"The EU and US have departed markedly from established practices in their sanctions regarding Ukraine, and the innovative approach presents global companies and compliance practitioners with new challenges."
Since March 2014, the United States and the European Union, along with several other countries, have accused Russia of various forms of intervention in Ukraine – first involving Crimea, and then more broadly in eastern Ukraine. In order to exert pressure on Russia, they have adopted economic sanctions.
The jury is still out as to whether sanctions are an effective diplomatic tool. Nevertheless, the use of economic sanctions is certainly on the rise, and both the EU and the US have long implemented sanctions against countries, entities and individuals around the world. The EU and US have departed markedly from established practices in their sanctions regarding Ukraine, and the innovative approach presents global companies and compliance practitioners with new challenges.
Sanctions have evolved dramatically in the last 25 years. For several centuries, imposing sanctions usually meant cutting off all trade and investment flows with a specific region or country. Some countries maintain such embargoes today. For example, the US maintains comprehensive embargoes against Syria, Sudan, Iran, Cuba and North Korea.
Starting in the late 1980s and increasingly throughout the 1990s, the United Nations and individual countries acknowledged the unintended negative humanitarian consequences of such embargoes and initiated a shift towards so-called “smart” or “targeted” sanctions. Interestingly, Sergey Lavrov (then Russian ambassador to the UN) was at the time advocating the use of targeted sanctions against Iraq, because of the perception that the general Iraqi population suffered unduly from comprehensive sanctions.
Targeted sanctions mean just that. They target specific individuals, groups or industry sectors to exert pressure on the persons that the countries imposing the sanctions hold responsible for objectionable policies or behaviours, while allowing those countries to avoid charges of collective and indiscriminate punishment. The EU is particularly keen on targeting and has made it a basic principle in its use of sanctions.
The Ukraine-related sanctions imposed by the EU and the US further push this trend away from country-wide embargoes. But the rationale this time has little to do with the humanitarian impact of sanctions or their unintended consequences on neighbouring countries. Rather, Russia’s economy is simply too large and too integrated in the world’s (and particularly the EU’s) economy for the US or EU to impose broad sanctions without inflicting serious harm on themselves. To address this concern, the governments targeted specific industries within Russia’s economy and crafted sanctions to limit any boomerang effects (ie, back-filling by third-country entities).
THE NEW SECTORAL SANCTIONS REGIME
In the US, the Office of Foreign Assets Control (OFAC) first imposed “sectoral” sanctions and targeted entities under these sanctions using its Sectoral Sanctions Identifications List (SSI List) on 16 July 2014, based on the third in a series of executive orders issued by President Obama in March 2014.
The EU started to target Russia directly as of 31 July 2014, banning all trade in military products between the EU and Russia, as well as exports of dual-use goods intended for military use, but also restricting Russia’s access to EU capital markets and targeting parts of the Russian energy sector.
On 12 September 2014 the EU and the US expanded the scope of their sectoral sanctions with coordinated, although slightly distinct actions. In the case of the US, OFAC amended Directives 1 and 2 under its sectoral sanctions and added Directives 3 and 4, as explained below. Directive 1 targets Russia’s financial institutions, Directive 2 targets Russia’s energy industry, and Directive 3 targets Russia’s defense industry. Directive 4 targets certain types of projects in Russia’s energy sector, discussed further below. The EU further tightened its sectoral sanctions across the board, putting particular emphasis on services and financial assistance.
Both governments’ sectoral sanctions were issued in conjunction with or in addition to traditional sanctions blocking the assets of certain designated entities, as well as with controls restricting exports to Russia.
The US targets Russia’s financial services sector using Directive 1, prohibiting all transactions in, financing for, and other dealings in, new debt of longer than 30 days’ maturity or new equity of entities listed under the Directive. The new “debt” targeted by these sanctions includes bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, banker’s acceptances, discount notes or bills, or commercial paper, if they have a maturity date of over 90 days. Letters of credit with a maturity of 90 days or less are not affected, which should limit the impact on trade transactions. The prohibition also applies to the rollover of existing debt –for example, through refinancing. “Equity” includes stocks, share issuances, depositary receipts, or any other evidence of title or ownership.
