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Ursula von der Leyen faces a time constraint in determining the fate of the frozen Russian assets worth billions of euros.
In a promise made by the European Commission chief, a proposal was expected to be presented before the summer break to utilize the “proceeds” from these Russian central bank assets held in Europe, which were frozen following the invasion of Ukraine by Russia.
However, efforts to hold Russia accountable have encountered issues, primarily due to legal objections and concerns raised by the European Central Bank.
The European Central Bank is apprehensive about the implications of targeting Russia’s foreign reserves to support Ukraine, as it could set a dangerous precedent for euro-denominated assets held by foreign governments. This action, as warned by the ECB, may cause central banks to question whether their property rights will be respected if they were to have a disagreement with Brussels in the future, potentially leading them to reduce their reserves in the euro currency.
It would be ironic if von der Leyen’s proposal were to fail on these grounds. However, her plan aims to address the legality concerns surrounding the utilization of Russia’s central bank reserves.
The most favored approach in Brussels is to target windfall profits gained by central securities depositories.
Central securities depositories hold securities on behalf of investors, primarily sovereign bonds for central banks. The largest depository, Euroclear, located in Belgium, holds approximately €180bn of the immobilized Russian reserves, accounting for around two-thirds of the total.
Investors receive regular coupon payments and the borrowed amount when sovereign bonds expire. Euroclear, in turn, receives the cash from treasuries and credits the investor’s (in this case, the Central Bank of Russia’s) cash account.
There are two cash balances involved: the deposit with Euroclear bank, which appears as a liability on Euroclear’s balance sheet, and the matching cash held by Euroclear on its own asset side.
Legally, only the central bank’s cash account in Euroclear belongs to Moscow, while the cash on the asset side is owned by Euroclear.
Typically, cash doesn’t accumulate as it is either withdrawn or reinvested. However, the imposed sanctions prevent this. Consequently, Euroclear’s balance sheet has significantly increased, creating arbitrage opportunities.
Euroclear offers minimal, if any, interest on the central bank’s deposit. Meanwhile, it earns a substantial 3.5% by depositing its cash assets with eurozone central banks, ensuring a secure placement. In the first quarter, Euroclear reported profits of €720mn on €88bn of Russia-related cash, equivalent to an annualized return of 3.3%. This figure is expected to stabilize at around €7-8bn per year as more assets mature and cash accumulates.
The allure of taxing this windfall profit tempts Brussels. However, this approach presents paradoxes. It would pit Ukraine against Euroclear’s shareholders who would profit from the custodian’s substantial earnings. Shareholders include Belgian insurers, global banks, and European state-owned financial groups, leaving Russia unaffected. Furthermore, the authority to tax profits lies with national governments, in this case, Belgium, not the EU.
Implementing this solution for a negligible amount of cash would lead to significant upheaval. Why risk alienating the ECB and discouraging global reserve managers for such small sums compared to Ukraine’s ongoing reconstruction costs of $411bn?
As one high-ranking official states, “If you are going for the big prize, go for the big prize.” In other words, if meddling with the foundations of international central banking, it may be more prudent to seize the entire amount.
Ironically, the EU has maneuvered itself into a position of inflicting maximal damage for minimal gain. As this contradiction becomes apparent, public opinion may favor the “in for a penny, in for a pound” argument. Regardless, a resolution must be reached.
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