5 ways Russian sanctions are affecting global
financial markets
The big threat now is from second-round effects, like
eye-watering energy prices and the war’s broader economic fallout.
BY HANNAH
BRENTON AND MATEI ROSCA
March 28,
2022 2:13 pm
It’s been
over a month since Russian troops attacked Ukraine — and financial markets are
still processing the reality of war in Europe and extensive Western sanctions
against Moscow.
The Moscow
Stock Exchange partially reopened its doors last Thursday, with restrictions on
foreign investors and short-selling propping up the market — which the U.S.
described as a “charade.”
“This is
not a real market and not a sustainable model — which only underscores Russia’s
isolation from the global financial system,” said Daleep Singh, the Biden
administration's deputy national security adviser for international economics.
But there's
also something more surprising: Outside of Russia, global financial markets
have stood firm. Aside from the selloffs hitting Russian stocks and companies
with strong links to Russia, broader contagion hasn't spread across markets.
Despite
surging commodity prices and volatility, "comparing markets today with
where they were before the invasion, investors might well let out a sigh of
relief," said Danni Hewson, a financial analyst at investment platform AJ
Bell.
This isn't
to say some parts of the global system aren't showing signs of strain or aren't
behaving unusually due to the war. A good example is the burgeoning political
debate over the use of cryptocurrencies to evade restrictions, and efforts of
Western countries, like Estonia, to clamp down.
But more
broadly, the big threat now facing the financial system is in the form of
second-round effects, like eye-watering energy prices, and the economic fallout
from the war. Soaring inflation and rising interest rates, in turn, could
swiftly change sentiment toward particular markets that have benefited from
investors’ search for yield for over a decade.
With those
risks in mind, the European Systemic Risk Board, the financial system’s
watchdog, has warned the war's effect on the EU could be “much larger than
currently expected” due to supply-chain disruptions and higher prices for
households and firms.
Here’s how
the war's impacting financial players so far.
Banks
EU bank
shares took a pummelling at the start of the war, especially among lenders with
substantial operations or lending portfolios in Russia. But banks and their
supervisors have repeatedly described the exposures as manageable — even in
cases of a total write-down. For example, UniCredit, Société Générale and
Raiffeisen, which all have notable links, have either sought to reassure their
investors or signaled a retreat.
"In
practical terms, carving Russia out of European banking will be far easier than
carving it out of European energy," said Sam Theodore, a senior consultant
affiliated with Scope Group.
In a
presentation to EU capitals earlier in March, the European Banking Authority
said exposures to Russia and Ukraine stand at around €90 billion, or 0.3
percent of banks’ books. But it did point to a broader risk: The worsening
economic outlook and higher rate of inflation are likely to hit banks by
hurting some borrowers' ability to repay their loans.
Plus,
banks' work is still ongoing as they wade through their books to freeze any
accounts or assets linked to sanctioned individuals or companies. The EU’s main
banking associations this week sent a letter to the European Commission asking
for more clarity on details like what counts as “control” of a company; when to
freeze Russian deposits; and how to close repo transactions with the Russian
central bank.
Insurers
Insurers,
too, are largely walled off. The European insurance sector has an overall
exposure to Russia of less than 0.1 percent of its total holdings, according to
quarterly data from the European Insurance and Occupational Pensions Authority.
The direct effect of the war in Ukraine and economic sanctions on the health of
European Economic Area insurers therefore “does not appear substantial,” the
insurance regulator said. But second-round effects are still a risk.
Insurers
can generally be hit on two sides, either through their large investment
portfolios or their underwriting. In the case of the latter, they may be on the
hook for indirect losses as well. Lloyd’s of London, the world’s biggest
insurance market, pointed to that risk last Thursday, when it said it expects
the conflict in Ukraine to be a major claim in the market this year. That’s
despite the fact that its underwriting in Russia and Ukraine only represents 1
percent of its global footprint.
Insurers
also have to brace for potential impact through exposures across aviation,
marine, credit risk and political risk business lines. For example, airplane
leasing companies are now fearing they may never get their planes back.
Fund
managers
Meanwhile,
fund managers with investments in Russia are stuck with “stranded assets.”
Pension funds, hedge funds and other asset managers have in many cases marked
Russian assets, ranging from stocks to commercial property, down to zero on
their books. But due to lack of legal clarity on transacting these assets,
they're in most cases refraining from attempting a sale.
That move
has led to some funds being shuttered to investor withdrawals — with at least
57 EU funds pulling up the drawbridge by the first week of March, according to
the EU’s securities regulator.
In a
presentation to EU capitals in mid-March, the European Securities and Markets
Authority said for the most part those closures came down to the difficulties
valuing assets rather than investors’ demands for their cash. One suggestion,
pitched by U.K. regulators, is that funds could use so-called side pockets to
separate out affected assets and keep the rest of the fund running as normal.
Russian
bonds and equities have also been dropped from some investor indices, such as
FTSE Russell and MSCI, due to the market being “uninvestable." Plus,
investors could be exposed to any default by the Russian state itself or its
major companies.
Clearinghouses
There's
been more turmoil in spiralling energy and commodity prices. This spike has a
knock-on impact in derivatives markets because banks have to stump up more cash
for margin calls if the price moves against their position. This has in the
past created a dash for cash in other markets. (Margin calls are when brokers
ask investors to deposit more money or securities into their account, in a
signal of market volatility.)
In its
presentation, ESMA described commodity derivatives as “bracing for impact,”
including through short positions and margin calls. The London Metal Exchange
was also forced to suspend trading in nickel, cancel trades and delay margin
payments — due to a short squeeze. Price turmoil returned last Thursday, and
LME is reportedly planning to double the size of its default fund starting in
April.
But this
isn't cause for broader panic, according to the Bank of England. It noted last
Thursday that while margin calls are at record highs, market participants have
been able to meet the demand for additional funds, partly thanks to handsome
profits they're making on intensified volatility and high pricing. Regulators
continue to monitor trading closely, the Bank said.
"The
invasion has led to significant stress in a range of commodity markets,"
the report said. "A key uncertainty is whether interconnections within the
financial system — for example between energy and other commodity markets,
wider financial markets and the real economy — might create feedback loops and
amplification mechanisms across the financial system more broadly."
Central
securities depositories
Another
major part of the financial system's plumbing is central securities
depositories, which play a vital role ensuring securities trades settle —
meaning one side delivers the bonds or stocks and the other pays up the cash.
So when Russian restrictions kicked in, the two main EU players, Euroclear and
Clearstream, were central in cutting off trades in rubles.
As a result
of sanctions, central securities depositories are likely to see their balance
sheets swell, Fitch Ratings said, describing the fallout as manageable. Blocked
coupon payments and redemptions will start accumulating in domestic accounts at
Euroclear or Clearstream, or in their frozen accounts at the Russian National
Settlement Depository (NSD), depending on “the willingness or ability of
Russian issuers” to credit foreign holders.
Clearstream
blocked the NSD's account last week, the Russian depository said Friday, while
Euroclear isn't processing any payments received into NSD's account until
there's more clarity from regulators. That could present another hurdle for
Russia to pay its international debts and avoid default, as Moscow is now also
demanding payments for gas in rubles.
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