Open Europe Flash Analysis
The Battle of Londongrad? How vulnerable is the City to sanctions on Russia?
Summary: Claims that the City of London would suffer major losses in case of financial sanctions against Russia are overblown. While it is true that there are some sizeable Russian investments in London, and it is home to a disproportionate number of Russian oligarchs, these are far from critical to a global financial centre such as London. The stock of Russian international investments in London is sizeable at £27bn, but it only accounts for 0.5% of total European international assets invested in London. For all the talk of the large number of financial services provided to Russia, these only amount to 1% of total UK exports of financial services, business services and insurance. This would suggest that accusations that the UK Government is blocking tougher sanctions over fear of losses to the City don’t match the facts.
Sanctions related to financial or capital markets, for example severing access to credit for state-owned enterprises or Russian banks, might be an effective strategy to exert more pressure on Russia (given its reliance on external financing). Such move would be far more damaging to Russia than the City of London – though it may involve some losses for the latter. This should not, and does not seem to be, a big concern for the UK government. In any case, if things get to this stage, other EU countries may suffer far greater losses than the UK through wider economic sanctions hitting, for example, gas supplies and exports.
1) What is the UK’s position on sanctions?
EU leaders have expanded the list of Russian and Ukrainian individuals subject to travel bans and asset freezes. They also reiterated that “any further steps by the Russian Federation to destabilise the situation in Ukraine would lead to additional and far reaching consequences for relations in a broad range of economic areas” and the EU would “prepare possible targeted measures.”
Much has been made of the leaked UK Government briefing paper which said that the “UK should not support, for now, trade sanctions...or close London’s financial centre to Russians.” For example, French Foreign Minister Laurent Fabius said that France would only consider cancelling the sale of its Mistral warships to Russia if Britain did the “equivalent with the Russian assets of oligarchs in London.”
However, the UK has been one of the most vocal in pushing for further sanctions on Russia and moving to the so-called “phase three” sanctions affecting trade and economic links in the event of further escalation in Ukraine. David Cameron has said,
“We should recognise that, yes, there may be consequences from some of these things, consequences perhaps for the City of London…But we should proceed knowing that what we are doing is sensible, legitimate, proportionate, consistent and right.”
2) What form could economic and financial sanctions take?
The EU has a broad range of potential sanctions open to it under the Common Foreign and Security Policy (CFSP). The EU’s most common approach is ‘targeted’ financial and economic sanctions on specific people, groups and entities. Such sanctions comprise an obligation to freeze all funds and economic resources of those targeted and a ban on making funds or economic resources available to them.
However, the EU has a much wider range of options at its disposal. Such sanctions could consist of export and/or import bans (which may apply to specific products such as oil, timber or diamonds), bans on the provision of specific services (brokering, financial services, or technical assistance), and bans on investment, payments and capital movements.
Examples of sanctions the EU has already imposed on other countries that could affect financial markets include:
Banning the opening of new branches, subsidiaries, or representative offices of a targeted country’s banks in the EU;
Banning institutions within the EU from granting financial loans or credit to enterprises in the targeted country that are engaged in certain sectors, such as petrochemicals;
Banning the acquisition of enterprises in the targeted country and the acquisition of related shares and securities;
Banning the direct or indirect sale or purchase of, or brokering or assistance in the issuance of public or public-guaranteed bonds of the government, central bank or banks domiciled in the targeted country;
Banning member states from providing public financial support for trade with the targeted country, including the granting of export credits, guarantees or insurance
Banning the provision of insurance and re-insurance to government or enterprises in the targeted country.
Typically, these broader economic sanctions are linked to specific activities in the targeted country (e.g. sectors linked to Iranian nuclear proliferation) or the state itself.
With respect to Russia, financial sanctions could include bans on providing financial services to certain Russian financial institutions, banks or state-owned enterprises, such as VTB Bank, Gazprom or Aeroflot.
3) How sizeable are the links between Russia and the City?
