The Dilemma of European Central Banks and Russian Assets
Introduction
In a time when tensions between Russia and Ukraine are at an all-time high, European Central Banks find themselves in a precarious situation. They are faced with the task of deciding what to do with hundreds of billions of euros of Russian money that have been frozen since the Russian invasion of Ukraine. Ursula von der Leyen, the head of the European Commission, promised a proposal to make use of these funds, but so far, objections from lawyers and the European Central Bank have hindered any progress. In this article, we will explore the dilemma of European Central Banks and Russian assets, as well as the potential solutions that have been proposed.
The Fear of Setting a Dangerous Precedent
The European Central Bank is concerned that targeting Russia’s foreign reserves to finance Ukraine would set a dangerous precedent for euro-denominated assets held by foreign governments. There is a fear that it could make other central banks nervous about whether their property rights would be respected in the future, potentially leading them to hold fewer reserves in the single currency. The ECB warns that such a move could have far-reaching implications and undermine trust in the stability of the euro.
However, the irony lies in the fact that Ursula von der Leyen’s proposed measure is specifically designed to overcome concerns about the legality of touching Russia’s central bank reserves. The most favored idea in Brussels is to target windfalls in central securities repositories.
Targeting Central Securities Repositories
Central securities repositories hold securities in custody for investors, primarily sovereign bonds in the case of central banks. Euroclear, the largest central securities depository in the region, holds around 180 billion euros of Russian reserves. By targeting windfalls in these repositories, Brussels aims to bypass legal complications and address the issue of frozen assets.
Sovereign bond investors receive regular coupon payments and the face value amount lent in cash when the bond matures. These cash flows are paid from treasuries to companies like Euroclear, which then credits the investor’s cash account, including the Central Bank of Russia. The legal distinction lies in the fact that only the central bank cash account at Euroclear belongs to Moscow, while the cash on the asset side belongs to Euroclear itself.
Due to blocking sanctions, cash has been accumulating on Euroclear’s balance sheet, leading to a significant increase in its normal balance sheet. Euroclear earns substantial profits on these cash holdings, with a return of 3.3 percent reported in the first quarter. Brussels sees this windfall as an opportunity for taxation, but such a decision would come with its own set of challenges and contradictions.
The Paradoxes of Taxing Windfall Profits
Implementing a tax on windfall profits earned by Euroclear would potentially pit Ukraine against Euroclear shareholders, who benefit from the custodian’s profits. This would create an adversarial relationship where Russia remains unscathed. Moreover, the right to tax profits lies within the jurisdiction of national governments, such as Belgium, where Euroclear is based, rather than the European Union itself.
While tempting, imposing a tax on windfall profits for a negligible amount of cash could lead to far-reaching consequences. It risks alienating the European Central Bank and discouraging global reserve managers from holding euro-denominated assets. The cost of rebuilding Ukraine far outweighs the potential gains from such a tax.
Exploring Alternative Solutions
Considering the challenges and contradictions associated with taxing windfall profits, it is crucial to explore alternative solutions. One approach could involve maintaining a diplomatic dialogue with Russia and Ukraine in an effort to resolve the frozen asset issue. By encouraging negotiations between the two parties, there may be an opportunity to reach a mutually beneficial agreement.
Another possible solution centers around leveraging the international community’s pressure on Russia to release the frozen assets. By engaging other countries and organizations, the European Union can work collectively to find a resolution that not only benefits Ukraine but also safeguards the integrity of euro-denominated assets.
Additionally, exploring the potential for international arbitration or creating a specialized tribunal dedicated to frozen asset disputes could provide a fair and transparent mechanism for resolving these challenges. This approach would ensure the protection of property rights while addressing the issue at hand.
Unique Insights and Perspectives
Delving deeper into the topic, it is important to understand the wider implications of freezing Russian assets and the potential consequences for the global economy.
1. Impact on Global Financial Stability: The freezing of Russian assets raises questions about the stability of the global financial system. As tensions between major powers escalate, the risk of economic disruptions and market volatility increases, affecting not only European Central Banks but also financial institutions worldwide.
2. Geopolitical Ramifications: The European Union’s response to the frozen assets issue has geopolitical implications. It signifies the EU’s commitment to protecting its member states and asserting its influence on the international stage. The outcome of this dilemma could shape future relations between Russia, Ukraine, and the EU.
3. Legal Precedents in International Law: The legal complexities surrounding frozen assets highlight the need for clear guidelines and frameworks in international law. The resolution of this issue will set a precedent for future cases, potentially impacting how frozen assets are dealt with in the future.
