International sanctions being prepared by the US and its allies for use against Russia if it takes military action against Ukraine would rock markets for several major commodities and unleash havoc in banking.
Senior officials from the US, UK and European powers are shuttling between capitals, thrashing out an agreement on a broad package of economic sanctions that they hope will deter Russian President Vladimir Putin from invading Ukraine. The Russian government denies any intention to snatch territory from its southern neighbour, but has amassed some 100,000 troops and massive firepower along Ukraine’s border, according to Western governments.
The US, whose sanctions regime is most far-reaching because of the importance of US banks and the US dollar to global trade, has indicated any future sanctions will target Russian financial institutions and officials, and will include export controls on crucial US technology products.
Analysts have also been scrambling to calculate the possible hit to global markets if entire export industries such as Russian gas, coal, oil, wheat and metals were to become off-limits to US allies. “Any commodity exported or originated from Russia would be a possibility to see sanctions imposed,” Maurice Thompson, a partner at law firm Clyde & Co, tells GTR. “Commodities like grain, coal and oil are the most obvious.”
A senior US government official, speaking to reporters on January 25, made clear the administration is “prepared to implement sanctions with massive consequences”, even if Russia’s military incursion stops short of a full invasion. “The gradualism of the past is out, and this time we’ll start at the top of the escalation ladder and stay there,” the official warned.
Russian financial institutions appear to be high on the list of targets in Washington.
A senior administration official who spoke on the condition of anonymity in the January 25 briefing suggested that the US and its European allies are nearing agreement on “the size of the financial institutions and state-owned enterprises that we’re willing to target”.
The US government has previously placed tough sanctions on Iranian banks and smaller financial institutions in other countries, but the major Russian banks such as Sberbank and VTB are much larger and more integrated into the global financial system.
Sberbank and VTB are among the banks that have been under a different range of US and EU sanctions since 2014 in response to Russia’s annexation of Crimea, but these are limited to curtailing their ability to raise debt and equity from other lenders.
Almost 40 Democratic lawmakers have created a wish list of sanctions they want to see imposed on Russia in the event of an invasion, in the form of a Senate bill that includes a list of banks that they want targeted, including Sberbank, VTB, Gazprombank, Alfa Bank, development finance institution VEB.RF and the Russian Direct Investment Fund.
The bill does not yet have the support of the White House, but Congress can pass its own sanctions legislation. The most likely course of action by President Joe Biden will be to shift the Russian financial institutions from the current limited sanctions programme onto what is known as the specially designated nationals and blocked persons (SDN) list, according to Adam Smith, a former US sanctions official, speaking at a webinar last week held by London’s Brick Court Chambers.
Any entity on the SDN list quickly becomes untouchable for any international bank with US exposure, which would be at risk of huge fines or being sanctioned themselves if they conduct transactions with an SDN entity.
For banks, the task of untangling themselves from existing customers or contracts will depend on the fine print of any sanctions, legal experts say.
“I think any bank that’s got a US, EU and Russian presence will be undertaking a number of different actions, but unless and until sanctions are imposed it’s a little bit of a guessing game. I think for now banks are preparing for a worst-case scenario,” Chloe Cina, head of Deutsche Bank’s global sanctions advisory, told the Brick Court Chambers webinar.
Cina said banks will be keenly watching how flexible governments will be on the speed of implementing the sanctions, whether businesses locked into contracts are allowed wind-down periods, and the eventual alignment between the US, EU and UK.
Clyde & Co’s Thompson says banks will have to closely dissect existing contracts that are hit by sanctions, because the agreements will not necessarily offer a “get out of jail free” scenario that allows the bank to exit the relationship.
For trade transactions, “the due diligence that any as-yet sales contract party will need to prudently go through will increase significantly”, he tells GTR.
“The obvious possible legal implication is that one will not be able to trade certain commodities to and from Russia, but often more challenging would be navigating how your trade may be adversely impacted by who you have, or are intending to contract with, given that both individuals and companies could face sanctions. [Know-your-customer] efforts will need extra attention to identify Russian beneficial owners.”
