’s decision to recognise the breakaway republics of Donetsk and Luhansk on February 21.

Johnson said that Putin’s order to send “peacekeepers” to the two regions amounted to a "renewed invasion" of Ukraine and warned MPs of "a protracted crisis". He added that the "first barrage" of sanctions would be extended if the situation escalated further.

Putin said the troops were needed to maintain order – a claim dismissed by the United States as "nonsense".

Johnson announced the UK was targeting the Russian banks: Rossiya, IS Bank, General Bank, Promsvyazbank and the Black Sea Bank. He also said three billionaires Gennady Timchenko, Boris Rotenberg and Igor Rotenberg were being sanctioned and any assets they had in the UK would be seized. The three men are all close personal friends of Putin and have become rich after they have won numerous large state contracts.

Rossiya is a privately owned bank with long-standing ties to the state. The Black Sea Bank is a Crimean bank and was created in 2014 after Russia annexed the region. The General Bank is a financial institution which also operates in Crimea. Promsvyazbank was formerly a successful commercial bank but got caught up in the Garden Ring banking crisis of 2017 and was taken over by the Central Bank of Russia (CBR). Since then the bank has become state-owned and re-tasked as a key bank dealing with Russia’s defence sector.

However, critics said the UK sanctions were weak. Tim Ash, senior sovereign strategist at BlueBay Asset Management pointed out the three billionaires were already the subject of US sanctions applied earlier and that none of the big state-owned banks had been listed, only smaller privately owned banks.

“Embarrassing from the UK – non-entity banks and oligarchs already sanctioned. I mean why bother? The UK just showed its weakness and soft spot for the London Laundromat,” Ash said in an emailed note.

Washington imposes first tranche of new sanctions

Johnson's announcement came as US President Biden unveiled a set of tough sanctions that he said were only the “first tranche”, threatening to follow up by targeting Russia’s “elite” in later rounds.

The US president laid into Putin’s decision to recognise the Donetsk and Luhansk regions as autonomous from the rest of Ukraine during his speech.

“To put it simply, Russia just announced that it is carving out a big part of Ukraine,” Biden declared, saying the US would stand by its Nato allies, while also insisting that the US “has no intention of fighting Russia.”

“Who in the Lord’s name does Putin think gives him the right to declare new so-called ‘countries’ on territory that belonged to his neighbours?” Biden said referring to the self-proclaimed Donetsk and Luhansk People’s Republics.

Biden went to announce that the US was imposing sanctions on the state-owned VEB bank that has become a de facto development bank and has been tasked with investing into Russia’s large infrastructure projects that are part of the 12 national projects investment programme. He also singled out the now state-owned Promsvyazbank that handles the financing of the Defence Ministry.

More painfully, the US will ban US investors from buying newly issued Russian Ministry of Finance ruble-denominated OFZ treasury bills that have been very popular with international investors, including US institutional investors such as pension funds and insurance companies. The ban allows existing bond holders to keep their bonds, but prohibits them from acquiring any new ones.

The OFZs are the Ministry of Finance’s workhorse bond used to fund the government’s activities. Currently international investors own some $40bn of OFZ bonds or just under 19% of the total outstanding. Biden said the sanctions were designed to “cut Russia off from international financing.” While the OFZ ban will be painful, the government does not rely on the bonds to fund its operations. In 2021 Russia ended the year with a $120bn current account surplus – enough to cover all the outstanding OFZs held by international investors three times over. However, as Elina Ribakova, deputy chief economist with the Institute of International Finance (IIF), pointed out in a recent bne IntelliNews podcast, removing foreign investors from the domestic bond market makes pricing the bonds more difficult and the market less efficient.

"We're implementing sanctions on Russia's sovereign debt. That means we've cut off Russia's government from Western financing," Biden said. "It can no longer raise money from the West and cannot trade in its new debt on our markets or European markets either."

Biden said the sanctions "have been closely co-ordinated with our allies and partners" and added: "We'll continue to escalate sanctions if Russia escalates."

A day earlier Biden signed an executive order that prohibits new investment, trade and financing by Americans in the two breakaway regions. The EU is also expected to announce more sanctions in the coming days.

