Policy Brief

16. Mai 2023

Toughening Financial Sanctions on Russia

Enforcing Energy Sanctions and Reducing Shadow Reserves Effectively

Financial sanctions are key in enforcing restrictions on Russian energy exports – in particular the G7/EU oil price cap regime –, due to financial institutions’ critical role in cross-border transactions. While the energy sanctions regime is having an impact on export earnings and budget revenues, evidence for potentially widespread violations is also emerging. Moreover, favorable external dynamics have allowed Russia to accumulate substantial assets abroad – “shadow reserves” –, which need to be kept out of reach of the regime.



Key Findings 

Task central banks and supervisory authorities with the identification of Russian foreign assets to ensure that funds cannot be used to widen monetary and fiscal policy space.
Limit channels for energy-related transactions to improve transparency.
Strengthen documentation requirements for financial institutions within the price cap regime to allow for more effective implementation and enforcement.
Punish sanctions violators through their reliance on the international financial system.
Address loopholes in the sanctions regime, including, possibly, through the strategic and limited use of secondary sanctions.

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Energy Sanctions: What Works and What Doesn’t

Complex Market Intervention Shows Some Results

Sanctions on Russian oil exports are one of the most complex interventions into global energy markets ever undertaken in the area of economic statecraft. Two focal measures deserve particular attention: 1) With its sixth sanctions package in June 2022, the EU established embargoes on Russian crude oil and oil products, which took effect in December 2022 and February 2023, respectively. (2) The G7/EU price caps reconciled the intention to keep Russian oil on the market – and thus prevent rising global prices – with the objective of limiting the country’s export earnings and fiscal revenues, after policy makers had rejected alternative proposals such as a customs tariff on Russian oil. The EU introduced exemptions to its embargo that allow Western shipping and maritime insurance companies to remain engaged in trade with Russian oil as long as the price remains below the cap. The price caps took effect coinciding with the respective embargoes.

Several months after the policy’s initial implementation, evidence emerged that the sanctions regime was showing some results. First, Russian oil largely remained on the market and global prices did not increase after the embargo took effect. On the contrary, since the announcement of the policy in July 2022, prices have come down substantially. Second, sanctions have created diverging dynamics in different segments of the Russian oil market. Where previously dominant European customers essentially disappeared and were replaced by Indian buyers (e.g., exports from Baltic and Black Sea ports), demand conditions changed dramatically, resulting in sharply lower prices. Where the embargo did not have any noticeable effect on the customer base (e.g., exports from Pacific Ocean ports), prices did not come under additional pressure compared to North Sea Brent in the post-embargo/price cap period. Discounts for Russian oil have led to a significant drop in export earnings. In Q1 2023, the country exported USD 38.8 billion worth of crude oil and oil products – a 29% decline vs. Q4 2022. Fiscal revenues have also taken a major hit. According to Russia’s Ministry of Finance, total federal government oil and gas revenues dropped by 52% in January-April 2023 compared to the same period in 2022. Together with sharply higher spending due to the war, this increased the budget deficit substantially.

Evidence for Sanctions Violations Emerges

While measures targeting Russian energy exports, in particular crude oil and oil products, have had a noticeable impact, evidence for potentially widespread violations of the price cap regime is emerging. Specifically, substantial amounts of Russian crude oil are being transported from the critical Pacific Ocean port of Kozmino with the participation of Western shipping service providers and are being sold above the G7/EU price cap threshold.

In the first quarter of 2023, roughly 50% of total exports from Kozmino involved companies that fell under the price cap regime – largely maritime insurance providers (see Figure 1). At the same time, not only were average export prices around USD 73/barrel, a closer look at their distribution shows that 96% of the total volume was priced above the cap level of USD 60/barrel. While connecting specific export transactions with ship tracking information has proven difficult – and differences in data coverage may partially explain discrepancies –, some conclusions can be drawn. If we assume conservatively that shipments for which prices cannot be identified were in compliance with the price cap regime; and if we assume further that these – as well as volumes priced below the cap – involved Western service providers, this leaves roughly 26 million barrels with prices above USD 60/barrel transported on G7/EU-owned or -insured vessels.

The existing attestation regime does not allow for an effective enforcement of the price cap, even when it comes to these G7/EU-owned or insured vessels. Specifically, price cap regulations identify shipowners and maritime insurance providers as so-called Tier 3 actors, and these companies are thus only required to obtain and retain attestations in which their customers declare that they have not purchased the cargo above the cap. They do not have to acquire any supporting evidence and are generally not considered in breach of the price cap – even if a sanctions violation took place – as long as they acted in “good faith.” While it is understandable that policy makers wanted to avoid creating onerous requirements that would render the system unworkable, or could have driven G7/EU service providers out of the Russian oil trade, this has turned out to be a key weakness of the price cap regime.

