Frozen Russian Assets to Finance Ukraine: Collateralization Instead of Confiscation

Two years after Russia’s full-scale aggression against Ukraine, support for funding Ukraine among Western states has shown the first signs of strain. Attention has thus turned to whether financial aid to Ukraine could be provided by harnessing the more than $300 billion in reserves of the Central Bank of Russia (CBR) that were frozen by Group of Seven (G7) states in the aftermath of the invasion. The sanctioning states remain divided over the feasibility and legality of confiscating the assets outright. The United States, with support from the United Kingdom, Japan, and Canada, is pushing for confiscation—meaning permanently depriving Russia of these assets to disburse them to Ukraine. The European Union, however, and some of its member states—notably Germany, France, and Italy—have expressed reservations about this plan due to the difficulty in reconciling confiscation with established principles of international law—primarily, foreign sovereign immunity—and its potential impact on financial markets.

In recent weeks, alternative proposals to use the frozen CBR assets without confiscation have gained momentum. On March 5, U.K. Foreign Secretary David Cameron announced that Britain is contemplating loaning these assets to Ukraine with the expectation that they will be recovered from Russian reparation to Ukraine after the war. This echoes a plan circulated by Belgium among G7 states in February, aiming to use CBR assets as collateral to raise debt for Ukraine. Proposals involving the collateralization of frozen Russian assets have also garnered attention in financial media. 

Collateralizing CBR assets presents an attractive proposition, offering Ukraine short-term liquidity while postponing the complex legal questions associated with confiscation. However, some observers have questioned whether collateralization truly represents a viable alternative to confiscation. As noted by one European official, “[U]sing the assets as collateral suffers from the same legal, economic and financial concerns as a confiscation and most legal departments across the G7 consider that.” 

The legality of collateralizing CBR assets is not straightforward. There are several methods by which collateralization could be pursued, each posing its own legal challenges. 

Key Factors to Evaluate the Legality of Collateralization

When assessing the legal viability of proposals to use CBR assets as collateral, four main factors must be considered: transfer of rights, third states’ involvement, permanent effects, and default risk.

Transfer of Rights

All collateralization proposals involve varying degrees of deprivation of Russia’s rights to control its property. However, this is not meaningfully different from what is already happening while CBR assets remain frozen. So long as this situation remains temporary and reversible, it is not legally problematic. Although CBR assets are state property in use for sovereign (central banking) purposes, and, as such, are immune from measures of constraint, such immunity may be temporarily suspended as a countermeasure. As set out in Articles 49-53 of the International Law Commission (ILC) Articles on State Responsibility, such a measure would serve as a means to induce Russia to comply with its obligation of cessation and reparation resulting from its unlawful aggression against Ukraine.

Third States’ Involvement

Given that CBR assets are not currently in the hands of the injured state (Ukraine) but of third-party states (G7 states), it is important to identify the extent to which each of the parties involved would be required to act under specific scenarios for a loan transaction to be legal under international law. In particular, certain measures taken by G7 states that interfere with Russia’s rights regarding its central bank assets may be justifiable only as “collective countermeasures.” Although there is a growing trend of state practice in support of such measures, their acceptance is still the subject of debate.

Permanent Effects

Given that, under 49 of the ILC articles, countermeasures must be “as far as possible” temporary and reversible, another factor to consider is whether collateralization may lead to permanent confiscation of CBR assets. According to Paul Stephan, the irreversibility of confiscation would make it inherently unsuitable as a countermeasure. Once state property has been transferred to a new owner, it is no longer possible to reverse that measure, even if the wrongdoing state has resumed compliance with its international obligations. Similarly, Ingrid (Wuerth) Brunk highlighted that confiscation does not fulfill the “inducement” purpose of countermeasures. Instead of seeking to pressure a state to provide reparation, confiscation acts as a self-help remedy that could be exploited for political reasons. However, there are circumstances in which a countermeasure, although not fully reversible, may still be justifiable. The enforcement of an award of damages by an international court may be one of these circumstances, since the effects of asset confiscation would be equivalent to the payment of what is owed by the responsible state. Therefore, it is critical to define on which conditions and at what point in time CBR assets might be permanently confiscated after their collateralization.

