Global sanctions on Russia accelerate focusing on sanctions circumvention and Russia responds
Partner, Global Co-Head Environment, Climate and Regulatory Law Group and the International Trade 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
Dr Tim Nikolas Müller
Frankfurt am Main
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G7 governments continue to seek ways to increase the effectiveness of their sanctions on Russia by clamping down on sanctions circumvention.
The 11th EU sanctions package on Russia is a particularly important development in this respect as it gives the EU greater freedom to target persons involved in sanctions circumvention, introduces a new anti-circumvention tool and enhances the sanctions-related reporting obligations imposed on EU persons. The UK and US governments have likewise introduced further anti-circumvention measures with the UK focusing on the provision of legal services and the US on targeting non-Russian persons engaged in sanctions circumvention.
Russia has responded by enhancing its counter-sanctions toolkit with a particular focus on regulating transactions where companies are seeking to exit Russia and enabling the imposition of temporary external management over entities owned by companies from so-called “unfriendly” jurisdictions. Overall, the sanctions landscape has never been more complex and difficult for companies to navigate. In this publication, we focus on recent EU, UK, US and Russian law developments.
1. The EU’s 11th package: circumvention in the spotlight
After four months of consideration and negotiation, the EU’s 11th sanctions package on Russia was published on 23 June 2023. The package is broad in its ambit and contains new restrictions touching on a range of financial and trade-related activities with an overall focus on countering sanctions circumvention.
Below we focus on four particular aspects of the 11th sanctions package – the EU’s greater freedom to target persons involved in sanctions circumvention, the EU’s new anti-circumvention tool, the enhanced reporting obligations imposed on EU persons, and the EU’s new transferrable securities restrictions – but it is worth noting that the package also:
- adds more than 100 additional individuals and entities to the EU’s asset freeze regime, meaning that the list now includes almost 1,600 individuals and almost 250 entities;
- expands the EU’s trade sanctions including prohibiting the export of certain new and second-hand cars and imposing a requirement on importers of sanctioned iron and steel goods that have been processed in a third country to prove that the inputs used do not come from Russia;
- imposes further restrictions on transit via Russian territory of goods and technology which may contribute to Russia’s military and technological enhancement or to the development of the defence or security sector, goods and technology suited for use in aviation or space industry, and jet fuel and fuel additives, exported from the EU to third countries;
- creates restrictions on access to EU ports and locks to any vessels that engage in ship-to-ship transfers, if it is suspected that the vessel is either in breach of the ban on importing seaborne Russian crude oil and petroleum products into the EU, or is transporting Russian crude oil or petroleum products purchased above the price cap agreed by the Price Cap Coalition;
- adds 87 entities to the list of entities directly supporting Russia’s military and industrial complex which are now subject to tighter export restrictions concerning dual use goods and technologies. The entities include companies registered in China, Uzbekistan, the United Arab Emirates, Syria and Armenia; and
- expands the EU’s sanctions targeting broadcasting with RT Balkan, Oriental Review, Tsargrad, New Eastern Outlook and Katehon now being subject to restrictions.
At the same time, the 11th sanctions package creates greater flexibility in relation to, for example, the disposal of certain types of securities held by specified listed entities and the setting-up, certification or evaluation of a firewall that removes the control exercised by a listed person over the assets of a non-listed EU entity which the listed person owns or controls and that ensures that no benefit accrues to the latter, thus allowing that entity to continue its business operations.
The new sanctions also underline that the EU has developed a highly complex and finely tuned legal framework that is able to reflect certain needs and constraints of the EU and its Member States. For example, provisions relating to the need for spare parts “necessary for the operation, maintenance or repair of Budapest metro line 3 cars” have been included.
Targeting non-EU companies: broader circumvention-related designation grounds
The 11th sanctions package has created the ability to target with asset freezing sanctions those individuals and entities that facilitate the circumvention of EU sanctions or that otherwise significantly frustrate the EU’s anti-circumvention prohibitions. This new designation criteria is designed to enable non-EU companies to be targeted and expands the existing circumvention-related designation criteria considerably. As such, this represents a significant further step towards EU sanctions having extraterritorial reach.
