A better way to craft a reparations loan

By Hugo Dixon, Lee Buchheit and Daleep Singh

The European Union needs to rethink the exact mechanism it is proposing for a reparations loan. The latest US peace plan underlines the risk that the bloc could be coerced to unfreeze Russia’s assets as part of an unjust deal. That would knock a hole in the Commission’s version of the reparations loan – as the EU or its member states would be on the hook to pay Moscow up to EUR 210 billion. Meanwhile, the Commission is struggling to persuade Belgium, where most of the assets sit, to back its plan.

Fortunately, there is a type of reparations loan that could both get Belgium on board and cut the risk of Russia getting its cash back. As with the Commission’s plan, it is legally robust and does not involve confiscating Russia’s assets. This alternative version has been out in the public domain since July. What is new in this paper is an explanation of how it could navigate some of the issues with the Commission’s version of the loan.

The original draft of the US peace plan would be terrible for Ukraine and Europe in many ways. Among other things, it calls for the EU to unfreeze the assets. While the bloc could say “no”, the Donald Trump might then threaten to stop supplying weapons and intelligence to Ukraine. Who knows what the EU would then do? This is not a far-out scenario. We saw a similar script play out in the spring. Although the US has since modified the draft, Trump’s position could easily swing at any moment in Russia’s favour. It is vital to protect against this scenario.

The double hurdle

The core idea in our version of a reparations loan is to create a “double hurdle” that Russia must jump before it gets its cash back. Under the Commission’s plan, Putin has to jump just one hurdle: he has to get the assets unfrozen without paying reparations, say by doing a deal with Trump or because Hungary stops the freeze. Under our alternative, he would have to jump a second hurdle: by persuading a European court that the EU had used the assets illegally. It is harder for the Kremlin to jump two hurdles than one – especially since the second one is high.

To understand the “double hurdle” concept, recall the detail of the Commission’s plan. The EU first borrows the cash associated with the Russian assets in Euroclear (and potentially other vehicles), and then makes a reparations loan to Ukraine. Moscow retains its claim against Euroclear but cannot ask for its cash so long as the funds are immobilised. But if the funds are ever unfrozen, Euroclear needs to repay Russia and the EU needs to repay Euroclear. If Russia has not paid reparations, Ukraine doesn’t have to repay the EU – and so the bloc needs to find the cash from its own coffers or member states.

Our plan starts by moving the entire Russian account from Euroclear to a different legal entity – probably a new EU vehicle set up for this purpose. The liability as well as the Russian assets would be moved. This is not confiscation as Russia would remain the sole beneficial owner of the account. The move would merely be a change of custodian.

The SPV would then invest the cash on Moscow’s behalf in a reparations loan. Like the Commission’s plan, this would be a limited recourse loan that Ukraine only has to repay if Russia pays reparations. It would, though, have an extra feature: Kyiv would pledge as collateral its claim for reparations against Moscow.

This creates a “double hurdle” for the Kremlin. If it is ever able to unfreeze its assets, all it ends up with is an IOU from Ukraine saying it will repay the loan if Russia pays reparations. To get its cash back, Moscow would then have to convince a European court that the SPV had breached its duty as a custodian by investing Russia’s cash in the loan to Ukraine. This will be tough. (See our plan’s legal basis below).

Cutting the Hungarian risk

A further advantage of our plan is that it reduces the “Hungarian” risk. The Commission’s plan relies on immobilising the Russian assets indefinitely. The Commission believes this can be done without a new Council decision by using Article 31.2 of the TEU. But member states such as Hungary could challenge this view at the European Court of Justice. If they won, the assets would be unfrozen. Russia would be able to demand its cash back, Euroclear would ask the EU to repay its loan, and the EU or member states would have to cough up the cash. This scenario is another sword of Damocles hanging over the plan.

Our plan cuts this risk because Moscow would have to jump two hurdles. It would not be enough for the ECJ to conclude that a new Council decision was needed before the Russian assets could be frozen indefinitely. The Kremlin would also need to persuade a European court that what the EU did with the assets was illegal.

Moving the Russian account from Euroclear

Bart De Wever, the Belgian Prime Minister, said after the October European Council that he wants to get rid of the Russian account from Belgium. His exact comments were:

“If there is somebody who wants to take the entire Euroclear balance…. and will sign for all the risks, he can have it. That would be the happiest day – maybe not the happiest day of my career, but it would be a happy day to see that money leave Belgium. I want to get rid of it.”

Our plan does just that. It would take Euroclear out of a political knife fight.

Transferring the Russian account to an SPV or other custodian is not a confiscation; Russia (and the Central Bank of Russia) will remain the sole beneficial owners of that account. Individuals and corporations are often told that their accounts are being moved to a third party, particularly when the original depositary becomes insolvent. What’s more, there is an important precedent for shifting sovereign assets. After the fall of Saddam Hussein, Iraqi assets outside the country were transferred to an account at the Federal Reserve Bank of New York.