The (Shadow) Reserves Challenge

Energy sanctions violations are a critical issue, but so is the Russian regime’s access to considerable foreign assets and their utilization to improve macro stability and finance the war. This touches upon two key dimensions: (1) official reserve assets that Russia had built up in recent years and that may or may not be immobilized by sanctions, and (2) “shadow” reserves accumulated abroad by Russian entities in the past fifteen months.

Uncertainty Surrounding Immobilized Reserves

Regarding pre-February 2022 reserves, which were above USD 640 billion, Ukraine’s allies imposed sanctions on Russia’s central bank (CBR) and the country’s sovereign wealth fund (National Welfare Fund, NWF) early on. This included banning transactions with the two entities and freezing assets. Governments that imposed sanctions do not provide information on the affected funds. We have therefore used data from Russian authorities to estimate that roughly USD 320 billion in foreign reserves (at current valuation) are immobilized, as they were – and presumably still are – held in the jurisdiction of the coalition imposing sanctions (see Figure 2). However, because CBR data on the currency and geographical composition of assets stems from December 2021, there is considerable uncertainty surrounding this number. It is quite possible that, while the CBR was likely not informed in detail about plans for the full-scale invasion, reserve managers were able to move assets right before sanctions took effect.

It is essential for coalition authorities to improve transparency regarding frozen (or immobilized) assets. Only then can agencies tasked with implementing restrictions on the CBR and NWF reliably remove these assets from the Russian state’s reach. Furthermore, while the initial measures to freeze Russian state assets may have effectively blocked part of the reserve stocks, they did not address the issue of reserve flows. Continued current account surpluses and Russia’s success in recovering some of the arbitrage created by the price cap regime have allowed Russia to continue generating substantial flows. A lack of transparency regarding beneficial ownership structures of financial flows is the key issue that policy makers need to address.

Accumulation of Assets Abroad

Russia saw net financial account inflows to the tune of USD 283 billion last year, largely driven by a record-high current account surplus of USD 233 billion (see Figure 3). Soaring commodity prices and the delayed phasing-in of sanctions on key exports such as oil and gas were key factors behind this extraordinary financial surplus. Other inflows consisted of returning resident capital and losses in official reserve assets. On the outflows side, close to USD 130 billion in non-resident capital left the country as foreign investors withdrew and external liabilities were repaid. So, what happened to the current account surplus and the corresponding financial flows? The CBR is under sanctions and cannot conduct reserve operations in dollars or euros, including on behalf of the Ministry of Finance. According to official balance of payments data, Russian entities – banks and corporates – accumulated new foreign assets to the tune of USD 147 billion in “other investments.” There are no further details of their composition available, aside from the information that USD 79 billion of the total is comprised of loans and deposits.

However, the amount could be even higher, as questions have emerged regarding the roughly USD 130 billion in non-resident outflows. In any case, Russia accumulated substantial foreign assets in 2022 – a development that will continue as the current account remains in surplus, albeit at a slower pace. While Russia recorded a surplus of only USD 18.6 billion in Q1 2023, 50% less than in Q4 2022, remaining foreign capital that could turn into outflows is also limited.

Lack of Transparency Facilitates Arbitrage Gains from Oil Trade

How can Russia take advantage of the lack of transparency regarding beneficial ownership structures to capture some of the arbitrage in the oil market due to sanctions? Russian entities’ involvement in the transport of oil as well as in the refinery sector of foreign countries presents a major challenge if Russia can find channels to use the money for foreign exchange acquisition and government funding.

Since the G7/EU introduced price cap(s), there have been major shifts regarding the transport of Russian oil, with new shipping companies emerging on the scene – and some of the new players are suspected of being linked to Russian entities. As the price cap(s) apply to so-called FOB (“free on board”) prices, which exclude the cost of transportation and insurance, this could enable Russia to capture some of the spread to CIF (“cost, insurance and freight”) prices ultimately paid by buyers. What’s more, in some cases this spread may be inflated and, in effect, represent attempts to circumvent the price cap regime.

For instance, Indian buyers paid an average FOB price of around USD 44/barrel in Q1 2023 for Russian crude oil (see Figure 4). The driving force behind the sharp discount to North Sea Brent was the EU embargo, which led to a dramatic shift in demand conditions in the segment of the market for Russian crude oil. Europeans, as the most important buyers, essentially disappeared – giving alternative customers considerable pricing power. At the same time, Indian customs data shows that the CIF price for crude oil imports from Russia in Q1 2023 stood at USD 70/barrel on average – creating a spread significantly wider than what should be expected based on the cost of transportation (despite the long distances). For the entire first quarter of 2023, this represents a value of USD 3.1 billion – a spread of USD 26/barrel applied to a volume of roughly 117 million barrels.

