The difficult implementation of financial sanctions against Russia

Baptiste Veille & Laura Fossion, Counsels, Compliance 4 Business

Léa Kecskes, Senior Associate, Compliance 4 Business

"Early this morning, Russian troops invaded Ukraine, a free and sovereign country. With these words, the President of the European Commission, Ursula von der Leyen, reacted to Russia's aggression on 24 February 2022. In this speech, the head of the European government announced from the outset, while the outcome of the conflict was still very uncertain, that the rest of the world's major economic powers had decided to sanction Russia. The message is clear: "Later today, we will submit a package of massive and targeted sanctions for approval by European leaders. Through this package, we will target strategic sectors of the Russian economy, denying Russia access to key Russian technologies and markets. We will weaken Russia's economic base and its capacity for modernisation. And, in addition, we will freeze Russian assets in the European Union and stop Russian banks from accessing European financial markets. While this is not a declaration of war, Europe is nevertheless determined to act against the invasion of Ukraine. The immediacy of the European response ("later today") indicates that the measures will have to be implemented without delay. The war is about to begin and it is not clear how long it will last.

Six months later, the war has taken root. European sanctions have followed one another to such an extent that the term 'wave' has moved from Covid-19 to countermeasure regimes. The life of compliance departments followed the same path. The regulated institutions had just adapted to the consequences of Covid-19 when an external event impacted their activities.

If the discourse can sometimes be warlike, the supporters of Ukraine immediately announced the colour and have not deviated from the trajectory since: the opposition to Russia will be economic, at worst logistical with regard to the delivery of arms to Kiev, but it will not be military.

Therefore, the compliance officers will be on the front line. Sanction regimes are coming and going and all banking and financial institutions, in the broadest sense of the term, are being asked to comply with prudential expectations that have been developed in a context of uncertainty.

1. A traditional application of classical concepts

An economic sanction can be defined as "a coercive measure imposed by a country or group of countries on another country, its government or individual entities with the aim of inducing a change in behaviour or policy" (Hossein G. Askari, John Forrer, Hildy Teegen and Jiawen Yang, Economic Sanctions: Examining Their Philosophy and Effectiveness, Westport, Praeger, 2003, p. 77). It covers all restrictions on the movement of goods, persons or financial transfers imposed by States. These restrictions may include taxes, asset freezes, but also bans on investments, imports and exports of certain goods (Consilium.europa.eu, "Different types of sanctions", 3  June  2022,  available at https://www.consilium.europa.eu/fr/policies/sanctions/different-types/).

Economic sanctions have long been a matter of practice. They were codified in public international law after the First World War. The Charter of the United Nations, in its Article 16, also stipulated that "if any member of the league resorts to war, it shall be considered as having committed an act of war against all the others. The latterundertake to break off all commercial or financial relations, to prohibit all relations between their nationals and those of the State in breach of the pact and to cease all financial, commercial or personal communications” (F. Coulomb and S. Matelly, "Bien-fondé et opportunité des sanctions économiques à l'heure de la mondialisation", Revue Internationale et Stratégique, 2015/1, n°97, p. 101).

Since the establishment of the Common Foreign and Security Policy (CFSP), set out in the second pillar of the Maastricht Treaty in 1992, the European Union has had the power to adopt international restrictive measures. The most prominent examples of economic sanctions remain the US embargo against Cuba, the Russian food embargo of 2014 and the sanctions against Iran's program.

2. Legal basis

The Security Council may take "measures to maintain or restore international peace and security under Chapter VIIof the Charter of the United Nations".

When a political agreement is approved by the EU Member States, the European External Action Service and/or the European Commission prepare(s) the necessary legal acts and submit them to the Council for adoption. These acts are binding on "any person or entity subject to the jurisdiction of the Union, that is to say, any person or entity within the EU, any EU national anywhere, as well as all undertakings and organisations incorporated under the law of an EU Member State". The sanctions put in place by the EU comply with obligations under international law and respect human rights and fundamental freedoms.

