Uncategorised
FEATURE: Wealth Managers Try To Measure How Deeply Russian Sanctions Will Bite

Following the recent sanctions imposed by the US and the European
Union over the ongoing crisis in Ukraine, Russia has remained
defiant, warning that these acts will backfire, causing further
economic woes for Western nations.
The new measures, the toughest against the Kremlin since the
height of the Cold War, aim to force Russia to change its stance
over its alleged support of separatists in eastern Ukraine by
targeting its financial, energy and arms sectors.
While the latest sanctions are expected to have limited
short-term impact on Russia, in the long-term, the economy, which
is already teetering on the brink of recession, is likely to feel
the strain. Economists have also said that EU economic interests
could be hit due to its close trading ties with Russia.
Chris Weafer, a partner at Moscow-based consultancy
Macro-Advisory, warns that as a result of the sanctions, Russian
high net worth individuals could permanently move their assets
away from Europe, although the new measures would “not materially
affect” the wealth management industry in total.
“We have already heard that Megafon, which is controlled by
Russia’s richest person, Alisher Usmanov, has moved its cash to
Hong Kong banks. This is a move I expect will be replicated by
other companies and increasingly, by individuals. But even when
sanctions risk ends, I expect to see much greater use of
financial services and wealth management from Asia, Singapore and
Hong Kong in particular,” said Weafer.
The latest sanctions signal a step up in resolve by the West and
come following a deepening of the crisis in Ukraine since the
downing of Malaysia Airlines flight MH17 in July.
As well as going after eight of Putin's top associates, the US
has expanded its sanctions to include three banks, the Russian
energy sector and defence companies.
Meanwhile, the new EU measures will restrict Russian state-owned
banks from accessing European capital markets and companies will
no longer be able to buy or sell new bonds, equity or similar
financial instruments with a maturity exceeding 90 days, as well
hitting the energy sectors and the export of arms.
“There will likely be two effects,” said Weafer. “The sanctions
threat should provide a boost to the development of domestic
financial services and secondly, Russians are more likely to look
to greater diversification in their wealth management,” he
said.
Weafer said that Russian businesses, many of which are owned by
high net worth individuals, would be hurt by the increased number
of obstacles they faced in order to carry out business and trade
with Europe.
“Even if the official sanctions are not hurting them
specifically, many Western banks and trade companies have adopted
a very cautious approach towards Russia risk and are on a
voluntary basis stopping or restricting trade with Russian
entities. That is also hurting profits and affecting the value of
their business and net worth,” he said.
“As a group, the wealthy Russians who are not part of the
political elite are very frustrated at the political events and
sanctions impact. But they have no political voice and very
little influence. They may not even complain too loudly inside
Russia,” he added.
Sanctions
A number of successful challenges to EU sanctions over the past
year have made the bloc wary of taking aggressive action against
Russia. Only now has the EU matched the hard-hitting measures
imposed by the US, following several rounds of mild
sanctions.
“The stance of the EU has changed significantly in response to
the downing of flight MH17 that was attributed to pro-Russian
separatists in Ukraine. These sanctions are substantively
different from the previous ones and are meant to hurt. It is
important to note that the EU sanctions have moved a step up in
targeting Sberbank, which the US sanctions have so far avoided,”
said Nonna Crane, a senior associate at Chadbourne & Parke, a
London-based international law firm which specialises in
sanctions.
Earlier this year, German chancellor Angela Merkel said that
legal considerations had played a significant role in the EU’s
reluctance to match US measures.
“We in Europe are bound to having an obvious connection to Crimea
– ie, the offence that is at the base of the sanctions,” said
Merkel. “That’s a different legal situation from the US.”
This followed the case last year of Iran's Bank Mellat, which
successfully got EU sanctions against it quashed and then sued
the UK Treasury for $4 billion in compensation for alleged lost
business (for an exclusive interview with Sarosh Zaiwalla, the
lawyer who won the case for the bank, click here). Commentators on the crisis have suggested
that because of this judgment, the EU has been wary of imposing
stricter sanctions against Russia and as a result previous
measures were largely cosmetic.
“The Bank Mellat ruling could be used by entities or individuals
affected by sanctions as a precedent to challenge them. Whether
we are going to see those targeted taking the same action remains
to be seen. With time, depending on how long the sanctions last,
we may see them challenged,” said Kevin Atkins, international
partner at Chadbourne & Parke.
“In order to challenge the sanction, an entity or individual
would have to demonstrate that there has been a substantive error
in that the restriction imposed upon it is not proportionate or
justifiable and there are a number of recent examples of
successful challenges of this nature at the EU and UK
level. EU challenges would be made to the general court of
the Council or the European Court of Justice whilst UK challenges
would be made to the High Court, with the right of appeal up to
the Supreme Court,” said Atkins.