The EU has stated that indications of cases of significantly frustrating the EU’s sanctions could include:
- the fact that the main activity of a third country operator consists of purchasing restricted goods in the Union that reach Russia;
- the involvement of Russian persons or entities at any stage;
- the recent creation of a company for purposes related to restricted goods reaching Russia; or
- a drastic increase in the turnover of a third country operator involved in such activities.
Indeed, the 11th sanctions package includes the designation of an entity expressly for sanctions circumvention, namely a Russian entity suspected of participating in the circumvention of the existing ban on semi-conductor exports. This adds to the list of entities from countries such as Iran, Syria, the UAE and Georgia that are already targeted with asset freezing sanctions.
Targeting jurisdictions involved in circumvention
The 11th sanctions package includes a new anti-circumvention tool that will allow the EU to put third countries on a list resulting in a prohibition on the sale, supply, transfer or export of targeted products to targeted jurisdictions. The list will specify the targeted products, focusing on sensitive dual-use goods and technology, or goods and technology that might contribute to the enhancement of Russia’s military, technological or industrial capacities or to the development of Russia’s defence and security sector, in a way that strengthens its ability to wage war. The core sale, supply, transfer and export prohibitions will sit alongside the standard set of associated prohibitions covering services such as the provision of technical assistance and financial assistance.
As of now, the list of third countries is blank. Instead, it is envisaged that the EU will use a graduated approach of:
- further strengthening bilateral and multilateral cooperation with the relevant third countries and providing technical assistance;
- targeting relevant individuals and entities with sanctions;
- entering into further dialogue; and
- only if the countries still fail to cooperate, where circumvention remains substantial and systemic, adding the relevant third country to the list.
Whilst the EU has not spelt this out explicitly, recent studies, for example by the EBRD, indicate that countries like Armenia, China, Kazakhstan or Turkey may be the first to be targeted.
Enhanced reporting obligations on EU individuals and entities
In its press release, the EU mentions “additional provisions on information exchange and reporting”. This represents an understatement, as, in relation to the EU’s sectoral sanctions targeting Russia, EU persons are now obliged to:
- supply any information which would facilitate the implementation of the relevant regulation to the competent authority of the Member State where they are resident or located within two weeks of acquiring this information; and
- cooperate with the relevant competent authority in any verification of such information.
Whilst a similar reporting obligation is found in other EU sanctions regulations, none relates to an economy as large as Russia and such a wide ranging set of prohibitions. Additionally, the carve outs to this obligation are limited. We therefore expect that, in the absence of any official guidance, it is likely that EU persons will seek to interpret this obligation narrowly, and only report information that would assist with the enforcement of the relevant regulation.
Enhanced transferrable securities restrictions
The 11th sanctions package extends the EU’s current restriction on the sale to Russian individuals and companies of transferable securities denominated in any official currency of a Member State issued after 12 April 2022, so that it now covers transferrable securities denominated in any other currency issued after 6 August 2023. This could impact on the ability of entities to exit Russia going forward.
2. The UK’s focus on circumvention continues
The UK has recently announced measures intended to enhance the effectiveness of its sanctions against Russia. This follows the UK’s measures in this regard announced in April (detailed in our publication here).
First, as part of the UK’s continued efforts to combat sanctions circumvention, the UK has introduced a new restriction that a UK person must not directly or indirectly provide “legal advisory services” to any non-UK person in relation to, or in connection with, any activity which would be prohibited by the UK’s sanctions, if done by a UK person or carried out within the UK. The restriction came into force on 30 June 2023, is broad in its ambit, and is subject to only limited exceptions. In the absence of further guidance from the UK government, in-house counsel appear to be caught by the prohibition, as well as potentially compliance professionals. Consequently, they will need to ensure that they do not violate the restrictions.
