CBR assets - the euro cent has finally dropped

A few comments on the Merz FT piece on funding Ukraine:

https://www.ft.com/content/3ac05cd3-483b-4106-9c2c-4f05e4ba744a

First things first, it is great that reality has dawned in Europe, and that with the long war in Ukraine now the base case, realisation that Trump will not write any cheques, that Europe is on the hook for the full $100 billion plus per annum in costs of keeping Ukraine in the war, and sustaining the first line of defence for Europe against Russian aggression.

As is, the numbers do not add up, and the IMF has been openly talking now about a $65 billion budget/BOP financing gap for the duration of its programme, likely extended out to 2028, and that excludes the annual $60 billion pa military funding costs.

European budget deficits are wide, populism rife and European taxpayers cannot be expected to pay a $100 billion a year bill, and not when $330 billion of Russian taxpayer money is sitting doing nothing in bank accounts at Euroclear, et al. As I have argued, ad nausea, it should be a scandal that this money has not been used already - and that our politicians prefer spending our taxpayer money ahead of the Russian tax payer.

But hey ho, finally the penny, or euro cent has finally dropped.

Second, in terms of the numbers, the €140 billion spoke about by Merz seems to be the funds sat in Euroclear, less the €50 billion allocated to the ERA. The latter is the scheme thought up last year to use the future interest stream from CBR assets to support Ukraine. But if the underlying assets are to be used, then I guess the assumption is there will be no interest stream, hence the idea I guess to repay the ERA. But if you include funds held in other G7 jurisdictions, then we could be talking about a G7 programme of close to $200bn, given $20-30bn each in the U.K., Japan, and the U.S. If that is the case, that represents at least two years of funding for Ukraine in war. Actually more as Merz only speaks about military needs met out of this new facility. I assume he is assuming the $65 billion IMF shortfall identified will be covered from existing multilateral and bilateral sources as is. So that further increases the firepower - quite literally - of this current programme, this assures Ukraine’s funding for 2-3 years to come. That sends a powerful message to Putin that Ukraine can financially sustain the long war, and you are going to pay for it. Sweet.

Third, in terms of the means - the EC issues a loan/bond, bought using CBR assets in Euroclear, or at banks in other G7 juridcations, and this is used to fund an SPV which then channels funds to Ukraine, a few thoughts specifically on this:

Obviously this helps alleviate concerns about confiscation - the underlying assets remain the property of Russia, but instead of owning bunds, Gilts or USTs, they are now zero coupon 30 year instruments issued by the EU for Ukraine. The assumption is that these funds are only paid back to Russia in thirty years time after offsetting against reparations - the NPV on a zero coupon in any event significantly reduces their value, or liability, thirty years down the line.

I would assume also that funds, while parked immediately in the SPV, are then only disbursed to Ukraine, and for military needs in support of the war, over an extended period of time - say 2-3 years. And if the war ends earlier, the funds can be used for recovery and reconstruction. With this in mind I think it would be wise to shape the SPV into more of a sovereign wealth like structure. In the short term it could be used as an asset management vehicle to maximise returns of funds held on account for Ukraine. Think here an EM credit fund could generate 8-10% return pa, and an EM local market fund high teen digits, at least this past year. Longer term though I think this sovereign wealth fund could provide a range of advantages, particularly in terms of the period of recovery and reconstruction. It could plan or programme that reconstruction, lead - drive the reform agenda in Ukraine, raise money on its own behalf and perhaps collateralised by CBR assets - leveraging up the bang (literally) for buck of these assets - act as a partner for private investment into Ukraine (GIC plus Temesek). I would imagine this entity would be jointly owned/managed by Ukraine and the G7 initially, but with ownership migrating fully to Ukraine, say upon EU accession. I have called this entity the Agency for Ukrainian Reconstruction and Accession to the EU (AURA). Three and half years into this war and after numerous Ukraine Recovery and Reconstruction conference zero progress has been made in setting the institutional framwork around recovery and reconstruction. Action now on the immobilised CBR asset front, and talk of creating an SPV for managing CBR assets presents a great opportunity to kick star creating such an entity, like AURA. Let’s just get it done.