The United States Ukraine-related sanctions targeting Russian persons and industries

November 2014 | SPOTLIGHT | GLOBAL TRADE

Financier Worldwide Magazine

In November 2013, Ukrainians began large scale protests against their government, which ultimately led to a coup and the installation of a pro-European government much to the dismay of Russian President Vladimir Putin. Putin responded by annexing Crimea in March 2014 and with other aggressive acts aimed at unsettling the new Ukraine government. In attempts to coerce the Russians to relent, the United States rolled out a series of economic sanctions, initially targeting key Putin allies and more recently aimed at cutting off business and resources to the energy, financial and defence sectors of Russia’s economy. The result is a complicated fabric of overlapping sanctions, some of which apply only to US persons and entities and others which apply extraterritorially. This article deconstructs that current sanctions framework.

Both the US Department of the Treasury and the US Department of Commerce administer programs under the Ukraine-related sanctions framework. Treasury’s Office of Foreign Assets Control, known as OFAC, is responsible for economic sanctions. The Commerce Department is responsible for export controls. Presently, there are four prongs to the current state of US Ukraine-related sanctions. In some cases, these prongs overlap and with respect to Russia’s energy industry, the sanctions and export controls have far reaching effects, ensnaring persons, entities and projects. With such a complicated, evolving framework, US persons and companies face significant risk doing business with Russian entities and in Russia, particularly in the energy sector. Moreover, non-US persons and entities must comply with extra-territorial export controls targeting Russian energy projects and companies. Finally, all of this must be considered with the backdrop of a fluid political situation, which means additional changes to the sanctions framework are always possible. As the following discussion demonstrates, the sanctions are inherently scalable; OFAC and Commerce can easily add persons, companies and products to the sanctions, expanding their reach and effect.

Blocking orders freezing assets of certain Russians

In March 2014 President Obama issued three Executive Orders. The EOs blocked property of specific individuals and companies that they own. As a result of these blocking actions, US persons are prohibited from doing business with the individuals and entities that OFAC named and with any company owned 50 percent or more in the aggregate by such blocked persons or entities. Correspondingly, the EOs froze all assets of persons and companies that OFAC blocked, if those assets are or later come into possession or control of a US person.

The Obama Administration predominantly targeted Russian business elite who presumably have close ties to Putin. The thesis was that these sanctions would impose serious financial pain on a select group of oligarchs who in turn would lobby Putin to change course on Ukraine policy. The sanctions appear to be effective in imposing financial pain on the targeted individuals, but they did not appear to alter Putin’s resolve.

Sanctions targeting Russia’s financial sector

When Putin did not change course, the US felt compelled to impose sanctions targeting Russia’s financial and energy sectors. These additional sanctions took the form in mid-July 2014 of two OFAC-issued ‘Directives’ (aptly named Directive 1 and Directive 2), establishing the so-called ‘Sectoral Sanctions’. In September 2014, OFAC amplified both Directives.

OFAC’s Directive 1 targets players in Russia’s financial sector such as the Bank of Moscow and Gazprombank, prohibiting US persons from providing financing for or dealing in new debt or equity for the benefit of those named entities. Importantly, this Directive does not prohibit US persons from doing other business with the named financial institutions or their subsidiaries. Rather, the goal of this sanction was to starve the key, named Russian financial institutions from US credit markets.

Sanctions and export controls targeting Russia’s energy sector

At the same time that OFAC targeted Russia’s financial sector, it issued Directive 2, starting a multi-faceted attack on Russia’s energy sector. Directive 2 took aim at key players in Russia’s energy sector such as Novatek and Rosneft, prohibiting US persons from providing financing for or dealing in new debt in relation to these entities. Like Directive 1, this Directive does not prohibit US persons from otherwise doing business with the named entities or their subsidiaries. However, unlike Directive 1, which is so far the only Sectoral Sanction targeting financial companies and activities, OFAC followed up in September 2014 with a separate Directive 4 that prohibits US persons from engaging in other transactions with certain energy companies, including some of the entities named in Directive 2.

Before OFAC amplified Directive 2, in early August 2014 Commerce stepped into the Ukraine crisis and established new, strict export controls with the goal of severely disrupting important Russian energy projects. To do this, Commerce revised the Export Administration Regulations, known as the EAR, targeting Russian exploration and production of deepwater, Arctic offshore and shale projects. Under these enhanced export controls, Commerce requires a licence, an application for which generally will be denied, for a long list of US products regardless of where those products are presently located, before the products may be exported or transferred to such a Russian project, regardless of the end user. The EAR implements a ‘follow the part’ jurisdictional concept derived from the ‘US nationality’ of the item originally exported from the US Commerce’s regulations therefore prohibit US and non-US persons from exporting or transferring US products such as drilling rigs, parts for drilling operations, subsea equipment, drill pipe and casing and many others to the targeted Russian projects. As a result, all foreign persons whose activities involve the export or reexport of items or technology controlled by the EAR must comply with the regulation or risk civil and criminal penalties. Additionally, Commerce imposed even more crippling controls against Gazprom, Gazprom Neft, Lukoil, Rosneft and Surgutneftegas by prohibiting the export or transfer to them of any US item whatsoever for these Russian oil and gas projects.

With the Commerce’s heightened export controls on the books for a month, OFAC then issued Directive 4 in September 2014. Directive 4 further enhanced the Obama Administration’s targeting of Russian deepwater, Arctic offshore and shale projects by prohibiting US persons from providing any good or services, regardless of origin, to such Russian projects.

As a result of this knitting together of various sanctions devices, Russian deepwater, Arctic offshore and shale projects are significantly cut off from US investment, technologies and even some of the most basic US oil or gas field equipment. It now is illegal under US law for anyone, wherever located, to provide such products to these projects. It is also illegal under US law for any US person to provide goods or services, of any origin, to key Russian energy companies for these projects.

Sanctions targeting Russia’s defence sector

Finally, in September 2014, OFAC issued an additional Directive that took aim at Russia’s defence sector (Directive 3) which prohibits US persons from engaging in certain financing activities involving specifically-named Russian defence sector companies – so far, Rostec. In coordination with OFAC’s September 2014 action, Commerce added five Russian defence sector companies to its Entity List and prohibits certain military-related exports.

David R. Johnson is a partner and Jenny J. Yang is a senior associate at Vinson & Elkins LLP. Mr Johnson can be contacted on +1 (202) 639 6706 or by email: drjohnson@velaw.com. Ms Yang can be contacted on +1 (202) 639 6757 or by email: jyang@velaw.com.

David R. Johnson and Jenny J. Yang

Vinson & Elkins LLP