Companies Need to Take a "Layered Approach" to Sanctions Compliance: US and EU Expand Sanctions Against Russia

On September 12, 2014, the United States and the European Union issued new sanctions against Russia, including sanctions targeting the Russian financial, energy, and defense sectors.

New US Sanctions

OFAC Trade Restrictions

The US Treasury Department, Office of Foreign Assets Control (OFAC) has issued Directive 4 prohibiting US persons from supplying, exporting or reexporting any goods, services, and technology:

• Related to exploration and production for oil in Russian deepwater, Arctic offshore, and shale projects
• Involving persons that OFAC designates under Directive 4 on the Sectoral Sanctions Identifications List (SSI List)

This prohibition is broad, and applies to all goods, services, and technology, whether US origin or foreign origin. Concurrent with its issuance of Directive 4, OFAC designated the following Russian companies under the directive: Gazprom, Gazprom Neft, Lukoil, Rosneft, and Surgutneftegas.

The above prohibition covers oil projects only, and does not extend to gas projects. Furthermore, the prohibition on the supply, export or reexport of services does not cover financial services.

Directive 4 applies to US persons, defined in the Ukraine-Related Sanctions Regulations (31 C.F.R. Part 589) as US citizens, permanent resident aliens, entities organized under the laws of the United States (including foreign branches), and persons located in the United States. The term does not include foreign-incorporated subsidiaries of US companies.

Directive 4 prohibits exports and reexports, and goes further to restrict evasion, avoidance, or conspiracy to violate the restrictions. However, it does not block the property of persons previously on or added to the SSI List.

The language in Directive 4 also refers to projects in maritime territory claimed by Russia. We do not read this language to expand the scope of "end-use" restrictions, beyond shale, deepwater and Arctic offshore. Rather, this language likely makes clear that oil projects involving shale, Arctic offshore, and deepwater in any maritime area that Russia claims, even if such claims are not recognized by the US Government or international community, are subject to the OFAC restrictions.

OFAC has not "grandfathered" pre-existing contacts and supply arrangements that are now subject to OFAC export, reexport, and supply restrictions. Instead, OFAC issued General License No. 2, to allow the winding down of activities now restricted by Directive, but only until September 26, 2014—a period of two weeks. Within 10 business days of the winding down of operations, US persons are required to file a “detailed report” with OFAC that specifies the parties involved, the activities conducted, and the dates of the activities.

BIS Trade Restrictions

On September 12, 2014, the US Commerce Department, Bureau of Industry and Security (BIS) issued a final rule adding Russian energy and defense companies to the Entity List, set forth in Supplement No. 4 to Section 744 of the Export Administration Regulations (EAR), 15 C.F.R. Parts 730-774.

BIS had added the same five energy companies to the Entity List that OFAC designated under Directive 4: Gazprom, Gazprom Neft, Lukoil, Rosneft, and Surgutneftegas. For these companies, a license is required where the exporter or transferor has reason to know that the item will be used for exploration for, or production from, deepwater, Arctic offshore, or shale projects in Russia. License applications are subject to a policy of denial where the export, reexport, or transfer relates to an oil project. There does not appear to be a similar policy of denial for gas projects.

BIS also has added the following defense companies to the Entity List: Almaz-Antey Air Defense Concern Main System Design Bureau; Tikhomirov Scientific Research Institute of Instrument Design; Mytishchinski Mashinostroitelny Zavod; Kalinin Machine Plant; and Dolgoprudny Research Production Enterprise. A license is required to export any item subject to the EAR to these companies, regardless of end use.

Finally, BIS has amended Section 744.21 of the EAR to require a license to export or reexport certain items to Russia where there is reason to know that they are intended for a military end use. The covered items are listed in Supplement No. 2 to Part 744 of the EAR. Previously, this “military end use” restriction applied only to exports or reexports to China.

