A changing sanctions landscape – enhanced risks for global investors, banks and companies
Partner, Global Co-Head International Trade and Regulatory Law Group
Partner, Global Co-Head International Trade and Regulatory Law Group, and Global Head of the firm's Environmental Law Group
Dr Udo Herbert Olgemöller
Frankfurt am Main
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Following the unprecedented sanctions imposed in the last 12 months, particularly on Russia, the focus of regulators and governments is now expanding to ensure that such measures are actively enforced and that circumvention is countered, so that sanctions can have the maximum impact.
In particular, the circumvention of sanctions has risen to the top of the agenda among G7 governments, with attention turning to non-G7 jurisdictions (including Hong Kong, Macau, Turkey, and a number of post-Soviet states, such as Uzbekistan, Kazakhstan and Belarus) and the role that they allegedly play in the circumvention of sanctions.
Whilst derivative designations have been a risk for entities for many years due to U.S. secondary sanctions, the UK and EU are increasingly following suit. Recent designations demonstrate the willingness of governments to target companies in jurisdictions that have not historically been a focus of sanctions regimes.
At the same time, sanctions issues have never been more sensitive in transactions involving a wide range of actors, including international banks and investors from a wide range of jurisdictions with global investment portfolios.
In this bulletin, we provide an overview of the current and emerging position in the U.S., UK and EU and outline the relevant considerations for companies and banks outside of those jurisdictions.
The United States maintains a range of sanctions regimes targeting a significant number of jurisdictions globally. Those targeting Russia include blocking (ie asset-freezing) sanctions and derivative designation sanctions implemented by Executive Order 14024 (EO 14024).
EO 14024 authorises the Office of Foreign Assets Control (OFAC) to designate as a Specially Designated National (SDN) any person that OFAC determines to be owned or controlled by, or to have acted or purported to act for or on behalf of, directly or indirectly, any persons whose property and interests in property are blocked pursuant to EO 14024. EO 14024 also authorises any person OFAC determines to have materially assisted, sponsored, or provided financial, material, or technological support for, or goods or services to or in support of (together, material support) persons whose property and interests in property are blocked pursuant to EO 14024. While OFAC has not articulated precise guidance as to what activities qualify as “acting for or on behalf of” or “material support”, historically, OFAC has taken a broad view of its own designation authority. Accordingly, non-US persons (e.g. persons who are not U.S. citizens, permanent residents, entities organised under the laws of the United States, or persons in the United States) who engage in dealings with SDNs are at risk of being targeted by blocking sanctions pursuant to EO 14024.
OFAC has actively used these designation powers to target persons and entities that it considers to be involved in the circumvention of sanctions.
For example, in April 2023, the U.S. government targeted a network of persons allegedly facilitating Russian oligarch Alisher Usmanov’s activities. The persons targeted by OFAC included:
- a Cyprus national, Demetrios Serghides, who, OFAC states, assisted Usmanov in acquiring real estate and managed assets for both Usmanov and Usmanov’s family members;
- the Sister Trust, a trust for which Usmanov and his sister are the settlors, of which Serghides was the protector;
- Pomerol Capital SA, the trustee of the Sister Trust; and
- a number of other companies owned by Usmanov and/or the Sister Trust, or of which Serghides was a board member, as well as a number of directors of such designated companies and individuals with ties to Usmanov and his businesses.
The U.S. further imposed a suite of designations on Russia-linked trust companies and targeted alleged Russian procurement and sanctions evasion. The targets included:
- Sequoia Treuhand Trust Reg, a trust services company based in Liechtenstein, which was designated due to its association with and provision of material support to Gennady Nikolayevich Timchenko;
- King-Pai Technology HK Co., Limited, a PRC-based supplier for multiple entities in Russia’s military-industrial complex; and
- Azu International Ltd Sti, a Turkey-based electronics company that has facilitated the backfill of electronics to Russia.
The UK has adopted a similar approach to OFAC, with the UK and U.S. governments coordinating their designations in April 2023 to target persons associated with the circumvention of the Russia-related sanctions. The UK’s designations included a similar targeting of Usmanov’s alleged financial network and related companies to ensure that his assets remain sanctioned.
In addition, the UK, also in coordination with the U.S., designated MTS Bank PJSC, a UAE-based entity. This reportedly led to the UAE withdrawing MTS Bank PJSC’s banking licence.
There is no doubt that such coordination is partly a consequence of the OFAC-OFSI Enhanced Partnership, announced in October 2022 to enhance both agencies’ capabilities in supporting effective sanctions implementation. Such collaboration is expected to extend to other shared sanctions regimes, and not only the Russia regimes.
Underpinning the UK government’s designations of persons allegedly involved in sanctions circumvention is the broad designation power that the UK government has taken, which includes the ability to designate persons who:
- are responsible for, engage in, provide support for, or promote any policy or action, or provide financial services, or make available funds, economic resources, goods or technology, that could contribute to destabilising Ukraine or undermining or threatening the territorial integrity, sovereignty or independence of Ukraine;
- carry on business of economic significance to the government of Russia;
- carry on business in a sector of strategic significance to the government of Russia;
- own or control, directly or indirectly, or work as a director (whether executive or non-executive), trustee, or other manager or equivalent, of a government of Russia-affiliated entity, or a person, other than an individual, which falls within the two bullet points above; and
- are owned or controlled, directly or indirectly, acting on behalf or at the direction of, or is a member or associated with, such persons which fall within the bullet points above.
