EU leaders meet on December 18-19  to vote on rules that would allow the seizure of billions of euros of Russian money frozen in EU accounts that will be used to back €210bn worth of Reparation Loans for Ukraine that is bound to trigger a significant retaliation by Russia if the vote succeeds. 

The idea of using Russia’s frozen cash is highly controversial as its legality is questionable. The scheme invites a blizzard of legal suits by Russia and could cause a massive outflight of funds from Europe as well as undermining the value of the euro that could undermine the stability of the European financial system. 

The Fitch ratings agency downgraded the European depository Euroclear with a negative watch outlook on December 17 due to the legal and financial risks associated with the scheme.

The idea is being championed by European Commission President Ursula von der Leyen and EU foreign policy chief Kaja Kallas, but has been fiercely resisted by Belgium, where the bulk of the funds are in the Euroclear, the European depository.

Seven EU countries oppose the seizure of the Bank of Russia's assets: Italy, Bulgaria, Malta, and Czechia have joined Belgium, Hungary, and Slovakia, which had previously opposed such a move. Both the International Monetary Fund (IMF) and European Central Bank (ECB) have questioned the legality of the scheme as well as a raft of private investors and banks. 

If the decision is approved it will bring down a storm of legal challenges by Russia that could overturn the decision leaving Belgium on the hook for €140bn of repayments to Russia and do irreversible damage to Europe’s financial system and the euro’s reputation.

Moreover, as bne IntelliNews argued recently in an opinion piece arguing the EU’s Reparation Loan vote needs to fail as it will also kill off any chance of a US-brokered peace deal that has made good progress since a Moscow meeting between Putin and the US envoys on December 3 followed by a Berlin meeting on December 14-15 where most of the points of contention were agreed, bar an agreement on security guarantees and the ownership of territories in the Donbas.

A successful vote on approving the Reparation Loan will only deepen a growing rift between Washington and Brussels as part of the US President Donald Trump backed 27-point peace plan (27PPP) is to use the Russian funds to seed a $100bn US-Ukraine reconstruction fund and a $200bn US-Russia investment fund.

Likewise, a recent decision to ring fence the money and head off a Hungarian veto by nixing the bi-annual need to renew the freeze on the CBR assets using Article 122 of the EU’s founding treaty that grants emergency powers in times of crisis, is also almost certainly illegal and will be challenged in court.

A lot rides on the success or failure of the vote. If it succeeds, then it will create €210bn, enough money for the EU to fund Ukraine for about two years. But if it fails, Ukraine faces a macroeconomic collapse sometime in the first quarter of 2026. According to EU and IMF estimates, without American financial assistance, Ukraine will need €136.6bn over the next two years to continue the war, and another €136.6bn just to cover budgetary needs, excluding defence spending, over the next four years.

Anticipating trouble, von der Leyen has suggested two alternatives: EU member states continue to fund Ukraine out of their own pockets; and the EU issues collective debt to raise the cash. The first option is anathema to the majority of cash strapped governments that will be unable to sell the idea to their electorate. Last year’s G7 $54bn loan to Ukraine was arranged in early 2024 as a EU collective debt deal and part of the €210bn the EU is trying to raise now will go to repaying that debt. But this new much bigger debt is in practice unworkable. To do it again would require a unanimous vote by all 27 member states and Hungary amongst others are certain to veto it.

How will Russia respond?

Putin has promised to retaliate if the EU confiscates its money. A blizzard of lawsuits is a foregone conclusion, but that is not all Russia can do.

The first thing the Kremlin will do is go after Western money trapped in Russia and confiscate funds held in special “C” accounts, totalling more than RUB500bn (€5.4bn; $5.9bn). Unlike the frozen Central Bank of Russia (CBR) money in the west, which is the property of the state, the ”C” accounts hold mostly privately-owned money of companies and banks.

These “C” accounts, created in 2022, hold payments such as dividends, coupons, and bond redemptions for non-resident investors from “unfriendly” countries. In 2024, a Russian court stated that JPMorgan alone held RUB243.3bn in the country, “primarily” in “C” accounts.

While access to the funds has been blocked for nearly three years, they have not been formally nationalised and technically the money in the accounts still belongs to their owners. Many Western companies have already written off this cash as irrecoverable, though some continue to hold out hope for eventual recovery.

While the money in the “C” accounts is very hard to get to, it is not totally off limits. There are a few permitted uses for the money such as tax payments or investment into government securities.

However, the Kremlin could immediately confiscate all this money, much faster and more simply than the EU can confiscate the Russian frozen funds, and transfer it to the budget. That would provide a much needed boost to the government’s revenues which is struggling to cover a swelling budget deficit.

Another option is to seize Euroclear’s money trapped in Russia. As Russia was hooked up to the international financial system in 2012 after it joined Clearstream and Euroclear settlement systems, Euroclear had an estimated RUB250bn ($3bn) of funds stuck in Russia’s depository and settlement system in 2023, when sanctions were imposed. Officials believe this figure may have grown substantially over the past two years thanks to interest payments. If the Kremlin takes this money, Euroclear would have to book the disappearance of these funds as a loss, a hit to the depository’s profits it would have to cover, adding to Belgium’s reluctance to seize the Russian money.

Another retaliatory option is to grab Western physical assets such as factories and real estate in Russia. In late September Putin signed a decree that expedites the valuation and sale of Western companies deemed “hostile.” The decree reduces the valuation period from months to just ten days, paving the way for faster nationalisations should EU asset confiscations proceed.