SSI List Changes

OFAC has reissued Directive 1 and Directive 2 under the SSI List, and issued new Directive 3, modifying the scope of the restrictions under the SSI List. OFAC also has modified previously issued Frequently Asked Questions (FAQs) and issued new FAQs providing interpretative guidance.

Directive 1 restricts US persons from transacting or dealing in new debt or equity of entities operating in the Russian financial sector that OFAC has designated on the SSI List. OFAC has revised the directive to prohibit transacting or dealing in new debt with a maturity of longer than 30 days – a significant reduction from the previous threshold of 90 days. As made clear by FAQ 371, the new threshold applies only to debt issued on or after September 12, 2014; dealing in an SSI entity’s debt with a maturity of 90 days or less is permissible if it was issued before September 12, 2014. OFAC also has added Sberbank to the list of Directive 1 entities.

Directive 2 restricts US persons from transacting or dealing in new debt of entities operating in the Russian energy sector that OFAC has designated on the SSI List, where such debt has a maturity of longer than 90 days. Significantly, OFAC has preserved the previously existing maturity threshold of 90 days for entities designated under Directive 2. On September 12, 2014, OFAC added Transneft and Gazprom Neft to the list of Directive 2 entities.

New Directive 3 restricts US persons from transacting or dealing in new debt of entities operating in the Russian defense sector that OFAC has designated on the SSI List, where such debt has a maturity of longer than 30 days. OFAC has designated Rostec as a Directive 3 entity.

We note that SSI List restrictions apply only to the debt (or equity, in the case of Directive 1) of a designated company that is issued on or after the date that the company is designated. FAQ #371 provides in part: “Transacting in, providing financing for, or otherwise dealing in any debt or equity issued by, on behalf of, or for the benefit of persons subject to Directives 1, 2, or 3 is permissible, if the debt or equity was issued prior to the date on which the person was determined to be subject to the relevant Directive.”

See our previous advisory regarding OFAC’s FAQ interpreting various aspects of SSI List restrictions.

SDN Designations

OFAC has designated as Specially Designated Nationals (SDNs) the same five defense companies that BIS added to the Entity List, set out above. As SDNs, their property and interests in property are blocked if in the United States or in the possession or control of US persons. This essentially cuts off US persons from all dealings with the listed companies. The restrictions also apply to companies that are owned 50 percent or more by the SDNs.

Compliance Considerations for Energy-Related Transactions

Companies should consider adopting a “layered” approach to compliance with US sanctions on the Russian energy industry, which have grown complex. Depending on the items involved, the end use, end user, and type of transaction involved, a company will need to consider the various restrictions that OFAC and BIS have imposed. A “layered” approach to compliance would include consideration of the following restrictions:

• BIS restriction for US and non-US persons: Items controlled under Schedule B and 8 specific ECCNs, applicable to oil and gas, regardless of end user.
  • BIS introduced the first US restrictions on export of certain items to the Russian energy industry on August 1, 2014, and those restrictions remain in effect. They focus on a narrower set of items than the new restrictions, but apply to all end-users for deepwater, Arctic offshore, and shale oil or gas.
  • Specifically, BIS requires a license to export the following items if they are for use in exploration or production on Russian deepwater, Arctic offshore, and shale projects:
    • Items listed on Supplement No. 2 to Part 746 of the EAR, known as “Schedule B”
    • Items controlled under eight specific ECCNs
    • Items under ECCNs that are controlled for export to Russia
  • The license requirement applies to both oil and gas projects. There is a presumption of denial for oil projects, but not gas.
  • The restrictions do not depend on who the end-user is
  • See our previous advisory on this BIS regime, which remains in effect.
• OFAC restriction for US persons: All goods, services, and technology for specified oil companies. Directive 4 prohibits US persons (not foreign persons) from directly or indirectly supplying any goods, services or technology—US-origin or foreign-origin—to the designated Russian energy companies when involved in deepwater, Arctic offshore, or shale oil projects. The restrictions do not cover financial services, or gas projects generally.
• BIS restriction for US and non-US persons: All items subject to the EAR for specified oil companies. The new BIS Entity List restrictions essentially restrict non-US persons from supplying items subject to the EAR to the Entity List designated Russian energy companies for deepwater, Arctic offshore, and shale oil exploration and production projects.
• OFAC restriction for US persons: Financial restrictions for specified companies. OFAC financial restrictions limit payment terms/credit for transactions involving SSI-listed energy companies to 90+ days. Notably OFAC has not reduced this threshold to 30+ days as it has for financial and defense companies designated under Directives 1 and 3.

