Sanction compliance has never been more critical, or more challenging. It is imperative that banks and corporates monitor the ever-changing sanctions landscape and develop tailored programmes to minimise their compliance risk. Clyde & Co trade and sanctions specialists Douglas Maag (US), Sophie Drake (Singapore), Patrick Murphy (Dubai) and Ben Knowles (UK) examine the issues.
Trade and economic sanctions can have a huge impact on companies and financial institutions. Even where the direct results of sanctions may be what governments intend, the knock-on effects are often far wider. Banks, producers and traders have difficulty in keeping up with the fast pace of change in sanctions legislation and the resulting increase in contractual and commercial exposures.
For example, new legislation introduced in January by the US is the fourth major legislative expansion of US sanctions against Iran in less than three years and comes hard on the heels of a further expansion of European Union sanctions introduced in December last year.
A big issue for companies is simply the cost of compliance. It is expensive to expand compliance teams and take legal advice every time the rules change. It is also difficult for companies to plan if they do not know whether the business will be lawful due to upcoming changes.
Because sanctions are politically motivated and regulators often do not understand how business works, sanctions are frequently introduced with immediate effect without any transitional provisions, which creates practical problems for goods in transit under legacy contracts. For example, the European Union’s latest widening of its sanctions regime against Iran came into effect on December 23, 2012. The new restrictions it includes on shipping technology and equipment were enforced from February 15, 2013, while for certain enterprise software the restrictions started to bite from January 15, 2013. The latest extension of US sanctions against Iran, the Iran Freedom and Counter-Proliferation Act, which was signed into law on January 2, 2013 at least shows greater commercial sensitivity, as the new measures will not become effective for another 180 days.
Influencing the supply chain
When sanctions are imposed with immediate effect, goods may be at sea or in port. This gives rise to a complex web of responsibilities involving not just the counterparties, but also the shippers, insurers and warehouses that are part of the supply chain. Complexity is further increased when supply chain companies are located in different jurisdictions. Insurers providing cover on an open cargo basis, for example, or as part of a treaty, will often not know which parties are involved in a trade and it may be unclear until after an event has occurred that there has been a sanctions infringement.
As there is almost no consultation with business before sanctions are imposed, the rules are often poorly drafted, creating ambiguity and confusion.
There is also seldom consensus among sanction setters because while each country involved may agree with the overarching principle, they may have very different views on the specifics.
Companies in countries that comply with UN sanctions targeting specific issues such as Iran’s nuclear proliferation can still find themselves affected by the economic sanctions of other countries, such as the US and the EU. In the UAE, for example, there are approximately 8,000 Iranian companies, many of which will conduct business with UAE companies. However, while a UAE insurance company, for example, could insure an Iranian company, if it looked to reinsure that risk on a European market, such as Lloyd’s, it would be unable to do so because of EU sanctions. Under the latest regulation these sanctions effectively amount to a blanket ban on insuring or reinsuring an Iranian company.
The financial services sector has become in effect the de facto enforcement arm of the sanction setters. Lack of resources within the entities that issue sanctions, such as the Office of Foreign Assets Control (OFAC) or HM Treasury, combined with the lack of familiarity with the practicalities of international trade, means that the financial services sector bears the brunt of sanctions oversight.
Banks must consider how they might be indirectly drawn into the reach of sanctions. EU sanctions, for example, do not go out of their way to focus on non-EU citizens and businesses, but US sanctions aim to cast a far wider net. The ‘big stick’ that the US possesses is the threat that banks found in breach of sanctions will be denied access to the US banking system. If banks are unable to settle transactions in US dollars they are effectively shut out from the international trading system. With this threat the US can extend its reach beyond companies over which it has jurisdiction to reach any company trading in US dollars with entities that are subject to US sanctions. Situations often arise where companies could trade legally within the existing sanctions regimes, but are operationally constrained because the banks will not take the risk.
To avoid being denied access to the dollar settlement system, international banks have paid large fines to various US authorities to settle sanctions violations disputes. In December, HSBC agreed to pay US authorities US$1.9bn to settle allegations that it had failed to implement anti-money laundering controls in Mexico and that it ignored US sanctions by allowing transactions without disclosing its links to Iran. The settlement came days after Standard Chartered agreed to pay US$327m to the US Federal Reserve and the Department of Justice to settle charges that it had violated sanctions on Iran, Myanmar, Libya and Sudan between 2001 and 2007. This was in addition to a US$340m fine the bank had already paid to New York’s Department of Financial Services.
Even when sanctions are lifted, companies can still face a very uncertain business environment. US sanctions against Myanmar, for example, were first introduced in 1990, and over time grew into a series of prohibitions contained in federal laws and executive orders. In response to Myanmar’s political reform efforts, last year the US administration suspended restrictions on new US investment, provision of financial services, bilateral and multilateral assistance, and certain imports from the country.
The way in which sanctions on Myanmar have been eased leaves uncertainty: the US has opted to waive or ease some (but not all) sanctions and could re-impose them at any time. Nevertheless, on the back of the lifting of sanctions, American multinationals such as Coca-Cola and PepsiCo have subsequently announced joint venture investments in Myanmar. US companies, however, are still barred from doing business with a list of “specially designated nationals” (entities and individuals) in Myanmar because of their alleged links to corrupt practices and oppression. Compliance is difficult because the necessary information to conduct proper due diligence is not always available and banned individuals may conceal their ownership interest behind complex subsidiaries.
Hefty penalties for sanctions infringement are driving behaviour change. Some companies may decide that it is better to stick to defined business in low-risk jurisdictions. For those deciding to continue in higher-risk jurisdictions, risk management and compliance have become as important as credit analysis. Compliance is a growing burden. The lack of official advice around implementation means trading companies, bankers and lawyers are having to devote more time and effort to compliance than ever before, which is slowing the speed and reducing the volume of business transacted. Education is critical to ensure employees ask the right questions and understand compliance procedures.