One Year Later Implementing Sanctions Against Russia | K2 Integrity

How to Integrate Risk Management and Network Solutions to Address the Rise of Strategic Trade Controls and Sanctions Evasion

This article originally appeared in the March/April 2023 issue of ABA Bank Compliance.

Approximately one year ago, in the immediate wake of Russia’s full-scale invasion of Ukraine, the United States (U.S.), United Kingdom (UK), and European Union (EU) launched a global sanctions campaign against Russia that quickly became unprecedented in its speed, complexity, and global impact.

As we now look back at the evolution of the global sanctions campaign against Russian aggression throughout 2022, both the impact and trajectory of this campaign have become clearer with important consequences for financial institutions’ (FIs) risk management programs.

This article is the second in a series and follows the first article, Sanctions Against Russia: Understanding the Evolving Picture and How to Respond, in the May–June 2022 issue of ABA Bank Compliance. The focus of this feature in particular is on how FIs should build upon their anti-money laundering (AML), sanctions, and broader counter-illicit financing (CIF) programs to address the twin challenges presented by the:

1. Rise of strategic trade controls; and
2. Expansion of novel sanctions designed to combat sanctions evasion by Russia and its proxies.

The additional complexity that these developments have created for FIs’ risk management programs further underscores the need for network solutions that have begun to emerge through pilot training and certification programs abroad.

PART I

The Rise of Strategic Trade Controls and Related Sanctions Against Seaborne Russian-Origin Oil

As the U.S. and other jurisdictions that have issued sanctions against Russian aggression (Sanctioning Jurisdictions) strengthened and expanded economic and financial measures throughout 2022, it has become increasingly clear that strategic trade controls are playing a substantial role in degrading Russia’s military capabilities and weakening Russia’s economy. These tactical strategic trade controls were soon followed by new trade-based sanctions targeting seaborne Russian-origin oil and petroleum products. These developments have already begun to impact risk management programs for FIs financing or settling cross-border trade in controlled or prohibited Items (as defined below) or providing services related to the sale of seaborne Russian-origin oil to markets anywhere in the world. Addressing these challenges requires FIs to first understand what strategic trade controls are, how they relate to sanctions, and how they have evolved to become a powerful tool in combating Russian aggression.

Strategic trade controls generally may be defined as those that jurisdictions impose on goods, software, or technology (collectively, “Items”) to restrict their flow to other jurisdictions for national security purposes—including nonproliferation, counterterrorism, and crime control. While jurisdictions impose economic sanctions for similar reasons, sanctions obligations generally attach to the activity of persons (e.g., restrictions or prohibitions on activity by U.S. persons), while strategic trade control obligations generally attach to Items (e.g., restrictions or prohibitions on use of U.S.-origin Items).

Strategic trade controls broadly encompass import, export, re-export, and transfer restrictions and prohibitions but are often referred to simply as export controls. Such controls may implicate a wide range of authorities in Sanctioning Jurisdictions, including distinct authorities governing application of strategic trade controls to both defense Items and dual use Items that could be used for civilian or military purposes.

With respect to military and defense Items, most Sanctioning Jurisdictions have had comprehensive trade prohibitions in place against Russia at least since Russia’s original invasion of Ukraine in 2014. Since Russia’s 2022 invasion of Ukraine, Sanctioning Jurisdictions have greatly expanded strategic trade controls against Russian end users or end use in Russia, with respect to dual-use Items (i.e., Items that can be used for both civilian and military applications). This expansion now means a near ban on exports of not only all dual use Items, but also many other Items of lower strategic importance but that can nevertheless be used by Russia in key sectors of its economy such as aviation, oil refining, computing, and manufacturing. Thus, although there is no outright ban on conducting business in Russia, the sanctions and restrictive strategic trade controls imposed by the U.S., UK, EU, and their allies and partners make it essential for anyone contemplating doing business with Russian counterparts (or those from Belarus) to ensure thorough due diligence and compliance with applicable laws and regulations.

