Global Sanctions Alert
SWIFT and the Ukraine conflict: Latest developments
3 May 2022 • 10 minute read
Written by:Michael McKee
On 26 February 2022, the EU, UK, Canada and the US published a Joint Statement on further restrictive measures in light of the Ukraine conflict. These nations committed to ensuring selected Russian banks are removed from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) messaging system.
Seven Russian Banks were banned from SWIFT on 12 March 2022 with three Belarusian entities then also being banned from the system on 20 March 2022. On 4 May 2022 Ursula von der Leyen, the President of the European Commission, announced the ban would be extended still further with Russia's largest bank, Sberbank, plus Credit Bank of Moscow and the Russian Agricultural Bank also to be excluded from the SWIFT system.
SWIFT is a Belgian-based financial messaging services cooperative supporting 11,000 banking and securities organisations, market infrastructures and corporate customers in more than 200 countries. As a result of the ban, these selected Russian banks will be unable to initiate payment instructions in eligible payment systems or receive inbound payments in those same systems.
Banned Russian banks and Belarusian entities may seek alternatives to SWIFT, such as routing payments via countries that have not imposed sanctions, such as China, which has its own payments system called the Cross-Border Interbank Payment System (CIPS). Russia has a SWIFT alternative known as the System for Transfer of Financial Messages (SPFS) which may also be used as may cryptoasset payments platforms.
Alternatives to SWIFT have critical interoperability, cost, security and speed constraints.
Banned Russian Banks
On 2 March 2022, the EU published European Council Regulation (EU) 2022/345 and European Council Decision (CFSP) 2022/346 in the official journal of the European Union. This Regulation and Decision identified the selected Russian banks that are subject to the SWIFT ban.
These banks are: VTB Bank (being Russia's second largest bank), Vnesheconombank (VEB), Rossiya Bank, Sovcombank, Bank Otkritie, Novikombank and Promsvyazbank.
The ban took effect on 12 March 2022.
The official journal also applies the measure to "any legal person, entity or body, established in Russia whose proprietary rights are directly or indirectly owned for more than 50%" by these Russian banks.
This list does not include Sberbank, Russia's biggest lender by assets, or Gazprombank, which is heavily involved in its energy sector. According to the EU press release, the European Commission "is prepared to add further Russian banks [to the list] at short notice."
Alexei Kudrin, Russia's former finance minister, suggested all Russian financial institutions being cut off from SWIFT could shrink Russia's economy by 5%.
Banned Belarusian Entities
On 12 March 2022, SWIFT published a statement noting that it had disconnected the selected Russian banks and would also disconnect the following three Belarusian entities (and their designated Belarus-based subsidiaries) on 20 March 2022 in accordance with a further Regulation, being Council Regulation (EU) 2022/398: Belagroprombank, Bank Dabrabyt and the Development Bank of the Republic of Belarus.
What is SWIFT?
SWIFT acts as the carrier of messages containing payment instructions between financial institutions involved a transaction.
The SWIFT organisation itself does not manage accounts for institutions, holds no institution funds and does not perform clearing or settlement functions. After a payment has been initiated using a SWIFT message, it must be settled through a payment system such as the Trans-European Automated Real-time Gross Settlement Express Transfer System (TARGET2).
SWIFT sends more than 40 million messages a day, 1% of which involve Russian payments.
SWIFT is jointly owned by 2,000 banks and financial institutions. SWIFT's board of directors comprises 25 independent directors appointed by its shareholders. According to Article 17 of the SWIFT By-laws, nations with more member institutions of SWIFT have additional rights to appoint directors.
SWIFT is overseen by the National Bank of Belgium, in partnership with major central banks around the world, including the US Federal Reserve and the Bank of England.
On 1 March 2022, SWIFT published a press release noting the Joint Statement and stating that SWIFT is engaging with these authorities to understand which entities will be subject to these new measures. SWIFT states that it will disconnect them when it has received a legal instruction to do so.
How are members removed from SWIFT?
Article 16(c) of the SWIFT By-laws state that:
"c. The Board of Directors may suspend or expel a Shareholder from the Company if it establishes in its opinion that such Shareholder:
does not observe the By-laws of the Company and/or the Corporate Rules or any undertaking towards the Company;
makes any arrangement or composition with or concerning its creditors;
is subject to regulations impacting its shareholding in the Company;
commits an act of negligence which may be prejudicial to the interest of the Company provided that the Board of Directors informs the Shareholder in writing of the reasons underlying its decision and that the relevant mandatory provisions under Belgian law are complied with."
Part 3 of the SWIFT Corporate Rules also provides that the board of directors should be provided a written report from SWIFT management for the termination of an existing shareholder. Termination (expulsion) is subject to section 7.3 on dispute resolution in the SWIFT Corporate Rules.
SWIFT has not published the minutes of the meeting of its board of directors in which the decision to ban the selected Russian banks and Belarusian entities was made in accordance with the Regulation (EU) 2022/345, Counsel Decision (CFSP) 2022/346 and Council Regulation (EU) 2022/398.
