Since Russia’s second invasion of Ukraine in February 2022, the United States, along with a global coalition of allies, has imposed an array of financial sanctions and other restrictive measures intended to isolate the Russian economy, hinder revenues, and limit access to the global financial system. Over the first two years of the economic pressure campaign, the sanctions were primarily list-based ( targeting specific entities) and sectoral (targeting Russia’s financial and energy sectors or specific transactions in the occupied territories), and were complemented by various other measures such as export controls.
In recent weeks, the compliance landscape added yet another degree of complexity. In late December 2023, the United States issued Executive Order (E.O.) 14114 to amend previously issued E.O. 14024. Most significantly, the amendment authorizes the United States to impose sanctions on foreign financial institutions that engage in certain transactions (that is, with persons designated pursuant to E.O. 14024 or involving Russia’s military industrial base).
Understanding what are US secondary sanctions
Secondary sanctions first gained notoriety as a defining characteristic of the Iran sanctions program. Some have argued that the isolation brought on through secondary sanctions helped drive Iran to the negotiating table to finalize the Joint Comprehensive Plan of Action (JCPOA). Secondary sanctions were also imposed as part of the Venezuela sanctions program before their use with Russia. These authorities are implicitly extraterritorial and carry potentially undesirable consequences for financial institutions in Europe, the Middle East, and Asia. Secondary sanctions serve as a mechanism to regulate the conduct of non-US-based third parties (such as foreign financial institutions).
In simple terms, the updated E.O. grants the Office of Foreign Assets Control (OFAC) the authority to impose sanctions on foreign financial institutions who facilitate significant transactions on behalf of persons designated for operating in certain sectors of the Russian economy. More specifically, under these new authorities, OFAC may penalize foreign financial institutions by imposing full blocking sanctions or prohibiting or restricting the maintenance of correspondent accounts in the United States. In practice, this leaves foreign financial institutions with a simple choice: to continue doing business with the US or to continue doing business with sanctioned parties and face consequences.
The implications of US sanctions for financial institutions
The recently expanded authorities introduce significant risks to financial institutions that may be unwittingly exposed to Russia’s efforts to circumvent sanctions, as it is well documented that Russia uses sophisticated tactics to evade detection and routes activity through third countries to maintain access to the global financial system. There have already been reports of increased Russian transactional activity in Armenia, China, India, Kazakhstan, Turkey, UAE, and Uzbekistan, to name a few. Several entities have already been sanctioned by OFAC and other allied authorities in relation to Russia’s efforts to continue its war effort in Ukraine.
As one example of controls to reduce risk exposure, it would be advisable for financial institutions to bolster due diligence it conducts on counterparties in transactions that involve jurisdictions known to pose greater risk for Russian sanctions evasion.
Beyond the more obvious implications for foreign financial institutions, there are certain provisions within E.O. 14114 that warrant further attention. For example, the E.O. does not require OFAC to establish whether a financial institution had reasonable knowledge of the sanctionable conduct prior to issuing secondary sanctions Additionally, the definition of “foreign financial institution” includes insurance companies and operators of credit card systems, despite their omission in the context of other sanctions programs. Further, the definition is wide-ranging and applies to most financial services companies, including the holding companies, affiliates, or subsidiaries of traditionally defined financial institutions.
OFAC’s advisory notice further identifies examples of activities that may expose institutions to secondary sanctions risks:
- Maintaining accounts, transferring funds, or providing other financial services (including payment processing, trade finance, and insurance) for any persons designated for operating in the specified sectors
- Maintaining accounts, transferring funds, or providing other financial services (including payment processing, trade finance, and insurance) for any persons, either inside or outside Russia, that support Russia’s military-industrial base
- Facilitating the sale, supply, or transfer, directly or indirectly, of the specified items to Russian importers or companies shipping the items to Russia
- Helping companies or individuals evade US sanctions on Russia’s military-industrial base
Based on recent history in the context of the Iran and Venezuela sanctions programs, it can be inferred that the United States will in fact deploy its newly established secondary sanctions authority. The US has also made clear its expectation that foreign financial institutions will undertake best efforts to ensure they are not involved with facilitating Russian sanctions circumvention or evasion — whether it be witting or unwitting. As such, foreign financial institutions should take necessary steps to scrutinize internal controls and carefully review transactions that could be impacted by these new measures.