These strategic trade control restrictions and prohibitions partially overlap with and complement related sanctions programs, but they include specific actions, requirements, and enforcement mechanisms independent of sanctions. With respect to U.S. strategic trade control authorities generally executed or administered by the Bureau of Industry and Security at the U.S. Department of Commerce (BIS), such actions, requirements, and enforcement mechanisms include:

• Broadly implementing a policy of denial with respect to licensing any dual use Items subject to any multilateral export control regime or the Commerce Control List of Items subject to anti-terrorism controls that require a license for use in Russia;
• Broadly denying all U.S. exports, re-exports, and transfers of items subject to the Export Administration Regulations for military end uses or end users in Russia and Belarus;
• Specifically targeting Russian and Belarusian military end users by adding them to the BIS Entity List. The Entity List is published by BIS to identify those engaged in activities either related to strategic trade control violations or sanctioned by the State Department. This action effectively cuts off these end users from nearly all items subject to the Export Administration Regulations (EAR);
• Specially targeting enablers of Russian aggression by adding over 200 entities to the Entity List, including entities in Belize, Estonia, Kazakhstan, Latvia, Malta, Singapore, Slovakia, Spain, and the UK, where such entities have supported Russian military efforts;
• Specifically targeting certain Russian oil refining capabilities through export, re-export, and transfer prohibitions and restrictions on oil refining equipment and technology to Russia and Belarus;
• Imposing sanctions on the export, re-export, or transfer of luxury goods for all end users within Russia or Belarus, as well as for the export, re-export, or in-country transfer worldwide of such luxury goods for certain Russian and Belarusian oligarchs and other designated actors; and
• Applying new foreign direct product rules to prevent exports to Russia of any foreign-origin items produced with U.S. advanced technologies, tools, and software, thereby preventing these items from being transferred to support Russia’s military capabilities.

The effectiveness of these strategic trade controls in both degrading Russia’s military capability and more generally, weakening its economy is evident through consistent reporting from various public and private sector sources. This includes the U.S. Department of State Fact Sheet on

The Impact of Sanctions and Export Controls on the Russian Federation, which cites the following examples:

• Russia’s increasing reliance on rogue countries such as Iran and North Korea for military weapons, supplies, and equipment;
• Russia’s cannibalization of existing airlines to replace items it can no longer produce or access abroad;
• Widespread and substantial crippling of Russia’s military and industrial production capabilities owing to shortages of foreign-origin components and/or technology, such as semiconductors; and
• Reversion to Soviet-era defense stocks due to Russia’s inability to replenish military supply chains.

(See www.state.gov/the-impact-of-sanctions-and-export-controls-on-the-russian-federation/.)

U.S. enforcement actions have further strengthened the effective application of strategic trade controls against Russian aggression. U.S. authorities are working with Ukrainian counterparts and coalition partners to deconstruct Russian military weaponry, equipment, and dual use technologies recovered on the battlefield in Ukraine. Based in part on such efforts, the U.S. Department of Justice has already brought criminal cases against several individuals and entities for violating U.S. export laws targeting end users or end use in Russia. (See www.justice.gov/opa/pr/justice-department-announces-charges-and-arrests-two-cases-involving-export-violation-schemes).

Many of these law enforcement cases also include criminal charges relating to sanctions violations, bank and wire fraud, and money laundering, underscoring the overlapping complexity of strategic trade controls, sanctions, and AML.

Beyond the expansion of strategic trade controls against Russian end use or end users, Sanctioning Jurisdictions have also launched an unprecedented campaign against seaborne Russian-origin oil and soon petroleum products by imposing a price cap on sales of such products to countries that have not prohibited the importation of Russian origin oil or petroleum products (third countries). This campaign is intended to constrain Russian government revenue while minimizing disruption to global energy markets.

Generally, the price cap prohibits providing certain services—including activities such as shipping, insuring, and financing—in relation to dealings in seaborne Russian-origin oil and certain petroleum products unless the sale price was at or below the cap amount. The price cap for Russian-origin oil and petroleum products is set by a Price Cap Coalition comprised of the G7, the EU, and Australia. In December 2022, the EU announced that the price cap initially would be set to USD 60 per barrel. The G7 is yet to announce the price cap mechanism for Russian-origin petroleum products.

