Sanctions “will stop Putin from using his war chest,” European Commission President Ursula von der Leyen pledged on February 26, days after Russia launched its invasion of Ukraine. “We will paralyze the assets of Russia's central bank.”

And, indeed, since attacking Ukraine, Russia has been hit with the harshest sanctions it has faced since the end of the Cold War. Already on February 22, the day after Russia recognized the territorial claims of the self-declared separatist republics in the Donbas region of eastern Ukraine, the United States and its allies blocked major Russian firms and elites from Western markets. Four days later, after Russia launched a full-scale attack on its southern neighbor, the United States, the United Kingdom, Canada, and the European Union sanctioned Russia’s central bank and kicked Russian banks off of SWIFT, the messaging platform for clearing international bank transactions. And as the invasion’s second week drew to a close and Russian forces encircled Ukrainian cities, U.S. President Joe Biden banned the import of Russian oil, natural gas, and coal into the United States, depriving the Kremlin of vital revenue.

Though Russia has thus far escaped an EU ban on its critical oil and gas exports, its banishment from global financial markets has already hammered its economy. The February 26 sanctions sent international investors racing from Russian markets. In mere hours, the ruble lost nearly a third of its value. Barred from selling its foreign currency reserves, Russia’s central bank hiked interest rates from 9.5 percent to 20 percent to staunch ruble selling and slow the currency’s depreciation, while the government ordered Russian exporters to disgorge 80 percent of their foreign currency revenues. Such measures will help the regime conserve dollars in the short run—but by massively raising the cost of business capital and consumer borrowing, they will inflict a powerful blow to Russia’s capacity to sustain a lengthy major war.

By all appearances, Russian President Vladimir Putin grossly underestimated the scale and scope of the sanctions response to his invasion. Having amassed $630 billion in foreign reserves, Putin was confident in his ability to weather whatever the West would throw at him.  But now, because of the sanctions placed on Russia’s central bank, he is cut off from his mountain of money.

Or is he?

Our research suggests that Russia may have stashed tens of billions of dollars in reserve assets in opaque offshore accounts, where it holds dollar-denominated securities beyond the reach of international sanctions and asset freezes. We see indications, in fact, that across two different periods—one in mid-2018 and the other late last year, as Russia built up troops on the Ukrainian border—Russia may have secluded up to $80 billion in Treasury securities offshore. Russia’s total offshore dollar holdings, of course, could be higher still. And there are signs, too, that Russia may have moved some of its dollars with help from a foreign government.

If the West aims to make Putin pay for and end his illegal aggression, then it should, as the saying goes, follow the money. And it may need new measures to prevent him from using that money to prolong the war for months while continuing to fund Russia’s economy.

HIDDEN IN PLAIN SIGHT

Though today’s financial emergency may be the worst to befall Russia since the ruble crisis of 1998, when Moscow was forced to restructure over $70 billion in debt, the West’s sanctions may be less watertight than media reports and the comments of world leaders suggest. If the United States and its allies are determined to use financial strangulation to force Russia out of Ukraine—and possibly to force Putin from power—they need to consider the ways in which the Russian government may have prepared to soldier on under even these historic restrictions. Importantly, we believe Putin’s regime may actually hold tens of billions of dollars’ worth of U.S. Treasuries that cannot currently be traced to Russia.

Back in 2018, there were startling reports in Western media that Russia had dumped nearly all of its Treasury debt. U.S. Treasury Department statistics at the time showed Russia’s holdings plunging from $96 billion to $15 billion over two months. We were skeptical that Russia had sold the $81 billion difference. After all, most international trade—and nearly 90 percent of foreign exchange transactions—involves U.S. dollars. Given that Treasuries are the investment of choice for any government with an imminent need for dollars, a selloff that size seemed implausible.

The Treasury Department’s data, however, did not mean that Russia had necessarily sold the entire $81 billion of securities. Russia could simply have moved the Treasuries outside the United States. We therefore examined figures from Russia’s central bank, which suggested a far smaller figure for Treasury sales—about $43 billion. That left $38 billion unaccounted for. Where had it gone?

We then examined holdings of Treasuries in the two most popular offshore centers: the Cayman Islands and Belgium, the latter being home to the international custodial bank Euroclear, which holds securities on behalf of depositors. Over the same two months of Russia’s alleged dumps in 2018, we found anomalously large rises in Cayman holdings of $20 billion and Belgian holdings of $25 billion. The $45 billion total was more than enough to account for the missing Russian holdings.

The Treasury Department does not disclose the identities of those actually purchasing securities, nor would U.S. officials necessarily have this information. Government surveys of brokers and custodians do not collect it. Euroclear itself might not even know the ultimate owners of securities it handles. Instead of dealing directly with Euroclear, the Russian central bank could, for instance, transfer its securities to a financial intermediary—such as a private bank, a shell corporation, or even a foreign government—and direct that entity to deposit them with the custodian. Such maneuvering could obscure Russia’s involvement altogether.

Regardless, in 2018 it should have been no surprise that Russia would move Treasuries offshore, as it was widely known that this option was available and effective. It had long been believed that China was parking Treasuries at Euroclear to disguise their ownership and shield them from scrutiny. In China’s case, it may have offshored the bonds to mask its interventions in foreign exchange markets, as it had long managed the renminbi’s dollar value by buying and selling reserves stored in the form of Treasury securities. Russia’s motivations, however, would be different.

