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Maximilian Hess is the founder of Enmetena Advisory, a fellow at the Foreign Policy Research Institute, and author of ‘Economic War: Ukraine and the Global Conflict between Russia and the West’. Yakov Feygin is an economic historian and author of the forthcoming book Building a Ruin: The Cold War Politics of Soviet Economic Reform.
The European Union finally managed to overcome Viktor Orban’s obstinacy yesterday and get its €50bn four year Ukrainian support package agreed – but sustaining Western support for Kyiv remains at greater risk than at any since Russia launched its full-scale invasion in February 2022.
Brussels’ move is significant, but the West is still a long way away from maintaining its level of commitment, with €228.26bn pledged between February 2022 and October 2023. A $60bn US aid package remains delayed by Congressional chaos that will only escalate ahead of the November election in which starkly differing views on funding Kyiv are on offer.
With so much uncertainty hanging over Western support, President Joe Biden’s administration is backing a plan to seize Russia’s more than $300bn in frozen government funds to help pay for Ukraine’s war effort. Despite calls endorsing such a seizure from esteemed economists, sovereign debt experts, legal scholars, and former diplomats, as well as a former president of the World Bank, European leaders are nervous about the potential for blowback and legal challenges. They have signalled confiscating the assets is a step they are unwilling to take.
European reticence is particularly disappointing not only because the concern is overhyped but because it evidences the West’s continued challenge in unified action. Though the UK has signalled its support for seizures, European buy-in is necessary for the policy to be effective. Roughly €180bn, two-thirds of the frozen funds, are trapped in Belgium because it is home to the clearing house Euroclear.
This does not mean that Europeans are not searching for constructive solutions. Belgium has at least pledged to transfer some €2.3bn in taxes it has earned on the frozen Russian assets to benefit Kyiv. It appears to be making good on its word. EU leaders have said to expect an agreement on a windfall tax for the frozen assets, which could raise the haul to €4.4 billion for 2023 although this will decrease as assets mature.
There is still a way for Europe to use Russia’s frozen funds to benefit Ukraine without seizing them. It can order that they be reinvested into Ukrainian war bonds. Such a strategy would lower the risk of a market reaction and the chances of success of inevitable Russian lawsuits.
Kyiv has issued war bonds since shortly after Russia’s full-scale invasion -primarily in the domestic currency, the hryvnia, but also with Ukrainian law dollar bonds. Further innovation can make these an ideal investment for the frozen Russian assets.
The proposed new class of war bonds would be structured as catastrophe bond. Cat bonds, as they are known, provide interest to the buyer in exchange for them taking the risk of losing the principal if the trigger event defined within occurs. They most frequently are structured to provide capital for natural disaster recovery, as well as to distribute the risk. The market for private Cat bonds has expanded rapidly and the market for government Cat bonds is growing as well. The World Bank even sells pandemic catastrophe bonds.
Ukrainian war Cat bonds could have their trigger set at costs of future damage to the country from Russia’s invasion. They should be structured to lower the risk of legal challenges from lawyers acting on the Kremlin’s behalf — i.e. only for future damages and in with market pricing, including interest. Investing into Ukrainian war bonds that include triggers to damages already incurred would be legally dubious.
However, there are ways to limit Russia’s future returns and turn them to Ukraine’s advantage. Interest payments on these bonds should not be in cash, but payment-in-kind (PIK), in the form of additional war bonds — militating against the risk that Russia is left earning cash interest claims at the end of the war and retaining the financial incentive against further aggression. These additional bonds should also be denominated in hryvnia to force Russia into buying Ukrainian goods or hard currency on money markets and thus, expand Ukrainian export opportunities.
Another option to explore is to link bond payouts to Ukraine’s postwar GDP performance. Given the damage already inflicted on Ukraine’s economy, such a link could capture the consequences of Russia’s earlier actions. Ukraine had successfully issued such debt before the war.
Finally, Russia shouldn’t be able to take any upside until it stops its aggression and pays for the damage it caused. The PIK interest may mean Russia is left with nominal claims, but under existing sanctions these will remain frozen. The West has pledged not to lift sanctions until Russia makes good on all damages to Ukraine caused throughout the war
The World Bank estimates the cost of rebuilding Ukraine at more than $411bn. Thus, investing Russia’s frozen funds into the Ukrainian Cat-War Bond also incentivises the West to maintain this commitment.
There is precedent for Washington to act in such a manner. Congress in 2000 legislated for the use of Cuban frozen assets to be used to pay for claims against Havana. The Biden Administration has directed Afghan sovereign assets frozen following the Taliban’s takeover to a foundation with bylaws requiring they be used to support Afghanistan’s economy.
But Russia has brought far dirtier tactics to Europe in attempting to weaponise Ukraine’s debt.
On the eve of the 2014 pro-Western revolution, Russia engineered a particularly sharp loan to the deeply corrupt Yanukovych administration in an attempt to retain influence and exert pressure over Kyiv. Putin’s Kremlin later instrumentalised the loan in its war against Ukraine by trying to block IMF support for Ukraine in the aftermath of its seizure of Crimea and initial invasion of the Donbas. The IMF had to effectively change its rules to prevent Russia from using this leverage to bring Ukraine to its knees. Last March the English Supreme Court ruled that Kyiv was entitled to a full trial to defend its claim that the agreement was signed under duress and that courts should take into account Russian uses of military force as part of their decision.
Directing Russia’s frozen assets into Ukrainian war catastrophe bonds addresses many of Europe’s concerns about seizure and increases the cost to Russia of continuing its conflict there. Every bomb, missile or drone Putin launches towards Ukraine would effectively also be blowing up Russia’s wealth while providing Kyiv with funding to resist and recover from the onslaught.
