Legal experts see the ongoing sanctions regime as one of the most arduous faced by trade financiers yet, writes Kevin Godier.


When it comes to sanctions, the trade finance industry is facing its most complex time ever: complicated restrictions are coming into quick effect with little notice, keeping lawyers across the globe on their toes.

“Different things are happening concurrently – the potential relaxations on Iran, alongside growing Russian restrictions, and the softening on Cuba,” declares Daniel Martin, partner at Holman Fenwick Willan (HFW).

At Thomas Cooper, partner Grant Eldred highlights the problems ensuing from the large scope of the various sanctions regimes. “The lists include not only named companies and individuals but also vessels and ports. In addition, un-named subsidiary entities are included and, with regard to Ukrainian/Russian sanctions, there is a further list relating to capital restrictions. The breadth and depth of such lists, with poorly defined parameters, is a significant additional challenge to trade finance business,”
he underlines.

By way of example, Eldred mentions a judicial review case brought by Rosneft in the High Court in which, inter alia, Rosneft asked to clarify a number of terms, including whether the term “financial assistance” used in the EU Regulation no 833/2014, included the processing of payments.

Problem areas are also cited by Jason Hungerford, senior associate at Norton Rose Fulbright. “In the past you could deal with counterparties, or you couldn’t. New sanctions regulations introduce an added layer of uncertainty, where the definitions of what is prohibited appear clear, but the application can be murky.” Hungerford adds that – in descending order – Russia, Iran, Cuba and Venezuela are being closely watched by sanctions lawyers.

According to Geoffrey Wynne, partner at Sullivan & Worcester UK, the significant size of the trade business flowing in and out of Russia has brought “a higher visibility” to the sanctions issue. But “regulators’ thinking has not been precise”, he argues. “Part of the problem is that past wordings for country restrictions on markets like Libya and Iran are not apt now for Russia, where
the focus is on doing business with certain people. Taking good advice and being vigilant of changes is critical, because the use of sanctions as a political weapon is here to stay.”


Russian pitfalls


The sectoral sanctions on Russia have increased the complexity of day-to-day trade finance activities as well as long-term business development, says Edwin Borrini, partner, Jones Day. “Some, but crucially, not all types of transactions with certain large Russian companies are prohibited by the US and European Union (EU). This is a new kind of format for sanctions which requires much more detailed consideration, often with specialist legal advice, than the simple ‘do not deal’ type of sanctions.” In this regard, participants “not only have to consider whether a particular trade is permitted, but also what the consequences of that trade might be”, Borrini observes. “If the trade is one step in a much larger transaction, but where the end result is a prohibited sectoral transaction, then the trade and its participants can be implicated, notwithstanding that the actual trade is permitted on its strict terms.”

At first glance, says Eldred, the capital and credit restrictions on Russia looked to be of greater concern to the capital markets. “But, of course, with the shortening to 30 days, they impact trade facilities as well, particularly any working capital facilities masquerading as trade finance facilities.”

Borrini adds that sanctions wordings also cover broad concepts, which are not always clearly defined, and can overlap. In the US, for example, certain types of transaction are now prohibited involving certain Russian banks and either medium to long-term debt or new equity, he notes. “When you look at the OFAC [the US Treasury’s Office of Foreign Assets Control] definitions of these terms, the term debt includes, but is not limited to, bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers’ acceptances, discount notes or bills, or commercial paper, but OFAC makes it clear that this list is not exclusive, so other forms of debt are still prohibited.” He stresses that there are similar issues in the EU with equivalent sanctions which refer to “transferable securities” or “money-market instruments”, explaining that “the concepts used by the EU have some crossover with the US sanctions but are separately defined terms with a different meaning.” The bottom line, he insists, is that “businesses need to navigate dealings with affected Russian companies very carefully indeed to avoid an inadvertent breach”.

On the key issue of dealing with an unsanctioned Russian entity, Martin recommends that clients document how they have reached complete satisfaction on the counterparty, and the deal. “After that it is a question of keeping updated on changing sanctions, and proactively anticipating forthcoming issues, to try and future-proof your contracts. If event X happens, what can I do to remove myself? The big change with Russia is that one cannot predict where it will go next. So how close to being sanctioned is your counterparty? What is its connection to government and other sanctioned entities? Could the receipt of the loan repayments or insurance premia become illegal? What is too close for comfort?”

“Diligence is key to continually protecting yourself,” agrees Hungerford. “If you can get an idea on what’s coming next, options can be examined, such as choice of currency or payment terms.”


Iran opening?