Many of the assumptions about UK reluctance to harm the City via sanctions on Russia lack context. While the absolute numbers look huge, the City of London is a global financial centre, so the share of Russian business must be considered in perspective.
One area that is often noted for its links to Russia is the London property market. Savills estimates that 2% of high-end home buyers in London are Russian. At the other end of the scale, Knight Frank estimates that 9.1% of ‘prime sales’ from June 2012 to June 2013 were from Russian and Commonwealth of Independent States nationals, although only 4.9% were from residents of those states. Given the significant shortage of supply and very strong demand in this market, any hit from removing the relatively small fraction of Russian buyers as a source of income is likely to be only temporary. Furthermore, any uncertainty and greater unrest in Eastern Europe could prompt renewed safe haven flows into London property.
In any case, while the UK may be home to a disproportionate number of Russian oligarchs, unless they have direct links to the Russian regime or the decision to invade Crimea, it might be difficult to impose individual sanctions using firm legal grounds. The executives of state-owned Russian companies, who may have assets in the UK, could be more legitimate targets but, again, the overall direct impact this would have on the UK economy is likely to be small. The indirect impact could be a reputational risk to the City if individuals from other countries think they could be targeted in future.
It is also far from clear that the UK would be particularly vulnerable compared to other countries if broader sanctions on Russian investment and financial trade flows were imposed. The level of Russian investment in the UK is quite significant – the stock of Russian assets held in the UK is £27bn. However, this is only 0.5% of total European assets invested in the UK, highlighting that, while the absolute numbers sound large, they are far from critical for the UK and/or the City. Furthermore, the level of UK assets invested in Russia is more sizeable – allowing it some leverage, but also potentially leaving it vulnerable to retaliation. This should perhaps be of more concern.
Source: ONS Pink Book 2013
Russian business does generate fees for the City, but it is far from clear whether they are particularly significant as a share of the total. As the graph below shows, UK exports of financial services, other business services and insurance are substantial but Russia accounted for only 1% of the total in 2012. This suggests, for all the services the lawyers, accountants and financial firms in the City provide to Russian interests, they are only a fraction of their overall international business.
Source: ONS Pink Book 2013
All that said, the basic fact remains, it is hard to discern the exact extent of links between Russia and the City. This is not least because FDI from Russia goes mostly to offshore centres, much of which comes back into Russia from these areas. Some may cycle through London, but it’s hard to determine how much exactly. Most evidence (such as investment from these offshore centres into London) again suggests it is not huge in the overall scheme of things. This also highlights that it might be hard to impose financial sanctions in practice.
Source: Central Bank of Russia
The EU has so far been vague on the broader economic sanctions it is considering imposing on Russia, and the obvious question remains who and what to target. Beyond the targeting of individuals discussed above, it is difficult to see how Russian links to the City and the financial services it provides could easily be isolated, since they will tend to be tied to other areas of Russian economic activity. As we will see below, wider sanctions on the Russian economy would potentially hit other EU countries harder than the UK.
4) What are other countries’ positions on sanctions and links to Russia?
One final point to consider is the position of the UK relative to the rest of the EU and the US. For the most part the UK has been one of the more ‘hawkish’, pushing for a strong approach. As the graphs below highlight, other countries have significant links with Russia – either through energy dependence or through trade.
In 2013, Russia was Germany’s 11th most important trading partner, with a trade turnover of €76.5bn. As the other graph below shows, plenty of other countries rely on Russia for a significant amount of gas. While the impact of this is not always clear cut – Poland and the Baltic countries have actually been some of the most hawkish – it will be a consideration.
Source: Destatis and Eurogas
Looking at who Russia trades with may also give an indication as to what is at stake. Clearly, on either side, the UK does not feature heavily, while countries such as Germany, the Netherlands, Poland and even France have stronger trading links to Russia.