Financial institutions with a presence in Russia could also be ensnared by an attempt to enact anti-sanctions regulations similar to those recently introduced in China.
A proposed law that has been languishing in Russia’s legislature, the Duma, would make it a criminal offence to comply with Western sanctions. If enacted, “this would put employees of foreign corporates or financial institutions in Russia at risk of criminal prosecution”, according to UK law firm Eversheds Sutherland.
So far, the White House does not appear to be contemplating forcing Swift, the global messaging service for interbank payments, to remove Russian banks or face sanctions.
In a section taking aim at Swift, the Democrats’ bill also calls for sanctions on providers of “specialised financial messaging services to Russian financial institutions” if Russian banks are not kicked out, and in 2018 the Trump administration successfully pressured Belgium-based Swift to boot Iranian banks from its network.
But as yet the US government has shied away from repeating those tactics against Swift. Cina also questioned the effectiveness of the move, noting that adding the banks to the SDN list would be a much heavier blow.
Russia is a major exporter of oil, gas and coal. The country’s near-30% share of Europe’s natural gas imports has ignited fears of a major shortage of the fuel if Russia crimps supplies or gas exports are sanctioned.
If war breaks out over Ukraine the price of oil may hit US$125 per barrel and natural gas US$200 in per barrel of oil equivalent, according to a January 25 research note authored by Rabobank analyst Michael Every. “Assuming all countries halt purchases of Russian energy, the potential price impact would be huge, with oil rising to US$175 and European gas to US$250,” he writes.
US officials have said they are in talks with other major gas producers – which include Qatar and Australia – to shore up Europe’s gas supplies in the event that supplies from Russia run dry.
Sanctions will have a more significant impact on global markets than an actual conflict, Every believes.
China is unlikely to heed US sanctions and could purchase Russian energy exports at low prices and potentially act as a conduit for exports into the rest of Asia, Every writes. This could split global energy markets into two camps, with US allies facing surging energy costs while countries that ignore the sanctions are able to buy energy from Russia cheaply. The same pattern would likely be repeated across other major economies, he says.
Russia is also a top supplier of key metals such as palladium, nickel and platinum.
Sanctions on Russian-produced metals including palladium and nickel would result in “huge upside pressure on prices”, according to a research note by commodities consultancy CRU. “It would also mean a further rush to stockpile, exacerbating global supply chain problems across swathes of industry.”
CRU says it is unlikely that the US will directly sanction Russian palladium exports, given Russia’s sway over the market, but that aluminium, nickel and copper are more at risk. “Given that all three markets are very tight, this could be a big issue,” CRU’s research manager Eoin Dinsmore writes.
But the shock to the global aluminium supply chain caused by Washington’s imposition of sanctions on Russian aluminium giant Rusal in 2018 – which were eventually watered down after aluminium prices shot up – may make the new administrators hesitant to wield the tool against crucial metals.
“Metal inventories are so low today that a replay of that error would be explosive for prices,” Dinsmore warns.
Wheat and grains
Exports of wheat, corn and other grains could be hampered by war or sanctions because of both Russia and Ukraine’s status as global breadbaskets with large shares of total global production.
Analysts say almost half of Ukraine’s wheat production and around 40% of corn production comes from east of the Dnieper River, the region being bordered by amassed troops.
Any war that breaks out in the next few weeks is unlikely to have an immediate effect on wheat and grain exports because it is not harvested or grown in Ukraine during the winter, but if conflict starts or is ongoing after April, planting will be hit badly and futures prices will rise, according to Rabobank’s Every.
“Sanctions would see an extraordinary impact given inelastic consumer demand,” he writes, pointing out that wheat prices rose 21% in 2021 on an estimated market deficit of 8.8 million metric tons, “and sanctions removing over six times that amount could see wheat prices double”. The expansion of wheat growing by other producers could not compensate for the huge structural deficit.
Ukraine’s importance in the global wheat market has actually risen since 2014, meaning the sudden absence of exports could be even more painful, according to a research note by commodities analysts Mecardo.