The evolving enforcement landscape of UK and EU sanctions against Russia

May 2024  |  SPECIAL REPORT: FINANCIAL SERVICES

Financier Worldwide Magazine

May 2024 Issue

The European Union (EU) and the UK made statements on the second anniversary of Russia’s invasion of Ukraine on 24 February 2022, emphasising the importance of sanctions enforcement and the need to close sanctions and trade control loopholes to ensure the effectiveness of the economic pressure being applied to Russia and its ability to continue its war efforts.

This article looks at the Russia sanctions enforcement landscape since February 2022 and highlights important changes on the horizon.

UK sanctions landscape

In late 2023, the UK government announced that it intended to create the Office of Trade Sanctions Implementation (OTSI). OTSI will be responsible for the civil enforcement of trade sanctions. OTSI will become another UK government agency responsible for enforcement – although quite specifically, only of civil law breaches of trade sanctions.

Given that the current patchwork of UK enforcement agencies is understaffed and under-resourced, it remains to be seen whether the creation of OTSI will lead to more enforcement action by the UK government. Nevertheless, the creation of a specialised unit, with well trained personnel, is something to be welcomed.

The UK government also announced a new Economic Deterrence Initiative in March 2023. The initiative provides £50m in funding to improve enforcement of the UK’s sanctions regime. However, it is not clear how and where this money has been spent and therefore what impact it has had on the UK’s ability to enforce sanctions and tackle export control violations.

Actual enforcement actions in 2023 were limited. On 14 December 2023, the Office of Financial Sanctions Implementation (OFSI) confirmed that, as of April 2023, it had 172 cases under live investigation. Nevertheless, there was only one enforcement action by OFSI in 2023 against a company regulated by the Financial Conduct Authority (FCA) – for a single instance of making funds available to an entity owned or controlled by a designated person.

In this enforcement action, OFSI used its disclosure power for the first time. The disclosure power is an enforcement tool introduced by the UK government via the Economic Crime (Transparency and Enforcement) Act 2022 which allows OFSI to publish reports of financial sanctions breaches where issuing a warning letter may be too lenient but imposing a civil monetary penalty may be too severe.

OFSI used this case to emphasise the importance of sanctions compliance for the industry. OFSI specifically highlighted failures in the company’s procedures for managing sanctions risk; namely, the company did not restrict debit cards where a possible name match to a designated person was identified. OFSI also highlighted how the company failed to properly resource its sanctions compliance process.

The company’s lack of resources at the weekend led to a material delay on restrictions being placed on a designated person’s debit card after an automatic sanctions alert was triggered. At the same time as OFSI made disclosure of these case details, it updated its penalties guidance to classify breach cases into three categories: lesser severity, moderate severity and serious enough to justify a civil monetary penalty.

HM Revenue & Customs (HMRC) published a notice in August 2023 stating that a UK company was fined £1m in relation to the unlicensed trade of goods in breach of Russia sanctions. As this was a compound penalty, under HMRC rules, the name of the company was not published. In September 2023, the FCA published the results of its review of firms’ sanctions systems and controls, with details of areas that firms should improve on (e.g., reporting of breaches); the review also stated that sanctions would remain an area of supervisory focus for the FCA.

In January 2024, the National Crime Agency (NCA) issued an alert to the art storage sector in which it warned of efforts by sanctioned individuals and firms to evade sanctions by using operators in that sector. Media outlets in February 2024 reported that an individual had been arrested by the NCA and charged with breaching Russia sanctions.

The UK continued to work with its G7 allies to liaise with several third-party countries to highlight the risks of circumventing trade sanctions and to support these countries to enforce sanctions effectively. The UK’s international efforts included visits by officials to Central Asia countries in order to share expertise on circumvention patterns, and work with member states of the EU to strengthen their approach to enforcement (for example, UK experts worked with Cypriot authorities to set up Cyprus’ National Sanctions Implementation Unit).

EU sanctions landscape

The EU’s approach to enforcement of sanctions is decentralised – there is no single EU agency responsible for the enforcement of sanctions. Enforcement takes place at national level. However, the EU has approved a new legal instrument which includes a common definition of, and minimum penalties for, sanctions violations. Harmonisation is expected to reduce inconsistencies between member states’ approach to enforcement.

