DESKAA to hit banks more than sovereign, as US Congress and administration try to outdo each other on sanctions

15 August 2018

“The DESKAA bill is a very serious proposition, and the recent fallout is an indication of the damage that could be done to the Russian markets if the bill is signed into law. We are in unprecedented territory,” the lawyer said.

The banks targeted by DESKAA (Vnesheconombank, Sberbank, VTB Bank, Gazprombank, Bank of Moscow, Rosselkhozbank and Promsvyazbank), were particularly hard hit in the fallout last week, as reported.

“These banks are the pillars of the Russian financial system, meaning that the government will not allow them to go bankrupt,” the lawyer added.

But, “despite state support, in practical terms all their corporate clients would need to move their accounts to private (unsanctioned) banks. In addition, private clients, many of whom hold deposits in hard currencies such as the US dollar (because of ruble volatility), may also be affected,” he continued.

The banks may also be deserted by other, foreign lenders operating in Russia. “European banks with no exposure to the US are also likely to avoid interacting with the sanctioned Russian banks if DESKAA is signed into law,” the lawyer said. European lenders Raiffeisenbank, UniCredit and Societe Generale (through its subsidiary Rosbank), all have a strong presence in Russia.

Sovereign sanctions

The sovereign appears to have got off lightly under the new sanctions proposals.

“The banking sector sanctions are much worse than the sovereign sanctions, as the sovereign does not need access to western financing. Private companies and individuals will be harder hit than the government,” the lawyer noted.

The sovereign has been active in the market in the past largely to maintain a presence and to preserve its credit ratings, he added.

“The Russian government can finance itself,” the portfolio manager agreed.

Still, the sovereign’s credit rating could be downgraded if its access to Western funding is cut off, which in turn might lead to a number of state-owned corporates being downgraded, which itself could lead to a negative spiral, he noted. Although it would likely only be the more conservative investors such as pension funds that exit Russia if there are sanctions on new Russian sovereign debt, according to the lawyer, others disagree.

“There would be a very negative market reaction if even only new sovereign debt was sanctioned, as the markets will see this as a sign of more sanctions to come,” the portfolio manager said.

More sanctions are certainly likely, and Russia is unlikely to let them go unpunished. However, the country does not have an effective arsenal with which to fight back.

“I am worried about the Russian response. A previous anti-sanctions law was watered down after opposition from Russian business groups to harsh measures proposed within, but if the US implements strong sanctions on Russia, then the Russian reaction is also likely to be hard hitting,” the lawyer said.

Caught in the crossfire

The DESKAA bill has strong bipartisan backing in Congress, but is currently in draft format, and it is uncertain how the final bill will look compared to its present form, according to the lawyer.

However, it is far from the only Russian sanctions bill out there. Before DESKAA, the Defending Elections from Threats by Establishing Redlines Act (DETER) was seen as the most likely sanctions bill to be enacted into law.

In addition, the US State Department announced that the administration will be hitting Russia with additional sanctions later this month relating to the Skripal case. But, “these [administration sanctions] are likely to be a continuation and expansion of the existing sanctions regime,” the lawyer said.

Russia could begin to feel the heat in November, when the administration could hit Russia with additional ‘draconian’ sanctions (a follow up to sanctions this month) if it does not comply with chemical weapons inspections the US has demanded.

But the chances of Russia cooperating are slim. “The Russian government will never agree to chemical weapons inspections,” the lawyer said.

However, “sanctions against Russian state-owned banks are already ‘draconian.’ So if the DESKAA bill goes through, further administration sanctions are likely to be on Russian oligarchs from the OFAC list published earlier this year,” he added.

“A lot will depend on domestic US politics, and not so much on what Russia does,” he continued.

Indeed, “this is largely an issue of a political backlash by institutions in the US against the administration, which has caught Russia in the crosshairs,” the portfolio manager agreed.

“The situation may well get worse before it gets better,” the lawyer said.

by Tomas Cutts