The UK’s sanctions also prohibit intentionally participating in activities while knowing that the object or effect of them is, whether directly or indirectly, to circumvent prohibitions or enable or facilitate contraventions of such prohibitions.
The recent designations demonstrate the UK government’s willingness to designate companies in jurisdictions that are not a primary target of its sanctions regimes, and to take measures to trace through financial networks to identify those responsible for facilitating sanctioned activities.
It is a similar story in the EU, which has an equally broad designation criteria, and a growing number of designations of entities and individuals due to their support of Russia. Like the UK’s sanctions, the EU’s sanctions on Russia also prohibit the participation, knowingly and intentionally, in activities where the object or effect is to circumvent sanctions prohibitions.
Significantly, on 9 May 2023, the European Commission announced further details of its proposed 11th package of sanctions against Russia, which will focus on “cracking down on circumvention”. The elements of the proposed package include:
- adding more products to the transit ban, including advanced tech products or aircraft parts that are going to third countries via Russia;
- a new tool to combat sanctions circumvention, to prevent the highly unusual trade flows between the EU and certain third countries, which eventually see the goods end up in Russia; and
- a ban of ‘shadow’ entities from Russia and third countries that are intentionally circumventing EU sanctions.
Such measures, if introduced, will provide a further mechanism for the EU to target non-Russian entities that are circumventing EU sanctions or supporting Russia contrary to the objectives of such EU sanctions prohibitions.
Additionally, the EU is reportedly considering the designation of a number of Chinese and Hong Kong companies for allegedly circumventing its Russia-related trade sanctions, a move that would likely further complicate relations with China. The list reportedly includes King-Pai Technology (due to its alleged provision to Russia of microelectronics that have defence applications) which is already sanctioned by the U.S. The designation of entities from Iran, Uzbekistan, Syria, Armenia and the United Arab Emirates is also reportedly under discussion. These designations would add to the EU’s targeting of non-Russian entities for assisting Russia. For example, the EU designated SUN Ship Management Ltd, a Dubai-based shipping company, as it was suspected of helping Russia circumvent restrictions on its oil exports.
Notably, in a similar vein to the OFAC-OFSI Partnership, on 16 May 2023, the U.S. and the EU announced an enhanced bilateral partnership to work closely on sanctions as a tool to address shared foreign policy goals. Moving forward, we can expect increased alignment between the U.S. and EU on sanctions implementation, promoting compliance and strengthening enforcement.
The impact on transactions
The impact of U.S., UK and EU sanctions on transactions is being keenly felt globally. For example, in our experience, since February 2022, any connections to Russia:
- are subject to significant additional due diligence by banks and purchasers, as well as investors from a wide range of jurisdictions who hold global investment portfolios;
- result in heightened sensitivity among banks involved in financings and acting as underwriters on equity or debt issuances; and
- may result in difficulties for companies under existing financial covenants or other contractual obligations with counterparties.
Ultimately, we have seen:
- a number of M&A transactions fail due to sanctions-related concerns or concerns related to a target’s connections with Russia;
- companies facing difficulties in maintaining key customer or supplier relationships due to concerns around their compliance with sanctions or connections to Russia;
- a move towards carving out of transactions' assets connected to Russia, potentially leaving sellers with stranded assets;
- companies facing funding difficulties where their investors are or may be linked to Russia; and
- investors whose portfolios include Russia-related investments facing exclusion from future investment rounds in respect of their non-Russia-related investments, or enhanced KYC requirements prior to being able to participate in future investment rounds.
Going forward, we also expect to see a focus among international banks on ensuring that their correspondent banking relationships do not put them in violation of the sanctions applicable to them or otherwise expose them to sanctions risks. This may result in greater scrutiny of their correspondent banks’ sanctions compliance programmes.
The direction of travel is clear – the UK and EU are increasingly willing to utilise their respective sanctions regimes against Russia where entities and individuals are undermining their effectiveness, in a similar way to the U.S. government. This was reiterated at the start of the G7 summit in Hiroshima, where, on 19 May 2023, the leaders of the G7 reaffirmed their commitment to preventing the circumvention of measures against Russia. More than ever, this means that non-Russian companies that conduct business with Russia should be considering how the U.S. and UK governments and the EU may perceive their business activities and the extent to which they may create a risk of designation.
Furthermore, companies that operate globally, require the services of international banks, or want to attract investors with global investment portfolios will likely need to ensure that they are acting in compliance with key sanctions regimes, or, at the very least, be able to articulate how they manage the potential sanctions risks associated with their business activities.
Allen & Overy’s global sanctions group has been tracking these developments closely and can assist in:
- evaluating risk exposure under U.S., UK and EU sanctions arising from direct or indirect relationships or dealings with Russian parties;
- advising on risks of violating, or becoming targeted by, U.S., UK and EU sanctions, and the best means of reducing risk while minimising impact to ongoing business operations;
- preparing risk-based policies and procedures to mitigate ongoing risk;
- training directors, officers, managers, and employees in sanctions risk mitigation;
- preparing contractual language to use with counterparties to reduce the risk of indirect exposure to designated persons from suppliers, customers, and other third parties;
- assessing and managing contractual sanctions obligations in financing and other agreements; and
- assisting with any contact from OFAC or other governmental entities or regulators in relation to sanctions matters, including requests for information or subpoenas.
Should you have any questions on the matters discussed in this article, please contact Matt Townsend, Ken Rivlin, Maura Rezendes, Jonathan Benson, Kuang Chiang, Jasmin Fraser or your usual contact at Allen & Overy LLP.