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5 ways Russian sanctions are affecting global financial markets – POLITICO Europe

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.

This article is part of POLITICO Pro

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