By contrast, the EU opted for much narrower, if equally taxing, measures to restrict Russia’s access to capital. The EU prohibited dealings in transferable securities and money-market instruments with a certain maturity with respect to specifically listed Russian entities, as well as non-EU entities owned or controlled by those Russian entities. The key differences are the explicit exclusion of payment instruments – the inclusion of which would have been too burdensome on the EU economy – and the exclusion of EU entities owned or controlled by listed Russian entities, since a prohibition to deal with their financial instruments could have caused significant instability on the EU capital markets.
Directive 2 targets Russia’s energy sector. It prohibits US persons from engaging in all transactions in, providing financing for, and other dealings in, new debt of longer than 90 days’ maturity for entities listed under Directive 2. Directive 4 also targets the energy sector by prohibiting US persons from, directly or indirectly, providing, exporting, or re-exporting goods, services (except for financial services) or technology in support of the exploration or production for deepwater (greater than 500 feet), Arctic offshore or shale projects that have the potential to produce oil in Russia or maritime areas claimed by Russia, and that involve any person listed under Directive 4. Examples of the services prohibited under this Directive include drilling services, geophysical services, geological services, logistical services, management services, modeling capabilities and mapping technologies. This Directive does not, however, prohibit the provision of financial services, such as clearing transactions or providing insurance.
As one might expect, the EU’s lack of energy independence and, more generally, the importance that the Russian economy plays for the EU, dictated some of the EU’s choices in imposing sanctions against Russia’s energy industry. The EU provided an exhaustive list of controlled products, and it is for EU authorities (and not economic operators) to decide whether or not transactions involving those products should be prohibited because of their connection with energy projects. This is a key difference from the US regime, which requires economic operators to abstain from certain transactions, irrespective of the nature of the product, if the product is ultimately intended to be used in one of the types of energy projects identified (but not defined) in Directive 4.
Directive 3 targets Russia’s defence sector by prohibiting US persons from engaging in all transactions in, providing financing for, and other dealings in, new debt of longer than 30 days’ maturity for entities listed under the Directive.
In addition to very stringent controls on exports of military and dual-use items to Russia or for use in Russia, the EU imposed severe restrictions on the provision of related technical assistance, financing or financial assistance, including any insurance or reinsurance services. Yet the EU considered it was necessary to clarify that some of those controls should not apply to the aeronautics and space industry, as well as for the maintenance and safety of existing nuclear capabilities within the EU.
IMPACT OF THE NEW REGIMES
These sectoral sanctions are a departure from previous sanctions practice. Historically, OFAC has embargoed countries or targeted certain individuals or entities within a country as specially designated nationals (SDNs) and blocked their assets. While the EU has long insisted that it would adopt only targeted sanctions, the level of specificity of the Russian sanctions is unprecedented; the EU seeks to achieve its policy objectives in Ukraine without compromising its energy security, financial stability or fragile economic recovery.
The sectoral sanctions against Russia constitute a new regime, demanding new types of compliance procedures from the private sector. Previously companies could generally screen their customers, transactions and related parties; if the transaction or party was a true hit against various sanctions lists, the company would either block, reject or decline to proceed with the transaction. These days, when a party or transaction hits against OFAC’s SSI list, or is included in the list of entities whose transferable securities cannot be traded in the EU, the story is not yet over. The company must still check whether the transaction meets the conditions of the relevant measure before it can determine whether sanctions prohibit the transaction.
The situation is made all the more complex by the concentration of wealth in Russia. OFAC has made clear that the prohibitions in the Directives apply to the named persons, their property, and their interests in property, which include entities owned 50 per cent or more by one or more persons identified as subject to the Directives. With some important exceptions, the EU has adopted a similar stance for some of its restrictive measures. As such, persons governed by EU or US sanctions may struggle to determine whether dealings with certain entities that may be owned or controlled by listed wealthy individuals or major corporations are prohibited or not.
The US and EU have continued to modify their sanctions regarding Ukraine. It is unclear whether sectoral sanctions will be expanded further, either by adding additional Russian firms to the SSI list, or by targeting new sectors of Russia’s economy. While the sanctions so far target only the financial, energy and defence industries, President Obama has also authorised sanctions against the metals and mining, and engineering sectors of Russia’s economy. Neither the US nor the EU has indicated what further steps, if any, it will take to further isolate the Russian economy while the conflict surrounding Ukraine continues.