As the whole world watches in anticipation while Russia continues to militarise near Ukraine’s borders, the financial sector is busy preparing for possible what-if scenarios. In 2014, sanctions were implemented after the annexation of Crimea, with Western powers deploying specific and limited sectoral sanctions designed to target those directly involved in the destabilisation of Ukraine. Now, as the US prepares a more severe “mother of all sanctions” package, more individuals within the Kremlin and parts of President Putin’s inner circle, including Putin himself, are at risk of being added to blacklists. Additionally, some of the harshest measures imposed on Russia, like exclusion from vital global banking infrastructures, are being seriously considered.
Overview: How did the world get here?
The latest conflict, stemming from ongoing disagreements with the imperfect 2015 Minsk peace deal, revolves around Russia seeking assurances that Ukraine will not join NATO. Western powers stand by the military alliance’s open-door policy, which touts the principle of national sovereignty and the right for all nations, including post-Soviet states, to decide for themselves on membership. Last year, Russian troops began mobilising at the Ukrainian border and sparked international criticism. Now in early 2022, an estimated 130,000 troops are believed to be at the border, and military drills with Russian ally Belarus are set to begin.
SWIFT and financial sanctions
As the international community speculates on Russia’s next exact move, retaliatory action in the form of sanctions is being actively discussed. One proposed measure, re-emerging from 2014 discussions, is the exclusion of Russia from the Society for Worldwide Interbank Financial Telecommunications (“SWIFT”).
SWIFT is a critical global electronic payment messaging system that on average handles 42 million daily messages. Barring Russia from the system has been coined the “Nuclear Option,” a move never before made against such a large economy. If implemented, both Western powers and Russia would surely face difficulties. Though it would exclude Russia from an important aspect of the international financial system, which allows it to accept global payments for gas, Russia has already prepared some cautionary measures. The Kremlin has created a domestic version of SWIFT known as the System for Transfer of Financial Messages (“SPFS”), which is made up of 400 member banks, including some from former Soviet states. While it has its limitations, SPFS exists as an alternative that could be incredibly useful during a painful adjustment period.
In addition to the EU’s business and financial interests in Russia, Europe is heavily dependent on Russia’s energy. This dependence is particularly true for key EU decision maker Germany. Excluding Russia from SWIFT would leave many member states vulnerable or scrambling to find a solution to pay for Russian gas. Moreover, fear of destabilisation surrounding the potential exclusion of Russia from SWIFT, is partly because of how it would impact the repayment of debts. Figures from the Bank for International Settlements (BIS) demonstrate that Italian and French banks carry the most Russian exposure, far surpassing that of the US. These factors have made the EU, in particular, wary of furthering this so-called “Nuclear Option”.
Another even more powerful option would be a US move to blacklist major Russian banks. While SWIFT is an important tool, ultimately, it is just that — a tool used for sending messages. Removing Russia from this system would certainly be a blow, but it would allow for loopholes and workarounds. Conversely, if major Russian banks like Sberbank, VTB or Gazprombank were blacklisted by the US, it would make it near-impossible for transactions to occur from anyone in the world. This move, which would result in the makings of a domestic financial crisis for Russia, would undeniably have global implications such as causing certain Western investment funds to fall. However, the US blacklisting of these big banks would have the most extensive and harshest direct impact.
Coordination necessary
Western sanctions effectiveness against Russia relies heavily on timely coordination among the US, EU, and the UK. Without a concerted, unified move, loopholes and asset flight can undermine sanction efforts.
Being a supranational organisation, the EU is required to reach an agreement on a sanctions package among its member states in what can be expected to be a lengthy bureaucratic process. As the UK assembled its own independent sanction regime as part of Brexit, it has been working closely with the US. The UK government has recently announced a new sanctions law that can extend to anyone who provides strategic support to Putin, including in significant sectors like chemical, defence, extractives, ICT and financial services. Critics, however, have noted the deep entrenchment of Russian oligarch wealth in London, which would hinder the effectiveness of such efforts.
As sanction discussions continue, the potential severity of forthcoming measures has settled in, with financial institutions preparing for different situations. Last month, the European Central Bank (“ECB”) asked lenders with significant Russian exposure how they would handle different sanction scenarios. Adding to the stress, financial regulators have warned major banks in the US, EU and the UK to prepare for possible Russian-sponsored cyber attacks, in the event sanctions are triggered by a Ukrainian invasion. However, until sanctions packages and their specific details are officially announced, in what will likely be an abrupt manner, financial institutions will continue preparing for what’s to come — calculating their exposure to Russian flows, reviewing Politically Exposed Persons (“PEP”) lists, assessing beneficial ownership and high-value accounts, and piecing together a reactionary compliance strategy.
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