Developments in sanctions and the law of unintended consequences

Sanctions are a powerful tool in international relations which have been increasingly used by governments and supra-national bodies to influence the behaviour of other nations. While the primary goal of sanctions is to compel a change in policy or behaviour, they can also lead to a range of unintended consequences that may create new challenges for those seeking to comply in a complex and fast changing regulatory environment.

In this article, we consider developments in the use of sanctions, the impact they have had on commodities traders – sometimes unexpected – and how traders can respond.

Why has the sanctions landscape changed so rapidly?

Sanctions are typically imposed to achieve specific objectives, such as:

• deterring military aggression or other hostile activities.
• pressuring governments to improve their human rights records.
• preventing nuclear proliferation.

Until a few years ago, the impact of international sanctions on countries with a global footprint was relatively limited. Simply put, Iran, Syria and the DPRK did not, in reality, enjoy significant bilateral trading arrangements with the West in the first place, so the imposition of sanctions had little practical effect. All that changed on 22 February 2022, when Russia invaded Ukraine. The international response to that decision has now seen multiple rounds of new sanctions imposed against Russian-related activities. These sanctions, while broadly aligned, are nuanced and reflective of each imposing government’s risk appetite, intelligence and exposure to, in particular, Russian-generated fuel sources. Given Russia’s extensive global trading relationships, the sanctions have had a significant impact.

What has been the impact?

The effect of the expedited passage of a range of sanctions onto the statute books has resulted in a number of unintended consequences. Some examples include:

Approvals and licences

While there is generally a level of coordination between governments and blocs in relation to sanctions targets, the same cannot be said for exceptions and permissions. Layers of prohibitions from different jurisdictions have resulted in the need for multiple rounds of approvals. This creates significant administrative and financial burdens for those who need to procure multiple approvals.

Disruption to correspondent banking

Certain correspondent banks have adopted a conservative approach to sanctions compliance, refusing to make what would otherwise be lawful payments on the grounds that to do so might constitute a breach of sanctions. Originally, the UK’s Office of Financial Sanctions Implementation (OFSI) had stated that this conservative approach was incorrect and issued a clarificatory general licence. However, OFSI later amended the law to align with the conservative approach adopted by the banks, creating rather than resolving uncertainty.

The meaning of “control”

The Court of Appeal’s obiter comments in Mints v PJSC National Bank Trust [2023] EWCA Civ 1132 suggested that every company in Russia might be subject to sanctions on the grounds that it could be controlled by Vladimir Putin. This created short-lived panic for those with any exposure to Russian counterparties which was, to a degree, remedied by a statement by OFSI that “for the purposes of regulation 7(4) of the Russia (Sanctions) (EU Exit) Regulations 2019, the UK government does not consider that President Putin exercises indirect or de facto control over all entities in the Russian economy merely by virtue of his occupation of the Russian Presidency. A person should only be considered to exercise control over certain private entities where this can be supported by sufficient evidence on a case-by-case basis.”¹ However, the delta between judicial commentary and non-binding guidance issued by OFSI continues to create uncertainty.

Freezing of a non-designated person’s funds as a result of their transfer from a sanctioned bank

This can occur whenever a bank has a UK nexus and considers it prohibited to process transactions involving sanctioned financial institutions unless there is a relevant exception or licence from OFSI. There is currently no clear exemption or licensing ground to rely on for a non-designated client’s funds to be unfrozen.

Interruption of supply chains

The UK has not sanctioned third country trading or transport of, for example, Russian coal to third countries. It has however designated Russian Railways and all coal and, indeed, the majority of Russian commodities, are transported in Russia via Russian Railways. Effectively, this could mean that UK persons are cut off from all Russian trade.

For commodities businesses, the impact has been potential regulatory exposure, exposure to legal challenges and litigation, and commercial and administrative headaches.

Globally, the result of these discrepancies and unintended consequences is a bifurcation of world trade and the creation of secondary markets. For example, Russian crude oil is now routinely exported to and refined in India and there has been a movement of vessel insurance to non-Western providers.

How can commodities companies respond?

There is no simple, or single, answer to how to address these issues. Sanctions risk should always be considered on a case-by-case basis. It is important to remain nimble as a business and ensure that compliance functions are well-versed in the application of sanctions to global business. Some sensible steps to consider include:

• Identify applicable regulatory regimes. This will involve having a checklist including the governing law of contracts, nationality of employees, location of the goods being traded, currencies involved, and locations where business is conducted.
• Conduct regular reviews of customers and their locations to ensure that newly sanctioned individuals or blocked industries are promptly identified.
• Identify any goods planned to be exported to counterparties in jurisdictions in which there are sanctions.
• Identify third party risks, for example, actual and potentially impacted suppliers and consider alternatives.
• Identify any transactions with sanctioned entities that involve ongoing or continuing obligations.
• Identify all contracts with exposure to sanctioned jurisdictions. Assess:
  • contractual rights, including force majeure, illegality, suspended performance termination or wind-down, rights to request amendment to payment terms, including changes to currency of the contract and pre-payment.
  • payment provisions.
  • sanctions-related warranties and indemnities.
  • notice provisions.
• Engage with banks and insurers to ensure that finance facilities and cover are not impacted.
• Prepare a sanctions compliance guideline policy which should include operational procedures and communications strategies sufficient to respond if new sanctions are imposed on short notice.
• Consider the need to apply for EU, UK and/or US licences for any activity that may otherwise be a breach of sanctions.

Conclusion

The effect of sanctions on a targeted nation is significant and ranges from damage to its economy to a reduced capacity to produce weapons. For commodities traders, the consequences of sanctions are also significant and the scope for further sanctions going forwards is readily apparent. Increased multilateral coordination on sanctions between the US, EU and UK has generally also broadened the scope of applicable sanctions. Considering this coordination, there is a heightened risk of both inadvertently breaching sanctions and running into practical difficulties. For instance, although a particular transaction may not have a US or UK nexus, many banks refuse to process payments which they view as presenting a US or UK sanctions risk to ensure their own compliance. Similar concerns can arise with insurers and other service providers.

Of potentially more immediate concern, however, is the enforcement landscape. Notwithstanding the various unintended consequences identified in this article and the speed and scale with which sanctions against Russia, for example, have developed, regulators are now turning their minds to ensuring compliance is a key part of doing business globally and this is achieved through enforcement activity. Therefore, traders are well advised to ensure that knowledge of and compliance with sanctions is firmly embedded in their business to minimise the potential for breaches and the costs of having to address queries from the regulators, or worse, having to defend an enforcement action.