The complicate G7 plan to finance Ukraine with Russian funds

The G7 was supposed to bring an outcome, albeit a result, on the burning issue of aid to Ukraine financed with seized Russian assets. And so it did.

Already several hours before Thursday afternoon’s session devoted to Kiev head of government Volodymyr Zelensky, news of the agreement reached at the diplomatic level was circulating in the major international media. And there was no reason to doubt that the leaders would provide their endorsement in the following hours. Which punctually occurred and was formalized in the final communiqué of the proceedings.

But behind the scenes of the understandable facade satisfaction with the result nevertheless achieved, heavy problems remain because this was a compromise at the lowest ebb, after which there would only be failure of the negotiations.

The solution was to proceed separately and in proportion to the size of their respective economies, each for himself, in order to arrive at the total sum of $50 billion to be lent to Ukraine, hopefully by the end of the year.

Each party (EU, Japan, Canada, U.S., and U.K.) will separately issue debt in the markets and provide loans to Kiev. Proceeds from the seized Russian funds (between $3 and $5 billion a year) will be used to repay principal and interest to investors. With the promise of the U.S. to make up any difference up to $50 billion.

If these funds are insufficient, it will inevitably be the budgets of each state that bear the corresponding burdens. And finalizing these complex legal steps will take at least another four to five months. Hopefully before the US presidential election. The Apulian G7 only laid the groundwork for intense technical and diplomatic work that is still in the making.

In this regard, emblematic are the words of Ursula von Der Leyen that “the financial ministers will discuss details for example, on the ‘backstop’ of the loan,” i.e., who will be the guarantor of last resort, and Giorgia Meloni, who spoke of an “outcome that is not a foregone conclusion that will now have to be defined from a technical point of view.”

In this regard, since words are stones and talk always stands at zero, the final communiqué constitutes only the first (shaky) stone on a path that looks bumpy.

The four key points of the plan

There are four key points that will have to be resolved and that could pose a problem for possible investors.

• The first is “extraordinary revenues.” Then we deduce that not all financial revenues will be put into the service of the ERA (Extraordinary Revenue Acceleration) loan, but only the “extraordinary” ones, i.e., exceeding the ordinary? Nice perspective for those who will then have to underwrite that loan!
• The second is “to obtain approval.” Using financial proceeds to service the loan does not require a magic wand. Regarding the parties (central depositories like Euroclear) that receive those proceeds, it is still considered an expropriation because they have sold assets that are normally shielded from legal action by the Russian government. As a result, they run the risk of encountering legal issues.
• The third is “consistent with all applicable laws,” repeated then “”within the constraints of our respective legal systems,” that is, “consistent with.” To keep Russian assets seized until all of Russia’s damages to Ukraine are repaid, one has to deal with the respective legal systems of the countries where those funds are deposited. In addition, appropriate parliamentary steps will have to be taken, where provided. These are certainly not limits that can be overcome with a snap of the fingers.
• The fourth is “let us instruct our relevant ministers and officials to operationalize these commitments so that we can start disbursing the loan before the end of the year.” There is no clearer way to say that the work site has just opened. Which is quite different from a done deal. “Vaste program,” Charles De Gaulle would have said.

But who would dare to take out a guaranteed bond on such a legally fragile basis? It is as if you went to the bank to ask for a loan so that you could help a friend in need whose house was burglarized. You would tell the manager that you had taken the burglar’s safe deposit box and that you planned to use the proceeds to repay the bank when they questioned you about the collateral that needed to be lent in order to give you the money.

At that point, the manager would raise objections about the stability and certainty of those proceeds (e.g., what would happen if that box was empty or didn’t yield as much as hoped?) and you would be forced to issue a nice mortgage on your home. Is it clear how this works? The guarantee of Russian funds is written on ice for those who have not yet figured it out. The “backstop” (the parachute, to use von der Leyen’s words) will be our money.

Yet, in April 2022, when Mario Draghi seemed to have pulled the rabbit out of the hat, convincing U.S. Treasury Secretary Yanet Yellen to converge on his proposal to seize Russian central bank financial assets held abroad (260 billion, of which about 200 billion are in the eurozone), it all seemed relatively easy. But since then, every meeting has always ended with a setback from the initial goal. After a few months, the topic of the confiscation of the entire capital, that is, the final expropriation to the Russians’ detriment, quickly disappeared from the radar, giving way to a discussion of only the proceeds from those assets. On Wednesday, however, a letter signed by over a dozen lawmakers from different EU members states persisted in urging the G7 to forgo half-measures and move forward with confiscation anyhow.

It came on the eve of the Puglia summit, with authoritative EU diplomatic sources dismissing the latest U.S. proposal with an eloquent “we might be stupid, but not to this extent.” The intention from Washington was to issue a loan, have the EU pay the interest on it (via proceeds from the seized Russian funds), which would also take over the guarantee toward the investors, channel those funds to Kiev through a special U.S.-Ukraine fund, and finally, have U.S. companies be the main providers of the aid.  So the EU would take all the risks, do all the dirty and shady transactions, then take the money and pass it on to the U.S. industrial complex. Logical solution

If the US had insisted on such a scheme, the EU would have put the backup plan on the table. That is, to act separately, each with its own legal, financial and, above all, political responsibilities. In some cases, there will also be to face the respective parliaments. It is still the case that such a plan has been thwarted, and Plan B is now the go-to option. “temporary,” as they were quick to point out even in the Financial Times.

It is unclear what share of the $50 billion-whose speed of absorption by Kiev is all to be assessed-will end up in military aid and what share will go to reconstruction.

Essential conditions for this scheme to work, at least in the coming years, is that the seized Russian assets continue to generate revenue. A fact that no one can guarantee. However, the other doubt regarding the duration of the seizure for as long (predictably long) as the loan will stand has been resolved-no one knows how. Russia will not see its assets again until the last penny of the loans issued by G7 members has been repaid.

And this aspect opens more than a crack on the euro’s resilience front. On Wednesday, the ECB published a report showing the decline, albeit modest, of the euro as a currency used in international trade, combined with the rise of the Chinese currency. But more importantly, it is highlighted and also underlined in the comments that by the end of 2023, the reserves of other central banks denominated in euros had declined by about 100 billion. A decline of about 5 percent. From Frankfurt they explicitly pointed out that the choices of some central banks (Switzerland and Japan in the lead) were also influenced by “sanctions-related measures.” What is worse, this influence may continue in the future.

In the face of this clash with the reality principle, little has turned out to be better than nothing. With the significant virtue, for which Giorgia Meloni must be credited, of having managed to bar the door to the embarrassing US plan. But of this, you will find no trace in the Italian (and other) newspapers.