CONTINGENCY PLANNING FOR POLITICAL RISK INSURANCE FOR UKRAINE

The IMF-led assistance package (which includes 1.8 billion in Macro Financial Assistance (MFA)
from the EU) has Ukraine on a short leash, providing limited financial support disbursed in
installments as Ukraine achieves reform milestones. This assistance is designed to keep Ukraine
alive, but it is not sufficient to help Ukraine attract the private capital it needs to make Ukraine
prosperous.

Ukraines economy offers attractive investment opportunities. New private investment would
produce growth and employment and create a more favorable environment for the reforms linked to
the Wests financial assistance, and especially the reforms that are part of Ukraines Association
Agreement with the EU.

The reforms that will make Ukraine prosperous have to be conceived and implemented by the
Ukrainian government and the Ukrainian people. But they cannot succeed without adequate support
from allies in Europe, the US and elsewhere. This assistance must include tools that catalyze
private investment.

Even though the EU is not ready to provide this assistance now, we respectfully submit that the
West, and especially the EU, should engage in contingency planning that would allow it to expand
its assistance quickly if and when it decides to do so.

It is easy to envision situations when action would be urgently needed. For instance, a frontal attack
on Mariupol would require assistance to Ukraine on a significantly larger scale. Preparing the
ground is a laborious process that is liable to take several months. Therefore it is only prudent for
the EU to engage in contingency planning as soon as possible. This would not obligate the EU to
take any further action; it would merely provide the EU with a policy tool that it currently lacks and
may urgently need.

At present the EU does not have the tools to provide adequate support, especially to catalyze
private investment. For example, the Macro Financial Assistance facility, which has been used to
channel EU assistance alongside IMF assistance for Ukraine, is small, inflexible, and only provides
budgetary support directly to the government. It does not allow for political risk insurance and other
incentives for private capital.
Moreover, most official insurance providers (such as the World Banks Multilateral Insurance
Guarantee Agency, the EBRD and the EIB) have either reached their exposure limits for Ukraine or
do not insure the risks that private investors are worried about. The Overseas Private Investment
Corporation (OPIC, a US-government agency) has capacity available for political risk insurance in
Ukraine. However, it is restricted to providing insurance only to US investors.

The EU should now develop a new regulatory framework for MFA that would

Allow the assistance to be scaled up, and

Be more flexible so that it can be used not only for direct budgetary support to governments
but also for political risk insurance and other incentives to the private sector.

This has two important advantages.

Guarantees require no cash outlays from the EU budget unless and until there is a loss.

The EU would make a provision in its budget to account for the possibility of future claims on
the budget. However, this provision would only be a fraction of the face value of the guarantee.
This would allow the EU to leverage its guarantee authority to great effect. For example, if the
EU must set aside 9% in its budget for a guarantee (as in the case of the MFA), then a 90
million provision can create a 1 billion guarantee.

To use guarantees for political risk insurance and other incentives in Ukraine, the EU only needs to
modify tools, practices and institutions that already exist, and in most cases are already part of the
EUs assistance arsenal.

The EU already uses guarantees to provide assistance to Ukraine. The EU funds its loans under
its MFA facility by borrowing in the markets (using its triple-A credit rating) and on-lending the
funds to Ukraine. A cash outlay from the EU budget would materialize only if Ukraine were to
default on its loan to the EU.

The EU also uses its guarantee authority to facilitate lending and investment operations by the
EIB outside of the EU (including Ukraine). The EU guarantee protects the EIB against losses
that could jeopardize its triple-A rating.

EU member states are major shareholders of international financial institutions that provide
political risk insurance and other forms of insurance to catalyze private investment in Ukraine
and elsewhere. The World Banks Multilateral Investment Guarantee Agency (MIGA) provides
political risk insurance. The International Finance Corporation (IFC - also a World Bank
agency) and the EBRD have debt, mezzanine and equity products that allow them to invest
alongside private investors, limiting the risks facing private investors. (The EIB can play a
similar role.)

Although OPIC is a US government agency and has no formal connection to the EU, it offers a
useful model (together with MIGA) for how government agencies can provide political risk
insurance. OPIC is now willing to increase its provision for Ukraine.

European officials may argue that, under present conditions, the EU would be taking on excessive
risk by providing political risk insurance in Ukraine. However, the arrangement being proposed
would not be activated unless and until the EU had decided to scale up its support for Ukraine
across the board. Once this decision has been taken and made public, Ukraine will have a much
better chance of overcoming its economic and political difficulties, which in turn will reduce the
risk of losses under a political risk insurance program.

