Sanctions against Russia: a Gordian knot for business

September 2023 | SPOTLIGHT | GLOBAL TRADE

Financier Worldwide Magazine

September 2023 Issue

As Russia’s invasion of Ukraine unfolded, the G7 reacted by enacting several packages of sanctions. Gradually increasing in intensity and scope, the sanctions against Russia targeted diverse sectors and individuals. The stated objective was essentially the same across the various measures adopted by the G7 countries: to target Russia’s ability to wage the war, hurt its economy, and force it to reconsider the campaign it waged in Ukraine. As time went by, cooperation intensified through official multilateral mechanisms, such as the Russian Elites, Proxies, and Oligarchs (REPO) Task Force and the Enforcement Coordination Mechanism, both of the G7, as well as a series of actions such as coordinated designations and pressure on non-G7 countries to encourage them to prevent the circumvention of sanctions.

However, for all the well-publicised initiatives, the reality was and continues to be that members of the G7 have diverged significantly in terms of the type and extent of sanctions they have introduced. For example, while the European Union (EU) banned legal advisory services provided directly or indirectly to the Russian government or legal persons, entities or bodies established in Russia, the UK banned the provision of such services to any non-UK persons only if such services related to activity prohibited under the UK’s sanctions regulations. While the EU ban on new investment in Russia was restricted to the energy and mining sector, the UK opted to restrict direct acquisitions of land, interests in Russian companies and joint ventures with Russian companies.

Divergence between regimes also means that it is increasingly difficult for multinational entities or those that transact or otherwise deal with them to establish what is prohibited. For example, the EU and UK sanctions generally apply to entities ‘controlled’ by a sanctioned individual or entity, with each regime approaching the determination of such control differently, while US sanctions apply only to entities where the sanctioned individual or entity has more than 50 percent ownership.

Moreover, while it has been relatively straightforward to freeze assets belonging to sanctioned individuals or entities once such ownership has been established, it is much more difficult to seize such assets or otherwise confiscate them. Sanctions are just a specific area of law within a given country’s legal system and, as such, they continue to interact with other areas of law, such as human rights law, which impact how an asset or economic source can be dealt with. Members of the G7 have, by and large, failed to follow through on such considerations.

Another consequence of the increasing plurality of sanctions has been an uptick in de-risking, especially at multinational financial institutions, which have significantly restricted their offerings to clients associated with Russia out of concern for navigating and complying with an increasingly varied array of sanctions.

More broadly, businesses are expected to keep evaluating their compliance protocols, often at considerable cost, while new measures and obligations are introduced. Prior to the sweeping sanctions against Russia, businesses generally had to deal with financial sanctions or sanctions related to the export of products. In the last 12 months, they have had to ensure that they comply with sanctions modalities previously unfamiliar to them, such as restrictions on the provision of different types of services, such as legal, architecture, IT and so on.

Western businesses operating in Russia will also feel that they are facing an increasingly painful dilemma. Complying with sanctions at home might require them to exit the Russian market altogether; practically, however, Russian countermeasures render such a process very difficult – for example, a business attempting to exit Russia might have to deal with severe exit taxes, the dangers of being put into interim administration, and personal risks to employees. Sanctions regimes have insufficiently acknowledged such difficulties.

Naturally, businesses have looked to governments for guidance, and again, the results have varied significantly. While the EU will typically publish and update suites of ‘frequently asked questions’ connected to its sanctions, the UK has hitherto refused to commit to doing so, making it harder for individuals to navigate their obligations. Significantly, the agencies tasked with administering sanctions outside the US historically have been grossly understaffed. As a result, they were ill-equipped to address the numerous queries by affected individuals and businesses. The infrastructure to support the administration, oversight and enforcement of sanctions simply was not there.

As we are now well into the second year of sanctions against Russia, the question that businesses urgently want answered is: where does it end? How long are businesses expected to comply with and implement increasingly austere measures?

Looking ahead, the focus will be on steadily moving away from entirely new, sweeping packages to the refinement and enforcement of existing measures. The EU is taking steps to harmonise the penalties for violations of its sanctions. The UK has doubled the headcount of its Office of Financial Sanctions Implementation (OFSI) and introduced legislation to enable it to pursue enforcement outcomes. However, enforcement remains rather conspicuously lacking. OFSI’s last fine was issued on 27 September 2022 and amounted to a penalty of £30,000 on a company for receiving money and publicity (the latter was treated as ‘intangible economic resource’) in contravention of the Ukraine (European Union Financial Sanctions) (No.2) Regulations 2014. Member states of the EU have mostly focused on sporadic enforcement actions centred around the export of goods. The REPO Task Force’s notice in March 2023 indicated that members are working together to update their respective legal frameworks to facilitate enforcement action, and it is likely that further measures will follow in that regard. However, to date there has been no coordinated enforcement mechanism implemented.

The courts, particularly in the UK, have already commenced their scrutiny of sanctions and related designations. It is expected that as jurisprudence builds, the scope of different regimes will be clarified, and the courts will interpret the legislation in a proportionate manner. Both in the EU and the UK, we have already seen instances of designations being successfully challenged, and more will undoubtedly follow.

MPs in the UK and MEPs in the EU have separately and jointly pushed for greater transparency around the introduction, calibration and implementation of sanctions. Such transparency would be welcome as it would encourage governments to carefully assess the impact of any planned and existing sanctions – for example, the UK backtracked on its long-announced pledge to limit deposits for Russians as it determined that the measure was disproportionate. Separately, the introduction of sanctions should not be reduced to a spasmodic practice guided by particular events; it should be methodical, and cognisant of broader impact on foreign policy. For example, ‘Western’ sanctions resulted in Russia simply sourcing material from third countries, as the infrastructure for enforcing them was not in place. In recent months, the UK, EU and US have collectively taken steps to liaise with such third-country suppliers, acknowledging in the process they cannot force them to comply with sanctions to which they are not bound. This, of course, put Western companies at a disadvantage by complying with measures by which competitors are not bound. More must be done to level the playing field on this issue.

For sanctions to work effectively, it is imperative that businesses get the guidance they need from governments and that governments acknowledge the commercial realities of competition with countries which do not implement Russian sanctions. If sanctions are the new world order, then new rules and resources are needed, including, for example, around the process for application and review of licences and authorisations or the formal harmonisation of certain rules around issues such as determining ownership or control by sanctioned individuals or entities.

Menelaos Karampetsos is an associate at Brown Rudnick LLP. He can be contacted on +44 (0)20 7851 6181 or by email: mkarampetsos@brownrudnick.com.

Menelaos Karampetsos

Brown Rudnick LLP