The new rules also define the circumvention of sanctions and ensure that this is a punishable offence. Examples include concealing or transferring funds that should be frozen, hiding the true ownership of property and not reporting necessary information when legally required to do so. The rules are expected to come into force in the near future and will require transposition into national legislation by member states.

Although this is a step in the right direction, the directive only creates harmonised criminal offences for intentional sanctions evasion. Successfully prosecuting ‘intentional’ sanctions breaches will be incredibly difficult. Given there has been very little criminal enforcement under the current EU legal test of ‘having reasonable grounds to suspect’ – that is, someone is subject to sanctions and dealing with them anyway – it is unclear how this directive will increase the likelihood of successful enforcement.

It is notable that this is the minimum requirement for member states, which may choose to criminalise sanctions evasion at a lower (and easier to prove) evidential threshold. In addition, the directive has a lower evidential threshold for criminalising certain export control breaches. Member states must therefore impose a ‘serious negligence’ test for these breaches. This means companies and individuals can be criminally liable on a ‘serious negligence’ basis for certain export control violations.

Separately, the EU introduced an anti-circumvention measure in the 11th sanctions package in June 2023 allowing it to designate persons and entities that engage in activities intended to frustrate the prohibitions in EU sanctions in respect of specific products (e.g., companies in non-EU countries that obtain goods from the EU with a view to later making them available to Russia). The rationale behind this measure is that it will lead to better enforcement of EU sanctions.

Certain member states also made efforts to increase the effectiveness of sanctions implementation: in a joint declaration in December 2023, Baltic countries pledged to adopt a common approach to sanctions implementation by 31 January 2024. This means, among other things, that the authorities of the Baltic states performing customs control will agree on a unified approach to cases when the route of the goods seems illogical and raises suspicions of sanctions evasion. Member states such as Germany and the Netherlands are reported to have commenced several investigations into suspected sanctions breaches.

Another initiative explored by both the UK and the EU in the enforcement realm is the confiscation of Russian state assets. While the UK has not published any concrete proposals, government officials have stated in various settings that they are exploring available routes.

The EU enacted legislation on 12 February 2024 to require European central securities depositories (CSDs) to hold aside any profits on their books that are generated from assets of the Central Bank of Russia that the CSDs have frozen as a result of EU sanctions. The EU’s plan is to eventually redirect these profits toward supporting Ukraine, and media reports in March 2024 indicated that the EU was preparing legislation to effect that. Practically, any moves to confiscate state assets remain fraught with significant difficulties both at the political and legal level.

It is expected that heightened rhetoric around enforcement both in the UK and the EU by state authorities will result in an uptick in enforcement actions in 2024. It is arguable that results may be indirect as well – media reports stated that over 100 UK companies voluntarily disclosed sanctions breaches in order to mitigate government penalties. As new statutory powers have come into force across the UK and the EU (e.g., OFSI’s disclosure powers), authorities will want to demonstrate their willingness to utilise their new powers.

After two years and several sanctions packages (13 in the EU and 22 in the UK), the UK and the EU are both under pressure to show that those who breach sanctions stand to pay the price. Trade sanctions are likely to be an area of particular focus for enforcement authorities, given that a stated objective in recent sanctions packages is the need to deprive Russia of the tools and technology it needs to continue its war efforts.

The UK and the EU will be keen to deter operators from undermining the effectiveness of sanctions, so it is also very likely that prosecutions against those that circumvent sanctions will increase. As sanctions and their deployment as a foreign policy tool are here to stay, their enforcement will take an increasingly prominent role in the remainder of 2024.

 

Paul G. Feldberg is a partner and Menelaos Karampetsos is an associate at Brown Rudnick LLP. Mr Feldberg can be contacted on +44 (0)20 7851 6159 or by email: pfeldberg@brownrudnick.com. Mr Karampetsos can be contacted on +44 (0)20 7851 6181 or by email: mkarampetsos@brownrudnick.com.

© Financier Worldwide

BY

Paul G. Feldberg and Menelaos Karampetsos

Brown Rudnick LLP

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