Legal challenges could pose new problems for EU sanctions on Russia

Arkady Rotenberg and Rosneft CEO Igor Sechin

We’ve discussed the economic and political challenges which the sanctions on Russia have caused for the EU. So far the economic pain has been managed (though Germany has been hit quite hard), despite outbursts from a few countries. The long standing political differences over how to deal with Russia have also been exposed.

However, now a new front has opened – a legal one. Both Rosneft and billionaire Arkady Rotenberg have launched legal challenges against the EU sanctions on Russia at the European Court of Justice (ECJ).

While the details of the challenges have not yet been revealed in full (the cases can be found here, here and here), Rosneft will be challenging the grounds for banning them and others from capital markets access, while Rotenberg will be questioning the decision to freeze his assets in Europe and impose a travel ban.

So, why exactly might this be a problem?

Well, the EU does not actually have a great track record of being able to legally enforce its sanctions despite the assumption that the ECJ would always back the EU. There are numerous recent examples:

• In September this year the EU General Court (a step below the full ECJ) ruled that the EU’s sanctions which froze Iran’s Central Bank assets were unlawful since the evidence behind them was so “vague and lacking in detail”.
• Similarly towards the end of 2013 there were a series of cases which saw the sanctions against numerous Iranian banks and companies overturned due to lack of sufficient evidence.
• In fact, there have been countless examples of this over the past few years since the ruling in the Kadi case, which essentially established the ability for sanctions to be challenged and precedent for them to be overturned on insufficient evidence.

The thrust is that the ECJ and EU system for legally enforcing sanctions is actually quite inadequate for a number of reasons:

• The decision to impose sanctions is essentially a political one. This means the evidence or research which goes into deciding who is sanctioned can often be limited. This makes justifying the sanctions in legal terms quite difficult.
• Where there is evidence it can often be confidential and provided by national government sources. However, there is no system for sharing, submitting or even holding confidential information at the ECJ. All evidence submitted to the court must be shared with the other side and is often made public. This makes many governments and intelligent services very uncomfortable. This combined with the point above means that in some cases the court is forced to overturn sanctions simply because it has not been given enough evidence to make a proper judgement.
• Those being sanctioned are often not the real target. The Russian sanctions are a prime example of this – individuals and firms around the Russian government have been hit to try and inflict pain and force a change of approach by the government. But this means that to legally defend the sanctions the link between the two must be conclusively proven and they must be shown to be involved in the activity which resulted in the sanctions.

(For a more detailed discussion we recommend reading this evidence submitted to the House of Lords on the isse).

It has taken a while for this to filter through. The main reason is that the original sanctions, which were focused on those involved in destabilising Eastern Ukraine and Crimea were easier to defend and legally prove. However, as sanctions have broadened and the objective has become causing general economic pain, the legal base has also become more stretched. Clearly, Rosneft and Rotenberg feel they are now at a point of vulnerability.

It’s hard to fully assess at this point in time just what chances they have of succeeding. The hope might be that the cases will draw attention and encourage those EU countries which do not fully support sanctions to apply more political pressure for an easing of the controls. Just today we have seen Hungary speaking out against them.

Even if Rosneft and Rotenberg were to win, history has shown that this is no guarantee of the sanctions being removed permanently. Previously, the sanctions have simply been reworded and instituted under a different legal base. Sure they can be challenged again but it is a very lengthy legal process. Alternatively, better evidence has been collected in due course and a more solid base for the sanctions provided. Of course, the EU would retain the right to appeal against any judgement.

With that in mind we wouldn’t expect any results for 12 – 18 months and in the meantime the sanctions will stay fully in place. In that sense, given the economic and political fallout from the sanctions so far not to mention the increasingly desperate economic crisis in Ukraine, many will hope the situation has reached some resolution before these cases ever have a chance to be resolved.

EU divisions delay sanctions on Russia, likely to focus on Rosneft

The EU last night finally reached an agreement on the latest round of sanctions on Russia, although the members agreed to delay implementation for a "few days" to allow time for the ceasefire to take hold and to reconsider the sanctions on the basis of whether the ceasefire holds or not.

