The Ukraine Liberty Bond: Unlocking Frozen Assets Without Breaking the Rules

The EU has been debating how best to use the roughly €200-240 billion of Russian assets that are in EU jurisdictions, mainly Belgium and Luxembourg, to fund Ukraine-related expenditure. In the end, only the income and proceeds earned on the assets are used, including as collateral for a $50 billion loan.

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The Ukraine Liberty Bond: Unlocking Frozen Assets Without Breaking the Rules

The EU has been debating how best to use the roughly €200-240 billion of Russian assets that are in EU jurisdictions, mainly Belgium and Luxembourg, to fund Ukraine-related expenditure. In the end, only the income and proceeds earned on the assets are used, including as collateral for a $50 billion loan. Russia retains the ownership title to the assets themselves, in accordance with the basic tenets of our constitutional and legal principles, and the rules of the game of the international monetary system. I believe that the current mechanism (utilizing the proceeds only) can be turbo-charged, using a financial markets-driven solution.

FREEZING IS NOT SEIZING

A key distinction must be made between the freezing and the seizing of assets. The former does not transfer the ownership title of the assets to a new owner, in this case from the Russian Federation to EU/relevant member state’s ownership. The latter does just that. The EU has been justifiably reluctant to violate, by political fiat, the basic tenet of the sanctity of ownership titles. This is a slippery slope, if ever there was one, creating the wrong kind of precedent. Today’s political bête noire is Russia: who guarantees that the precedent will not be abused tomorrow by other political forces to expropriate property from opponents or other states?

There are pragmatic reasons, over and above the jurisprudential reason above,  underlying the reluctance to seize the assets of a sovereign state, albeit one that has violated art 51 of the UN Charter and launched an illegal war of aggression against a peaceful and democratic state, committing in the process countless war crimes and atrocities.

The first is that such a seizure will in all likelihood lead to capital flight. Why would other states keep their money in Europe if the legal ownership to the title is not sacrosanct? China, Saudi Arabia and other Gulf states, Latin American central banks and others will certainly find the expropriation by political fiat unsettling at best, threatening at worst.

The second reason is global financial stability. The international monetary system, unlike the World Trade Organsiation (WTO), is based on an intricate and complex web of global institutions and regulations, entered into voluntarily and gradually by states without being in one round of negotiations, adhering to the so called “Rules of the Game”. The ultimate aim of this intricate system is to maintain trust in the monetary and financial systems. If titles to assets are not going to be governed by these rules but by political decisions, then the trust factor, crucial to the functioning of the system, will wobble.

The calculation then, if the assets are seized, is whether the risks of the outcome of the illegal Russian war of aggression on Ukraine outweighs the risks of financial and monetary crises. For Belgium, where the bulk of these assets sit, this is a key systemic risk calculation. Whereas these are assets in so far as the Russian Federation holds the legal title to them, they are liabilities for Euroclear, where they are deposited, and therefore in a systemic sense,  for Belgium. The additional pragmatic consideration is to what extent would such a seizure be considered a hostile act by Russia, inviting a response, for example in the Hybrid Threats and Warfare spectrum. There are also other pragmatic issues of a similar nature.

Therefore, the solution the EU formulated rightly combined two elements: respect for the sanctity of ownership and the legal certainty necessary for the functioning of a free democratic order on the one hand; and the political imperative to act when a member of the United Nations Security Council that violated the very core of the international order by illegally invading the territory of another member of the UN, on the other. This solution was to keep the roughly €200-240 billion of assets as the property of the Russian Federation, but to authorise the use of the income it generates for Ukraine-related expenditure.

DRAW BACKS TO THE CURRENT REGIME

There are two key draw backs to the current regime. The first is one of principle. The aggressor is not made to pay the necessary substantial amounts commensurate with the damages he has caused, let alone the damage caused morally to the international community by violating international law. The second is practical. The Ukraine-related funding requirements, on an ongoing cash flow basis, greatly surpass the annual returns achieved on investing the €200-240 billion, which could be in the region of €15-30 billion per annum (assuming a 5-10% net annual income).

TURBO-CHARGING

The question therefore is: can the full amount of the assets be accessed and used without compromising the legal ownership title?

I propose a complimentary market-driven structure to use the whole of the €200-240 billion, whilst simultaneously meeting the challenging legal tests of ownership mentioned above: the EU Ukraine Liberty Bond.  How would this work?