The Russian oil price cap is not the first prohibition implemented by Sanctioning Jurisdictions related to the importation of Russian oil and other energy resources. The U.S., UK, EU, and Canada had already announced bans against the importation of Russian oil, oil products, and other energy commodities into their jurisdictions. Russia remains free to export such products to third countries without similar bans. However, Russia relies extensively upon fleets and services provided by Sanctioning Jurisdictions such as Greece for shipping vessels and the UK for insurance to support the complex logistics associated with moving its energy products around the globe. This reliance on Sanctioning Jurisdictions may effectively compel parties participating in the global trade of Russian oil to comply with the price cap, including third countries that continue to purchase oil from Russia.

Understanding the complexities of expanding strategic trade controls and the new price cap on seaborne Russian-origin oil and petroleum products is increasingly important for FIs providing financial services in support of cross-border trade or the global oil and petroleum industry. As discussed in greater detail in Part III below, such FIs will need to consider specific types of programmatic controls to identify, assess, and manage risks associated with violations of these new requirements.

PART II

The Expansion of Sanctions Programs to Combat Russian Sanctions Evasion

As Sanctioning Jurisdictions have dramatically expanded and strengthened sanctions against actors and activities supporting or benefitting from Russian aggression, sanctioned Russian actors have engaged in systematic patterns of sanctions evasion.

Long before the 2022 wave of sanctions against Russia, many wealthy Russian individuals with perceived ties to the Russian government held their assets outside of Russia. These were most notably in tax havens and financial centers, including countries with strong financial crime frameworks like the UK and the U.S. Such offshore wealth accumulation makes it easier for the owners to move the assets through the global financial system without the funds being labeled as coming from Russia. To further complicate the detection of such assets, sanctioned Russian oligarchs have created webs of trusts and other legal entities to conceal or to pass their ownership interests to not-sanctioned close associates or family members, as revealed in a number of reports and enforcement actions. (See www.theguardian.com/world/2023/jan/06/roman-abramovich-trusts-transfer-leak-russia-sanctions and www.theguardian.com/business/2022/dec/01/banks-failing-to-comply-with-anti-corruption-rules-and-sanctions-lists-magnitsky.)

Such efforts to form or restructure legal entities require professional services like accounting, trust and corporate formation, consultancy, and legal advisory services. To curb such evasive measures, on May 8, 2022, the United States prohibited U.S. persons from providing accounting, trust and corporate formation, and management consulting services to any person located in the Russian Federation (See home.treasury.gov/system/files/126/determination_05082022_eo14071.pdf).

Furthermore, the U.S. government noted that it will proactively seek to impose blocking sanctions on persons who operate or have operated in these sectors of the Russian economy.

1. These novel, activity-based restrictions that can lead to blocking sanctions are particularly powerful in their global reach. Any party anywhere in the world may be sanctioned by OFAC for providing these types of services to Russian actors, thus deterring those in nonsanctioning jurisdictions from engaging in activities that undermine the efforts of Sanctioning Jurisdictions.

On June 3, 2022, the EU Council undertook similar measures by prohibiting EU persons from providing certain professional services including accounting, auditing, bookkeeping or tax consulting services, or business and management, and later, certain legal advisory services. (See eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv%3AOJ.L_.2022.153.01.0128.01.ENG.)

Finally, in alignment with its coalition partners, the UK adopted a similar ban on UK persons from providing auditing or trust and company-related services to Russia in December 2022.(See www.legislation.gov.uk/uksi/2022/1331.) In parallel to these novel sanctions against services that can facilitate sanctions evasion, the U.S. and other Sanctioning Jurisdictions have consistently imposed blocking sanctions on individuals and entities acting for or on behalf of sanctioned parties (i.e., persons often labeled as “enablers”).

For instance, on April 20, 2022, the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) designated several entities and individuals engaging in Russia-related sanctions evasion, and for the first time, the EU introduced a new listing criterion that provides the authority to “sanction persons who facilitate the infringements of the prohibition against circumvention of sanctions”. (See home.treasury.gov/news/press-releases/jy0731 and eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv%3AOJ.LI.2022.259.01.0122.01.ENG.)