New EU Sanctions

The EU has enacted Council Regulation No. 960/2014, which amends Council Regulation No. 833/2014 to enhance existing financial and export restrictions related to Russia, as well as introduce new restrictions. The EU also has designated certain individuals for asset freezing and travel bans, as noted below.

Financial Restrictions

Pursuant to Council Regulation No. 960/2014, EU has strengthened sanctions against the Russian financial sector and has introduced new sanctions directed at the Russian defense and energy sectors.

First, the sanctions prohibit investment services, assistance, and dealing related to transferable securities and money market instruments with a maturity longer than 30 days, issued after September 12, 2014 by five major Russian banks previously listed in Annex III to Council Regulation No. 833/2014. This is a significant reduction in the previous maturity threshold of 90 days, which still applies to transferable securities and money market instruments issued between August 1, 2014 and September 12, 2014.

Second, Council Regulation No. 960/2014 prohibits investment services, assistance, and dealing related to transferable securities and money market instruments with a maturity longer than 30 days, issued after September 12, 2014 by the following entities in the Russian defense and energy industries:

• Defense: OBK Oboronprom; United Aircraft Corporation; and Uralvagonzavod
• Energy: Rosneft; Transeft; Gazprom Neft

The foregoing restrictions also apply to (1) entities owned more than 50% by the listed companies, as well as (2) entities that act on behalf of or at the direction of those companies.

Third, Council Regulation No. 960/2014 prohibits the making of “new loans or credit” with a maturity exceeding 30 days available to the foregoing entities after September 12, 2014. This restriction does not apply to loans or credit related to otherwise lawful imports or exports. It is not clear if this restriction applies to the extension of payment terms to covered entities, which is the case under US sanctions as per guidance provided by OFAC.

Export Restrictions

Council Regulation No. 960/2014 prohibits the export of dual-use goods and technology to certain listed entities that the EU has described as “mixed defense” companies. These companies are: JSC Sirius; OJSC Stankoinstrument; OAO JSC Chemcomposite; JSC Kalashnikov; JSC Tula Arms Plant; NPK Technologii Maschinostrojenija; OAO Wysokototschnye Kompleksi; OAO Almaz Antey; and OAO NPO Bazalt.

The new provision bars dual-use exports to the listed companies, whether for civil or military purposes. The restrictions do not apply to exports related to contracts executed before September 12, 2014. Furthermore, they do not apply to exports for the aeronautics and space industry, or for the maintenance and safety of existing civil nuclear within the EU, so long as the end-use and end-user are not military.

Previously, Council Regulation No. 833/2014 prohibited the export of dual-use goods to military end-users and end-uses in Russia. This prohibition remains in effect.

Services Restrictions

Council Regulation No. 960/2014 prohibits the following services related to production and exploration for deepwater, Arctic offshore, and shale oil projects: (1) drilling, (2) well testing, (3) logging and completion services, (4) supply of specialized floating vessels. This new restriction, coupled with the previous restriction on export of specified goods for such restricted projects, is clearly aimed to eliminate most of involvement by EU-connected companies with such projects.

The prohibition does not apply to services related to contracts executed before September 12, 2014.

Insurance/Reinsurance Restrictions

Council Regulation No. 960/2014 prohibits insurance and reinsurance for the supply of military-controlled items to Russia. This adds to the prohibitions related to military exports previously set out in Council Regulation No. 833/2014, which restricted financial and technical assistance.

