The EU stumbles to an imperfect solution for funding Ukraine

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Greetings and a happy second Sunday of Advent. For those in the Christian tradition, we wish you a peaceful Advent period — and for all our readers, we are doing our bit with a Sunday-only Free Lunch service until we break for Christmas. Tej is back in the saddle next weekend.

This week, the European Commission finally presented a formal proposal for its long-trailed “reparations loan” for Ukraine, tied to Russian central bank reserves blocked in the EU. It was promised by commission president Ursula von der Leyen more than two months ago, and promoted by German Chancellor Friedrich Merz in an important FT op-ed shortly afterwards. Belgium, where most of the blocked reserves sit in the securities depository Euroclear, has resisted it all the way.

What was published on Wednesday was the sort of tangled ball of legal intricacy that only the EU can produce. It tries to resolve two sets of tensions: getting money to Ukraine without anyone having to pay for it, and making it possible to take decisions on something that precedent suggests would need unanimous agreement but for which no such unanimity exists at present. The result is ugly, far from optimal — and might just about work.

The urgency should be clear: Ukraine’s money could run out in the first half of next year, and Russia and the US are trying to push it into a surrender — an aspect of which would be the expectation that Moscow regains access to its reserves (perhaps as much as €300bn across the west, of which about €210bn is in the EU). Given that Russia’s willingness and ability to undermine European democracies will depend on its success in trying to own Ukraine, it is no exaggeration to say that Europe’s future hangs in the balance.

The proposed solution is a complex piece of financial and legal engineering. Conceptually, it has three parts (legally, the proposal apparently stretches across 11 documents):

The EU lends money to Ukraine that it only has to return if and when Russia pays it reparations

The EU raises this money by forcing financial institutions to cheaply lend it cash that has accumulated because Russia cannot withdraw its deposits due to sanctions

EU law is changed to remove any risk that sanctions might be lifted or Russia might otherwise be able to claim its money back

(The “reparations loan” label should strictly only describe the first point but, in the debate now, it has come to mean the combination of the first two — including the special funding method.)

Why this complicated construction instead of just borrowing in markets so as to lend on to Kyiv? Because of an assumption that the EU itself has a money problem. This is from the commission’s proposed regulation:

The capacity of the Union and of its Member States to provide additional funding to Ukraine is currently limited and does not correspond to the magnitude of the needs. Mobilisation of additional significant resources by the Member States to be able to finance Ukraine would constitute an important economic challenge.

This is simply not true. The reparations loan, if it is passed, would amount to less than 1 per cent of annual EU GDP in additional financing. If this was funded through normal borrowing, it would increase the government debt-to-GDP ratio for the bloc from the current 82 per cent to 83 per cent. Markets would not even notice.

But this is where we are. The complex reparations plan is an effort to get out of the political quagmire caused by EU member states trying to pretend they are not having to put up the money for Ukraine’s survival — without actually forcing Russia to pay for the destruction it has caused. It may be the best we’ve got to work with. But we should still be clear about the shortcomings. Here they are.

EU taxpayers were always going to be on the hook. Unless and until you are willing to actually make Russia pay, of course EU taxpayers will ultimately back an EU loan (or grant) to Kyiv. So, too, in the reparations loan proposal. The money raised from banks holding Russian reserves — mostly Euroclear but, in a welcome development, all other EU banks with smaller holdings as well — will be owed back to them by the EU itself, with some guarantees from capitals or the next EU multiyear budget. In addition, the EU will reimburse member states — this is intended for Belgium — that find themselves losing arbitration claims by Moscow. Again, national guarantees may be raised, but the buck stops with the EU — and hence all member states. The same is true of the powers the proposal gives the EU to take up loans for liquidity reasons.

Perhaps this is why the EU is putting its taxpayers ahead of Ukraine’s reconstruction needs. As written, the regulation would require handing over any reparations money received from Russia to the EU until the loan is paid back in full. That may motivate the EU to call for reparations up to that amount — but, correspondingly, put it in the mood to compromise beyond that point. The result would be a Ukraine left in ruins even if at peace although everyone recognises the EU would then have to find more money. A realistic and morally justifiable scheme would subordinate the loan repayment to all other documented reconstruction needs, or at least prorate it with them.

More importantly, Russia is not actually being made to pay. The only thing that could, in fact, remove EU taxpayers’ liability is if Russia were forced to pay. The reparations loan proposal does not do this, despite its name. From the text of the regulation again: