The need for creative ideas to fund Ukraine has never been more apparent. Two years on from Russia’s illegal invasion, its army is struggling on the battlefield in part because of lack of ammunition. Meanwhile, President Joe Biden has so far failed to persuade the U.S. Congress to approve more military aid.
Western governments are debating whether to seize $300 billion of Russian assets which were frozen at the start of the war. A rather different idea, which I proposed last month, is that Kyiv could finance itself by issuing “reparation bonds”, backed by its claim for war damages against Russia. I have fleshed out that idea in a joint paper with Lee Buchheit, a veteran legal expert in sovereign debt, and Daleep Singh, who on Monday returns to the White House as deputy national security advisor for international economics, but who was writing in a personal capacity.
The idea in a nutshell is that Ukraine would pledge its claim for reparations against Russia to a syndicate of its allies in return for a loan. If Moscow refused to pay the damages, the allies could then use Russia’s frozen assets to pay off the loan. The justification for doing this is the widely recognised legal principle that, if a creditor controls a debtor’s assets, it can set off those assets against an unpaid debt.
SET-OFF TO THE RESCUE
Ukraine has an indubitable claim under international law for reparations against Russia. The cost of rebuilding the country now stands at $486 billion, according to a World Bank study. The problem is that Moscow’s frozen assets aren’t sitting in Kyiv. If they were, the Ukrainian government would have a moral and legal right to set off the $300 billion as part payment for the damages Russia has caused.
In contrast, the countries that have custody of Russia’s assets - mostly the Group of Seven rich democracies and European Union countries - don’t have a claim for reparations against Moscow. Therefore they don’t as yet have any debt against which they can set off the frozen assets.
But that would change if Ukraine pledged a portion of its war damages claim against Russia as collateral for a loan. If Moscow refused to pay reparations, the G7-led syndicate would foreclose on the collateral and assume title to Kyiv’s claim against Russia. At that point, Moscow would owe the lenders money - and the lenders could set off the frozen Russian assets they are sitting on against that unpaid debt.
SHARE AND SHARE ALIKE
There are several wrinkles to this idea. For one, the bulk of the assets, about 191 billion euros ($205 billion) are held at Euroclear, the Belgian-based clearing house. Only $5 billion are held in the United States.
If each of Ukraine’s allies lent it money according to its share of frozen Russian assets, tiny Belgium would be on the hook for a vast amount while the U.S. would only provide a small sum. This is a political non-starter. And yet for the legal principle of set-off to apply, the party with the debt has to be the same as the one sitting on the assets.
Using a syndicated loan structure would overcome this problem by allowing the syndicate to divide up the financial burden however it wished. This is because syndicated loan agreements contain a “sharing clause”. This is a promise by each party in the syndicate to share (pro rata according to its exposure) any disproportionate recovery it realises on the loan.
In this case, Belgium would do most of the setting off and most of the sharing. It would purchase economic interests (called “sub-participations”) in shares of the loan held by other members of the syndicate so that its exposure matched the assets it is sitting on. But Belgium would not pay immediately. It would first set off the assets against its augmented claim and then use the cash proceeds to pay for the sub-participations.
MORE NITTY-GRITTY
Another question is whether the syndicated loan would put an additional financial burden on Ukraine, whose creditworthiness is already shot to bits. But this would not be the case if the syndicated loan is structured as a “limited recourse” obligation, with the syndicate agreeing that Russia – or its frozen assets – would be the sole source of repayment. That way Kiev would not be on the hook and the lenders would not be exposed to Ukrainian credit risk.
Even then, the loan would not be free of risk. Russia would presumably fight it tooth and nail. This is why it would be important to make the mechanism as legally robust as possible.
For a start, Ukraine could not just arbitrarily declare that Russia owed it money. An internationally recognised body would first have to award it damages. The United Nations General Assembly has said that Russia must make reparations and that an international reparation mechanism is needed, so there’s something to build on.
The set-off mechanism will also work best if the entity holding the Russian assets is the same as the one to which Russia owes the reparations debt. In some cases, the assets are deposited in private financial institutions, like Euroclear. So ideally, each country holding frozen Russian assets would move them to a central government depository. The U.S. already has the authority to do this. Others, though, may need to pass legislation to get it.
This structure is, of course, more complex than just confiscating Russia’s assets and giving them to Kyiv, as some commentators wish. But some G7 countries, especially in the EU, are reluctant to move forward without a strong legal basis.
A syndicated reparation loan could achieve a similar outcome in a legally robust way. It could also provide Ukraine with sufficient cash to defend itself against Russia for several years - potentially changing the dynamics of the conflict.
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