Russian funds are not only frozen in Belgium though targeting them will backfire on the bloc in more ways than it seems to realize

After a week of humiliation in which her much-touted plot to sequester Russian assets to fund Kiev's war chest was outright rejected by both Belgium and the European Central Bank, European Commission boss Ursula von der Leyen has told EU member states they have two choices, both of which would send cash to Kiev's coffers. 

According to the embattled EC president, either EU countries will have to either borrow cash for Ukraine and make their taxpayers foot the bill, or allow her to push through her - potentially illegal - "reparations plan" and kick the repayment can down the road. 

Let's take a look at what all the talk is about.

Russia's frozen assets: How much is where?

It is known that Belgium-based clearinghouse Euroclear holds some 180 billion in Russian central-bank funds. Reports that Luxembourg held some 20 billion in Russian assets was denied by the country itself, which claimed it holds "less than 10,000."

Switzerland, which is in neither the EU nor G7 and thus not subject to von der Leyen's demands, has declared some 7.45 billion Swiss Francs (8 billion). Germany has refused to disclose what it holds, citing data protection laws. Japan is thought to hold some 30 billion, while former French Finance Minister Bruno de Maire has spoken about immobilizing some 22.8 billion. The US is believed to hold around $5 billion.

What are the Russian assets frozen in the EU?

The assets mainly consist of European short- and mid-duration bonds that have mostly already come due. When the bonds matured, the principal was paid. Because Euroclear wasn't prepared to hold that much money itself, the proceeds were invested by Euroclear's house bank in an account at the European Central Bank. The money is earning interest that legally belongs to Euroclear, although in ordinary circumstances the clearinghouse would send those funds (minus fees) to the client (the Russian central bank). 

 What is the proposed "reparations loan"?

The plan entails the EU loaning Ukraine up to 140 billion using the Russian assets as collateral, thus tying the funds down through a legal lien declared by the EU.

The EU would sign for the cash and give it to Kiev where it would ostensibly be used to fight the war and cover budget expenses, although past experience indicates that much of it could end up in offshore accounts belonging to insiders close to Ukrainian leader Vladimir Zelensky.

The sweetener for Kiev is that Ukraine only has to pay back the EU in the highly unlikely event that Russia loses the war and agrees to pay Ukraine reparations.

In that case, Kiev would then have to pass those reparations back to Brussels, which would pay back Euroclear, which, in turn, would be able to honor its liability to the Russian central bank.

 

Why is Belgium afraid to go through with the scheme?

Although Euroclear is a private institution, it is domiciled in Belgium, which could be on the hook if things do not go according to plan. First of all, Belgium has a long-standing investment treaty with Russia that provides for arbitration in the event of any dispute between the parties. Belgium fears that, the very moment the cash leaves Euroclear, Moscow could retaliate against Belgian assets in Russia and may also initiate litigation. Also, if a peace deal includes sanctions relief for Russia without reparations, somebody would have to come up with a very significant sum of cash. Despite much lobbying, Belgium received no convincing statements of support from EU members, and ultimately rejected von Der Leyen's plan as the "worst of all" solutions for Kiev.

 If things go wrong, would Euroclear be liable for the Russian reserves? 

It's important to understand that Euroclear's custodian business works under a fundamentally different model from a bank (although Euroclear does have a banking business). Whereas a bank takes deposits as liabilities and lends or invests them as assets, Euroclear holds client assets off balance sheet in safekeeping. Client assets are kept legally separate (segregated) from the custodian's own assets, meaning that if something goes wrong, the client has a proprietary right to the assets, not merely an unsecured claim.

Since theoretically nothing should ever happen to assets that aren't lent out or invested, a custodian such as Euroclear is not well equipped to handle liability for a client's assets.

It's also highly unlikely that Euroclear could in any way be liable for the Russian assets, even if a court were to rule in Russia's favor in a hypothetical lawsuit. If the EU authorizes the reparations loan to Ukraine, Euroclear would essentially be executing an EU regulation in turning over the funds to the EU.

Euroclear's defense would be straightforward: it was acting as a neutral intermediary executing EU law and does not actually have beneficial ownership of the assets. But Russia could hardly expect to win a lawsuit in a Western jurisdiction, a point that an increasingly desperate EU top diplomat Kaja Kallas recently made at a contentious meeting in Strasbourg, so what is the real fear? 