All relations between SWIFT and each member, as well as the SWIFT by-laws and SWIFT Corporate Rules, are governed by the laws of Belgium.
On 14 March 2022, the Financial Times reported that various bankers and financial regulators (not named) are concerned about the prospect of a cyberattack (or attacks) against SWIFT. SWIFT provided a statement to the Financial Times noting that it takes "security very seriously" and has "a strong control environment in place for physical and cyber security."
Alternatives to SWIFT
As part of the Crimea-related sanctions of 2014, Russia was threatened with expulsion from SWIFT. Western countries did not proceed with this action, but this did prompt Russia to begin the development of its own cross-border transfer system, SPFS.
At the end of 2020, there are 23 foreign banks connected to the SPFS from Armenia, Belarus, Germany, Kazakhstan, Kyrgyzstan and Switzerland. There are also plans to link SPFS to payment systems in China, India and Iran. These plans may be accelerated to the extent that a significant number of Russian banks are banned from SWIFT.
SPFS is not seen as a viable alternative to SWIFT, given that the system currently works only within Russia and is subject to high transaction costs.
Bank-to-bank connections
Russian banks may choose to deal directly with non-Russian banks to process payments using traditional payments channels such as fax, email, and any available bilateral messaging systems. This would likely add delays and additional costs to the payments process which may be passed on to the payer/payee.
It may also lead to payments business transferring to non-sanctioned Russian banks that are not subject to the SWIFT ban.
Cross-Border Interbank Payment System
The CIPS is a payment system offering clearing and settlement services for its participants in cross-border RMB payments. It is a significant payment infrastructure in China.
In advocating for Russia not to be banned from SWIFT, Austrian Chancellor Karl Nehammer said "the suspension of SWIFT would affect the Russian Federation less than the European Union," and argued Russia could use its "own payment system, and secondly, it would immediately switch to Chinese payment systems."
The identity of participants is not in the public domain. But according to the CIPS Participants Announcement No 73, in January 2022 CIPS has 75 direct participants and 1205 indirect participants. Russian banks likely will be both direct and indirect participants of CIPS.
Cryptoasset payment networks
Banning Russian banks from SWIFT may result in Russian payment being processed in decentralised networks such as bitcoin.
According to Banco Santander, Russia's import/export flows total around USD570 billion annually, a volume that could be accommodated on the bitcoin network. Bitcoin processes USD20 billion in on-chain transactions per day, or more than USD7 trillion per year.
Impact of the ban
For counterparties to contractual relations, the removal of Russian and Belarusian institutions and the from SWIFT due to European Commission Decisions may provide grounds for recission due to illegality.
DLA Piper expects that counterparties may seek to rely on illegality, including as an event of default, in a variety of commercial and financial arrangements.
There remains considerable uncertainty as to the status of in-flight transactions at the time that SWIFT access is banned. These payments will be subject to their respective payment systems' contingency, liquidity management and resolution mechanisms.
The impact of the SWIFT ban has been largely overshadowed to date by the sanctioning of Russian persons and firms; and the actions of some card schemes and corporates to cease operating in Russia. Russian banks not subject to the SWIFT ban, such as Sberbank, are facing significant liquidity challenges as deposits are withdrawn and liabilities are drawn down. Sberbank closed its European legal entities in compliance with an order by the European Central Bank as a result of EU sanctions.
The Bank of Russia has lowered reserve requirements for Russian banks and continued to increase interest rates to over 20%, given the liquidity gap in the Russian banking system, which is reported to be USD68 billion. On the day of the announcement of the SWIFT ban on the initial 7 Russian banks, Russian citizens withdrew close to a trillion Roubles, which represented 6.5% of the monetary base.
The SWIFT ban, as well as sanctions and other corporate actions, could contribute to a default on Russian obligations abroad. This may result in a liquidity shock to Western markets, given that Russian entities owe more than USD100 billion in the next financial year, according to IMF estimates. Both Russian banks' and Russian government instruments have been subject to credit rating agency downgrades.
Despite continuing concerns in the market around the Russian Government perhaps not being able to make payment of interest and principal on its US Dollar denominated debt, it has, so far, avoided default and succeeded in making payments on its overdue debt in US dollars from those of its USD reserves which are not frozen in the US and elsewhere. However, with sanctions continuing to bite and substantial bond payments continuing to fall due by the Russian Government, both before and after the current US Office of Foreign Assets Control's current special licence, which allows for "the receipt of interest, dividend or maturity payments" on debt or equity liabilities, terminating on 25 May 2022, those concerns around Russia's ability to continue to pay remain. While the effects of such a Russian default cannot be predicted, it is notable that Kristalina Georgieva of the IMF stated in March 2022 that while such a Russian government default is no longer an improbable event, she discounted the idea of a wider shock to the global financial system should this default occur.
Tags: #SWIFT #ukraine #sanctions #SWIFTban #russia
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