Fourteen years ago Zoltan Poszar, a Credit Suisse analyst, learned about the power of financial contagion. Back then, he was working at the Federal Reserve investigating the plumbing of the credit world.

When Lehman Brothers collapsed in 2008, he saw how unexamined interlinkages in the market’s financial “pipes” could generate unexpected shocks, particularly in the tri-party repurchase sector (where short-term loans are extended against collateral between multiple parties).

Today, however, Poszar is pondering whether a similar chain reaction might occur as a result of western sanctions on Russian institutions. “We are dealing with pipelines here — financial and real,” he recently told clients. “If you jam the flows by making [Russian] banks unable to receive and send payments, you have a problem [like] when a tri-party clearing bank did not return cash to money funds for fear of ending up with an intraday exposure to Lehman.”

Investors should take note. Thankfully there is no sign of serious problems in those financial pipes right now, let alone a Lehman Brothers-style shock. Yes, there are hints of stress in some market corners; the gap between the price of cash Bunds and derivatives, say, has swung sharply wider (seemingly because investors are grabbing securities they can use as collateral in deals).

European bank shares have sold off, amid fears about their loan exposures to Russia. There is concern that some emerging market funds will dump non-Russian assets to cover losses on frozen Russian holdings. And there is also gossip among traders about whether the dramatic swings in commodity prices or interest rates have wrongfooted some overleveraged hedge funds; memories of the 1998 collapse of the Long-Term Capital Management fund are being revived.

Yet what is perhaps most notable about markets this week is how smoothly they have continued to function in the face of unprecedented financial “shock and awe”.

This might be explained away by the fact that the overall scale of Russian financial assets is relatively small compared to the global financial system as a whole. However, another important factor is that western regulators and investors are more skilled in dealing with shocks than they were before 2008 — precisely because they have had so much practice with the financial crisis, the Covid pandemic and a decade of quantitative easing. It has become almost normal for risk managers to imagine six (once) impossible things before breakfast, to paraphrase Lewis Carroll.

However, it would be dangerous to be too complacent. One reason is that the full impact of sanctions has not really rippled through the system yet; the formal exclusion of seven Russian banks from the Swift messaging system only comes into effect on March 12. Another is that we simply do not know how a freeze of Russian assets will ricochet around interlinked contracts.

The main point that investors need to understand, notes Adam Tooze, a professor at Columbia University, is that “Russia’s reserve accumulation, like reserve accumulation by other oil and gas producers such as Norway or Saudi Arabia, is a source of funding in western markets — [and] part of complex chains of transactions that may now be put in jeopardy by the sanctions.”

It is hard to track the nature of these chains with precision, since cross-border data on financial flows and counter parties is patchy. Consider, for example, the situation around US treasuries. Back in the spring of 2018 it was widely reported, on the back of US Treasury data, that the Russian central bank had sold $81bn of its $96bn pile of treasuries holdings, apparently to avoid future sanctions. That sounded dramatic.

However, Benn Steil and Benjamin Della Rocca, economists at America’s Council on Foreign Relations, later did a forensic analysis of different national data bases. From this, they decided that $38bn of those Russian holdings had simply gone “missing” from the US data; Russia had seemingly “moved” [the bonds] outside of the United States to protect against US seizure” — primarily to Belgium and the Cayman Islands. Whether they are still there is unclear, Steil tells me.

Yet while these flows are opaque, Poszar has also crunched through (different) arcane data bases, in a bid to track both the $450bn of non-gold foreign exchange reserves recorded on the books of the Russian central bank holds, and the estimated $500 bn of liquid investors apparently owned by the Russian private sector.

That leaves him guessing that Russian players have “just over $300bn [held] in short-term money market instruments” outside Russia and “about $200bn of this represents the lending of US dollars in the FX swap market”. How these contracts (and other interlinked derivatives deals) will be handled in the face of sanctions is unclear; but lawyers are currently scrambling to find some answers.

Don’t get me wrong: by highlighting the risks in this financial pipework I am not predicting a Lehman-style shock. Nor am I suggesting that these dangers are a reason for the west to roll back sanctions. My point, rather, is this : financial war, like the real variety, creates unpredictable aftershocks and collateral damage. It would be naive to think this will only hit Russian players.

[email protected]