On the face of it, this is exactly what the sanctions regime – consisting of embargoes and price caps – was intended to accomplish: create downward pressure on prices for Russian oil exports and leave arbitrage outside of Russia’s reach. However, this only works if Russian entities cannot capture the discount. With their involvement in shipping, and potentially inflated spreads between FOB and CIF prices, this is in question. Of course, the huge arbitrage in the market for Russian oil also provides incentives for other types of side deals that could channel money to the original sellers. There is also speculation that some of the trading companies involved in oil transactions may be connected to Russian entities, providing further opportunities to circumvent the price cap regime.

A related issue is the shift of refining from Russia to third countries. We know that purchases of Russian crude oil by China, India, and Turkey have picked up in recent months, while countries in Europe have stepped up product imports from these places. In a way, this is exactly what the sanctions regime attempted to achieve: keep Russian crude oil on the global market to guarantee price stability while reducing export earnings and fiscal revenues, including by removing the value added of the refining process from the country. However, in some cases, Russian companies are (partial) owners of refineries in third countries – e.g., India’s Nayara, of which Russia’s Rosneft owns 49%. The sanctions regime can still achieve its objectives in such cases – but only if a reshoring or, more broadly, channeling of money accumulated abroad to Russia’s war effort is prevented. Our proposals for sanctions below would make this more difficult.

Location of shadow reserves

Returning to the overall issue of foreign asset accumulation, or “shadow reserves,” there is no official information on where these are located – and, thus, how easy or complicated their reshoring and use may be in practice. However, a closer look at the location of companies involved in Russian oil exports allows us to draw some conclusions. As far as the physical destination of shipments is concerned, there are essentially three: the European Union (in the form of pipeline oil and some seaborne exports exempt from the embargo), China, and India (see Figure 5). In terms of trading companies, the initial buyers in many cases, three additional countries play an important role: Hong Kong, Switzerland, and the UAE. Given existing sanctions – fairly comprehensive in the case of the EU and at least partial in the case of Switzerland –, it seems reasonable to assume that assets are largely, albeit not exclusively, accumulated in four jurisdictions: China, India, Hong Kong, and the UAE.

Using Financial Sanctions for Enforcement

Financial sector sanctions could be an effective tool for stepping up implementation and enforcement of existing restrictions on Russian oil exports. The first key issue is to increase transparency so it is harder for Russia to arbitrage the price difference between its export prices and international market prices in its own favor. The second key issue is to limit access to (shadow) reserves from previous oil and gas sales by identifying them and limiting their accessibility. Finally, bank supervisors and central banks should play a larger role in financial sanctions enforcement.

We propose the following specific measures to improve transparency with respect to energy trade-related financial flows as well as Russian holdings of foreign assets – and to limit the extent to which Russia can use energy-related export earnings to continue its war in Ukraine.

1. Identify reserve assets abroad. The current location of Russia’s reserves is not public knowledge. The last available information is from December 2021 from the CBR itself. Public disclosure of locations from Western authorities would increase transparency and make enforcement more credible. Sanctioning countries should clearly identify Russia’s foreign assets held in their jurisdictions and ensure that they are effectively removed from the reach of Russian entities. Central banks and bank supervisory authorities should be clearly mandated to request information from all financial institutions in their jurisdiction to establish and disclose Russian ownership of assets.

2. Investigate shadow reserves. While sanctions may have effectively immobilized a substantial share of Russia’s pre-war reserve stocks, they did not immobilize new flows. We have shown that at least USD 150 billion in new foreign assets were accumulated in 2022. Furthermore, we identified several avenues through which Russian entities could circumvent the energy sanctions regime, including the lack of disclosure of the beneficial ownership of companies involved in the oil trade on several levels. It is critical for coalition countries to use all available tools to identify the geographic location of these assets and to prevent their use for Russia’s war on Ukraine. Such information can be partially obtained through rigorous analysis of detailed financial account data. When information gaps emerge, central banks should ask central banks in third countries to explain gaps.

3. Restrict channels for financial flows to better monitor implementation of energy sanctions. Limiting the channels through which cross-border financial flows can take place would make monitoring easier. Comprehensive restrictions (e.g. SDN listing or comparable measures) on additional Russian financial institutions as well as cutting off more Russian banks from SWIFT would reduce the number of banks through which energy transactions can be conducted.

4. Strengthen documentation requirements. The financial sector plays a key role in conducting Russian energy trade. Sanctioning countries can gain information on transactions by stepping up reporting requirements for financial institutions on financial operations related to fossil fuel trade.