• The “liabilities” are removed in full from Euroclear into a Special Purposes Vehicle (SPV) with the Russian Federation retaining the legal title to the “assets” of the SPV.
• The EU issues a 50-year maturity “sovereign” bond in favour of the Russian Federation for the full face value of the whole of the roughly €200-240 billion. In legal effect, the EU “borrows” the €200-240 billion for 50 years. This means that the EU provides a sovereign guarantee for the full repayment to the Russian Federation in 50 years’ time. To emphasize, the €200-240 billion will remain the lawful property of the Russian Federation. This structure, therefore, fully respects the need to protect ownership titles in a free democratic system, guarantees stability in the global monetary and financial system, and minimizes the risks of capital flight.
• The pricing of the bond will be determined based on the sovereign risk allotted by the debt capital markets to the EU (as the borrower). This should be quite minimal given the EU’s credibility, although the long maturity of 50 years may add extra borrowing costs, in addition to potential market concerns over the EU’s and the Euro’s systemic risks. As an idea, The European Investment Bank could act as the Lead Arranger.
• To cover all eventualities, and to minimise the possible various extra systemic risk-premiums related to the EU, and to make the bond as secure as possible (thus further respecting the legal certainty requirements), member states will agree on guaranteeing, back to back, tranches of the EU bond, vis-à-vis the EU. So that, should the EU default, for whatever reason, after 50 years or should it default on interest payments, the rightful owner of the €200-240 billion, i.e. the Russian Federation, will be assured of repayment.
• The sanctions regime in place means, of course, that the income on the €200-240 billion, including the interest paid by the EU, will nonetheless be seized by the EU to pay for Ukraine-related expenditure, together with any other income that the €200-240 billion may generate.
• Down the road, circumstances may open the way for the bond to be securitised (this terminology is used here in the context of financial markets terms, not in defence and security terms!) to enable the EU and the member states to de-risk this item from their public finances obligations (for the member states this will include de-risking their contingent liabilities associated with the guarantees that they provided to further secure the bond). Securitising the debt means selling tranches of the €200-240 billion, that has been borrowed by the EU, to other lenders who would be willing to buy these tranches of the bond. But that is a subject that is likely to be a long way off, though it could provide a strategic and long-term roadmap for how the EU and member states may be able to “exit” this debt undertaking.
• In the anticipated negotiations on a lasting peace agreement, a further guarantee may be demanded from Russia both for pragmatic as well as for good faith reasons. In the terms of the peace agreement, a provision can perhaps be negotiated that, should the Russian Federation breach the terms of any eventual peace agreement, the EU will then be entitled to seize the SPV and its assets. Such seizure will be legal respecting the integrity of the legal and international monetary systems. Russia is unlikely to agree to such a clause, which will at least diplomatically expose its ill intended expansionist plans. But from an “Art of Deal” perspective, it can hardly be faulted!

CONCLUSION

Ukraine-related expenditure will only grow. Global debt markets are nervous. This limits the ability of states and public institutions (sovereign and quasi-sovereign borrowers) to borrow in the same manner to which they have become accustomed in the past three decades or so.

Domestic expenditure items across the EU will also only grow as well, whether for housing, education, healthcare, greying of society, foreign policy, or indeed defence and security. The challenge facing the EU, and member states, is how to reconcile rising domestic and defence expenditure requirements with simultaneously growing Ukraine-related commitments. The opportunity here is that for the majority of member states, these are themes of common interest. The quantity of cash available is a key issue: size matters. Hence the need for a market-driven solution that compliments the legalistic solution, and that will enable the EU to answer the question of how to release the use of the whole of the €200-240 billion whilst respecting ownership titles, and how for Belgium how to de-risk Euroclear and maintain its credibility in the global financial market place.

The Ukraine Liberty Bond can also present an opportunity for the UK and the EU to further deepen their cooperation in support of Ukraine. The EU can invite the UK to join the Bond scheme with the Russian assets currently frozen in the UK.  This will enhance the size of the pot, and utilise the UK’s deep and extensive global financial markets reach and expertise.

There will be many details to be worked out both politically as well as in terms of the debt capital markets, but as a scheme, I believe that the EU Ukraine Liberty Bond can be the answer.

Bernard Siman is a Senior Associate Fellow at the Egmont Institute and is Head of Financial Diplomacy and FinTech at the Brussels Diplomatic Academy of the Vrije Universiteit Brussel (VUB). 

(Photo credit: Wikimedia Commons)