Operating under constraints: Sanctions and a rebalanced portfolio

When Russia occupied Crimea and parts of the Donbas region in Ukraine in spring 2014, in many ways, it created an existential crisis for the EBRD. The Bank was very much at the centre of the geopolitical storm, with forces pulling us in opposite directions and no opportunity to hide.

It was the most fundamentally transformative crisis in the Bank’s history and created a multitude of unparalleled challenges, with no precedent to guide management. It affected all aspects of our business model, delivery and ambition – not just with regard to Russia, but for all regions.

Russia was not just another country. It was the linchpin of everything the Bank did and a critical target for transition delivery.

Success overall very much depended on success in Russia. To “lose” Russia called into question our broader potential for success and possibly widespread shareholder support. At the time, Russia was the Bank’s biggest country of operation by far, with Annual Bank Investment (ABI) there and the Russian portfolio accounting for roughly 25% of the total, with seven offices and 140-plus staff. It was the biggest transition challenge, given the deeply embedded state-controlled legacy, but it was also the most sophisticated investment climate and best opportunity for positive demonstration effects across the Bank’s other investee economies. It was also the most demanding country of operation.

With ever-growing pressure from the G7/EU shareholders for the Bank to be part of the evolving sanctions regime, Bank management had to confront a multitude of questions. With regard to Russia specifically, what was the Bank legally required/allowed to do without violating the Agreement Establishing the Bank? How could we wind down our Russia presence without jeopardising our Russian investments, staff and clients?

More broadly, we had to consider that this could require a substantial downsizing of both our business and ambitions. Could we offset the loss of Russia through enhanced investment activity in other regions? Could we deliver on our transition mandate if the most important piece of our region was no longer part of our mandate. Could we manage the increased risk to our portfolio (particularly in Russia, but also Ukraine), as well as the rating-agency impact? Could we protect our investments in Ukraine and elevate our investment activity there substantially to offset Russia’s malign impact on the investment climate? And lastly, at a much more intangible level, how could we convince our clients of our continuing relevance while also keeping our staff – in Russia, in Ukraine and everywhere else – motivated and safe.

There were no immediate answers to many of these questions, but we could not afford to stand still. We had to move forward with confidence: remain stead, not overreact one way or another, focus on clients and staff, let the politics play out at a higher level, and be responsive but not excessively so. We were very conscious of avoiding provocations that might cause irreparable harm to the Bank’s existing investments and staff in Russia. And we knew that we had to fulfil our commitments in Russia to avoid undermining confidence in our commitments elsewhere. Despite all the emotion at shareholder level (on both sides), our best strategy was to protect the long-term health and reputation of the Bank.

We concentrated on multiple parallel work streams. Most of the legal questions became moot when a majority of Bank shareholders in July 2014 backed a definitive decision not to approve any further new investment in Russia.

With regard to business ambition more broadly, management decided to push forward, undaunted, with a proactive pivot strategy, transferring staff and resources to escalate our business in the two regions where we judged there to be the most investment activity upside: Central Asia and the very new SEMED region.Management also felt an essential allegiance and duty to assist Ukraine in withstanding this assault on its economy and sovereignty. However, the Board needed to be convinced that we could deliver on this within the risk constraints we faced. At the first Board meeting after the Crimean occupation, I asked: “if not us, who?”

Fortunately, the Board responded as hoped, leading to the Bank doubling our focus and activity in Ukraine. Management also decided to maintain its commitment to fairness for staff, with no forced redundancies and maximum flexibility, despite reducing the number of Russia offices from seven to just three within months.

It quickly became clear that we needed to prove to ourselves, our shareholders and our clients that we could deliver and demonstrate transition and overall impact across all of our regions, despite Russia’s absence from the mix. The prospect for achieving that business delivery depended on staff being motivated and clients being reassured – no small management challenge given the overall context. But we threw ourselves into it and, over time, one success at a time, built the momentum to recover. The responsiveness of the EBRD machine over the second half of 2014 was truly remarkable to behold. In reality, however, that machine comprised the people who responded to the call to deliver in a most remarkable way.

Behind the scenes, an equally critical and impressive effort was underway – to manage the existing portfolio of roughly €9 billion (including the Bank’s largest equity portfolio) to protect clients, avoid defaults and forestall government intervention. Similarly, the portfolio in Ukraine needed to be protected from conflict disruption in occupied regions, as well as capital flight.

Neither was a pretty process (with non-performing loans at the end of 2014 remaining steady in Russia at 2.7 per cent, but increasing to 26.6 per cent in Ukraine), but the result was critical for the Bank’s ongoing viability.

The results were quite amazing – indeed, surprising to some. In the second half of the year, the Bank managed to more than offset the €1.8 billion ABI gap created by lost Russian investment, with total ABI up by 4% for the year. ABI in Central Asia, SEMED and Türkiye increased by 46 per cent, 140 per cent and 51 per cent, respectively, for a total increase of €1.7 billion. And the Bank’s crisis support programme for Ukraine kicked in rapidly, with ABI increasing by 50 per cent on the year in 2014.

The relative success of this pivot strategy provided gave the Bank the confidence to realise that its business model and transition focus had broader applicability. This realisation underpinned its move on to the next phase of its expansion – with Cyprus, Lebanon and the West Bank and Gaza following relatively quickly – ultimately leading to new operations in
sub-Saharan Africa.

In the end, what was at first a massive shock to the Bank’s system turned out to be a catalyst for the more diversified strategy that has led the Bank to where it is today.

Phil Bennett | Former EBRD First Vice President