Asset Freezes/Travel Bans

Council Regulation No. 959/2014 broadens the bases upon which persons can be sanctioned for undermining Ukraine’s sovereignty, amending Council Regulation No. 269/2014 to include “conducting transactions with the separatist groups in the Donbass region of Ukraine” as a basis.

Council Implementing Regulation No. 961/2014 designates 24 individuals for asset freezing and travel bans, including persons affiliated with the Ukrainian separatist movement and the governments of Crimea and Russia. The sanctions apply to entities owned or controlled by the listed individuals.

Compliance Considerations for Energy-Related Transactions

As with the US sanctions, companies should consider a “layered” approach to EU energy sanctions. This approach would take into consideration the items involved, the end use, end user, and type of transaction. Such an approach should include consideration of the following main restrictions (other non-energy-specific aspects of the sanctions may also be relevant to energy transactions):

• Technologies listed in Annex II to Council Regulation No. 833/2014
  • Prohibited on restricted oil projects: The export of listed technologies is prohibited where they are for use on Russian deepwater, Arctic offshore, and shale oil projects. Member States may not issue a license for such exports, except for exports related to contracts executed before August 1, 2014. The prohibition does not cover gas projects.
  • Authorization required on all projects: Authorization is required to export listed items to Russia, regardless of end use.
• Services
  • Prohibited: Performance of the following services is prohibited where they relate to production and exploration for Russian deepwater, Arctic offshore, and shale oil projects: (1) drilling, (2) well testing, (3) logging and completion services, (4) supply of specialized floating vessels. The prohibition does not cover services related to contracts executed before September 12, 2014.
  • Authorization required: Authorization is required to provide technical assistance, financial assistance, and brokering services, related to items listed in Annex II of Council Regulation No. 833/2014, to persons in Russia.
• Financial transactions
  • Securities and money market instruments issued by Rosneft, Transneft, and Gazprom Neft: Investment services, assistance, and dealing in transferable securities and money market instruments issued after September 12, 2014 are prohibited where they have a maturity of longer than 30 days.
  • “New loans or credit” to Rosneft, Transneft, or Gazprom Neft: Extending “new loans or credit” with a maturity of greater than 30 days to the three listed entities is prohibited. It is not clear if this includes the extension of payment terms.

Background

Many of the new sanctions build on existing restrictions we previously have summarized. On the US side, these pre-existing sanctions include:

• “Blocking” of SDNs
• No dealing in new debt (and in certain cases, equity) of certain companies operating in the Russian financial and energy sectors, which have been designated on the Sectoral Sanctions Identifications List (SSI List)
• Restrictions of certain transactions with the Russian defense industry
• Restrictions of the export of certain goods, services, and technology for the exploration or production for Russian deepwater, Arctic offshore, and shale projects that have the potential to produce oil or gas

The EU had enacted similar restrictions, although the export restrictions noted above generally do not apply to the Russian gas industry.

See our previous advisories with regard to the SSI List and the energy-related export restrictions noted above.

Conclusion

The new sanctions reflect ongoing cooperation between the United States and EU in imposing sanctions against Russia, as well as a continued willingness to ramp up sanctions in response to Russia’s involvement in the crisis in Ukraine. There is not much “daylight” between the US and EU sanctions, as the allies have harmonized many of the core export and financial restrictions noted above.

One key area in which the US and EU sanctions differ, and which figures to be very significant for companies, is the extent of export restrictions related to the Russian energy industry. The United States now prohibits essentially all exports within its jurisdiction to the five designated companies where the export is related to exploration and production for Russian deepwater, Arctic offshore, and shale oil projects. Furthermore, General License No. 2 (applicable to US persons) provides for a relatively brief wind-down period of fourteen days and requires the filing of a detailed report with OFAC. Notably, while the EU has not enacted the same strict export restrictions, it has prohibited certain core services related to the Russian oil industry.