The impact of sanctions has hit Russia harder than many expected and has left investors nursing a combination of heavy losses and long-term uncertainty. Sanctions are the prime cause, but it is the actions of Russia to defend the rouble and prop up their financial system that will create lasting damage.
In equities, market closure has frozen investor positions leading to write-downs and a permanent sense of chaos at the Moscow Exchange, now in its third week of closure. We may see the stock exchange added to the sanctions list, which would make it all but impossible to either exit positions or invest anew. The US is threatening broader sanctions which would be tantamount to a wider embargo on investment into Russia.
In bonds, we are about to see technical defaults through either non-payment or payments in roubles. But the market is unpredictable, with some dollar repayments honoured, burning investors who exited prematurely. All of this will hit investors hard, but ultimately starve the Russian economy of much needed capital.
The impact of this will be significant and long-lasting. Even in the unlikely scenario that the conflict is resolved, and sanctions are unwound, Russia would probably languish in junk territory for some time to come.
Russia will continue to be excluded from major equity and bond indices. Both ratings and reputation will take time to recover. Opportunistic buyers will quickly return should sanctions be lifted, but assets connected to the Russian government, especially in commodities and financial services, will likely remain un-investable for the foreseeable future.
The outlook for investment in China will be more uncertain. This could have a much more profound impact on the global economy, given the far greater exposure of western investors. The scale of investment and interdependency may yet stay China’s hand with respect to supporting Russia’s war effort. In any event, investments in China will face far more scrutiny for reputational reasons, not only because of current geopolitics, but also issues around Uighur slave-labour, which has exposed western investors before.
China is assessing the feasibility of on-shoring or ‘near-shoring’ its dollar assets to ensure they cannot be confiscated should the Peoples Bank of China be sanctioned in a scenario where China is seen to be too supportive of Russia, leading to secondary sanctions.
The pace and enthusiasm in China for breaking the dollar’s stranglehold will increase. Initiatives like CIPS, the Chinese alternative to SWIFT, will be given fresh momentum and new participant-firms who have similar concerns will join. This dynamic increases the significance of recent discussions between China and Saudi Arabia on pricing oil contracts in yuan instead of dollars. The e-yuan project will also continue to advance.
Alongside a reappraisal of Russian, Chinese and other Eurasian assets, the crisis is likely to see a pull-back from emerging markets. This is significant for the climate change agenda, including the commitments from COP to support mitigation and adaption in the developing world. Investor and government perspectives may turn inward, leaving the climate finance targets in greater doubt. This could further undermine global commitments to climate change and the underlying legitimacy of COP.
A pull back from globalisation will invite more scrutiny of foreign ownership of domestic businesses, including in the UK. After the Ukraine crisis, national security considerations will have greater weight and more transactions will be subject to scrutiny. Regardless of the investor country of origin, the government will need to be seen to take a stronger interest.
ESG has taken a beating, both in reputation and performance terms. Not only have sky-high oil and gas prices led to underperformance in funds overweight in renewables, but ESG indexes that included Russian assets, post-Crimea, are now of questionable worth.
We are likely to see a more expansive approach to E, with a more permissive view of oil and gas as a means of transition, even if the destination is still renewable energy as the ultimate guarantor of energy security.
On S, there will be greater scrutiny of the geographies where fund assets are held, with exclusions likely to be based on market as much as sector. Defence stocks are swiftly being added to indexes and funds, even as arguments surface about which weapons are permissible. On G, corporates will be under more pressure on board composition, structure, transparency and even tax planning.
The whole range of ESG issues have in fact become more salient, yet both legislators and index providers have failed to anticipate the emerging reality. The packed legislative agenda (including a lot of new ESG related trade policies) will not go away but there are now louder questions from market participants about its underlying worth.
Crypto-assets are increasingly seen by regulators as a tool of money-laundering and sanctions busting. On the outbreak of war, bitcoin and other crypto-currencies slid as the dollar strengthened, suggesting that even in an era of high inflation, the new world order promised by crypto-evangelists is some way off.
But there are factors which suggest crypto-assets' importance in the global economy will increase. The initial slide was followed by a surge when President Biden’s executive order on crypto regulation was announced. This suggests moving digital assets inside the regulatory perimeter is ironically a necessary condition of their success, despite their libertarian genesis. More profoundly, if the global monetary system does bifurcate, and the yuan achieves reserve currency status, as current trends suggest that it eventually will, bitcoin and other crypto-assets are more likely to play a bigger role in such a monetary duopoly than when they are competing solely against the dollar, especially if high inflation is here to stay. Given though the restrictions that China itself has placed on the yuan on exchange and convertibility, such a world order is years rather than months away still.
Simon Horner is a Director at Flint and advises financial services clients on climate, ESG issues and technology. Before joining Flint he was Innovation Director at the City of London Corporation. He played leading roles in both the Green Finance Taskforce and the Kalifa Review
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