This means that EU regulations imposing, for example, freezing measures are directly applicable in the member states and do not need to be transposed into the law of each State. However, following a regulation imposing restrictive measures, states must adopt legislation to establish sanctions for breaches of the restrictive measures and to designate competent authorities in the event of a breach (Consilium.europa.eu, "Best Practices on the Effective Implementation of Restrictive Measures", 27 June 2022, op. cit.).

In view of the numerous sanctions in place, regulated entities are also concerned about the implementation of these sanctions and are called upon to be more vigilant. Regulated entities are expected to put in place the necessary means to prevent the violation of economic sanctions and to put in place an adequate compliance framework.

3. Context

Since 2014, the European Union has gradually imposed sanctions against Russia, following the illegal annexation of Crimea and the failure to implement the Minsk agreements (Consilium.europa.eu, "Chronology, EU restrictive measures against Russia regarding Ukraine", 26 July 2022, available at https://www.consilium.europa.eu/fr/policies/sanctions/restrictive-measures-against-russia-over- ukraine/history-restrictive-measures-against-russia-over-ukraine/ ).

Sanctions have increased dramatically since February 2022 following Russia's invasion of Ukraine. The EU has imposed individual sanctions, economic sanctions and diplomatic measures. Belarus is also subject to sanctions, being involved in Russia's invasion of Ukraine (these sanctions are aimed at those responsible for supporting, financing or implementing actions against Ukraine). The aim of the economic sanctions is to reduce Russia's ability to continue its aggression against Ukraine.

Sanctions are mainly aimed at the financial, aviation and space, trade, energy, transport, technology and defence systems. The legal instruments used to put economic pressure on Russia are diverse:

• Prohibitions related to military products ;
• Extension of export control measures ;
• A total ban on all transactions with certain Russian state-owned enterprises (Council Regulation (EU) No 2022/428 of 15 March 2022 amending Regulation (EU) No 833/2014 concerning restrictive measures in view of destabilising actions by Russia in Ukraine) ;
• US embargo on Russian oil and gas products;
• Suspension or cancellation of strategic projects ;
• Measures impacting the entire financial infrastructure ;
• Personalised sanctions and asset freezes on Russian banks and a number of individuals;
• Sectoral restrictions.

In order to ensure effectiveness, the European Union has worked with the United States, among others, to agree on the sanctions. The EU is also working with the World Bank Group, the European Bank for Reconstruction and Development (EBRD), the Organisation for Economic Cooperation and Development (OECD) and other international partners. A working group was also set up following Russia's invasion of Ukraine, called "Russian Elites, Proxies and Oligarchs", including the G7 countries and Australia. It is necessary to point out that, although the EU collaborates with many groups, third countries each decide unilaterally on the sanctions they will impose.

4. Sanctions against Russia

The European Union has adopted several packages of sanctions against Russia in order to weaken the Kremlin's financial capacity and impose economic and political costs. These sanctions packages include individual sanctions, economic sanctions, media restrictions and diplomatic measures.

The main sanctions taken by the EU since the beginning of 2022 against Russia are: 

the embargo on Russian oil and coal, the exclusion of several Russian banks from the Swift banking system, the freezing of the Russian Central Bank's assets outside Russia, the closure of European airspace to Russian aviation, the closure of EU ports to Russian ships, the closure of EU roads to Russian carriers, a ban on the sale of aircraft and equipment to Russian airlines, an embargo on Russian gold, a ban on the broadcasting of certain Russian media in the EU and the freezing of the assets of Vladimir Putin and Russian oligarchs (Consilium.europa.eu,  "Update on  EU  sanctions against  Russia",  22  July  2022).

Firstly, asset freezing measures, the most common financial sanctions, are imposed on individuals and entities in order to prevent them from financing their illegal practices. These restrictive measures consist of freezing the funds of the persons concerned, but also prohibiting the making available of funds to these persons (Finances.belgium.be,           "Financial sanctions",    available at https://finances.belgium.be). 