At the same time, Moscow is dangling a carrot in front of Western investors by adding rules that allow for possible exchange of their frozen assets for Russian ones. These include modifications to “C” account regulations, the creation of new “in-accounts” with guaranteed withdrawal rights for fresh investments, and a legal differentiation between "old" and "new" investors.

This mechanism has been used before to return money to Western investors that bought the short-term treasury bills, the GKOs that were the precursor to the current Russian Finance Ministry’s OFZ treasury bills, that were trapped in “C” accounts after Russia defaulted on its bonds in the 1998 financial crisis.

Lawsuits and arbitration

Russia has a good chance of winning lawsuits in Europe, forcing Belgium to repay the funds. While governments are free to freeze central bank funds, technically they remain the property of their owner. Europe would have declared war on Russia to be able to legally confiscate the money.

The CBR fired the first salvo in the coming legal battle by filing a lawsuit last week in the Moscow Arbitration court against the Euroclear depository, demanding RUB18.2 trillion ($229.36bn) be returned.

While the Moscow court has no jurisdiction over Euroclear, the move is important as it begins building the paper trail that will later be perseverated to European Arbitration courts, which do have jurisdiction.

Ukraine’s national gas company Naftogaz won a landmark arbitration case against Russia’s Gazprom in Stockholm in 2018 and subsequently collected approximately $2.1bn as part of the award. Naftogaz won a second arbitration lawsuit in the Hague’s Arbitration Tribunal in 2023, this time for $5bn as compensation for the company’s assets in Crimea seized by Russia in the 2014 annexation of the peninsula. As of late 2023, Naftogaz began legal proceedings in the US to enforce the award and seize Russian state assets located abroad.

These legal cases are serious. As Russia’s assets are in Europe they are subject to EU law and so are protected by Europe’s own strong property rights. Any European entity that loses a case to the Russians will be obliged to pay.

London bankers are particularly worried as they hold a lot of Russian money, a favourite banking haven for Russian businessmen, although exactly who holds how much remains a commercial secret. This month the Financial Times reported that London bankers have asked the government to indemnify them against Russian lawsuits after the UK government promised to seize some $8bn of Russian assets frozen in Britain. European banks are also in the firing line.

Legal shell game

The European Commission (EC) has been working on the scheme to seize the Russian money and use it, while technically leaving the Russian ownership of the money untouched.

Of the Russian money held in Euroclear, most of it has already been converted into cash. About €176bn of the Russian bonds has matured and the proceeds were retained under the sanctions regime. Roughly €9bn of the assets are still in the form of securities — mainly bonds that have not yet matured and are due in 2026 and 2027. It is this enormous cash pile that is so tempting.

Moreover, this cash earns interest too, so the pile continues to grow. It is this interest profit earned each year – around $3bn annually – that has been tapped so far to fund Ukraine, and skimmed off as taxes on the interest payments that do not belong to Russia.

What is being proposed at the European Council meeting in the coming days is how to legally get hold of the cash pile.

The scheme looks like this: the EU will issue zero-coupon bonds. Member states provide guarantees on the bonds, making these securities extremely reliable – in other words a good proxy for cash. Euroclear has the right to swap Russia’s cash pile for these bonds. From an accounting point of view it makes no difference if Russia’s assets are in the form of cash or very high grade bonds.

In exchange for these bonds, the cash pile can then be paid out to the EU members who can use it to make the Reparation Loan to Ukraine. This is not debt to Ukraine and doesn’t go on its national balance sheet as the obligation is to pay off the bonds should they ever be redeemed. On paper nothing has changed – Russia still owns its money.

But from a banking point of view, you have freed up a huge amount of cash and replaced the obligation to Russia with pieces of paper – nothing more than a promise to repay the face value of the bonds.

The key to this scenario is that the bonds do not pay a coupon so it costs the EU nothing to issue them. Moreover, the bonds do not mature so will remain paper promises forever. The only time the bonds can be redeemed (i.e. turned back into cash) is when Russia pays Ukraine reparations, hence the name – which will never happen.

There are still several problems with this scheme. The first and biggest problem is that the EU is proposing to swap Russia’s cash for bonds but if a court rules in Russia’s favour or the sanctions freezing the money expires. Russia is still the owner of this money and will have to be paid – in cash.

Belgium is in the firing line here if it is the one issuing the bonds, so will be on the hook for the whole amount if the bonds need to be redeemed, hence Belgium’s Prime Minister Bart De Wever’s objection to the scheme as the other EU states are not willing to share this risk.

Secondly, there has been no talk of reparations in any of the negotiations with Russia and clearly Moscow will flatly refuse to pay reparations. The only way to get Moscow to pay reparation is if it is defeated militarily, which was never going to happen thanks to Europe’s “some, but not enough” strategy of giving Ukraine enough money and weapons so it can’t be defeated, but not enough to win the war.

At the centre of the Reparation Loan scheme is the idea that the promise of the bond can only be redeemed out of the reparations Russia will pay at the end of the war. As this is clearly a fantasy, that puts bankers in a bind. Under EU prudential banking regulations, particularly the Capital Requirements Regulation (CRR) and Banking Union rules, it is illegal to make a loan you know will never be paid back, thus opening a whole new channel of potential lawsuits.