West struggles for winning formula on Russian sanctions

Reuters

By Peter Apps, Warren Strobel and Luke Baker

LONDON/WASHINGTON/BRUSSELS (Reuters) - Western states used targeted sanctions to isolate Libya's Muammar Gaddafi and push Iran into nuclear negotiations. Using similar tactics against President Vladimir Putin's Russia is a challenge on an entirely different scale.

Not only is the volume of Russian money in the international system much greater than anything tied to Gaddafi or Tehran but the sophistication with which it is moved, held and sometimes hidden is also much greater.

Some of the Western bankers, money managers and oil traders who help keep that money moving are unconvinced sanctions will have a truly significant effect.

There is also a question about political will in the European Union, which relies on Russia for a third of its energy needs, to go further.

U.S. experts traveled to Brussels this week and held what one U.S. official called "exceptionally tense" meetings with representatives from EU and some non-EU nations.

The Americans expressed concern that the Europeans would not be able to agree tougher trade, energy and financial sanctions, said the official, speaking on condition of anonymity.

The sanctions "are having an impact economically but they are not changing behavior, that's the paradox and that's why we need to tighten the squeeze", the official said.

As pro-Russia militants seize more public buildings in Ukraine's turbulent east and violence escalates, President Barack Obama and Germany's Angela Merkel met in Washington and agreed that further measures would be taken if Moscow continued to destabilize its neighbor ahead of elections on May 25.

But Obama acknowledged that some of the 28 EU member states would be more vulnerable to such sanctions than others. "Not every country is going to be in exactly the same place," he told a White House news conference with Merkel.

In turn, Merkel said that if required "we will move to a third stage of sanctions. I will underline this is not necessarily what we want."

Existing sanctions have largely targeted individuals and, while there has been an outflow of capital from Russia, there is little evidence that the measures are forcing Putin to rethink.

Russian buyers have pulled back on new New York real estate deals while Russian banks and firms are turning to Asia to borrow money as Western lenders shy away.

But there are no signs of any effect on London's superheated property market, where oligarchs like to park their money.

"The Russian economy is globally integrated in ways that Iran or Libya never were," says Nigel Inkster, former Deputy chief of Britain's Secret Intelligence Service (MI6) and now with London's International Institute for Strategic Studies. "It will be much harder to apply sanctions."

Washington has long used its banking muscle to force financial institutions to help it freeze out its enemies. After the September 11, 2001 attacks, it was able to damage Al Qaeda.

The threat of depriving Swiss banks of U.S. licenses forced Switzerland to open up its secretive banking sector.

During the 2011 Libya war, Western states were able to target the front companies and individuals Gaddafi was using to both sell Libya's crude oil and buy refined fuel to supply his army. At the same time, they helped the opposition find buyers for oil from rebel-held Libya.

After Washington sanctioned Gaddafi, the U.S. government seized about $39 billion of his assets in a single weekend, one former U.S. Treasury official recalled.

With Iran, the U.S. Treasury and others added a steady flow of new targets to sanction in order to block off routes Tehran created to try and continue trading.

BUSINESS AS USUAL?

After Washington announced new sanctions on Monday including travel and financial restrictions on Kremlin ally Igor Sechin, head of state oil firm Rosneft, oil traders and executives - both Russian and Western - saw little immediate impact.

"So he cannot fly to drink with U.S. energy executives," said a Russian oil trader. "But otherwise business will continue."

Rosneft itself, 20 percent owned by BP, is not covered by the sanctions and Western firms said they would continue to trade with it.

A senior U.S. Treasury official defended Washington's incremental approach and said Russia is "an economy that is losing international financing," citing Russian firms', and even the government's, increasing difficulties in financing debt.

"There's a cumulative effect that grows over time. Sanctions tend to have medium-term effects. That's where we think this is headed," said the official, who spoke on condition of anonymity.

The EU sanctions have been even more tightly focused, imposing travel bans and assets freezes on Russians and Ukrainians involved in the annexation of Crimea, but stopping short of targeting specific companies.

Wider trade sanctions would cause pain on both sides.

"I think everybody recognizes that if we move to sectoral sanctions, that would have an impact on the global economy, and on national economies," said another U.S. official this week.

The sanctions' effect on Western trade and business with Russia's energy sector look modest, at least so far.

Some major oil firms have expressed reservations about new projects in Russia but few, if any, existing business deals have been suspended.

Exxon Mobil Corp's partnership with Rosneft to explore for oil in Russia's Arctic shelf is shielded from the latest measures and will likely continue as Arctic oil production is in the interest of both sides, experts say.

IN NEW YORK, RUSSIANS GONE

While few believe Russia will be completely isolated, given recent efforts to woo Asia, some impact is evident.

Only a few years ago, Russians were the largest single group buying luxury New York apartments.

"They're gone," said Sotheby's International broker Nikki Field said. "They've been gone since the Crimean outbreak."

Rich Russians now seem to be moving money to Europe.

Central bank data showed an estimated $64 billion capital left Russia in the first three months of the year, as much as in the whole of 2013.

Money in London or elsewhere in Europe could be more easily seized than if it remained in Russia. But money managers and transparency campaigners say the wealthiest hold assets in trusts and fund companies that make them hard to reach.

Furthermore, Britain is wary of deterring rich investors.

Capital flight will strain Russian banks as they and other companies find Western lenders more reluctant. Executives now look to Asia in the hope of finding business there.

Rosneft's Sechin toured Asia in March, while Putin will visit China this month. State-backed Sberbank held roadshows in Singapore and Hong Kong in April while gas giant Gazprom will also meet investors.

Asian buyers, particular China, have provided a lifeline to Iran but have used the sanctions to justify paying less.

Whether Asia can meet Russia's need for investment and lending is unclear.

"Over the long term, (Asia) may supplant the European and American markets for us, but it won't be quick," Alexander Ivanov, deputy head of state-run bank VEB, told reporters after Western banks declined to syndicate a new loan.

(Additional reporting by Adrian Croft, Justyna Pawlak and Jan Strupczewski in Brussels and Timothy Gardner in Washington; Editing by Giles Elgood) nL6N0NO3AM

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