Second, the scope of the UK’s sanctions has been extended to reflect the practical realities of the on-going conflict. Sanctions measures affecting “non-government controlled Ukrainian territory” have recently been extended to the Kherson and Zaporizhzhia oblasts regions. The UK’s sanctions targeting Belarus have also recently expanded, for example, by extending the existing import and export restrictions to various goods such as gold, cement, and machinery-related goods. The categories of transferrable securities issued by Belarusian entities that are targeted has also been broadened.
The UK has also announced forthcoming legislation to permit the UK to:
- maintain its Russia-related sanctions until compensation is paid to Ukraine;
- introduce a new voluntary route for frozen Russian assets to be released if donated for Ukrainian reconstruction;
- require persons and entities designated under the Russian sanctions regime to disclose any assets held in the UK; and
- require those holding assets in the UK on behalf of the Central Bank of Russia, the Russian Ministry of Finance, or the Russian National Wealth Fund (NWF) to disclose them to the Treasury.
These last two measures are again intended to combat sanctions circumvention.
In broader developments, the UK’s sanctions are included in the UK government’s proposed reforms to the “identification doctrine”. This is the English law rule on how criminal liability is attributed to a company or partnership via the conduct of certain senior individuals. The proposed change significantly broadens the range of employees who can trigger corporate criminal liability, meaning it will be easier for businesses to be prosecuted for sanctions offences (see here for our article on this development). At the same time, HM Treasury is consulting on possible changes to the supervision of regulated sector entities in relation to sanctions matters. These developments demonstrate the focus on ensuring the effective implementation and enforcement of the UK’s sanctions regimes.
3. The US government maintains the pressure
The United States has also continued to expand its sanctions and export controls targeting Russia. Recent developments underscore the risk to non-Russian parties who continue to engage in dealings, directly or indirectly, involving Russia.
On 19 May 2023, the Biden administration, in coordination with the G7 and other international partners, substantially expanded the scope of restrictive measures targeting Russia. Notably, the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) imposed blocking sanctions on 22 individuals and 104 entities, with touchpoints in more than 20 countries or jurisdictions, targeting those attempting to circumvent or evade sanctions and other economic measures against Russia, the channels Russia uses to acquire critical technology, Russia’s future energy extraction capabilities, and Russia’s financial services sector.
The US Department of Commerce’s Bureau of Industry and Security also added 71 entities to its trade blacklist, significantly expanded the territorial reach and categories of items covered by US export controls targeting Russia, and issued a joint supplemental alert with the Financial Crimes Enforcement Network urging continued vigilance for potential Russian export control evasion.
In addition to the list-based measures described above, OFAC issued determinations identifying additional sectors of the Russian economy and categories of services subject to sanctions pursuant to Executive Order 14024 and Executive Order 14071, respectively. Following the latest determination pursuant to Executive Order 14024, persons (including non-Russian persons) may now be targeted with sanctions for operating or having operated in the following sectors of the Russian Federation economy:
- defense and related material;
- financial services;
- trust and corporate formation services;
- management consulting;
- quantum computing;
- metals and mining;
- manufacturing; and
For certain of these sectors, such as the architecture, engineering, construction, manufacturing, and transportation sectors, this includes the provision or receipt of goods, services, or technology to, from, or involving such sectors.
The sector determinations pursuant to Executive Order 14024, which complement other Russia-related sanctions authorities, reflect a heightened designation risk for both Russian and non-Russian parties. OFAC has also previously advised that the United States is “prepared to more aggressively use its authorities under existing US sanctions programs to target such persons whose activities may constitute material assistance, sponsorship, financial, material, or technological support for, or goods or services to, or in support of (together ‘material support’), sanctioned persons or sanctionable activity.” As part of its 19 May action, OFAC imposed sanctions on entities from numerous jurisdictions outside of Russia pursuant to Executive Order 14024, including China, Estonia, Hong Kong, India, Singapore and the United Arab Emirates.
These latest measures, which build upon previous rounds of sanctions and export controls, highlight the US government’s focus on:
- preventing parties from engaging in activities intended to circumvent or evade Russia-related sanctions and export controls; and
- targeting actors, both inside and outside of Russia, who engage in sanctionable conduct.