  • According to EU and US regulations, financial institutions are so-called “Tier 2 actors” as far as the price cap regime is concerned. Thus, they are only required to request, retain, and share documents that show oil was purchased at or below the price cap “when practicable” – or, alternatively, obtain attestations from customers in which they commit to compliance with the price cap. Requirements should be strengthened significantly by mandating that financial institutions retain and share full documentation just like “Tier 1 actors.” This should include a record on the original contracts that include the price of the transaction. While this might sound like an excessively onerous obligation to financial institutions, further restrictions on which institutions can engage in transactions with Russia would mean only a few banks would have to obtain such contracts. It would then be easy for them to establish the appropriate routines.
  • To increase overall transparency, financial institutions should be required to inform enforcement agencies of any transactions under the oil price cap that they facilitate . In addition, they should notify such agencies of any suspicious activities that may indicate a violation of the price cap regime.
  • Sanctions should be enforced on a strict liability basis, including with regard to the financial institutions involved in transactions. Currently, Western entities involved in violations are generally not considered in breach of the price cap as long as they acted in “good faith.” This is too lenient a standard for effective enforcement.

5. Limit financial access to shipping companies without maritime insurance. Should a shipping company lose its maritime insurance due to sanctions violations, it can continue to transport Russian oil as long as a certain type of insurance is not required by any parties involved (e.g. ports). This not only undermines the effectiveness of the sanctions regime but also represents a significant risk for ecological disasters. Supervisors should explore whether financial sanctions could be applied to reduce financial access of oil shipping companies that do not have proper maritime insurance.

6. Targeting third-country financial loopholes is increasingly important. Third-country financial hubs, e.g., Hong Kong and the UAE, can be used to circumvent sanction coalitions. In the past, the United States has used extraterritorial or “secondary” sanctions –  the threat of imposing penalties on persons and organizations not subject to the sanctioning country’s jurisdiction –to address this challenge. However, such measures are a very controversial element of the foreign policy toolbox. For instance, the European Union views extraterritorial sanctions as a violation of international law. Nonetheless, for financial sanctions to be effective it is critical to target financial channels outside of the coalition’s immediate jurisdiction. To be less intrusive, we propose limiting such an approach to enforcement of the price cap regime. Governments should explore avenues through which this can be achieved – either the strategic and limited use of secondary sanctions or the imposition of restrictions on third-country institutions that engage in certain transactions with Russian entities. Furthermore, G7 countries should move to reduce the share of transactions taking place through off-shore centers.

Conclusions: Strategic Measures Instead of Broad Restrictions

Rather than imposing broader financial restrictions that may prove counterproductive due to their high administrative and political costs, we propose focusing financial sanctions specifically on the enforcement of the energy sanctions regime and on limiting the increase of shadow reserve assets, including through offshore centers.

Cross-border trade flows must find a counterpart in international financial flows. The more restrictions are imposed on financial transactions, the more overall trade will be affected. To keep Russian oil supply on the global market, financial sector transactions must take place in some form. Our suggestions of financial sanctions are targeted specifically at making it more difficult for Russia to sell oil above the price cap, not at limiting financial exchange in general.

The threat of restrictions in the financial sphere or sanctions in general will motivate Russian actors to develop alternatives. In fact, Russian authorities have spent considerable effort in recent years, especially since 2014-15, on establishing domestic systems for many types of financial transactions, including information exchange, credit card payments, and rapid transfers. For example, the CBR has actively developed the SPFS (the Russian “SWIFT” payment system) since 2014. This helped insulate the economy from the impact of additional sanctions and has limited the effect of some of the measures imposed since February 2022. Since 2022, further adjustments have taken place. Additional sanctions may lead to further shifts in the international financial architecture. In addition to increased reliance on domestic systems, Russian authorities have also tried to strengthen links to China’s CIPS in recent years. This has proven to be much more challenging in practice than in theory, but the current geopolitical environment will certainly lead to intensified efforts in this direction.

Both China and Russia are by now fully aware that the financial system can be weaponized and therefore are both actively investing in alternatives. It is up for debate whether the narrowly defined expansion of sanctions as proposed in our note would accelerate the development of alternatives. The focus on a narrow set of measures specifically linked to the energy price cap has the advantage of actually strengthening China’s and emerging economies’ negotiating power vis-a-vis Russia. As such, the proposed measures are more likely to reduce Russia’s profits and limit the ability of financial centers to reap extra profits through financial operations outside the West’s system. In that sense, they are also different from export restrictions and their enforcement in third countries, which would directly undermine trade rather than relative market power. On the whole, we therefore believe that our proposals are an effective and acceptable way of increasing pressure on the financial resources available to the Russian regime.

Bibliografische Angaben

Wolff, Guntram, Benjamin Hilgenstock, and Elina Ribakova. “Toughening Financial Sanctions on Russia.” May 2023.

DGAP Policy Brief No. 10, May 16, 2023, 10 pp.

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