The emergence of these novel sanctions programs targeting professional services and other sectors of the global economy—with blocking sanctions like the rise of strategic trade controls discussed in Section I above–will require FIs with customers operating in global markets to adjust and strengthen their sanctions, AML, and broader CIF risk management programs.

PART III

Addressing Challenges Posed by the Rise of Strategic Trade Controls and Sanctions Evasion

Meeting the compliance challenges associated with rapid and extraordinary developments in trade controls and activity-based sanctions (described in Parts I and II above), will require FIs to rely more than ever on risk management principles grounded in AML/CIF programs. FIs should consider broadening their application of these AML/CIF risk management principles to address these specific risks. Such efforts by FIs should both leverage and benefit from steps that many have already taken to strengthen their AML/CIF programs in response to the initial wave of sanctions issued against Russia earlier in 2022.

With respect to the rise of strategic trade controls, FIs will need to consider the heightened compliance and enforcement risks associated with customers and transactions that deal with or implicate dual use and other controlled Items that could be destined for Russia, directly or indirectly. In particular, FIs may bear potential liability associated with providing financial services to those engaged in strategic trade control violations or failing to detect and report suspicious activity related to such violations. To address these challenges, FIs can leverage their AML and broader CIF risk management programs to identify and segment customers, products and services, and geographic markets that present heightened risks of strategic trade control violations with respect to Russia, Belarus, or Russian or Belarussian end users.

To this end, on June 28, 2022, and reflecting a “whole of government” approach to the prevention of Russian circumvention to U.S. strategic trade controls, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) and BIS published a first of its kind joint alert (the Joint Alert), warning of Russian and Belarussian attempts to circumvent U.S. strategic trade controls implemented in 2022. The joint alert was FinCEN’s third regarding sanctions imposed on Russian in response to the war in Ukraine. (See fincen.gov/news/news-releases/fincen-and-bis-issue-joint-alert-potential-russian-and-belarusian-export-control.)

Twice in March 2022, FinCEN urged FI vigilance against Russian attempts to evade sanctions, and reiterated the need for detecting suspicious transactions involving real estate, luxury goods, and other high-value assets. Also on June 28, 2022, OFAC issued determinations pursuant to prior Executive Orders implementing the new measures, including the prohibition of the importation of Russian gold (EO 14068), as well as new sanctions and export restrictions on key state-owned conglomerates in Russia’s defense industry (EO 14024).

FinCEN and BIS encouraged FIs to monitor for efforts by third parties to evade such controls, finding that FIs are at an increased risk of unknowingly facilitating the export of prohibited goods. The Joint Alert listed particular commodities with a higher risk of diversion to unauthorized end-users in Russia and Belarus and outlined transactional and behavioral red flags that could indicate attempts to avoid sanctions.

The Joint Alert provided specific guidance to banks, but also recognized the potential role of other FIs that support cross-border trade such as credit card operators and foreign exchange dealers that may provide services such as financing or payment processing. Among the types of financial services identified for potential facilitation of evasion, the Joint Alert noted:

1. Processing payments for exported goods;
2. Issuing lines of credit for exporters;
3. Providing or handling the payments supported by letters of credit;
4. Processing payments associated with factoring the accounts receivables by an exporter;
5. Providing general credit or working capital loans;
6. Handling a wire transfer as part of a correspondent banking transaction; and
7. Issuing or paying insurance on shipping and delivery of goods to protect against non-payment.

With respect to such product and service risk segmentation, the Joint Alert further noted that FIs engaged in export-related financial activity should consider access to information relevant to identifying potentially suspicious activity. Importantly, the Joint Alert not only addressed traditional trade finance in which FIs may have access to their customers’ end-use certificates and other extensive export documentation, but also specifically referenced open account trade transactions processed by intermediary FIs and accompanying information contained in payment orders such as Society for Worldwide Interbank Financial Telecommunications (SWIFT) messages. Identifying and addressing risks related to strategic trade control violations through such intermediated open account settlement will almost inevitably require shared risk management protocols with correspondent banks to identify transactions related to those customer segments engaged in trade that may require relevant licenses. This is particularly true with respect to Russian and Belarussian end users or end use in Russia or Belarus.