4. Economic Repercussions for Ukraine: The outcome of the frozen assets dilemma will have significant economic repercussions for Ukraine. If the funds are released and used for reconstruction efforts, it could provide much-needed resources to rebuild the country’s infrastructure and support its recovery. However, a failure to resolve the issue could hinder Ukraine’s path to stability and economic growth.
The Way Forward
As the European Central Banks navigate the complex landscape of frozen Russian assets, it is crucial to find a balanced and sustainable solution. The resolution should not only address the immediate concerns of Ukraine but also uphold the integrity of euro-denominated assets and safeguard the stability of the global financial system.
By engaging in diplomatic negotiations, exploring alternative solutions, and leveraging international pressure, the European Union can work towards a resolution that benefits all parties involved. It is essential to consider the wider implications and long-term consequences to ensure a fair and sustainable outcome.
Summary
The dilemma surrounding the frozen Russian assets held by European Central Banks poses significant challenges and potential consequences. While Ursula von der Leyen promised a proposal to make use of these funds, objections from lawyers and the European Central Bank have hindered progress. The fear of setting a dangerous precedent and the complex legal distinctions surrounding central securities repositories contribute to the complexity of finding a resolution. Exploring alternative solutions and considering unique insights and perspectives contributes to a comprehensive understanding of the broader implications of this dilemma. Ultimately, a balanced and sustainable resolution should be sought to address the immediate concerns of Ukraine, uphold the integrity of euro-denominated assets, and ensure the stability of the global financial system.
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Time is running out for Ursula von der Leyen to decide what to do with hundreds of billions of euros of Russian money.
In June, the head of the European Commission promised a proposal “before the summer holidays” to make use of the “proceeds” of hundreds of billions of euros in Russian central bank assets in Europe, funds that have been frozen. since the days that followed the Russian invasion of the Ukraine.
So far, however, commitments to make Russia pay have tended to wither in the face of objections from lawyers and the European Central Bank.
The region’s central bank fears that any targeting of Russia’s foreign reserves to finance Ukraine would set a dangerous precedent for euro-denominated assets held by foreign governments. I would be, warns the ECBmake other central banks nervous about whether their property rights would be respected should their government one day fall out with Brussels, and encourage them to hold fewer reserves in the single currency.
It would be ironic if the von der Leyen promise failed on these grounds. Because what he is likely to propose is a measure designed precisely to overcome concerns about the legality of touching Russia’s central bank reserves.
The most favored idea in Brussels is instead to target windfalls in central securities repositories.
These deposits hold securities in custody for investors, mainly sovereign bonds in the case of central banks. By far the most important is Euroclear, which holds around 180 billion euros (about two-thirds of all Russian reserves tied up), according to the government of Belgium, where Euroclear is based.
Sovereign bond investors receive regular coupon payments and the face value amount lent in cash when the bond matures. These cash flows are paid from Paris, Berlin or other treasuries to companies like Euroclear. When Euroclear receives the cash, it credits the investor’s cash account (in this case, the Central Bank of Russia) with its banking division.
Thus, there are two cash balances in question: the deposit at Euroclear bank, a liability on Euroclear’s balance sheet, and the equivalent cash held by Euroclear on the asset side of its balance sheet.
The key is that, legally, only the central bank cash account at Euroclear belongs to Moscow. The cash on the asset side belongs to Euroclear.
Normally, cash does not accumulate; the investor withdraws the cash or reinvests it. But that’s what the blocking sanctions prevent. As a result, Euroclear has almost tripled its normal balance sheet, making for a good arbitrage operation.
Euroclear pays little or no interest on the central bank deposit. But you can earn a fantastic 3.5 percent by depositing your cash assets with eurozone central banks, the safest possible location. The numbers add up: Euroclear reports earning 720 million euros in profit on 88 billion euros of Russia-related cash in the first quarter, an annualized return of 3.3 percent. As more assets mature and cash accumulates, this could stabilize at around €7-8bn a year.
No wonder Brussels is tempted by a tax on this windfall. But this outcome would be riddled with paradoxes. It would pit Ukraine against Euroclear shareholders, who would benefit from the custodian’s windfall profits. They include Belgian insurers, global banks and European state financial groups; Russia would remain intact. Furthermore, the right to tax profits belongs to national governments, in this case Belgium, not the EU.
This solution would also cause a lot of discomfort for a negligible amount of cash. Why alienate the ECB and discourage global reserve managers for what are, in the end, very small amounts compared to the cost of rebuilding Ukraine of $411 billion and counting?
As one high-ranking official says: “If you go for the big prize, go for the big prize.” In other words, once he goes to meddle with the foundations of international central banking, he might as well confiscate the lot.
Perversely, the EU has maneuvered to maximum damage for minimal gain. As this contradiction takes hold, public opinion may well prefer the “for a penny, for a pound” argument. In either case, something will have to give.
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