Consultations are underway as western partners co-ordinate their responses and more sanction. The US has already prepared a “the sanctions from hell” bill of more extensive sanctions that name 13 banks and also the Nord Stream 2 gas pipeline as possible targets.

There are a lot more possible sanctions listed in the "sanctions from hell" bill and with this short list the White House has signalled that it will keep much of its powder dry so that it can impose more sanctions should the situation in Ukraine deteriorate further.

Likely amongst future sanctions by the US will be the inclusion of more names to the Specially Designated Nationals (SDN) list that is used to sanction individuals that kicks them out of the US banking system, bans their trade with Americans and freezes their US assets, sources told Reuters.

The White House also suggested that it wants to spare ordinary Russians pain from sanctions, which may be an allusion to refraining from placing bans on things like smartphones and other products that use US technology.

Biden made no mention of export controls in his press conference, but they are likely to feature heavily in the new sanctions and target specific goods, including: aviation, maritime, robotics, artificial intelligence, quantum computing and defence, according to earlier comments by US officials.

"Key people" could also face "massive sanctions," White House national security official Peter Harrell said in a speech in Massachusetts as cited by Reuters.

The European Union is close to agreeing sanctions on Russia that would put politicians and officials on blacklists, ban trading in Russian state bonds, and target imports and exports with separatist entities, senior EU officials told Reuters on February 22.

"We've got to ensure that whatever happens, Russia will feel the pain ... to make sure Russia has absolutely no incentive to go further," Irish EU Affairs Minister Thomas Byrne told Reuters.

Like the other countries, the EU appears to be getting ready to target individuals and includes putting on an EU blacklist those who were involved in the decision to recognise the breakaway regions in a repeat of the initial sanctions that were put on individuals that were involved in organising the referendum that annexed the Crimea in May 2014.

That could involve all members of the lower house of the Russian parliament who voted in favour of the recognition, one EU official said, as cited by Reuters.

Bonds and banks involved in financing separatist activities in eastern Ukraine could also be targeted, according to EU officials, who stress these sanctions on the way would only be the “first round” and more sanctions could follow.

"It's the first package, not the last package," an official told Reuters, adding that the EU had co-ordinated its action with the United States overnight and that this was mirroring sanctions taken when Russia annexed Crimea in 2014.

Metal prices soar, capital markets crash

As the gloves come off markets reacted, with the Russian stock market and the national currency shedding value, which the prices of metals traded on the London Metals Exchange (LME) soared on supply interruption fears.

The Russian RTS stock market index sunk to below 1,200 after Putin’s speech, but recovered some ground to end trading on February 22 at 1,227 as markets digested the relatively mild nature of the sanctions imposed so far.

Likewise the ruble weakened to RUB80.1 to the dollar, passing the psychologically important RUB80 mark, but the national currency also recovered some ground to end trading on February 21 at RUB79.3.

“The Russian market was hit by intensified geopolitical tensions. The RTS index (-13%) collapsed to the 1,200 level, while the RUB-valued MOEX Russia index (-10%) closed slightly above the 3,000 mark. All equities posted negative dynamics on elevated volumes. Rosneft (-20.5%) underperformed the broader market. Banks also posted weak performance,” Sova Capital said in a note. The state-owned retail banking giant Sberbank and its sister bank VTB were amongst the most sold stocks (-19.4% and -20.4% respectively), as investors feared it would be singled out for sanctions. Investor darling, Russian internet champion and the most valuable tech company in Europe also saw heavy selling.

Commodity prices were also hit by the uncertainties introduced by the impending new sanctions. Prices for aluminium and nickel prices jumped to multi-year highs in London, Reuters reports. Benchmark aluminium prices on the LME were already up 20% YTD after increasing 42% the year before. The recent peak of $3,380 per tonne was only pennies short of 2008's record high price of $3,380.15/ton.

Traders fear that new sanctions on Russia could curb the country's aluminium exports and rising energy prices will idle some smelters. Goldman Sachs recently raised its forecast price for aluminium to $4,000 per tonne.

Nickel prices also jumped as 7% of the world’s nickel is produced by Norilsk Nickel in Russia’s far north. Prices for nickel peaked at $24,925/tonne on February 22, the highest since 2011, as the metal is already in short supply.