New UK sanction ideas on Russia are toothless
The UK's foreign affairs committee report, released on Monday, holds the US Treasury’s sanctions strategy in high regard, because of the immediate impact on financial markets. But it misunderstands the reason for the US-driven sell-off, and so its recommendations are faulty as well.
The committee's report regards the US's sanctions from April 6 as a success, pointing to the slide that ensued in Russian stocks and the rouble.
It attributes the wave of selling that followed to the sanctions having a “clear and direct impact on the Russian economy” and says “the significant impact of the newest US sanctions on Russia demonstrates the potential value in targeting Kremlin-linked individuals as a way of putting pressure on the regime to change its aggressive and destabilising behaviour”.
But it was not the targeting of Oleg Deripaska or indeed the companies the US chose to sanction in its latest round that prompted the severe reaction in the markets that the report seems to admire.
It was the detail of the sanctions — namely that investors were told to dump their holdings and given a short window of time to do it.
That wave of forced selling is what scared the living daylights out of EM investors in Russia, not just the individuals and companies named.
Bond and equity investors in Russia were not so worried about the effect of aluminium prices on Russia’s economy or Deripaska’s closeness to Kremlin. They were worried first and foremost that in a few days, or weeks or months, they would be told they had to sell the debt or equity of another, as yet unnamed, company or bank, and those asset prices would be subject to a similar nosedive.
The UK foreign affairs committee report does not, however, recommend triggering that sort of forced selling.
But the UK's recommendations cannot be expected to have anything like the same reaction in the financial markets without a requirement for forced selling — as indicated by fact that Russian bonds on Monday barely budged on news of the recommendation.
There are plenty of reasons to think forcing a market crash isn't a desirable way to carry out foreign policy, but even if that's the aim of sanctioning Russian entities, the report gets the link between cause and effect wrong.
In other areas, the committee's report seems to identify problems without providing effective solutions, such as its addressing of the “loophole” that allowed the Russian sovereign to print international bonds via VTB, a sanctioned entity, embarrassingly for the UK, only a few days after the poisoning of Sergei Skripal in Salisbury.
The report acknowledges that a straight, but internationally coordinated, restriction on Russian sovereign debt is likely to be unpalatable because of the destabilising effect on the world economy.
But the alternative remedy, preventing VTB from working as a bookrunner on the deals, is unlikely to be enough.
First, what about all the other Russians banks that could in theory act as a bookrunner? Even if all western banks are scared off Russian sovereign deals, non-sanctioned Alfa Bank, for example — a big private bank in Russia — used to appear on Russian international bond mandates.
Even if Alfa can't command the same level of international distribution, it may not matter. Investors will want Russian sovereign bonds or feel they must buy them because of their share of the main EM indices — and will find a way to buy them even through a lesser-known bookrunner. If Alfa can't do it, an African or Asian bank could easily step in. Pricing may not be as perfect without EM syndicate veteran George Niedringhaus at the helm, but surely it would still be possible?
This proposal can't stop Russia accessing international bond markets for new primary deals — but it's unclear what it is supposed to achieve. It's unlikely to push prices down. Sanctions that stopped Russian entities from raising new funds created a scarcity of supply, which has meant that those bonds actually rallied.
To be fair, the report does acknowledge that removing VTB as a bookrunner would make it harder, not impossible, for Russia to raise debt, .
But it feels as though the recommendations over sovereign debt are mostly about the UK wanting to punish Russia for the embarrassing post-Skripal print, rather than an actual desire to cut the country off from debt financing.
The report does contain several sensible suggestions to improve the effectiveness of sanctions. One example is making it clear what steps need to be taken by sanctioned entities, their owners or the government, for sanctions to be removed.
And the UK’s Russian sanctions do lack force. The committee deserves praise for acknowledging the problem. But as far as its bond market recommendations go, the bark here is not as bad as the bite probably needs to be.