Default Risk

Although not a condition for its legality, it is important to understand who would bear the risk of default if Ukraine were unable to repay the debt accrued through collateralizing CBR assets. Collateralization proposals often assume that Ukraine holds a legal claim against Russia for war reparation exceeding the value of currently frozen CBR assets. This assumption is reasonable given that, under Article 31 of the ILC articles, the responsible state is obligated to provide “full reparation” for the injury caused. As of Feb. 15, the World Bank estimated the cost of Ukraine’s recovery and reconstruction at $486 billion—far in excess of the $300 billion in frozen CBR assets. However, war reparation often involves lump sum payments that may not cover all damages resulting from the conflict. Moreover, in the absence of an award of damages by an internationally recognized body, Ukraine or the G7 states may be unwilling to confiscate the assets due to the uncertain legality of such a move. Therefore, it is possible that Ukraine may find itself exposed to its creditors for a sum exceeding the amount lawfully recoverable via the frozen CBR assets.

Option 1: Placing CBR Assets Into an Escrow Account to be Used as Collateral by Ukraine

The most straightforward way to collateralize CBR assets is to put them at the disposal of Ukraine, so that Ukraine can offer them as a guarantee to investors when issuing bonds or receiving loans. According to a former Biden administration official, this could be achieved by placing CBR assets into an escrow account—an account where the assets are held in trust by a third party on behalf of those owning the money—which could then be used by Ukraine as collateral. 

This would involve vesting Ukraine with control of the CBR assets, given that Ukraine must be legally capable of pledging them as guarantee to its investors. As Philippa Webb argued, this transfer of rights could be temporarily justified as a countermeasure, so long as it is done on the condition that the assets will be returned to Russia upon provision of reparation. Moreover, given that G7 states would be required to transfer custody of CBR assets to a third party, they would arguably be participating in this countermeasure.

Legal challenges may, however, arise in the case that Ukraine is unable to repay its bonds or loans. At that point, the guarantee (CBR assets) will have to be released to the investors to fulfill their contractual claims. This would involve the permanent confiscation of the assets, accompanied by the associated legal challenges. The hope among G7 states is that by then, Russia will have provided its reparation or an international court will have awarded damages to Ukraine. However, in the absence of a lawful way to seize the assets, the risk of default in this scenario would ultimately fall on the private investors.

Option 2: “Investing” CBR Assets in Ukraine’s Bonds Subject to the Obligation to Provide Reparation 

To shift the default risk away from private investors, an alternative is to have Russia assume this risk by “investing” its assets in Ukrainian bonds. According to Maximilian Hess and Yakov Feygin, one approach to achieve this while still linking the use of CBR assets with the obligation to provide reparation is for Ukraine to issue catastrophe bonds. Commonly known as cat bonds, these instruments are typically used in the context of natural disasters. They represent high-risk investments, where bondholders risk losing their principal if a specified trigger event occurs, such as a hurricane or flooding. Ordinarily, if such an event is triggered, the invested funds are redirected toward reconstruction efforts. To compensate for this elevated risk, investors typically receive a high interest rate.

By investing CBR assets in Ukrainian cat bonds, Russia would retain ownership of its investment and be nominally entitled to repayment with interest. However, the pivotal trigger event for these bonds, marking the risk of Russia losing its initial investment, would be Ukraine’s award of damages for war reparation—through either a judgment or a negotiated settlement. Russia would then forfeit its assets, transferring ownership of them to Ukraine, which would then relieve Ukraine of any legal obligation to repay the outstanding amounts.

Similar to Option 1, under this approach, Russia would temporarily lose the right to manage its assets, with the G7 states facilitating their investment in Ukrainian bonds. However, compared to Option 1, there is a stronger argument for justifying this suspension of rights as a countermeasure, as the permanent confiscation of CBR assets would occur only if damages were awarded to Ukraine. To bolster this justification, the trigger should also hinge on Russia’s refusal to comply with a reparation award. Additionally, the bond should stipulate that the amount taken from the CBR assets must be deducted from any war reparation to prevent double recovery for the same wrongful acts.

Nevertheless, challenges may arise if an award of damages fails to materialize by the bond maturity date. While refinancing would be possible, Ukraine could ultimately find itself indebted to Russia—a paradoxical situation that may leave Ukraine with no choice but to confiscate the CBR assets, potentially triggering further legal challenges.

