Mon, Apr 11, 2022

Russia Sanctions Usher In New Age Of Economic Warfare

In the weeks since Russia invaded Ukraine, and reactions turned the world of sanctions on its head, few sanctions attorneys have had a moment of respite to see where the pieces have fallen. Some are reflecting on where their compliance programs had gaps. Others continue struggling to keep pace with daily developments.

With the outlook of the war in Ukraine uncertain, multinational companies with continued exposure to Russia could be wondering what comes next.

A longer view on U.S. policymaking sees recent actions as an omen, predicting future weaponizing of regulations, as well as trade realignment and geopolitical division.

Historically, U.S. sanctions that have been used to drive regime change experienced limited success. They have been used as blunt financial weapons against governments like Venezuela, Cuba and Iran.

Each of these governments maintain power for varying reasons. The challenge has been a "rally round the flag" effect, where views against the U.S. harden and economies subsist on exports to non-Western governments.

Over the last few decades, this blunt tool has been sharpened by each successive U.S. administration to the point where Russia is now experiencing unprecedented punishment that is only beginning to unfold.

The spark to this fire was a 2021 top-to-bottom review by the U.S. Department of the Treasury's Office of Foreign Assets Control of its sanctions programs, resulting in an October 2021 summary report outlining areas for improvement.1

These areas included greater multilateral coordination and calibration to minimize unintended impacts, ensuring clarity and modernization of enforcement capabilities. Russia has been a dramatic early test of the intended policy changes.

At the start of Russia's war against Ukraine on Feb. 24, the Biden administration detailed how each sanction would be designed to maximize long-term impact on Russia and minimize effects on the U.S. and global consumers.2 The administration further committed to take additional action if the military incursion progressed.

The scale of the resulting sanctions and the level of coordination between allied governments in the weeks since has been so unprecedented that it is difficult to imagine anyone at the start of the invasion accurately predicting their impact. The multilateral coalition's ability to stay united for as long as it has, while challenging, is the primary contributor to the efficacy of sanctions.

In late February, cutting off Russian banks from the Society for Worldwide Interbank Financial Telecommunication messaging system was considered one of the more severe options on the table. Weeks later, following pressure from Congress and the U.S. public, other actions by OFAC targeting economic infrastructure and the funding of the Russian economy from the energy industry have combined to make the SWIFT block look like a moderate option.3

More importantly, the multilateral coalition has stayed together while European partners continue considering how to unwind their exposure to Russia. This leaves few cards on the table for the U.S., except comprehensive sanctions akin to the North Korea program.

Among the additional options available, the U.S. may action provisions of Section 228 of the Countering America's Adversaries Through Sanctions Act to target non-U.S. persons in the event China intervenes to save Russian companies from default.4 This would be a startling escalation of tensions between the U.S. and China where the U.S. financial system is leveraged against China's.

Russia has already exceeded Iran as the most sanctioned nation, with over 5,200 new sanctions since Feb. 22, and just over 7,900 in total from the U.S., the United Kingdom, Switzerland, Canada, Australia, Japan and the European Union.5 Outdated sanctions programs akin to carpet-bombing campaigns have evolved into wide-scale precision bombing operations. This is the new reality of economic warfare.

The most immediate, unintended consequence for global consumers has been the additional blow against supply chains combined with the biggest commodity shock since the 1970s. Major container shipping companies have suspended their primary shipping activities to Russia, with the notable exception of Chinese conglomerate Cosco Shipping Corp. Ltd.6 Trade networks near Russia, particularly for the marine transportation of crude oil, were thrown into chaos.7

Even if oil supplies return to meet demand, gas prices will continue to show their downward inelasticity, complicating inflation and the U.S. Federal Reserve's ability to act. This will undoubtedly be a campaign issue during the next two American election cycles and may wear down support from the American public for the economic war effort.

Global food production is another tipping point. Russia and Ukraine are significant suppliers of the world's wheat and fertilizers, and with global supply restricted, economies with lower trade power will lose out first. This may place emerging economies in the Middle East and Africa in a particularly tenuous situation with famine risks and geopolitical instability.

Skyrocketing energy and food prices typically do not lead to periods of global peace and stability — they compound regulatory uncertainty and strain globalization. The new approach to sanctions could also drive a wedge into existing geopolitical cracks created by trade wars, countersanctions and diplomatic saber-rattling.

The U.S. Department of Defense, in a November 2021 report, provided details on China's intention to reach certain military modernization goals by 2027 that will enable it to "compel Taiwan's leadership to the negotiating table on Beijing's terms," without U.S. military interference.8

Imagine being a Chinese policymaker looking at Russia's economic hardship on one hand and having over $1 trillion in U.S. Treasury bonds in the other. Not that China needed another reason to build economic defenses against U.S. sanctions, but recent actions against Russia should remove any doubt.

