Briefing

An epic undertaking: navigating a more fragmented, higher risk sanctions landscape

For commodity traders, geopolitical risk is no longer something that sits in the background of a transaction. It is much higher on the agenda and for good reason: depending on the jurisdiction, it can determine whether a trade is both permissible and economically viable, whether banks will finance it, whether insurers will cover it and whether the board and shareholders are willing to back it.

In this article, we analyse why and how the current sanctions landscape has changed, identify particular areas of challenge and offer signposts for navigating safely through the trading process.

The current sanctions landscape: multiple challenges

Matt Damon’s Odysseus had to navigate two hazards when he approached Scylla and Charybdis. In the current trading environment, businesses trading oil, gas, metals, agricultural products and other commodities are likely to find sanctions compliance less a question of finding a safe route through and more one of continually adjusting course in the hope of getting the deal done safely. This is because they now face a combination of sometimes conflicting trials.

The pace of change

Sanctions have always been deployed as an instrument of foreign policy. What feels different today is the speed with which the political environment can change and the extent to which businesses find themselves directly exposed to those changes. The sanctions landscape can change significantly between first negotiations and the time a cargo is loaded, financed, shipped and paid for.

Diverging approaches

The United States, EU and UK are not necessarily travelling in the same direction, particularly in their approaches to Russia and Iran. Businesses operating internationally now have to manage several overlapping, sometimes conflicting, sets of restrictions. The comfort offered by tried and tested risk management procedures may be beguiling, but businesses should not plug their ears to the danger that things may have changed, even during the course of a transaction. Being alert to change is critical.

Businesses also need to understand that even goods which seem to them to be innocuous can pose dangers, much like the famous wooden horse. Because sanctions now target even ordinary commercial activity, traders cannot assume that their activities are outside the scope of sanctions – governments are using sanctions to achieve their own geopolitical objectives, moving beyond traditional areas for legal compliance such as military and high tech goods, and those geopolitical objectives will differ across the sanctions regimes, meaning that a range of different goods are now targets.

Counter sanctions

Countermeasures adopted by other states add yet another complication. A course designed to avoid one set of rocks can bring a transaction uncomfortably close to another.

The challenge for businesses: a greater burden to shoulder

Several factors are contributing to a greater weight of responsibility being placed on commodities businesses.

Activity of entities outside the traditional jurisdictions

The fact that trade does not disappear simply because sanctions are imposed is particularly apparent in commodities markets. When established European, UK or US participants withdraw, commercial activity may instead move towards businesses in jurisdictions which have not adopted equivalent restrictions. The fact that a particular trade has migrated outside its traditional markets does not, by itself, point to improper activity. It can be entirely lawful “parallel trade”, reflecting the fact that different countries have made different policy choices. However, it also introduces a new risk for businesses: the potential involvement of participants willing to disguise the true nature of a transaction through intermediaries, opaque corporate structures, unusual trading routes or misleading documentation.

As with Penelope’s suitors, all may not be what it seems and careful testing is required. Commodities businesses should be alert to the fact that changes in counterparties, routing, ownership structures, documentation or payment arrangements may be indicators of sanctions risk.

Secondary sanctions

The weight of responsibility is also increased by secondary sanctions. Traditionally, US secondary sanctions were intended to influence the conduct of non-US businesses through measures such as the “menu” of sanctions available under legislation, including the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010. A non-US company could find particular US governmental or commercial opportunities closed to it even though it was not itself subject to the underlying US primary prohibition.

The commercial calculation can now be considerably starker. The possibility that a business itself might be designated can operate as an extremely powerful means of changing behaviour outside the sanctioning state’s ordinary jurisdiction. For an international commodity trader, shipowner, insurer or financial institution, designation may in practice be existential.

As a result, even where a transaction does not breach a rule directly applicable to a business, it should consider whether participating might expose the company, a financing bank or another essential participant to separate sanctions consequences.

Greater expectations from regulators

For some time, regulators have increasingly expected businesses to identify wider sanctions risks, rather than simply checking whether the immediate contractual counterparty is named on a sanctions list. They expect businesses to investigate warning signs rather than taking documents and transaction structures at face value.

Imagine sanctions risk like a donut – counterparty risk sits at the center and of course businesses are expected to screen their counterparties to manage that risk. However, they also have to think about the wider ring – all aspects of the transaction, including the cargo, the full supply chain and any other individuals or entities involved in the trade.

Navigating a safe course: risk-based compliance, early assessment and senior scrutiny

A company’s exposure can arise not only from its own conduct but also from the conduct and identity of participants elsewhere in a transaction or supply chain. For a trader, that might mean a supplier, customer, distributor or intermediary; for a bank, its customer; and for an insurer, an assured or other participant in the underlying trade.

The enormous growth in sanctions lists means that conventional screening can produce an equally enormous volume of potential matches. Technology can dispose of many obvious false positives, but difficult cases still require experienced human analysis. Meanwhile, those seeking to circumvent restrictions have become more sophisticated.

Risk-based compliance

For commodity businesses, this points towards a more risk-based allocation of compliance resources. Screening remains essential, but it is only one part of the exercise. A full understanding is now required as to:

who is behind a counterparty
where goods have come from and their destination
how they are being transported
which banks and insurers are involved
why a transaction has been structured in a particular way

Greater transparency between participants is likely to be part of the answer. A request for information which might once have appeared unusually intrusive can now be a routine part of establishing that a transaction is one which everybody in the chain is willing and able to support.

Early assessment

The point at which sanctions questions should be asked is also changing. Increasingly, they belong near the beginning of the commercial conversation rather than at the end.

Before committing significant resources to an opportunity, traders need sufficient visibility over the supply chain, counterparties and payment arrangements to decide whether the trade is realistic. A transaction which is legally possible but requires disproportionate due diligence, generates repeated escalation or cannot obtain satisfactory financing or insurance may ultimately be commercially unattractive.

Senior scrutiny

Sanctions issues are increasingly dealt with at senior management and board level. They now affect market selection, appetite for particular trades, relationships with financial institutions and insurers, contractual risk allocation and, ultimately, corporate strategy.

Horizon spotting: what does the future hold?

Sanctions respond to international events and, if the present level of geopolitical instability persists, there is little reason to expect either the number of restrictions or their complexity to diminish.
Three likely trends seem particularly important for commodity businesses:

Persisting divergence
First, divergence is likely to remain a defining feature of the landscape. Companies involved in international trade will need to become increasingly comfortable with the possibility that the US, EU and UK rules applicable to the same transaction may produce different answers, while measures imposed by other countries may point in the opposite direction.
The importance of substance
Second, the emphasis will continue to move beyond simple list screening towards understanding ownership, control, supply chains and circumvention risk. Compliance is increasingly about the substance of the transaction rather than merely the names on the contract.
Greater judicial involvement
Third, the courts will play a larger role. As sanctions impact an ever wider range of commercial arrangements, disputes are inevitably growing. Judicial decisions on matters such as ownership and control, including the treatment of trust structures and settlors, are adding another source of law which compliance programmes must follow alongside legislation, designations and regulatory guidance.

HFW comment

There is no obvious end to this particular odyssey.

For commodities businesses, successful navigation will instead depend on identifying relevant risks early, concentrating compliance resources where they matter most, understanding the commercial as well as the legal consequences of sanctions, and ensuring that decisions taken today remain defensible when the regulatory or geopolitical weather changes tomorrow.