In addition, the financial sector is the sector most affected by economic sanctions. It is now forbidden to invest in Russia, but also to carry out transactions with the Russian Central Bank and the Central Bank of Belarus. 

Finally, the sanctions exclude the main Russian banks from the Swift interbank platform, a network for the transfer of financial information used worldwide.

Finally, there are numerous import and export restrictions against Russia. The EU has drawn up a list of prohibited products in order to maximize the negative effects of economic sanctions. Products that cannot be exported from the EU to Russia are, for example, high technology, transport machinery, energy, aviation and space equipment, luxury goods, etc. Products that cannot be imported into the EU include crude oil and refined oil products, coal, gold, steel and iron, wood, cement, as well as seafood and spirits.

5. Financial sanctions - due diligence: the rise of external screening providers?

The relevant EU regulations impose on EU operators and those operating in the EU an obligation of result regarding the freezing of assets and the prohibition of making funds and economic resources available directly or indirectly. However, the means used by operators to ensure compliance with the obligations and prohibitions are not further developed in EU legislation.

EU-regulated entities must therefore conduct appropriate due diligence calibrated to the specificities of their business and the related risk exposure. It is the responsibility of each institution to develop, implement and regularly update an EU sanctions compliance program. Those program should necessarily reflect its business models, geographical areas of operation and specificities, as well as the risk assessment of customers and staff (ec.europa.eu, "Commission consolidated FAQs on the implementation of Council Regulation No 833/2014 and Council Regulation No 269/2014", 29 July 2022, available at Consolidated version of the frequently asked questions concerning sanctions adopted following Russia's military aggression against Ukraine and Belarus' involvement in it (europa.eu)). 

Entities subject to the anti-money laundering law are required to have and implement a set of effective supervisory procedures, policies and internal control measures in order to comply with the binding provisions, particularly with regard to sanctions. This monitoring system ensures the screening of customers (identification and verification of the identity of customers and UBOs, counterparties, etc.) and of transactions involving the receipt/making available of funds, financial instruments or economic resources in order to detect whether they are not subject to a sanction measure. It also defines the due diligence measures that must be put in place to review business relationships, the frequency of which is linked to the risk profile of each relationship.

Therefore, and even more so in the current context, it is necessary for the compliance function to ensure due diligence on business relationships in the broadest sense. Due diligence includes checking that the recipients of funds or economic resources are not on sanctions lists and that the securities held by the business relationship are not linked to an entity subject to the lists, etc. Due diligence will also include media checks (internet and newspaper searches, media surveys, etc.). All of this will help to find evidence that a contractual counterparty is either designated or not by the sanctions lists or is, for example, controlled by a person designated by the lists.

The restrictive measures taken against Russia were a reminder of the diversity of sanctions that can be adopted against a State and the complexity of their implementation (Esbanque.fr, "Financial measures against Russia: international sanctions and compliance", 22 April 2022, available at Financial measures against Russia: international sanctions and compliance - Compliance Blog (esbanque.fr)). For example, we cannot ignore the complexity of identifying the beneficial owner of an entity (UBO). The case of the Russian oligarchs, professionals in hiding fortunes in opaque entities whose true owners are extremely difficult to determine, demonstrates the harsh reality. The voices of economists are being raised: when will there be a global register of assets that will make it possible to "link all types of assets, companies and other legal structures not to their legal owner, which is often only a facade, but to the actual beneficiary, the person who really owns"?( Lecho.be, "Our process of freezing Russian assets works well, not in every country", 19 April 2022).

Since February, there has been a steady stream of sanctions against Russia and its nationals at the European level, requiring companies to allocate time and resources, both financial and personal, to ensure a regular monitoring process. These complex lists of sanctions are bound to evolve frequently, with implementation always having to be done at short notice. Faced with this situation, many companies have decided to turn to paid screening tools or even automate their monitoring system in order to be able to control the frequency of new sanction lists and quickly identify positive results.