This further alignment between Russia, China and their allies may result in the primary unintended consequence warned of by U.S. policymakers — including former U.S. Treasury Secretary Jacob J. Lew and former Deputy Coordinator for Sanctions Policy at the U.S. Department of State Department Richard Nephew — that these countries will continue to shift away from the U.S. economy and financial system.9 An economic drift leads to a regulatory drift, complicating regulatory compliance for foreign companies.

Companies considering leaving Russia also risk nationalization and countersanctions. Nationalization would entail the forced replacement of a company's local management and the sale of its assets.10 These same companies will need to navigate relationships with local partners should they intend to return to Russia in the near future.

First reported by Russian media on March 10, at least 59 major brands have been threatened by Russian law enforcement and regulatory agencies with criminal and judicial action.11 Russia has since had an increasingly harsh response in a desperate effort to save its economy from collapse.12 Such actions will complicate any future sanction deescalation, which will be essential for a negotiated peace.

Many of these unintended impacts from sanctions combine with and further trends that compliance officers have grappled with since the start of the pandemic — economic, fiscal and political volatility leading to regulatory and reputational risks.

Some multinational companies will continue to be challenged by the deluge of sanctions and the opacity of their third parties. Since late February, companies with developing compliance programs have become trapped in a cycle of reacting to the news of the day and investigating whether their vendors, suppliers and customers are exposed to any one of the more than 5,200 new sanctions.

Compliance controls in the private sector have been hamstrung by the limited availability of corporate data for years, made no easier by the lack of corporate transparency in offshore jurisdictions.

With so-called Russian oligarchs shifting their assets across borders daily, it is understandable for compliance programs to feel one step behind sanctions evaders.

The multinational companies that focused on risk mitigation and reputation prior to the war, whether due to foresight or not, will continue to show resilience through volatility. Their brands will be protected, their supply chains will stay reliable and secure, and they will be crucial in enforcing sanctions.

Many of these successful companies will be large financial institutions and multinational corporations with substantial compliance budgets, reinforced sanctions monitoring programs and fully vetted third-party networks. Such companies already had robust sanctions-monitoring systems that allowed them to react quickly.

They minimized their links to the Russian government and oligarchs at risk for sanctions. Such companies exposed to Russia also prepared regulatory disclosures and planned for inevitable litigation risks. Companies with a robust governance program have a plan B and can weather any storm.

Particularly as the winds of global politics continue to shift, compliance programs will operate in an atmosphere of uncertainty and changing regulatory regimes. A recommitment to sanctions compliance programs that not only comply with regulatory expectations but protect their organizations against unknowns in the future will be key.

 

Sources
1https://home.treasury.gov/news/press-releases/jy0413
2https://www.whitehouse.gov/briefing-room/speeches-remarks/2022/02/24/remarks-by-president-biden-on-russias-unprovoked-and-unjustified-attack-on-ukraine/
3Of note: E.O. 14068 banning signature Russian imports such as luxury goods, E.O. 10466 banning imports of certain Russian energy products, and § 734.9 foreign-direct product rules expanding export controls to goods manufactured in foreign countries
4https://home.treasury.gov/system/files/126/hr3364_pl115-44.pdf; https://www.reuters.com/world/us-sets-some-red-lines-china-over-support-russia-2022-03-23/
5https://www.castellum.ai/russia-sanctions-dashboard
6https://www.reuters.com/business/worlds-biggest-container-lines-suspend-shipping-russia-2022-03-01/
7https://www.hellenicshippingnews.com/supply-chains-complete-chaos-for-the-shipping-industry-amid-russia-ukraine-war-and-china-lockdowns/
8https://media.defense.gov/2021/Nov/03/2002885874/-1/-1/0/2021-CMPR-FINAL.PDF
9https://www.foreignaffairs.com/articles/world/2018-10-15/use-and-misuse-economic-statecraft
10https://www.washingtonpost.com/business/2022/03/10/russia-nationalize-foreign-business-ukraine/
11https://iz.ru/1302632/natalia-bashlykova/dalnie-po-spisku-v-rf-sozdan-perechen-iz-60-pretendentov-na-natcionalizatciiu
12https://www.reuters.com/business/how-russia-could-use-bankruptcy-law-punish-foreign-companies-2022-03-18/; https://www.washingtonpost.com/outlook/2022/03/25/russia-is-threatening-move-that-will-haunt-its-economy-decades/

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