Overview
Today's Deep Dive is 1,439 words and a 9-minute read.
Since Russia’s further invasion of Ukraine in February 2022, more than 16,000 individuals and 12,000 entities have been added to sanctions lists, actions designed to impede Russia’s ability to prosecute war against Ukraine. As a result, Russia is now the most sanctioned country in the world. Yet despite the extraordinary extent of the sanctions, Russia has been successfully building alternative markets and trading networks that channel military and dual-use items through countries opposed to unilateral sanctions regimes. Sanction evasion schemes are undermining the effectiveness of Western sanctions on Russia, which over time risks undermining the political will necessary to sustain policies that have economic costs to the countries imposing sanctions.
To tighten sanctions enforcement, the US has leveraged the dominance of the US dollar in the international financial system by imposing extra-territorial sanctions, so-called secondary sanctions, targeting companies and individuals from other nations aiding in sanctions evasion and certain other disfavored activity. Long opposed to secondary sanctions, some US allies are revaluating and tweaking their sanctions policies, making incremental changes to the territorial reach, with potential significant impact.
Scale of the Sanctions Evasion Problem
Within a year of the Russian invasion, the US began signaling that Washington would focus on sanctions enforcement as part of its efforts to maximize the impact of sanctions, rather than simply adding new names or new sectors to the target list. On March 2, 2023, the Department of the Treasury’s Office of Foreign Asset Control (OFAC), the Department of Justice and the Department of Commerce’s Bureau of Industry and Security (BIS) issued a joint compliance note warning of the use of third-party intermediaries and transshipment points allegedly used to evade sanctions and export controls directed at Russia, and exposing common tactics to disguise the involvement with sanctioned individuals and entities and to obscure end users. The reason for the shift was that US intelligence was reporting that US origin-goods with military applications were arriving in Russia in alarming quantities. Most companies implicated in the reports were multijurisdictional and included manufacturers or sellers of microelectronic components, electromechanical instrumentation and imaging technology, along with precision-manufacturing machinery.
Despite efforts, sanction evasion is believed to have grown in sophistication and breadth, with many countries becoming transit hubs in networks meant to obscure the illicit trade. The US began imposing sanctions on non-Russians involved in aiding Russia to evade sanctions, designating individuals and entities in Belarus, China, Hong Kong, Turkey, the United Arab Emirates, Iran, Kazakhstan, Kyrgyzstan and Uzbekistan. In December 2023, the White House issued an Executive Order, authorizing the US Treasury Department to impose secondary sanctions on foreign financial institutions that participate in transactions that aid Russia’s military-industrial base.
The G7 has emerged as a key multilateral institute for coordinating policy and actions against Russia aggression in Ukraine. The G7 has been keenly focused on building a consensus among members to establish export restrictions on specific goods, services and technology, and to align sanctions targets and close loopholes being exploited by Russia and its enablers.
One challenge has been scaling actions to keep pace with the emerging economy of circumvention when G7 members have different laws, practices and preferences guiding their national sanctions policies.
Shifts by US Allies to Expand Reach of Sanctions
Imposing sanctions on third parties beyond the immediate jurisdiction of a country’s sanction regime, compelling them to comply with sanctions on a second party or face sanctions themselves – i.e., secondary sanctions – is controversial. US allies historically have pushed back hard over the years, for example opposing US extraterritorial and secondary sanctions on Cuba and Iran. In a major test of wills, in 1996, the US pushed the limits of international tolerance for secondary sanctions with the Iran and Libya Sanctions Act of 1996, in which the US promised to sanction any foreign entity investing in either country. The act was met with international condemnation, including a blocking regulation in the EU and an EU call for the WTO to rule on the legality of the Act, which was canceled after the US promised to apply the law “fairly” – and in fact, the Act in its original iteration was never enforced.
Times and stakes have changed. With their own national security threatened, there is a new willingness to consider ways to extend the jurisdictional reach of their own sanctions to target sanctions evasion. That does not mean, however, that anyone should expect a wholesale embrace and slew of new secondary sanctions policies. What is emerging is an incremental shift, with Canada, the UK and EU slowly amending or introducing new policies and authorities. None of these changes are explicitly termed secondary sanctions, and the extent to which they will be used is not yet clear.
In February 2024, Canada amended the Special Economic Measures Act (Russia) (SEMA) to reflect expanded authority to prohibit activities with persons unrelated to a foreign state targeted by SEMA sanctions. SEMA now authorizes the government to designate and prohibit certain activities by non-Canadians outside of Canada. Before the change, the government could only prohibit activities by Canadians or by individuals inside Canada.
In June 2024, in the “14thRound” of sanctions against Russia, the EU required EU companies to “undertake their best efforts” to ensure that non-EU entities that they own or control do not participate in activities that undermine EU’s Russian sanctions. The EU also added more non-EU entities located in third countries to the Military End User List (three were added earlier in February 2024). The EU has prohibited EU companies from using the Russian System for Transfer of Financial Messages (SPFS) as well as banning transactions with companies from third countries that use SPFS for transactions and who are listed in a new and yet to be filled annex.
In July 2024, the UK government added new language to its sanctions policy, expanding the Russian designation criteria to include providing financial services, or making available funds or other economic resources, goods or technology to persons involved in obtaining a benefit from or supporting the Russian government. The UK says the expanded authority will enable it to target overseas financial institutions that facilitate sanctions evasion and meets the UK’s G7 commitments to prevent Russia from exploiting the international financial system to support its war against Ukraine.
Compliance and Operational Risks for Western Businesses
Efforts by G7 members to close gaps in their respective sanctions regimes and the dynamic environment of new circumvention schemes add uncertainty for businesses. What is permissible today may very well not be compliant tomorrow in some or all G7 jurisdictions.
For example, on September 18, EU sanctions envoy David O’Sullivan said in remarks to a think tank that the EU could target financial institutions that fund transshipment of battlefield products to Russia. The EU has sanctioned Russian banks; targeting non-Russian banks is not out of the question at this time.
Secondary sanctions (direct or indirect) can provoke a strong response from the government of the country hosting the targeted entity. Normally, the US seeks to engage the government in advance in hopes that the host government will act to stop the business activity and avoid a diplomatic clash. This has been successful in some jurisdictions, but not all.
Openly discussing the potential for secondary sanctions is a double-edged sword. It can lead less risk tolerant companies to desist from potentially sanctionable activities, as has been the case with large Chinese banks after the US indicated they were on the US sanctions radar. It can also provoke retaliation, actual or threats, a form of collateral damage against other business interests. After the EU and UK added Chinese companies to their respective lists blocking exports of certain dual use items, Beijing warned the measures would have a "negative impact" on economic and trade ties. Both China and Russia have already taken steps to retaliate against countries expanding sanctions against them: in late 2023, China adopted an anti-foreign sanctions law, setting the legal foundation for China to take countermeasures against “discriminatory and restrictive” foreign sanctions, and Russia has taken similar countersanction measures. Both countries have also stepped up the pace of countersanctions.
Multinational companies and companies with international supply chains should actively monitor developments, as the risk for increased use of secondary sanctions is high. Additionally, new regulations can be unclear, such as the precise meaning of the new EU requirement for EU companies to “undertake their best efforts” to ensure that non-EU entities are compliant. Maintaining situational awareness can assist businesses to anticipate and manage an increasingly complex compliance environment, in addition to operational and reputation risks as a consequence of the Ukraine war which, regrettably, looks at this time to continue into the indefinite future.