This is despite the fact that by almost all accounts fighting has continued in Eastern Ukraine over the weekend and into today. However, for now, all those involved seem keen to maintain the ‘ceasefire’ and suggest the deal agreed on Friday remains in place.

First a couple of thoughts on why both sides are so keen to keep the deal in place, despite seemingly flagrant violations:

Ukrainian government: Kiev is keen to push for stability for a couple of reasons. The upcoming election is weighing on thinking and if it is ever to be seen as viable and legitimate it must take place during a calm environment. Kiev may see the ceasefire as first steps towards this. Furthermore, it seems unlikely to be a coincidence that Ukraine found a renewed vigour for the ceasefire just as the IMF warned that the prolonged fighting could lead to another $19bn bailout for the country next year. Lastly, Ukrainian forces had been suffering heavy losses as Russian forces became more involved and bolstered the rebels – this ceasefire allows Kiev to regroup and plan how to deal with this new resistance.

Russia and the pro-Russian rebels: The ceasefire came at a perfect time for Russian President Vladimir Putin – right in the middle of EU sanctions negotiations and NATO meetings – and played on divisions within the two groups. It turned attention away from what was happening on the ground in Ukraine and the potential Russian influence. It allowed the rebels to regroup and prepare to take back some more of the land they had lost in previous weeks. There also seems to have been an increasing shift towards Mariupol which looks to be a new strategic objective for the rebels.

From the EU perspective, while the official line is that they want to give the ceasefire time, the more likely influence is the concern around the economic impact of sanctions and the potential Russia retaliation. The talks over the past week have reportedly seen the reemergence of significant divisions within the EU over sanctions (although they never really went away).

While the official details are yet to be released, the sanctions have been widely reported. We discussed the options in detail here, but the key points are:

• Ban European financing with a maturity of over 30 days to Russian state-owned oil and defence firms. This will include Rosneft, Gazprom Neft and Transneft (the main oil pipeline operator). A large number of Russian defence firms are state-owned but few, if any, look externally for funding.
• Ban European companies from providing services to Russian firms which are associated with oil exploration and production (be it deep water, Arctic or shale).
• Expand the list of banned high-tech energy and dual use goods which cannot be exported by European firms to Russia.
• Reduce the allowed level of financing to Russian state-owned banks from 60 to 30 days.
• One option which is not entirely clear is a potential limit to the syndicated loans to Russian state-owned entities. This would essentially limit loans given by groups of banks (a fairly common practice used to spread the risk of lending over many parties).

Our initial feeling is that this will be a modest increase in the current sanctions. They remain very specific and targeted on a few state-owned firms, and particularly their access to European capital markets. They also remain only forward looking. Below are a few stats to give a feeling of the impact.

Above we have updated a graph we produced previously, which now shows which Russian state-owned banks, defence and oil firms have issued shares on the London Stock Exchange. In this instance, there is only one issuance to be added – the $10.65bn listing by Rosneft in 2006. Let's not forget that Europe gets around 35% of its oil from Russia, and while the global oil market remains much more fungible and varied than the gas sector, hitting Rosneft is probably the main story of these sanctions.

A quick peak at Rosneft’s latest financial statement also hints at why they are so concerned by potential sanctions that they have asked the Russian state for a loan of $42bn (around RUB 1,550bn). Out of RUB 2,179bn ($58.8bn) in loans and borrowings, around RUB 1,536bn ($41.5bn) is in the form of long term bank loans in dollars and/or euros. A significant portion of this is likely to have been provided from foreign banks, meaning Rosneft could face issues rolling over these loans. Furthermore, the amount they have requested almost exactly corresponds to their net debt levels (show in the chart below) with Rosneft even admitting that the main motivation for asking for assistance from the Russia state is to help finance its net debt amid the US and EU restrictions on its market access.

One final point to note here is that the sanctions on syndicated loans could be particularly important for a company such as Rosneft, not least because it is an instrument it has used previously, for example to help finance its purchase of TNK-BP.

 

As with all these sanctions while the direct impact could be limited it will further add to the indirect freezing of business between the West and Russia. Furthermore, Russia looks set to retaliate once again – with the idea of banning commercial flights from the West from Russian airspace being reheated. All of this could of course be offset by positivity if the ceasefire holds – but that remains a big if at the moment.