Option 3: G7 States Issuing a Loan to Ukraine Using CBR Assets as Collateral

To prevent Ukraine from accumulating financial debts to Russia, an alternative is for the G7 states to act as creditors for Ukraine using CBR assets as collateral. In a recent paper, Hugo Dixon, Lee C. Buchheit, and Daleep Singh propose that G7 states issue a syndicated loan to Ukraine backed by the CBR assets they control as guarantee for repayment. This approach aligns with remarks made by Cameron, in which he advocated for “a syndicated loan or a bond that effectively uses the frozen Russian assets as a surety to give that money to the Ukrainians.” 

A similar variation, suggested by Martin Sandbu, proposes that G7 states establish a “special purpose vehicle” (SPV) to issue bonds, with frozen assets serving as collateral. Investors in the market would be able to purchase these bonds, and their investments would then be channeled to Ukraine as a loan from the SPV. The main advantage of using an SPV is that the risk connected to the loan is transferred from the G7 states to private investors, but the G7, as owners of the SPV, would remain in control of the loan. This was, for example, the case with the European Financial Stability Facility, which was created as a temporary crisis resolution mechanism by euro area countries in June 2010.

In both proposals, the underlying concept is that when Ukraine is awarded damages against Russia, these funds can be used to repay the G7 (or the bondholders, in the case of the SPV). Specifically, if Russia fails to fulfill its obligation to pay damages voluntarily, Ukraine can set off the damages claim against the claim held by the G7 against Ukraine.

The primary advantage of this option is that CBR assets would remain under the control of the G7 states, requiring no transfer of rights over these assets when issuing the loan. However, given that Ukraine does not hold these assets, the only guarantee of repayment it can offer the G7 is its legal entitlement to claim reparation from Russia. Once specific damages have been awarded to Ukraine by an internationally recognized body, the G7 could commence foreclosing on its collateral, namely Ukraine’s entitlement to such reparation. Precisely because Ukraine owes money to the G7 and Russia owes money to Ukraine, these sums can be set off against each other.

The main legal challenge with this proposal is the absence of any international legal precedent whereby an injured state delegated its right to claim reparation for an internationally wrongful act to other states, at least to our knowledge. Adding to the complexity, CBR assets remain protected by immunity, preventing G7 states from offsetting their claim in the same manner as a private creditor collecting a third-party payment from another private entity. To lift immunity and confiscate CBR assets against Russia’s will, G7 states would need a legal justification, which could only be found in the law of countermeasures. But even leaving aside the potentially problematic nature of such a permanent countermeasure, a key issue remains. By taking this countermeasure, the G7 states would be seeking to obtain reparation from Russia for their own benefit to set off Ukraine’s debt to them. However, it is unclear whether the legal entitlement to take countermeasures can be transferred from Ukraine to the G7 in this manner.

In sum, this option could potentially result in the G7 states being faced with a difficult choice: either confiscate the frozen CBR assets despite the related legal challenges or accept the risk of Ukraine defaulting on its debt. This outcome may very well be the intended objective. According to Dixon, Buchheit, and Singh, it would provide G7 states with a direct financial incentive to withhold the assets until reparation is provided. However, this eventuality should be fully understood before committing to this course of action.

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Exploring legally viable alternatives to confiscation of CBR assets remains a complex but essential task, demonstrating a commitment to both supporting Ukraine and upholding international law. However, no perfect solution exists, and all options involving CBR assets as collateral carry inherent risks.

The discussed options hinge on temporarily suspending legal obligations owed to Russia, which is legally feasible so long as it aims to pressure Russia to provide reparation to Ukraine. However, in all scenarios, there are potential dilemmas if damages are not awarded to Ukraine or if a negotiated settlement is not reached. In such cases, difficult decisions may be necessary, including whether to confiscate the assets or accept the risk of Ukraine defaulting on its debt. Whether the G7 or potential investors in the market are willing to take on such a risk remains to be seen. 

The viability of collateralizing CBR assets is intricately linked to the question of risk allocation. Accepting some level of risk is unavoidable. Mobilizing frozen assets during an ongoing conflict with uncertain outcomes inherently carries the possibility that confiscation, though undesirable, might ultimately be unavoidable.

While legal avenues exist to pursue alternatives, G7 states must be fully transparent about the potential consequences of the chosen course of action and be prepared to accept the resulting risks. After all, supporting a nation under aggression inherently involves a degree of risk, but inaction carries its own set of risks, potentially emboldening the aggressor and jeopardizing international security.