The EU would, of course, first have to instruct Euroclear to move the account to a new SPV. This might be done by a directive from the EU or possibly the Belgian government. One option would be to copy the method that the Commission has proposed, under its plan, for obliging Euroclear to invest its cash in an EU debt contract. This involves a “regulation on the basis of Article 215 TFEU”. This can be passed by qualified majority voting. Other options could use the fact that De Wever routinely describes Belgium’s role as the principal custodian of blocked Russian assets as a nearly existential threat to the country’s financial position. Authorising a transaction that would shift that burden in its entirety to a third party outside Belgium would appear to be both necessary and prudent. 

Transferring the account would also reduce Belgium’s need for guarantees. In particular, Euroclear would no longer need a liquidity guarantee because the account would have moved elsewhere. The new SPV would not need a liquidity guarantee either. After all, if the assets were ever unfrozen, all that Russia would get was an IOU from Ukraine. This would not entitle it to cash unless it paid reparations.

Despite saying he would love to be rid of the Russian account, De Wever might still want an indemnity. He might argue that Russia could sue Belgium under its bilateral investment treaty for not hanging onto the account. But the fact that an EU directive instructed Belgium to do so would give it a complete defence against such a claim. It would, after all, then be illegal for Belgium not to move the account. Given the remote risk that Russia would win such a legal action against it, the EU and member states should have little anxiety about providing Belgium with the necessary indemnity.

Our plan’s legal basis

Russia initially deposited assets at Euroclear. When these turned into cash, Euroclear’s relationship with Russia switched from that of a depositary to that of a bank. If the entire Russian account is moved to an SPV, it would be possible to restore the depositary relationship. The cash would then belong to Russia and the SPV would be responsible for its safekeeping as its custodian.

The SPV would need to invest the Russian cash in something. The most responsible thing to do would be to invest it in a zero-risk instrument.

It might be thought that depositing the cash with the ECB – or investing in a triple-A rated bond such as a Bund - would be the lowest-risk investment. But even these carry a tiny risk. It is conceivable that the ECB or German government could default.

The only investment that is zero-risk by definition is an investment in Russia’s own obligation. This is because, if Russia defaults on that, it saves the precise amount of money it loses on its investment. No other investment, even Bunds or an ECB deposit, gives that kind of assurance.

But the SPV could not invest in any ordinary Russian obligation because it is EU policy that Moscow only gets its cash back if it pays reparations. If the cash was invested in an ordinary Russian bond, Moscow could default on that bond and save exactly the same amount of money invested in the bond. It would effectively have got its assets unfrozen without paying reparations.

There is, though, one zero-risk investment consistent with the policy that Russia only gets its cash back if it pays reparations: a reparations loan. Although this is nominally a loan to Ukraine, it is effectively an investment in Russia’s own obligation. This is because Kyiv only has to repay it if Moscow pays reparations and Russia would receive as collateral Ukraine’s reparations claim.

The most responsible thing for the SPV to do would therefore be to invest Russia’s cash in a reparations loan. Moscow will struggle to convince a court otherwise.

If the Kremlin ever becomes entitled to demand the return of its funds, the custodian will discharge its obligation by transferring to Russia legal title to the reparations loan. 

Moscow would, of course, object. It might argue that the SPV should instead pay it cash. But even if it persuaded a court to back this weak contention, that would not be the end of the matter. The custodian would argue that, if it had a liability to provide cash to Russia, it must be deemed the owner of the loan to Ukraine. What’s more, since Moscow had refused to pay the war damages, the SPV would have inherited Ukraine’s claim against Russia. It would then have both a claim against the Kremlin and an obligation towards it. Under the standard legal principle of set-off, it could net off the obligation against the claim. 

Russia could seek to challenge this set-off. It could, for example, argue that Ukraine’s reparations claim is not valid. But this is a weak case given that countries must, under international law, pay reparations for damages caused by illegal acts. Moscow would therefore have to persuade a European court that its invasion was not illegal or that it had not caused any damage. Good luck to it.

Our plan would also be entirely reversible. To get its cash back, all Russia would have to do is pay reparations as it is required to do under international law. Ukraine would then repay the loan. This reversibility makes our plan consistent with the doctrine that countermeasures should be reversible and only be used to induce a country to follow international law. As such, it provides further defence against any Russian legal challenge.

Conclusion

Ukraine’s claim against Russia for damages caused by the invasion is legally indubitable. The remoteness of Russia’s willingness to honour that claim has no bearing on its legal vitality or validity. 

The overriding objective of this proposal is to put Russia in a position in which it cannot - morally, politically or legally - assert a claim for the return of its immobilised assets while simultaneously defaulting on its obligation to pay damages for its illegal invasion of Ukraine. The two obligations must either both be performed together or neither be performed at all. 

It might be argued that our plan carries risks that are not present in Commission’s plan. But these risks are small. By contrast, the Commission’s plan has a significant risk - namely that Russia might get its assets unfrozen without paying reparations. The EU should therefore adopt our plan – or at the very least test it out with Belgium in case it cannot get its plan over the line.