Stashing dollar-denominated securities in offshore accounts makes them harder to target for U.S. sanctions. The Kremlin has keenly felt the threat from sanctions since its 2014 annexation of Crimea and subsequent military backing of pro-Russian separatists in eastern Ukraine, when Western countries froze Russian assets and restricted its trade. For this reason, then, hiding Treasuries offshore would be an attractive option for Putin. His $38 billion stash of dollar assets, if still hidden in Belgium, the Caymans, or another haven, could be critical for Russia’s ability to purchase essential imports or meet interest payments on its sovereign debt.

PUTIN’S WAR CHEST

Once Putin began preparing for a major invasion of Ukraine, the stage was set for another big move in Russia’s Treasury stash. According to U.S. Treasury Department numbers published on February 15, Belgium’s—that is, Euroclear’s—Treasury bond holdings surged in December 2021 by a whopping $47 billion. (The Cayman holdings stayed flat that month.) That spike is Belgium’s largest one-month rise since early 2014.

China was almost certainly behind the 2014 surge. Throughout that year, the assets of its central bank, the People’s Bank of China (PBOC), rose in tandem with Belgian Treasury holdings. The PBOC was evidently building up its war chest of dollar reserves and storing them in Treasuries, held through Euroclear. In 2021, however, the PBOC’s reserves stayed flat, indicating a different source for the sudden rise in Belgium’s holdings.

That source is likely Russia. By December, the Kremlin undoubtedly anticipated that if it invaded Ukraine, harsh Western sanctions would choke off its access to dollars. To stave off the worst effects of such sanctions, it would make sense for Russia, prior to invasion, to buy up dollar-denominated assets and stash them in offshore accounts. That would explain the massive uptick in Belgian Treasury holdings. In any case, no other single country with motive to disguise its holdings from U.S. authorities could possibly account for it.

Following Western sanctions, Euroclear has stopped clearing purchases of Russian securities and other ruble-denominated transactions. These moves align with other Western companies’ steps to counter Russia’s invasion, and as far as we can tell, Euroclear has followed all of its obligations under existing sanctions. But Euroclear has not announced restrictions on anyone selling non-Russian securities, such as Treasury bonds. And although the sanctions have banned transactions with major Russian banks, Moscow could easily have used non-Russian intermediaries when placing its Treasury holdings with Euroclear. In other words, the Russian central bank could have structured its transactions to bypass sanctions altogether. Mere months before being slapped with allegedly comprehensive financial sanctions, then, Russia may have secluded yet another $40 billion or more in Treasuries from which it can draw in a pinch.

CHINA’S HELPING HAND?

It is not yet clear which intermediaries Russia would have used to stash Treasuries offshore. One strong possibility, however, is China, with which Putin now appears allied. In December 2021, at the same time that Belgium’s Treasury holdings surged by $47 billion, Russia’s central bank reported a massive $41 billion increase in its currency and deposits held at “other national central banks.” That jump dwarfed all other monthly changes in this statistic since Russia began reporting it in 2005. And the most likely recipient of those deposits is the PBOC.

The Russian central bank and sovereign wealth fund hold an estimated $140 billion in Chinese bonds—about four times the total in early 2018. Data from June 2021 also show China holding 14.2 percent of Russia’s foreign reserves, the largest share of any country. And their partnership extends well beyond the financial arena: late last year, Russia and China held a series of joint military exercises and issued joint diplomatic statements aimed at the West. It would make sense, therefore, for Russia to deposit $41 billion in renminbi or assorted currencies with the PBOC. The PBOC could have then exchanged the currencies for dollars, crediting Russia for a $41 billion deposit, and used the dollars to buy Treasuries for storage at Euroclear. Chinese President Xi Jinping, who just last week condemned Western sanctions as “harmful to all sides,” appears fully supportive of that sort of maneuvering.

This money would not necessarily leave a clear trail in the PBOC’s massive $3.2 trillion balance sheet, as the central bank could have spread it across multiple line items. The PBOC could, for example, have deposited some with state-controlled banks and directed them to buy Treasuries for safekeeping at Euroclear. Such an arrangement would explain why the PBOC’s currency and deposits with China-headquartered banks jumped by an unprecedented $13 billion last December—at the same time that the anomalous Belgian and Russian financial data were recorded. Alternatively, the PBOC might have kept the transaction off its balance sheet altogether. It is impossible, based on the information we have now, to know how Russia and China might have structured such an arrangement, but regardless, Russia would be able to withdraw the dollars whenever it pleases. The PBOC would simply sell the Treasuries and transfer the proceeds to Russia. Western authorities would be none the wiser, while Western financial institutions would not necessarily have violated any sanctions policies. And by circumventing sanctions this way, China and Russia would work to erode Western financial and political influence.

SEAL THE GAPS

In early December, the Biden administration disclosed intelligence reports that foresaw Putin’s invasion of Ukraine. Yet the U.S. government only published its data on the soaring Belgian bond stash nine days before Russia launched its attack in February. Had U.S. authorities been able to monitor Euroclear’s changing holdings in real time, it would have added to the early indications that Moscow was planning to go ahead with an invasion.

There are clear limits to the financial detective work that we can do from our desktops.  But our research suggests that Western governments may not be doing all they can—and should—to choke off Russia’s access to the dollars it needs to fund its war in Ukraine. The keys, we believe, lie in Russian money flowing through Brussels and Beijing.

As financial sanctions become the West’s weapon of choice in facing down aggressive autocracies, the United States and its allies need to better integrate cross-border “follow the money” strategies into their diplomatic and military arsenal to ensure success. Such strategies can help authorities close loopholes in existing sanctions, detect and restrict evasive transactions through financial intermediaries, and penalize state and third-party actors that undermine global restrictions. Moreover, they can buttress conventional intelligence efforts in predicting and countering adversary behavior. Sanctions programs that do not root out large-scale evasive money flows, however, will prove too porous to deter or reverse targeted behavior.