How sanctions may hurt Russia

Restrictions in these 9 areas would bite

 

Russia’s invasion of Ukraine is the most significant ground war in Europe since the Second World War. Russia controls the skies above Ukraine, has encircled major cities and appears to be planning the installation of a puppet government. Whilst the NATO alliance will not put troops on the ground, governments in the US, EU and UK are determined to impose restrictions on Russia which will make Putin pay for his actions.  

Investors now expect a wide range of financial sanctions to be imposed against major players in the Russian economy. Some of these sanctions, such as the targeting of key Russian state assets and companies as well as influential Russian nationals close to the Kremlin, are likely to be implemented within days. Other sanctions, not directly targeted at specific companies or individuals, such as trade restrictions and access to technologies, could take weeks or even months to be implemented.  

Here are nine areas we believe will be considered:

1 - FINANCIAL SERVICES

We expect sanctions to be implemented under five different categories:

  • The targeting of specific Russian banks. Russian banks are likely to be the first targeted. So far, OFAC, OFSI and the EC have already targeted several Russian banks, including VEB and Promsvyazbank, while major economic players like VTB have also come into the crosshairs. Investors can expect these banks to be subject to an immediate asset freeze and trade ban with major economies including the US, EU and UK. The nature of the global financial system, in particular the centrality of the US dollar in global payments, means that OFAC sanctions will have a far-reaching impact on international transactions involving Russian state-owned banks outside of the US.  

  • Technology licences for banks. Sanctioning bodies could target technology licences for Russian financial institutions. Similar trade restrictions were imposed against Russia’s oil and gas, financial services and defence industries following Russia’s annexation of Crimea in 2014. These sanctions banned the provision of long-term financial or investment services to certain Russian banks involved in the oil and gas and defence sectors. We consider these sectoral sanctions could now be expanded to include Russia’s technology sector.

  • Transactions in Russian state debt. Major sanctioning bodies could impose restrictions against transactions in Russian state debt. Such sanctions have previously taken place by OFAC against Venezuela. Initially, sanctions are likely to be imposed against new issuances of Russian state debt, which would prevent investors from subscribing to new Russian government bonds and securities. It is possible that more wide-ranging measures could be taken to target dealings in all issuances of Russian debt, although exemptions are likely to be issued to protect US, European and UK customers already exposed to it. We note that since June 2021, OFAC has prohibited US banks from providing new financing to the Russian government. 

  • Access to USD, EUR, JPY and GBP. Sanctioning bodies could block Russian access to major global currencies. US dollars continue to dominate in international financial transactions. Since all international transactions in US dollars are ultimately cleared through the US Federal Reserve or through certain US financial institutions, Russian companies may be prevented from even carrying out the most routine international transactions. Previously, OFAC has suspended financial institutions from US dollar clearing for allegedly violating sanctions against Iran and Sudan, among others.

  • Access to SWIFT. Major sanctioning bodies could prohibit financial messaging service SWIFT from dealing with certain Russian financial institutions. SWIFT has twice been indirectly targeted by sanctioning bodies. In 2012, it agreed to not forward messages to any Iranian bank or individual that had been blacklisted by the EC. In 2018, following the re-imposition of OFAC sanctions on Iran, SWIFT suspended access for some Iranian banks. SWIFT is, however, unlikely to be targeted unless it is part of a coordinated response by OFAC and the EC. German Chancellor Olaf Scholz, when asked about SWIFT, said: "We need to keep sanctions ready for later times." 

2 - Capital Markets

  • Sovereign debt: On 23 February, the US, EU and UK announced a ban on the trading of Russian sovereign debt (including secondary trading). Although the cost of sovereign borrowing has increased in response to this action, it is unlikely to materially affect the Russian economy: Russia’s external sovereign debt pales in comparison to the USD 630bn cash reserves that Russia has accumulated, largely since 2014, in order to sanction-proof control over domestic money flows.

  • UK stock markets: London has for many years been a go-to market for Russian companies looking to raise Western finance and, arguably, legitimise their business and ownership structures. On 24 February, Boris Johnson announced that Russian companies in London will no longer be able to borrow or sell equity on Russian markets, a move which will limit the number of new London listings and force capital intensive companies to delist in order to access capital. However, this move may arguably not go far enough to act as a deterrent: since the UK brought in sanctions in 2014, there have been only three new listings and a number of high profile de-listings.   

  • Exclusion from payment systems: The UK has greater powers to control actors in its financial system, including the ability to block access to payments networks and securities depositories. Currently, the UK has only exercised these powers in respect of sanctioned individuals and corporates (including Russian banks) – but if tensions escalate, it could go further and freeze access by a wider range of individuals and corporates connected with the Russian state. Coupled with the closure of access to SWIFT, such a measure could be highly damaging to the Russian financial system.  

 

3 - Oil and GaS

The EU has announced it will implement a package of severe sanctions against Russian individuals and companies, that will “hurt the Russian economy in its heart”, as stated by Belgian Prime Minister Alexander De Croo.  