Regarding customer risk segmentation, the Joint Alert advises that FIs with customers in shipping/maritime or export/import industries should rely on internal risk assessments, customer due diligence requirements, and other Bank Secrecy Act obligations to adopt “appropriate risk mitigation measures.” Such reliance on AML controls could also apply to other higher risk customer segments, such as those generally dealing in controlled Items that may require a relevant license.

As to geographic risk segmentation, the Joint Alert specifically referenced 18 countries identified by BIS as “common transship-ment points through which restricted or controlled exports have been known to pass before reaching destinations in Russia and Belarus.” The Joint Alert cautioned that while this list of countries is neither prohibitive nor exclusive, it “can assist in the risk-based screening of export-related financial transactions.”

In addition to the Joint Alert’s focus in explaining the importance of AML programs to address risks related to strategic trade control violations regarding Russia and Belarus, the timing of the Joint Alert’s issuance underscores the importance of integrating these efforts with sanctions compliance programs. FinCEN and BIS issued the Joint Alert one day after the G7 announced new rounds of sanctions and enforcement efforts against sanctions and strategic trade controls evasion. This further signaled the importance of integrating risk management efforts across Sanctioning Jurisdictions and across AML, strategic trade control, and sanctions risk domains (See www.justice.gov/opa/pr/attorney-general-merrick-b-garland-announces-launch-task-force-kleptocapture.)

Separately from managing strategic trade control risks, FIs will also need to consider detailed guidance issued by the U.S., UK, and EU on the price cap mechanism implemented on seaborne Russia-origin oil and petroleum products.

The guidance issued by these Sanctioning Jurisdictions explains obligations of participants in oil trade transactions, based on their role in such transactions. Such guidance advises FIs in transactions related to seaborne Russian-origin oil to request the price of the underlying oil or seek customer representations to ensure that this price does not exceed the established cap before proceeding with the transaction.

To address the risks of sanctions evasion, FIs should consider three advisory alerts published by FinCEN in 2022 warning regulated entities about the increased risk of sanctions evasion in the context of Russia (www.fincen.gov/resources/advisoriesbulletinsfact-sheets). The alerts highlighted several red flags for FIs’ awareness, including:

• Use of corporate vehicles to obscure ownership, source of funds, or countries involved;
• Use of third parties to hide the identity of sanctioned persons attempting to conceal the origin or ownership of funds;
• Use of virtual assets to move funds;
• High-value transactions related to real estate, artworks, precious metals, or other high-value assets;
• Presence of trade routes known to serve as possible transshipment points for exports to Russia and Belarus;
• Inconsistency between the information provided in relation to a transaction and publicly available information; and
• Emergence of new parties to transactions without apparent economic or business purposes.

Often such typologies may be detected by the Transaction Monitoring function, underscoring the importance for cross-training compliance staff to identify and escalate potential sanctions risks.

In May 2022, U.S. Treasury Department Deputy Secretary Adewale Adeyemo further emphasized the responsibility of FIs in combating sanctions evasion, including with respect to foreign FIs that may facilitate such evasion. Speaking at the Institute of International Bankers (IIB) in New York, Deputy Adeyemo stated, “if you provide material support to a sanctioned entity, we can extend our sanctions regime to you and use our tools to go after you as well.…you need to make sure that not only are you making sure that you’re watching flows into your financial institution, you need to also help by reminding the businesses that you support that they, too, you don’t want them to be providing material support to Russian oligarchs or Russian businesses as well.” (See www.nytimes.com/2022/05/13/us/politics/russia-sanctions-evasion-treasury.html and home.treasury.gov/news/press-releases/jy0782.)

Combating such Russian sanctions evasion will require FIs to stay knowledgeable about sanctions evasion typologies and adapt their risk-based AML/CIF programs accordingly.

To address the sanctions and related money laundering risks associated with new sanctions programs targeting professional services to Russia and Russian actors, FIs can leverage their AML and broader CIF risk management programs to identify and segment customers engaged in such services. FIs should engage such customers to ensure they are aware of these new sanctions and have programs in place to manage these risks. FIs can pursue a similar approach to customers engaged in other Russia-related services subject to current or future activity-based sanctions.

