Ukraine needs cash to keep defending itself against Russian aggression. The United States and European Union are struggling to keep writing cheques to the country. They’re also reluctant to hand over $300 billion of Russian central bank reserves, which Western governments froze at the start of the war.
Here is a proposal for a fallback plan. Kyiv could raise money by selling bonds backed by future claims for war damages against Moscow.
It would be better if Ukraine’s backers just gave it more cash, as the United Kingdom did last week. But elsewhere fatigue is setting in. U.S. President Joe Biden has so far failed to persuade Congress to approve a new $61 billion package for Kyiv. Meanwhile, Hungary blocked the EU’s planned 50 billion euros in aid last month, although other member states are determined to find a way round the problem.
Efforts to seize Russia’s frozen assets are also making slow progress. Not only are lawyers arguing whether confiscation would be legal. Politicians wonder whether it would be wise, though they are actively exploring doing so, according to the Financial Times.
Issuing “reparation bonds” would circumvent these problems. Ukraine would sell securities which pay out if - and only if - it receives reparations from Russia for the damage done by the war. Interest payments could also roll up and only become payable if Kyiv gets compensation.
The bondholders would not have a contractual claim on the Kremlin’s frozen reserves. But given that Russia is unlikely to pay up willingly, these assets would be the most likely source of cash to pay for damages.
Since the reserves are accruing interest, they could be used to pay both the bonds’ principal and coupons. This would be different from confiscation, because the assets would only be transferred if a legitimate compensation mechanism first ruled that damages were due to Ukraine.
Ukraine would have a plausible way to collect on any damages awarded up to the value of the reserves. It could therefore issue reparation bonds up to $300 billion. But it would only get anything like this sum if the United States, EU governments and other allies were willing to buy the securities.
A LONG AND WINDY ROAD
Kyiv has a compelling case for damages of well over $300 billion against Moscow. Russian President Vladimir Putin’s invasion of Ukraine is illegal and has caused havoc. The cost of rebuilding the country had reached $411 billion by last February, according to a World Bank tally. It will keep rising.
The legal principle that a country should “make full reparation for the injury caused by [an] internationally wrongful act” is well established. There is also a recent precedent of a state doing so. After Iraq invaded Kuwait in 1990, the United Nations Security Council set up a compensation commission which forced Baghdad to pay $52 billion in damages. The money came from siphoning off a portion of Iraq’s oil revenues.
The international community will find it harder to impose its will on Russia. After all, the UN Security Council won’t vote to set up a compensation commission as Russia is one of five countries that can veto its resolutions. That said, the UN’s General Assembly - which has less power than the Security Council but where no state has a veto - has already said that an international reparation mechanism is needed. It has also called on members to set up a register of claims against Russia.
In response, the Council of Europe, an intergovernmental group committed to promoting the rule of law, is setting up a register. There has so far been no decision on which body should adjudicate on claims. But the UN General Assembly’s support gives legitimacy to actions to hold Russia accountable for its war damages.
The process of extracting reparations from Russia will nonetheless be tortuous. Iraq only made its final compensation payment in 2022, over 30 years after it invaded Kuwait. Ukraine needs money now. Reparation bonds could solve this timing problem.
CUTTING THE DISCOUNT
One objection to the idea is that the bonds would be so risky that investors would demand a deep discount. So Kyiv wouldn't get anything like the full $300 billion. After all, even if a judicial process awards Ukraine damages, Western governments may be reluctant to transfer the title of Russia’s reserves to Kyiv. Ukraine itself might also agree to abandon reparation claims against Moscow as part of some future peace deal.
This is why the ideal anchor investors would be Western governments. They have a lot to lose if Ukraine fails to hold off Russia’s assault. They are also well placed to mitigate the bonds’ risks. The United States and its allies have the power to determine whether Russia’s frozen assets are used for compensation. They will also have a big say on the shape of any peace deal. If Western governments conclude that the Kremlin should get its reserves back, that will be because they conclude the wider gains of peace dwarf the costs of giving up $300 billion.
Meanwhile, the legal basis for using Russia’s reserves to pay off the reparation bonds would be strong if Ukraine assigned claims for damages against Moscow to the Western governments which bought the bonds, says Lee Buchheit, a veteran legal expert in sovereign debt. The governments could rely on the common law principle of “set-off”, under which an entity’s assets can be used to pay its debts.
If Western governments weren’t willing to buy all the reparation bonds, Ukraine could divide the bonds into several tranches, suggests Daleep Singh, chief global economist at PGIM Fixed Income. Governments could buy the riskiest tranches, leaving regular investors to buy the least risky ones. That would reduce the discount Ukraine would have to take on selling the bonds.
Reparation bonds aren’t the only innovative idea about how to get Kyiv cash now. But they don’t rely on confiscating Moscow’s assets, which is the basis of many other proposals. If Ukraine’s allies can’t write more mega cheques, the bonds could be a good fallback plan.
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