Sanctions on Iran could disappear, of course, as a result of the Joint Comprehensive Plan of Action (JCPOA) announced on April 2. For the near future, however, the JCPOA announcement will not change the existing sanctions with respect to Iran, which remain fully in effect. The stated aim of negotiators is to reach a final agreement on the text and annexes of
the JCPOA by July 1, 2015, which would be followed by a comprehensive lifting of all sanctions on Iran.

Eldred advises that parties seeking a first-mover advantage must install strategies to ensure that, with the gradual easing of sanctions, these windows can be exploited without the risk of accidental breach of sanctions remaining in force. “The political situation in the US and the verification likely to be required under the JCPOA is likely to make trading opportunities uncertain for some time to come,” he says.

Martin adds that people need to understand the extent to which sanctions have been lifted, and recognise any risk of sanctions being re-introduced very quickly. “Check that everyone in your company – and those whom you rely on for business, such as correspondent banks and insurers – understand the current position, and that everyone is ready to move on together, with a consensus view of counterparty risk. As things move rapidly, counterparty screenings should take place more than once through the transaction, because there can be changes in listings, challenges to listings and changes to the percentage of shares
held by sanctioned individuals.”

Recognising that the Iranian market is potentially very lucrative for western oil and gas players, Hungerford counsels against any actions that can be construed as an indirect dealing. “Planning is fine, but there is a line where planning can become a sanctionable activity,” he says. “Pay close attention to local developments and subtle policy shifts.”

Borrini cautions that even if the new deals with Iran and Cuba are agreed and implemented, businesses will still need to take account of any contractual commitments they have made to third parties with respect to Iran or Cuba. “Over the past few years, financial agreements and/or government contracts involving US and EU entities have increasingly required confirmations that the businesses will not have any dealings with Iran or Cuba. Notwithstanding final agreement of any sanctions relief, such commercial agreements may continue to foreclose businesses from dealing with Iran or Cuba, and, thus, such terms may need to be amended or waivers obtained on a case-by-case basis. Businesses should not expect waivers to be given automatically in my view,” he says.


Eliminating uncertainty


Lawyers earn their fees by pinpointing and simplifying grey areas, explains Wynne. “Transactions are possible with all countries – even where there are individuals who are sanctioned – but finding the permitted transactions can be a challenge. Any market where EU and US sanctions diverge can obviously be problematic. Cuba and Sudan are examples of this. We also feel that restrictions on Russian-owned banks are tougher from the EU than the US. It is always in such imprecise areas that clients say: ‘I’ve got to know. Can I pay under an LC or not?’ Clients might want a clean opinion on whether an entity is sanctioned, or perhaps, in a case where finance already exists, to work out whether it can be sustained.”

As always, the key is knowing who you are dealing with, emphasises Hungerford. “KYC has been very important for some time. There is a higher standard in the US, where there is an understanding that some entities and individuals may not be on the list but are still subject to sanctions. In the EU, that additional due diligence is now a factor in the Russian sanctions, and corporates bear the burden of detecting entities acting on behalf of those who are named in sanctions.”

“Just checking your direct counterparty is unlikely to be sufficient – you need to understand who you are dealing with in terms of ownership structure and end user in most circumstances,” says Borrini. “Often, the best advice is to take a step back and look at this one transaction in the context of their entire business, which often gives a different outcome from just looking at the single transaction without any wider context.”

Martin notes that against the background of fines handed out by regulators, some banks are operating
as if the transaction is prohibited, even when this is not so. “The discrepancy between the size of fines as against the revenue – and profit – received by banks for processing a transaction skews banks towards saying ‘no’, whenever the factual position has any element of grey.”

According to Eldred, interpretation and enforcement remain the greyest areas in relation to almost all sanctions regimes. “If one draws a parallel with the recent shift in attitude to international tax accounting, where ‘avoidance’ is often considered as ‘evasion’, the EU and US circumvention legislation has potential to be a very powerful weapon for many years to come,” he points out. “In the age of email and other electronic records, enforcement has a long tail and often comes years after the event.” He underscores that US and EU authorities were keen to use the Iranian financial sanctions to impose heavy fines against financial institutions, although this was also justified by a failure by those institutions to implement anti-money laundering procedures effectively.
Companies take note

Martin notes that, over the last 15 months, as Russian sanctions have increased, he has seen that the understanding of how to mitigate risk outside of financial institutions is underdeveloped. He adds: “Most enforcement actions are against financial institutions, and so corporates are running into strict language from banks and insurers that strives to cover against enforcement action. Banks tell us they want corporations to take sanctions more seriously, in order not to rule out the business that remains legal for them.”

Martin makes a final point that two paragraphs in the UK’s 2015 budget indicate that British companies should be particularly aware of the changing sanctions environment. “The indications are that the Treasury is to take a more proactive approach on enforcement, and that there could be more UK fines for sanctions breaches in coming months,” he warns.