What used to be an unnecessary cost is now an essential investment to limit the risk of human error. Violation of these lists would not only lead to legal sanctions but also to serious damage to the company's reputation.

The game of comparing the various external screening providers on the market begins, and there are many!

6. Between extreme measures and uncertainty

The Russo-Ukrainian conflict is marked by uncertainty. Uncertainty about Russian intentions, uncertainty about Ukrainian resilience, uncertainty about the strength of the Russian economy, etc. These elements were reflected in Western fears. The preliminary fear of an invasion by the Russian Army has turned into a fear of a rapid defeat of Ukraine. Now it is the duration of the conflict that is causing all the concern. Western sanctions have always been, in the will of the legislator, proportionate to the context. These rapid developments have necessarily created a great deal of uncertainty among the institutions subject to the AML.

The sanctions discussed in this article are the result of a major news item that occupies a very large part of the media, political and economic fields. In addition to the crucial issue of monitoring official sanctions texts, all those involved in compliance are exposed to the news and to proposed sanctions. This has been particularly the case with the debates surrounding the possible blanket exclusion of Russia from the SWIFT network. These debates necessarily cause uncertainty for the compliance officer, who is then exposed to a double risk, that of not having fully integrated the sanctions decided by a competent body, and that of anticipating, going beyond the prudential framework in force.

Every regulated institution is of course obliged to fully integrate the adopted sanctioning regimes. A misinterpretation of a planned exemption has already led to high fines (OFSI, 31 March 2020, "Penalty for breach of financial sanctions").

Nevertheless, this fear of deficiency in the internal prudential framework should not run counter to other principles set by the regulator. In this respect, it can be noted that on 1st February 2022 the National Bank of Belgium published circular NBB_2022_03 on prudential expectations in relation to de-risking. The latter reminds institutions of the extent of their obligations. In this respect, the risk-based approach should not result in non-exposure to risk. Each institution must necessarily face a certain exposure and its internal prudential framework must allow it to mitigate this to an acceptable level. Similarly, it is necessary to recall that the fight against money laundering by regulated institutions is not exclusive to the business relationship; any suspicion, including among prospects, must be reported to the regulator.

In the early days of the conflict, some compliance departments were able to propose a ban on all business relations with persons with links to Russia. Such a decision, necessarily blind to the realities of each situation, cannot be perceived by the regulator as constituting adequate compliance with anti-money laundering obligations. The European Union also points out in this respect that Russian citizens who are not individually targeted are not excluded, a priori, from carrying out operations with regulated institutions within the European Union.

In general, there is uncertainty about the lack of uniformity in the fight against money laundering. This gap, which is not specifically related to the war in Ukraine, concerns the lack of harmony in the fight against money laundering at the European level. To address this gap, the European Union has already indicated its willingness to create the European Anti-Money Laundering and Counter-Terrorist Financing Authority. Although the various regulators are carrying out, in coordination with the other state authorities, a certain amount of accompanying work, there is nevertheless a dichotomy between the scale of sanctions and the scale of the application of sanctions against Russia.

The European Journal of Compliance & Integrity is a new journal of Anthemis directed by Arnaud Lecocq and Alexandre Bartholomeeusen focussing on the topics that compliance actors are confronted with in the exercise of their profession.  This quarterly magazine aims to quickly become a reference tool, with a high scientific added value, while offering a practical and concrete viewpoint by tackling subjects such as: the fight against corruption, the fight against money laundering and the financing of terrorism, the protection of personal data, international sanctions and embargoes, the denunciation of abuses, the social responsibility of companies, the respect of competition law, the relations with clients, the new compliance professions (Compliance Officer, AMLCO, DPO, Fraud Officer, ESG Officer, etc.).

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