Source: Russian Federal Statistics Service
The $19.1bn exposure of UK banks to Russia highlights a similar point. It is lower than that of France, Italy and Germany, all of which have much smaller banking sectors – meaning their exposure as a percentage of assets will be larger (albeit not huge in this instance). This suggests that any specific sanctions on banking services could in fact hit other parts of Europe harder than London. The US and the UK do have much larger “other potential exposures”. This includes things such as issuance of Credit Default Swaps (CDS) on Russia, which are calculated at a ‘notional’ level not a fair value. This overestimates the true impact, but more importantly, such swaps are unlikely to fall under the sanctions, as the issuance or purchase of such instruments does not constitute direct ties to Russia.
Source: BIS consolidated banking statistics
There are clearly plenty of issues which will need to be factored in when considering the impact of various sanctions. It is clear that the sanctions will have different effects on different countries and balancing these impacts will be one of the biggest challenges facing the EU. All that said, it’s not clear the City will be any worse off than other countries’ financial sectors or other key sectors of EU economies.
For more information contact Raoul Ruparel on +44(0)757 696 5823 or the office on +44(0)207 197 2333.
 European Council, Conclusions on Ukraine, 20 March 2014: http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/141707.pdf
 Mail, 4 March 2014; http://www.dailymail.co.uk/news/article-2572977/Secret-documents-accidentally-shown-photographers-revealed-Britain-not-support-military-action-against-Russia-NOT-reflect-Governments-final-decision-says-Hague.html#ixzz2wVCSKSrl
 French Embassy in London, ‘Laurent Fabius highlights importance of responding to Crimea situation’, 18 March 2014; http://www.ambafrance-uk.org/Crimea-vote-has-absolutely-no
 Cited by the Telegraph, ‘I’m prepared to hit City to punish Putin, says David Cameron’, 10 March 2014; http://www.telegraph.co.uk/news/worldnews/europe/ukraine/10688532/Ukraine-crisis-Im-prepared-to-hit-City-to-punish-Putin-says-David-Cameron.html
 Cited by the FT, ‘Prospect of tough sanctions on Russians hits City realpolitik’, 20 March 2014: http://www.ft.com/cms/s/0/787a89ea-af72-11e3-bea5-00144feab7de.html#slide0
 Prime sales in central London are considered those above £1 million. Knight Frank, International Buyers in London, Residential Research, October 2013: http://resources.knightfrank.com/GetResearchResource.ashx?versionid=2017&type=1
 ONS Pink Book 2013, Part 3 Geographical Breakdown: http://www.ons.gov.uk/ons/rel/bop/united-kingdom-balance-of-payments/2013/index.html
 This is the latest data available but it should be kept in mind that, given the Cypriot crisis and ensuing write downs and capital controls, the amount of FDI flowing there from Russia will have changed. Central Bank of Russia, Russian Federation: Outward Foreign Direct Investment Positions by Geographical Allocation in 2009-2012: http://www.cbr.ru/eng/statistics/print.aspx?file=credit_statistics/dir-inv_out_country_e.htm&pid=svs&sid=ITM_586.
 Destatis, German foreign trade 2013: https://www.destatis.de/EN/FactsFigures/NationalEconomyEnvironment/ForeignTrade/ForeignTrade.html
 Eurogas, Statistical Report 2013, p.8: http://www.eurogas.org/uploads/media/Eurogas_Statistical_Report_2013.pdf
 Russian Federal State Statistics Service, External trade of Russian Federation with other countries and by commodity structure: http://www.gks.ru/wps/wcm/connect/rosstat_main/rosstat/en/figures/activities/
 BIS, Consolidated Banking Statistics, Table 9E, Foreign Exposures on select individual countries, ultimate risk basis: http://www.bis.org/statistics/consstats.htm. One point to note is that, since this is on an ultimate risk basis, some of these foreign owned banks could in theory be located in London and some of their claims on Russia could pass through there. However, this will not have any impact since profits and fees are returned to these countries.