Effectiveness
Opinion on the effectiveness of sanctions is divided and many
observers are sceptical that they will force Putin to reconsider
his Ukraine strategy.
On the one hand, as Russian trade and investment are spread
across multiple jurisdictions, it is therefore not dependent on
one country and could see its way through the storm by expanding
trade elsewhere.
However, analysts have pointed out that as a result of Russia's
weakened economic performance in recent years and slow growth,
authorities will want to minimise as much negative impact as
possible. Asset bans and visa restrictions targeted at the
wealthy may also increase pressure on Moscow to negotiate a
settlement.
While the Russian economy expanded by 1.3 per cent last year, the
Washington-based International Monetary Fund has projected a much
lower 0.2 per cent growth this year due to the sanctions, in
contrast to the forecast last year of 3.3 per cent.
“Russia is going to feel the pressure this year, and gross
domestic product decline will continue in 2015. However, even
without the sanctions the Russian economy would be weak. It is
anyone’s guess if sanctions are effective and trigger a policy
change towards Ukraine by Russian authorities,” said Michal
Dybula, an economist at BNP Paribas.
Macro-Advisory's Weafer said that it was still too early to tell
whether the new sanctions would bring about a change in policy
from Moscow.
“Will they change Russia’s political stance towards East Ukraine?
There is no evidence of that as yet. But the downing of MH17,
which directly led to this move to stage three sanctions, was a
major game-changer. It is still too early to be able to say what
the political impact will be - but there will be a clearly
negative economic impact,” said Weafer.
Banking
The EU has been heavily criticised by Russia’s biggest banks for
including the financial services industry in its new round of
sanctions.
Sberbank, Russia’s biggest bank by assets, said in a statement
that the new EU sanctions would do nothing to ease the troubles
in Ukraine and that they undermined “the foundations of the
global financial system".
Weafer said that blocking the state banks from accessing US
dollar and Euro debt beyond a 90-day maturity will cause a
“squeeze” on the domestic Russian debt market.
“The banks will of course get access to state money via the
central bank and the big corporations will also get access to
state funds. But the small and medium-sized enterprises and
individuals will find it tougher to access new debt and the cost
of both servicing existing debt and any new debt will be higher,”
said Weafer.
“We have estimated a 100-basis point rise in the short-term
interest rate, which will hurt Russian GDP by nearly 1 percentage
point after three to four quarters. This is quite a significant
impact that will not only be weighing on the respective banks
with restricted access to capital markets, but feeding into the
Russian economy,” said Dybula.
“Certainly we are expecting the pressure on the Russian currency
is going to remain high as private capital outflows accelerate.
Wider ramifications of this will be that less money is available
for domestic investment, which will harm overall economic
performance,” he added.
In response to the crisis in Ukraine, a number of Western banks
have already cut their exposure to Russia to protect themselves
from potential risk as a result of the ongoing instability in the
region. Citigroup, the US bank with the largest footprint in
Russia, cut its total exposure by 5.3 per cent to $8.9 billion
for the three months ending on 30 June, while Bank of America
Merrill Lynch reduced exposure by 40 per cent in the first half
of the year to $3.9 billion.
“With banks already reducing their exposure to Russia, the new
sanctions are only going to exacerbate this,” said Dybula.
EU impact
But what about the impacts of sanctions on the EU?
So far, in retaliation to the sanctions, Russia has imposed an
embargo on food imports from the EU, US and some other Western
countries, leading the European Commission to promise financial
support to EU vegetable and fruit growers.
The Polish prime minister has already said that sanctions would
reduce Poland’s GDP by 0.6 per cent by the end of the year.
UK exports to Russia and Ukraine account for just 0.5 per cent of
UK GDP, suggesting that little damage would be done to the UK
economy overall. More significantly, Russia and Ukraine account
for 1.1 per cent of EU GDP and 1.6 per cent of German GDP.
“I tend to think that some countries will be affected more than
others, particularly those with stronger ties to Russia through
financial or trade links,” said Dybula.
“The biggest hit we are going to see in terms of GDP will be the
countries in Central and Eastern Europe. Poland in particular has
been hit by Russia's ban on food exports, while Russian sanctions
against Germany's manufacturing industry could hurt GDP by more
than 1 per cent,” he added.
Weafer said that current sanctions could hit London harder than
most other EU countries and warned that the potential future loss
could be significant.
"If Russian banks and big corporations are now forced to seek
alternative banking and financing arrangements in Asia or
elsewhere, then they may keep those new relationships when the
sanctions end," said Weafer.
"Russia has long-term plans for a huge increase in investment and
for new listings. Normally the bulk of that would have gone
through London. Now it may be more spread between other locations
and London’s dominance of Russian banking may be lost," he added.