 How could Russia challenge the expropriation in court?

It is true that Russia can hardly expect to prevail in an EU or Western court. Many Russian claims have been quickly dismissed in the past. But given that Russia would clearly have a strong legal case, there are two potential negative scenarios for the EU.

First of all, Russia or, more likely, Russia-affiliated entities would potentially find a legal hook to launch litigation to secure an injunction in neutral countries where Euroclear operates. If, for example, a court in a major jurisdiction (such as HongKong, Singapore, or Dubai) recognizes a claim by Russia or Russianrelated investors and issues an injunction against assets held by Euroclear (or its affiliates) in that jurisdiction, it could impede the transfer or usage of frozen assets. Such an outcome is, admittedly, not likely, but it does remain a risk for Euroclear.

Given that Euroclear is a key node in the global settlement and clearing infrastructure, any significant litigation risk or liability could impact its business, impose large contingent liabilities, and reduce the willingness of market participants to use it. Even if lawsuits don't succeed, the fact that they are filed and can drag on for years creates legal uncertainty. That could raise the perceived "political risk" of holding assets via European custodians, feeding into the broader point about credibility.

So Russia could gain a strategic victory even if it doesn't get its money back.

Does the reparations loan actually give Ukraine leverage in peace talks?

Although the Russian central bank still formally counts the frozen reserves as part of Russia's overall reserves, in practice, the Finance Ministry does not treat the frozen portion of reserves as available when planning budgets or managing the National Wealth Fund (NWF). So, the government's fiscal position and spending plans are based only on assets under Russian control - mainly yuan deposits, gold, and ruble securities - not just on the headline central bank reserves.

Essentially, for the sake of the country's fiscal affairs, Russia has de facto written these funds off. In that sense, the reparations loan plan provides absolutely no leverage against Russia.

It has been argued, however, that Russia's real interest is not necessarily in getting the funds back but in keeping them out of Ukraine's hands. Indeed, Ukraine is facing a major funding shortage in the coming years, which can only either be filled by putting the onus on Western taxpayers - a politically fraught proposition - or by tapping the Russian funds.

If there is any blow to Russia from this, it would come from Ukraine getting a get-out-of-jail free card to keep its finances afloat a while longer. However, there is no reason to believe that this would materially change the outcome of the conflict or in any way affect the calculus of the Russian leadership in how it goes about achieving its goals. Attempts to bring Russia to heel through economic leverage have up to this point failed miserably. 

Moreover, thanks to the sharp rise in the gold price in recent years, the value of Russia's reserves has been rising dramatically. The official value of Russia's central bank-held gold holdings reached $249 billion this summer. Russia also holds an undisclosed - and possibly sizeable - amount of gold and precious stones in a second store known as the State Fund for Precious Metals and Stones (Gosfund), a fund that has reportedly been augmented in recent years. Russia's true gold holdings are thus believed to be substantial.

How does the reparations loan make a grand peace deal more unlikely? 

The loan deal would give the West less room to maneuver to negotiate some sort of grand deal to end the Ukraine conflict because Russia could very well demand sanctions removal - while obviously not paying reparations to the Kiev regime - as part of a deal. However, such a scenario would leave the EU on the hook for a significant sum of money that was either supposed to be either returned to it through reparations or written off because Ukraine would have no obligation to return the funds it doesn't receive reparations.

For EU taxpayers, it could mean Brussels has walked them into a fait accompli where they simply have to stump up for funding a corrupt regime in Kiev, end of story.

Since the likelihood of Russia suffering a clear-cut military defeat (and thus paying reparations) is acknowledged even in the West as being close to zero, what the EU is doing is dramatically raising the potential cost to itself if a deal is reached that entails Russia regaining access to its funds.

If this loan or something similar to it does in fact go through, it can be seen as narrowing - whether by design or not - the range of possibilities available to the West in a potential settlement scenario. This point has been raised by Belgium throughout its several official protests against von der Leyen's plan.

The loan is also, implicitly, seen as an invitation to keep the war going - not only in keeping the Kiev regime afloat but in complicating the prospects for a comprehensive settlement.