Compliance risks escalate as Russia sanctions pressure intensifies
The unprecedented economic sanctions imposed against Russia and Russia-connected entities have forced compliance officers at Western companies to respond rapidly and assiduously to ensure their companies comply with the measures. All the while their boardrooms are having to make snap decisions, weighing up the wider reputational risks of their business ties to the country.
Over 750 international firms with operations in Russia have been scaling back or withdrawing altogether. The Wall Street Journal reports that some companies are reconsidering investments elsewhere in Europe, scrapping merger plans or conducting further due diligence on acquisition targets and assessments of legal and financial risks.
Scrutiny from lawmakers and regulatory authorities on Western companies with Russian exposure continues to grow, with at least one major bank already being probed by a US congressional committee.
The pace and scale of economic restrictions against Russia have placed considerable pressure on compliance departments, especially in the early phase of the conflict with reports of teams at major global banks working round-the-clock to gain a fuller understanding of the implications of measures about to come into force.
Sanctions complexity – a minefield of risks
Over the past few weeks, new sanctions have been imposed on an almost daily basis with the span of measures steadily widening as the conflict continues. The US, EU, UK and a host of other Western countries, from Australia, Iceland to the Bahamas, have weighed in with measures, creating a highly complex sanctions regime.
For compliance departments, the Russian business environment has become almost impossibly complex, with risks seemingly at every turn as the number, range and scope of sanctions increases.
Prominent among the restrictions are US, EU and UK sanctions on over 1,000 Russian individuals, businesses and banks and bans on exports to Russia of so-called dual-use goods (having civilian and military applications); a Western freeze on the assets of Russia’s central bank and the removal of some Russian banks from the worldwide SWIFT payment system; as well as US prohibitions on new investments in Russia and Russian gas and oil imports, the UK phasing out the latter by the end of 2022.
Possible secondary sanctions – more compliance headaches
The challenges for due diligence and sanctions compliance teams could become even more demanding as the US is considering the imposition of secondary sanctions. Already, there are signs of evasion, with Russian business people reportedly both investing in Turkey, which is not enforcing sanctions, and liquidating cryptocurrency in the UAE, which has also not imposed sanctions.
Secondary sanctions target individuals and entities outside the US’s legal jurisdiction that do not comply with its primary sanctions, potentially locking them out of America’s financial system. Some secondary measures are already effectively in place, as US restrictions on Russian gold sales effectively apply to non-US global banks with correspondent representation in America.
Pressure for greater ownership transparency
Keeping up with the growing list of sanctioned entities, goods and services will test the capacities of compliance teams, especially as it can often be challenging in jurisdictions such as the UK to determine the identity of the beneficial – or ultimate – owner of the company you are doing business with.
It is routine for global business people – encompassing those whose activities are wholly legitimate – to conceal their interests in companies through complex ownership structures or by registering them in secretive offshore financial jurisdictions. It is also a convenient tool for those seeking to evade sanctions or conceal illegal activities.
A recent study co-produced by the publication openDemocracy highlighted the potential challenges facing compliance departments, in an environment where any ties to Russia – whether to its leadership or otherwise – can cause severe reputational damage. The study noted that more than 600 British companies set up in the last year are controlled from Russia, raising “fresh concerns that unaccountable British company structures are being used to prop up oligarchs linked to Vladimir Putin”.
UK looks to close “Londongrad” loopholes
In March, the UK sought to begin addressing concerns raised about London’s links to Russian business by bringing forward the Economic Crimes Act which requires the ultimate owners of foreign companies that have acquired UK property to reveal their identities through a Register of Foreign Entities – which, the government says, is the first of its kind in the world.
Campaign group Transparency International estimates that £1.5 billion worth of British property has been acquired by Russian individuals who stand accused of corrupt practices or close ties to the country’s leadership. £830 million of this total is believed to be owned via offshore companies.
The new legislation will clearly help due diligence professionals to better navigate the beneficial ownership challenges, but the campaign group cautions that for the law to work to optimum effect Companies House, the registry of companies incorporated in England and Wales, and UK law enforcement need the resources to properly check details submitted to the property register.
US raises sanctions evasion red flags but urged to do more
In the US, FinCEN has set out a series of guidelines to help financial institutions identify potential sanctions evasion activity, such as the use of shell companies to obscure ownership and the use of third parties to shield the identity of sanctioned persons seeking to hide the origin or ownership of funds. At the same time, some anti-corruption experts have been urging the US government to tighten anti-money laundering measures, end the ability to form shell companies and broaden beneficial ownership disclosure requirements.
For companies sourcing goods and commodities from Russia, the task of screening suppliers will become more taxing as international sanctioning authorities begin to target Russian supply chains. American companies are particularly exposed as, according to Deloitte, they make up 90 per cent of the more than 374,000 businesses that rely on Russian suppliers. Some of the latter may seek to conceal the identities of sanctioned owners or subsidiaries.
Another emerging challenge is that measures imposed by sanctioning authorities are not always aligned, so for instance the FT has pointed out that the US and the EU differ over the size of the stake in an entity a sanctioned individual or company must have for it to be considered under their control. For the US, it is 50 percent or more. For the EU, more than 50 percent. Additionally, says the paper, “if two sanctioned people or entities together own more than half of a company, the EU and the US consider that to count as control, but the UK does not”.
With more sanctions likely to come into force in the weeks and months ahead, the compliance landscape is set to become increasingly perilous. Growing numbers of firms have already decided that the reputational risk of remaining engaged with Russia is too high. Even those that remain and scrupulously adhere to restrictions could yet suffer in the court of public opinion.
Clearly, decisions over whether to exit or stay must be carefully considered given the possible fallout. But as these deliberations proceed in corporate boardrooms, compliance teams are faced with more immediate and complex sanctions challenges, set to loom ever larger as the conflict continues.