Finally, as noted above in the context of managing strategic trade control risks through open account settlement, FIs should consider how customer segmentation, outreach, and collaboration could lead to shared risk management programs to address risks related to sanctions and trade controls against Russian aggression more effectively and efficiently. These actions could provide a basis and a model for building a network approach to broader CIF risk management.

PART IV

Accelerating a Network Approach to More Effective and Sustainable Risk Management

The unprecedented complexity of sanctions against Russian aggression ultimately requires a network approach to drive systemic and sustainable sanctions implementation. Examples include unprecedented public sector initiatives, such as the U.S. interagency Task Force KleptoCapture and the multilateral REPO Task Force. The additional complexity brought on by the rise of strategic trade controls and novel sanctions to combat Russian sanctions evasion has only heightened the need for expanding these efforts to the private sector through shared risk management initiatives.

Yet many of the network solution elements we outlined a year ago remain to be acted upon–particularly with respect to combining operational efforts across private sector interests and integrating actions between public and private sector stakeholders. It has been challenging to bring together public and private sector relationships, information, tools, and expertise necessary to implement and continuously advance sanctions and strategic trade controls. More time and dedicated initiatives are needed to build trusted relationships across key public and private sector stakeholders and to develop a shared understanding of the risks, requirements, and collective interests in developing many of the network solutions we outlined a year ago.

A network approach to training, however, has emerged as a relatively quick way to begin developing relationships, trust and other building blocks that can lead towards more operational network solutions. FIs should consider how newly designed and integrated public and private sector training initiatives abroad, including those sponsored by the U.S. Department of State, can facilitate a network approach to managing Russia sanctions-related risks more effectively and efficiently. Initiatives are now underway in several countries particularly vulnerable to actors and activities subject to Russia-related sanctions or trade controls.

These initiatives have broadly begun to be piloted and have also begun to build stakeholder relationships within those countries that will form the basis for continued training and capacity building in 2023 and beyond. By integrating such outreach, training, and capacity building, several of these countries may begin to develop elements of a common network solution to implement Russia-related sanctions and trade controls more effectively and address related risks.

These jurisdictional public and private sector training and certification pilot programs are similar to programs launched in other countries to facilitate a network approach to strengthening implementation of sanctions and trade controls against terrorism and weapons of mass destruction proliferation. These programs also incorporate integrated foundational and advanced training on AML obligations, which are essential to facilitating effective implementation of all sanction programs, regardless of the underlying threat.

In each of these instances, the expertise of FIs has been particularly helpful in assisting other private and public sector stakeholders develop a common understanding and shared interest in building and implementing risk management programs to address complex and heightened risks associated with sanctions and strategic trade controls. Such collaboration may begin to generate the trust required to take next steps towards more operational elements of a network solution across key private and public sector stakeholders within and across these jurisdictions.

These experiences provide powerful examples of how U.S. FIs can build more effective and shared risk management relationships with other private sector stakeholders–including correspondents and other higher risk and strategically important customer segments–through integrated training and capacity building initiatives focusing on Russia-related sanctions and trade controls. Through these initiatives, FIs may gain confidence in exploring how to expand such integrated training and capacity building to include public sector authorities particularly focused on strengthening implementation of sanctions and trade controls against Russian aggression. In turn, these initiatives can help generate the trust required to expand such collaboration to more operational elements of a network solution.

Moving in this direction will continue to be challenging and will require leadership and commitment from key public and private sector stakeholders. Such leadership and commitment should be grounded in the recognition that the campaign against Russian aggression has provoked the most complex application and integration of sanctions, strategic trade controls, and underlying AML/CIF regimes in history. FIs and individual organizations engaged in global commerce cannot manage these risks alone. When confronting challenges to network solutions necessary for effective implementation of these measures, public and private sector stakeholders should look to those defending our principles of collective security in Ukraine to remember what is at stake in getting this right.

The authors would like to thank Michael Geffroy, Leslie Kuester, Katya Hazard, and the broader K2 Integrity sanctions team for their thoughts and contributions to this article.

ENDNOTES

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