Europe will eventually join the US in sanctions that target Russia’s energy sector, ‘financial warfare’ expert predicts
Europe will likely eventually join the United States in sanctions targeting Russia’s energy sector, according to Juan C. Zarate, who served as deputy national security adviser and deputy treasury secretary during the George W. Bush administration.
Zarate also sees the potential for secondary sanctions targeting China, as well as a range of Russian responses to moves against its economy. He is the author of a book called “Treasury’s War: The Unleashing of a New Era of Financial Warfare” – and now an executive at compliance firm K2 Integrity.
He spoke to MarketWatch on Friday, shortly after the Biden administration and its U.S. allies moved to revoke special trade status as part of the growing Western response to the Russian president’s invasion of Ukraine. Vladimir Poutine.
The questions and answers below have been edited for clarity and length.
Market surveillance: How do you assess the sanctions against Russia? Are these the toughest penalties of all time?
Zarat: What makes them so severe is the scope, pace and target of the sanctions. By scope, I mean that all sanctions hit all key elements of the Russian economy, other than oil and gas from a European perspective.
For the most part you have sanctions involving all parts of the economy and in particular the financial system, which is dramatically unplugged and isolated – including the central bank and the seven bank de-SWIFT.
The pace – the degree of all these things happening over the course of two weeks is dramatic and unprecedented. And then the target – you have the 11th largest economy in the world, which is subject to these large-scale sanctions.
Market surveillance: How effective are these sanctions?
Zarat: A really important starting point is what do we mean by effectiveness, and what do we want the sanctions to do?
If we are talking about efficiency in crippling the economy, then I think the large-scale measures to isolate the Russian financial system — to disconnect it from SWIFT, to restrict the central bank’s access to reserves — in combination with the private sector divestment and exit – this is the most impactful. Because it is really starting to cripple the ability of the Russian economy to function.
If we talk about effectiveness to change Putin’s mind, I’m not sure that these actually do that and can roll back the tanks. What you hope is that the combination of the military resistance on the ground in Ukraine, the broad international opprobrium and the isolation of Russia, the effects on the economy, as well as the effects on the wealth of those who surround Putin, the oligarchs, become important.
If you think about the mindset of the regime itself, it’s the combination of all these things that becomes most important in how it plans its next steps.
Market surveillance: What awaits Russia itself as it manages the sanctions?
Zarat: We’re in uncharted waters as to what’s going on here, because I’m not sure any economy has faced such a swift set of measures to not only isolate the economy, but to truly collapse it. The fact that they haven’t yet opened the Moscow stock exchange, imposed restrictions on foreign currency withdrawals, and begun to take quite drastic measures to protect the economy all suggests that you have a possible implosion of the economy itself.
What is most devastating is the economy’s inability to transact. This is why CL00 oil,
and NG00 gas,
the lifeline is still so important, because it’s not just a source of income, but it’s an avenue of transaction that remains open and has not been closed, when so many other things are closing , be it the doors of McDonald’s MCD,
or divestment by the Norwegians.
Market surveillance: The United States has banned imports of Russian energy products, but Europe has not taken this step. Do you think that Europe will end up making this gesture?
Zarat: It will become a target, and it’s already being discussed. Part of it has to do with the timing, winter. Part of it has to do with whether or not they can find a suitable replacement, if the tap is turned off.
If the war continues, countries will want to take other measures that will punish Russia and cripple the country, especially if there is no military response. If Russia is undeterred and continues its atrocities, countries in Europe will have to look to the oil and gas sector and consider shutting it down.
Market surveillance: What do you think of the measures announced on Friday regarding the revocation of most favored nation trading status and the banning of Russian vodkas, seafood and diamonds?
Zarat: What you see are measures to close the loopholes in the area of trade and sanctions. These are additional measures to ensure that Russia does not profit in any way from trade with the United States, and that the American measures actually support what the private sector can already do.
Related: US and Canadian liquor stores and taverns pull Russian vodka from shelves
Market surveillance: Some experts stressed the importance of having clear conditions for the lifting of sanctions to encourage de-escalation. What do you think the United States and its allies should do to set the stage for the end of sanctions at some point in the future?
Zarat: It’s a pretty simple message. The sanctions that have been imposed and will be imposed become potential carrots at the negotiating table, if the Russians stop what they are doing and withdraw from Ukraine. That must be the message at this point, as Russia moves forward, because any other signal – of an “exit ramp” or whatever – would weaken the sense of resolve around the sanctions themselves.
Market surveillance: You have been a Coinbase COIN advisor,
the exchange of cryptocurrencies. What do you think the invasion and sanctions mean for crypto? Keep an eye out for ransomware attacks, with BTCUSD cryptocurrencies,
Zarat: We’re looking at space, and there are three aspects to that.
One: Do we or could we see crypto and the crypto-economy as a way to evade sanctions? This is certainly something authorities are looking into, and we know responsible crypto market players are sensitive.
Second: are we seeing an increase in ransomware attacks, possibly based in Russia, trying to leverage crypto payments to raise funds – and doing so outside of the controls of the current sanctions regime? There’s this potential that we’re watching very carefully, which is sort of a combination of our crypto regulatory compliance work and our cybersecurity work.
Finally, this broader strategic question: is Russia capable of finding alternative systems, if you will, whether it’s connectivity to the Chinese system or even exploiting the crypto-economy to perform transactions and move assets? Our opinion is that we have not reached a level of maturity for the crypto economy in Russia to allow for a wholesale change or economic transfer in the field of crypto.
Market surveillance: How has it been for you at K2 Integrity and other companies working in risk and compliance since the invasion began and sanctions began?
Zarat: It’s busier. Obviously, there is a desire to understand the sanctions, first and foremost. We have clients who need to understand their direct and indirect exposure to Russia, and how to manage this.
There’s a broader desire to increase capacity – so training, testing, certification around sanctions, which we provide. We’ve also found that this is a time when institutions considering improving or strengthening their sanctions compliance regimes come to us, or come back to us, to have that conversation.
Market surveillance: What else do you think MarketWatch readers should know about sanctions?
Zarat: The United States has had a privileged position in being able to use sanctions aggressively against targets. It is simply important that readers understand that this is an area of competition and conflict where the United States has maintained great power that is now exercised in concert with others. And that’s important because it talks about the role of the DXY dollar,
the importance of US capital markets SPX,
the strength of the economy, faith and confidence in our system. All this allows us, in a moment of crisis like this, to use economic and financial measures that have a real impact.
Another point is that you will see, on an ongoing basis, additional measures that will be taken not only by the United States but also by other authorities. The question of secondary sanctions will arise – the targeting of, say, Chinese entities that facilitate Russian activity or the circumvention of sanctions.
Finally, this point on competition and conflict indicates what the Russians can do in response. Some of that will be in the economic realm – expropriation of property, doing things to harass institutions that stay, or try to relax and struggle to do so. The kind of thing that throws sand into the gears. They can and will use other means, such as cyberattacks, to retaliate.