The Russian Angle in Cyprus
A lot has been made about the fact that Russian money was in Cyprus and that Cyprus was an offshore tax haven. A lot of people are claiming all of this money is mafia-related or in Cyprus to dodge taxes. And it is this claim, especially in German circles, which is driving the politics of the issue. These claims are way overblown.
Below are some thoughts on this for subscribers.
The German news link I posted last night alleging capital flight by government officials just prior to the bank holiday should be seen in that light. In this article, I am going strictly on what I know via reliable sources. However, I do not know Cyprus well enough to be able to say if the characterizations of the situation there are accurate. I just want to flag this from the outset because I am going to be talking about the Russian angle on the Cypriot situation.
How much of the money in Cyprus is really illegal or mafia-related? My sources are telling me these claims of mafia money are greatly exaggerated and that Cyprus’ banking system is home to far more legitimate money than people are making out. The Russian money is mainly medium and large corporates who are using Cyprus as a tax dodge in the way that US corporates use Ireland. Remember the accounts about Apple Spain nearly doubling their revenue but still reporting a net loss (link in Spanish)? This is because Apple routes its funds through Ireland as a tax dodge as Ireland has a corporate tax rate of 12.5%. Cyprus serves the same purpose for Russian money. And Luxembourg, which interestingly is one of the only countries that stood up for Cyprus in the Brussels negotiations, serves the same purpose for Germany. So you are talking about legitimate money from corporates from Russia and pensioners or high net-worth individuals from Russia and England.
And note that my source also mentions that Cyprus often uses English law. They issue sovereign bonds under English law for example. So this could explain why Russian corporates prefer to use Cyprus as a funding conduit in the same way that German corporates use Luxembourg. As an aside here, when I worked in the European bond markets, most of the bonds I dealt with were registered in Luxembourg in the way that many corporates issue bonds out of a corporate shell in Delaware, because of the familiarity courts in those jurisdiction have with laws pertaining to corporations.
We know via accounts from the Financial Times that Cyprus is merely a conduit for Russian money in many cases. For example, the FT writes:
Much of the Russian money that travels to Cyprus ends up coming right back to Russia, with many Cyprus-based companies of Russian origin borrowing from Russian banks and using the funds to reinvest back into Russia.
This explains why the Cypriot President was trying desperately to maintain his country’s banking status as a tax haven. This should also explain why Vladimir Putin is apoplectic about what the EU is doing to the Cypriot banking system. Yes, he wants to go after the tax dodgers but he also wants to preserve the Cypriot banking system as it serves as a vital conduit of funds for Russian business. There is another claim about Russia here too that deserves mention. ANd that is the claim that Russia allegedly routes money for aid to Syria through Cyprus. I have heard this. But the Syrian claim is just hearsay, though I believe it is a potentially important factor in Russia’s negotiating stance if true.
The bottom line here is that Cyprus is much less a dodgy place for illegal money to live and more of an offshore banking centre like Ireland that also serves as a place to conduct business in fair and transparent courts like Luxembourg or Delaware. I believe Cypriots rightly feel unfairly maligned by all of the talk about Russian mob money which is being used to make the case for expropriating the deposit money.
The last I have heard of the situation in terms of the Russian angle comes via Reuters. Apparently, the Eurogroup has not budged on its negotiating stance. I got confirmation of this from two widely read newspapers, one in France and one in the Netherlands. And so the Cypriots are turning to the Russians for help.
Finance Minister Michael Sarris said he had reached no deal on financing with his Russian counterpart, Anton Siluanov, but talks were continuing.
Cypriot officials disclosed that the country’s energy minister was also in Moscow, ostensibly for a tourism exhibition. Cyprus has found big gas reserves in its waters adjoining Israel but has yet to develop them.
“We had a very honest discussion, we’ve underscored how difficult the situation is,” Sarris told reporters after talks with Siluanov. “We’ll now continue our discussion to find the solution by which we hope we will be getting some support.
“There were no offers, nothing concrete,” he said.
Austria’s finance minister made clear the European Central Bank could soon pull the plug on Cypriot banks after the island’s parliament rebuffed EU demands for a levy on bank deposits to raise 5.8 billion euros.
Not a single lawmaker voted for a proposed levy that would have taken up to 10 percent from larger accounts, many of which are held by Russians and other foreigners, while sparing small savers with less than 20,000 euros in the bank.
It was the first time a national legislature had rejected the conditions for EU assistance, after three years in which lawmakers in Greece, Ireland, Portugal, Spain and Italy all accepted biting austerity measures to secure aid.
So that’s where we stand. The Cypriot banks are insolvent and cannot re-open until they are recapitalized. Unless the EU institutes capital controls there will be a bank run which collapses the Cypriot banking system even if a recap deal is reached. The Eurogroup stands firm in its position that private sector involvement must be 5.8bn euros because the Germans, backed by the Finns and the Slovaks in particular, do not want to put up more aid in this election year. Knowing all of this and given how the Cypriots have rejected the deposit levy, Cyprus is desperately searching for other ways to get funds to recapitalise its banks. And negotiations with Russia are a main part of this search given Cyprus’ use by Russian corporates.
Update 730 EDT: Nouriel Roubini has tweeted that the Russians are negotiating with Cyprus on aid in return for rights to Cyprus’ gas assets and bases as the Russians are losing a military base in Syria and need another one in the Mediterranean.
Update 830 EDT: Let me say this right now. If you institute capital controls, there is no way Cyprus can continue to operate as a banking centre. They are done, just like Iceland. The big problem then in comparison to Iceland is the currency issue as it affects sovereign debt. I believe Cyprus will default on sovereign debt. More focus will be on this issue.
Update 1600 EDT 21 Mar: Yves Smith confirms much of what I have written here and more. Please see her post on Krugman’s Bad Math on Cyprus. Yves also shows that the talk of a domestic housing bubble may be overblown as well.
I will update you when more information becomes available. Please note that I have been doing a lot of tweeting on this topic since early Saturday. If you’re not already on twitter, you should be. Twitter is an invaluable source of real-time news. Follow me at @edwardn.
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