Issues that must be addressed

The implementation of this contingency plan requires resolution of three issues:

The EU must draft a regulatory framework for extending assistance under the MFA facility to nonmember states. Since the entry into force of the Lisbon Treaty (in December 2009), legislative

decisions on individual MFA operations have been taken by the European Parliament and the
European Council under the ordinary legislative procedure (known as co-decision), which is a
lengthy decision-making process. The Commission introduced framework regulation in 2011 to
streamline the process by laying down the key rules governing MFA in a formal legal act, but then
withdrew it because of disagreement among member states. As a result, the EU operates in a
relative legal vacuum when extending assistance to non-member states, so each operation has to be
approved individually. This has slowed and sometimes blocked decisions on assistance for nonmember states.

The new framework should allow the MFA facility to cover the provision of political risk insurance
to the private sector. At the moment, MFA funds are restricted to balance-of-payments assistance
provided directly to the government. They cannot be used to directly benefit private sector
investment. The simplest solution is to delegate the task of providing political risk insurance to an
existing international institution such as MIGA. For example, the guarantee could be used to
establish a trust fund administered by MIGA and available for private investors in Ukraine from all
over the world. Such trust funds have been used elsewhere by MIGA. MIGA also already has a
significant portfolio of exposures in Ukraine, and is therefore familiar with political risk in Ukraine.
The virtue of this solution is that the European Commission would relinquish its fiduciary
responsibility to MIGA and transfer a complicated technical task from the political arena to an
existing institution that is qualified to deal with it. In addition, it would also meet the legal
requirement that all investors should be treated equally.

The EU has to decide whether to allocate funds to Ukraine under its existing budgetary ceiling or in
addition to it. Allocations under the existing ceiling require only a qualified majority; supplemental
budgets have to be approved unanimously.
One way to reduce the amount that the EU has to allocate to Ukraine is to solicit contributions from
individual member and non-member states. For instance, Germany has offered $500 million for
rebuilding Eastern Ukraine but Eastern Ukraine is bound to remain under Russian influence for the
next several years. It would be more cost effective to contribute that amount to the MFA. It could
then be leveraged up eleven-fold (assuming that the current provision requirement is maintained)
using the MFAs guarantee mechanism. Norway, Switzerland, Canada and Japan could be persuaded
to make similar contributions to the same MIGA fund.
The prevailing political consensus prefers to keep Ukraine on a short leash, especially as there are
so many other contingencies such as Greece, ISIS and asylum seekers. This may be tenable in the
very short term until July 2015 but not beyond, for reasons that will be spelled out in the next
section.

Timetable

Since President Juncker cancelled his trip to Ukraine, the time to officially present the Contingency
Planning proposal will be at the donors conference scheduled for April 27-28th. The April 27-28th
meeting itself will become a dress rehearsal for a real donors and investors conference to be held in
the early fall.

This allows sufficient time to prepare the ground. Brussels is reasonably well prepared. The three
Presidents - Juncker, Tusk, and Schulz- are favorably disposed, although some members of their

staff are reluctant to move without the prior consent of the German Ministry of Finance which they
have declined to give. Therefore, gaining Chancellor Merkels support is critical and only President
Poroshenko can obtain it. President Hollande will follow Merkels lead.

By the end of June it will be clear whether the cease-fire holds or not. If Russia resumes a largescale military offensive involving Russian troops and/or weapons, failure to support Ukraine on a
much larger scale risks losing Ukraine. Europe would have to spend a lot more on its own defense
than the amount it should have spent on helping Ukraine to defend itself.

If the Minsk Agreement holds, Ukraines allies will still have to extend the sanctions against Russia
until the end of 2015 or such later date when Russia fulfills its obligation to put its border with
Ukraine under OSCE supervision.

That will be the appropriate time for Ukraines allies to balance the extension of the sanctions with
a declaration that they will do whatever it takes (using Draghis memorable phrase) to enable
Ukraine not only to survive but to make significant political and economic progress in spite of
Putins hostility.

Sanctions on their own merely reinforce Putins narrative that Russias political and economic
difficulties are due to the hostility of the Western powers that are determined to destroy Russia. By
contrast, if the sanctions are counterbalanced by large-scale and effective assistance to Ukraine it
should become obvious to the Russian people that Russias difficulties are due to Putins policies.

By June, it will be too late for Putin to resume large-scale military action. The Ukrainian army will
have been sufficiently reinforced by new recruits, some training and some equipment to be able to
offer resistance and the new Ukraine will have made enough progress to bring the oligarchs and
the bureaucracy of the old Ukraine under control to allay some of the suspicion with which it is
currently treated. Therefore Russia will have no alternative but to change its policies towards
Ukraine for the better.

Looking ahead two to three years Russia will be running out of currency reserves and its economy
will be in deep depression. By contrast, the Ukrainian economy will be recovering from the wounds
it has suffered from President Putins aggression and it will serve as an attractive role model for the
Russian people to follow. Europe will be amply rewarded for the investments it will have made in
Ukraine.