Many EU states are highly dependent on Russian gas, with Germany currently importing 49% of its supplies from the country. Italy stands at 46%, Bulgaria at 77% and France at 24%. This high dependency could lead the EU, possibly under Germany and Italy’s push, to adopt a gradual approach to sanctions, temporarily holding off from including gas companies in the list.  We currently see three possible scenarios:   

  • EU sanctions Russian gas companies with immediate effect; 

  • EU does not sanction Russian gas companies now – but could potentially introduce such sanctions later; 

  • EU does not sanction Russian gas companies, but Russia cuts the supply of gas to Europe in retaliation against EU sanctions. (This is the worst-case scenario for the EU, which would appear doubly weak for not sanctioning Russian gas companies, but see its gas supply cut anyway in what would be passed by the Kremlin as yet another show of strength).

4 - Other Commodities

Outside of oil and gas, there are a number of other commodities Western sanctions could target. For many of these sectors, particularly titanium, sanctions would likely bite both ways, inflicting serious disruption on Western companies.  

  • Potash: Russia is the world’s second largest producer of Potash, the key ingredient in modern fertilisers. Belarus, which Western governments have indicated will also be targeted in upcoming sanctions regimes, is the world’s third largest producer. Together the two countries account for over a third of global production. OFAC listed Belaruskali, Belarus’ state potash company in August 2021, while the EU has also put embargos on the import of certain grades of potash. Major Russian companies in the sector include EuroChem, Uralkali and the London-listed chemical company PhosAgro.  

  • Vanadium: Russia also produces 17% of the world’s vanadium, a key component in steel manufacturing. The London-listed Evraz is a major producer.  

  • Titanium: Russia’s VSMPO-Avisma is the world’s largest producer of titanium sponge. It has long term agreements to supply Western aircraft manufacturers including Airbus and Boeing. As such, any sanctions against the company could be highly disruptive to Western manufacturers. 

 

5 - Russians In London 

  • Golden visas. The UK has already scrapped the so-called “golden visa” scheme under which high net worth Russian nationals can obtain dual nationality. It is expected that other EU states – such as Portugal – will be expected to close off well-trodden routes which enable Russian nationals to obtain citizenship whilst retaining their Russian passports.   

  • UK property. According to Transparency International, Russian businesspeople and officials accused of corruption or links to the Kremlin own at least 150 properties worth GBP 1.5bn. The UK government has previously announced that it will be creating a beneficial asset register which records the ownership of UK property, including companies and real estate. However, a widened sanctions regime could give this bite: sanctioned individuals cannot sell, rent or re-mortgage property, effectively freezing their use of assets.  

  • Deposit limits. The UK will soon limit the amount of money that Russian nationals are able to deposit in their UK bank accounts. With this balance thought to be as low as £50,000 this may hit upper-class Russian nationals who have significant wealth but whose ability to access finance and cultural connections with the UK has not yet been hit by sanctions. 

  • Political donations. Russian dual-nationals have previously been able to obtain access to UK political figures through political donations, most heavily into the ruling Conservative party. According to research by the SNP, the Tories have received over GBP 2.3m from Russian sources. In the current political climate, there will be enhanced scrutiny of such donations, resulting in a reduced level of access to prominent UK political figures. 

 

 6 - Professional Services

 Some UK law firms, accounting firms, and other professional advisors earn large fees for advising Russian clients on their UK affairs. The widening of sanctions will make that a less lucrative business. This week, for example, the body that regulates UK solicitors (the SRA) reminded all UK law firms that their professional conduct rules prevent them from facilitating commercial transactions for sanctioned individuals and connected entities. The consequences of breaching these rules may include criminal sanctions for the professionals involved. 

  

7 - Sporting Events

Investors also need to be wary about sporting restrictions that could affect Russia and Russian companies. There are already significant doubts that major sporting events, such as the 2022 Champions League Final in St Petersburg and the Russian Grand Prix in Sochi, will not go ahead. It is also possible that international sporting federations such as FIFA and the International Olympic Committee (IOC) could bar Russian teams from future events. Russia is already in a precarious position with the IOC given previous doping scandals, including the recent episode with Russian figure skater Kamila Valieva. The sponsorship from Russian state-owned companies to major sporting organisations is also under threat. The German football team Schalke 04 has already removed the logo of Russian state-owned energy corporation Gazprom from their jerseys. 

 

8 - Travel Restrictions

Already poorly connected even from former Soviet Union states, wider travel restrictions on all Russian nationals would hit the country’s emerging middle class the hardest. Russian tourists are travelling in ever greater numbers to destination such as Turkey, Finland and Spain as well as popular beach destinations such as Thailand and the Maldives. The UK has already prohibited all scheduled Russian airlines from entering UK airspace and a US and European wide travel ban would be deeply unpopular in Russia and increase popular pressure on Putin.  

 

9 - Banning Dual Nationality

Making Russians who have dual nationality choose between Russia and their new domicile could be an effective way to damage the Russian economy and re-politicise some of the wealthy oligarchs who have lost influence in the Kremlin. UK Labour MP Chris Bryant has already called for the end of dual nationality for those coming from undemocratic states that are not fleeing persecution. Singling out Roman Abramovich, Bryant said he “should no longer be able to own a football club in this country. We should be looking at seizing some of his assets including his GBP 152 million home”.

Nationalising the assets of the few oligarch who chose Russia over their adopted country would be a populist move but also help plug deficits. Aside from the damaging effects of capital flight to Russia some intelligence sources suggest that Russian billionaires now based in Europe and the US would be forced to fund Russian opposition and even Ukrainian resistance to encourage regime change.