4. The Russian government’s response
In response to the sanctions imposed principally by the G7 states, the Russian authorities have enacted a number of counter-measures aimed mainly at restricting:
- the fire-sale of the Russian assets of international companies; and
- outflows of cash from Russia.
Most of these counter-measures apply to the transactions involving persons associated with the jurisdictions that have introduced sanctions against Russia, including the US, UK and all EU Member States (the Restricted Persons).
The key counter-measures that significantly restrict Russian operations of the Restricted Persons now include:
- transactions involving direct or indirect dealing with shares in Russian companies;
- transactions by Restricted Persons in respect of real estate located in Russia;
- distribution of dividends by Russian companies to Restricted Persons in excess of a certain minimal threshold amount;
- repayment of loans by the Russian residents to the Restricted Persons in excess of a certain minimal threshold; and
- the provision of loans to Restricted Persons by Russian residents.
The restricted transactions referred may only be executed subject to receipt of a regulatory consent either from the President, the Governmental Commission for Control over Foreign Investments in the Russian Federation, or the Russian Ministry of Finance, as applicable. Such consents will typically be issued subject to various conditions including, where relevant, a requirement for a substantial discount to the sale price and an exit tax.
There is a continuous discussion regarding the criteria and conditions associated with the issuance of the consents and we expect that the conditions and criteria will eventually become more stringent.
In addition to the counter-measures described above, the Russian government continues to work on further measures to counter the G7’s sanctions. This includes the consideration of various potential measures aimed at taking control over the assets of the G7 investors in Russia in response to the freezing of Russian assets by a number of G7 countries.
Thus, on 25 April 2023, Russian President Putin issued Decree No. 302 “On temporary management over certain assets” pursuant to which the Russian President has the right to introduce temporary external management over:
- movable property and real estate located in Russia;
- securities and participation interests in the charter capital of the Russian legal entities; and
- property rights, in each case owned by persons affiliated with unfriendly States (the Designated Assets).
This right is exercisable by the President if:
- the unfriendly State: deprives or restricts ownership rights of the Russian Federation, the Russian legal entities or the Russian citizens over the assets located in a so-called unfriendly State; otherwise restricts their property rights; or threatens to introduce the said restrictive measures; or
- if there is a threat to the defence capability or national, economical, energy or other security of the Russian Federation.
As a default rule, the Russian Federal Agency for State Property Management is authorised to manage the Designated Assets, although the Russian President can appoint a different external manager for a specific Designated Asset. The external manager can exercise any and all rights of an owner of the Designated Assets except that the external manager is not allowed to sell or dispose of the Designated Assets and must safeguard them. All costs incurred by the external manager in connection with the management of the Designated Assets will be covered from revenues generated by the respective Designated Assets. The external management over the Designated Assets can be revoked only by the Russian President in his absolute discretion.
Currently, the list of Designated Assets over which such external management has already been introduced is appended to the Decree and only includes:
- the Russian subsidiary of Uniper; and
- the Russian subsidiary of Fortum,
both which operate in the Russian energy sector.
However, this list can be further expanded by the decision of the President to cover other assets and it is expected that at some point this list might be expanded.
5. Concluding remarks
Non-Russian companies operating in Russia continue to face an unprecedented number of hurdles and ever-increasing risks as the EU, UK and US continue to broaden the scope of their sanctions. The Russian government’s response has also made exiting the Russian market increasingly difficult. Allen & Overy’s global sanctions group has been tracking these developments closely and can assist in:
- evaluating risk exposure under US, UK and EU sanctions arising from direct or indirect relationships or dealings with Russian parties;
- advising on risks of violating, or becoming targeted by, US, UK and EU sanctions, and the best means of reducing risk while minimising impact to ongoing business operations;
- advising on Russian counter-sanctions issues;
- 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, Anton Konnov, Udo Olgemöller, Tim Mueller, Thomas Declerck, Jonathan Benson, Ben Vallimarescu or your usual contact at Allen & Overy LLP.