The unparalleled onslaught of sanctions imposed on Russia in the past month has by some measures created its desired effect. The so-called ‘economic blitzkrieg’ against the Russian state has pushed the economy into free-fall with the ruble collapsing dramatically, leading to panic buying and stringent capital controls. To maximise economic impacts and dissuade Russia from continuing its brutal attack on Ukraine, the international community has gone beyond adding yet more names to sanctions lists to come up with more creative, targeted, and (it is hoped) effective ways to sanction the country. It has targeted strategic sectors and areas of financial activity to push Russia’s economy to the brink, in the hope of forcing a change in behaviour and reaching a political solution.
Financial mechanisms
The once hotly-debated ban from SWIFT was partially implemented on 12 March 2022, effectively eliminating seven designated Russian entities and their Russia-based subsidiaries from the important international messaging system used between financial institutions. The sanctioned institutions were strategically selected for their involvement with Russian industry, foreign investments, security and defence, while attempting to prevent the harshest negative impact on business and energy-reliant European countries. Russia’s biggest bank Sberbank and third-largest lender Gazprombank are notably missing from the list.
In principle, excluding these key institutions will make dealings burdensome and slower as financial institutions will be forced to use less secure and outdated methods of interbank communication or Russia’s own domestic system, which has noted significant challenges. While some analysts allege the ban’s impact will ultimately be minimal, estimates from 2014 claimed that a SWIFT ban could lead to a 5% drop in Russian GDP.
Sanctions have also been placed on Russia’s Central Bank by the EU, US, UK and others. By effectively freezing Russia’s access to its foreign exchange reserves, international payments are made more difficult, as is the ability to keep the ruble stable. Expanding on measures taken in 2014 that strategically targeted entities in specific sectors, Western governments have imposed new and extended capital market sanctions. 70% of the Russian banking system and vital government and state-owned companies will no longer be able to refinance in EU capital markets, and the issue of trading in Russian sovereign bonds has been suspended in key financial centres, including the US and the UK.
Trade restrictions
In an effort to constrain Russia’s technological and military capabilities, sanctions have been placed on targeted strategic sectors including export bans on technologies that support oil refining, defence and security, aviation and space. Airbus and Boeing have even halted maintenance supplies and support to Russian airlines, which is expected to lead to long-term operational issues across the country.
Other dual-use goods such as computers, telecoms, and semiconductors have also been subject to export bans. Semiconductor chips, which are used in everything from mobile phones and computers to military drones and supersonic jets, are prohibited from sale to Russia if they contain US inputs (which includes chips made in Taiwan and elsewhere). The US is the dominant player in chip design, research, and development, and holds many patents for high-end chips. The government believes banning their export will have “massive consequences” for Russia’s military-industrial complex, given the increasingly technological nature of modern warfare. Putin himself said in 2017 that the leader in artificial intelligence will ultimately become “the ruler of the world”, and so the hope is that stymying Russian access to crucial technology will be a significant blow that will thwart his ambitions.
Travel and shipping
In an attempt to physically isolate Russia, measures have been imposed to restrict the movement of goods and people. The Russian national carrier Aeroflot has been barred from EU and UK airspace, and Russian registered ships are prohibited from entering UK ports. Some ports are also refusing to unload Russian cargoes, even where this is not actually prohibited under current restrictions. To further curtail operations in this strategic sector, the UK has also blocked Russian aviation and space companies from accessing its distinguished insurance sector, likely leaving Russia’s commercial airlines to turn to China.
Energy
Despite general unity on the new sanctions approach, the energy sector remains an important exception. Less-dependant states have taken action: the US (which relies on Russia for only about 3% of its oil) has banned the import of Russian oil, liquified natural gas, and coal, and the UK has initiated a plan to phase out Russian oil imports by the end of 2022. However, the EU’s heavy though unevenly distributed reliance on Russian energy makes for a fragmented response. While the Baltic states have halted the import of Russian gas and turned to reserves stored in Latvia, countries like Germany, which imports 55% of its gas from Russia, are resistant to an all-out embargo. In addition, heavily discounted Russian oil is still being purchased by countries including India and China, which would limit the effect of a total Western embargo.
The energy sector is a significant vulnerability for the Russian economy; oil accounts for a striking 44% of Russia’s exports and contributed 40% of last year’s budget revenue. Oil and gas exports bring in hard currency and will complement the Central Bank’s efforts to control the ruble, with signs that the banking system may be gradually stabilising. However, as the atrocities of war crimes in Ukraine unravel further, intensifying pressure on key EU decision-makers may result in the imposition of harsher energy sanctions.
“Self Sanctions”
Driven by pressure from public opinion and shareholders, many Western companies have gone beyond complying with obligatory sanctions to divest or pull out of Russian markets. Visa, Mastercard and PayPal services have been suspended, and energy companies including BP and Shell have divested or withdrawn their operations. The German pharmaceutical and life sciences company Bayer has even threatened to suspend crop supply sales for next year’s harvest. Unsurprisingly, iconic Western fast-food brands like McDonalds, Coca-Cola, and Starbucks have followed suit in closing their doors, leading to significant job losses. French luxury house Chanel has closed its stores in Russia and even stopped selling goods elsewhere to people who intend to take them to Russia, which it claims is to comply with EU sanctions banning the sale of luxury goods to the country. Globally, many shops in the West have voluntarily removed Russian vodka from their shelves in an expression of solidarity, though inflicting little economic impact.
Culturally, Russia has also been banned from multiple international cultural and sporting events including football, hockey, ice skating and even the Eurovision song contest. While these measures mainly carry cultural weight, they signal collective disapproval that will isolate Russia further.
Will the sanctions work?
The international community has been swift in implementing a range of sanctions, taking a broad approach and identifying innovative and strategic ways to hurt Russia's economy while bracing for the inevitable impacts on their own. Yet Russia shows no sign of abandoning its attack on Ukraine — bringing to question the reality that sanctions may not have their intended effect on Putin and the war, but instead impact everyday citizens the most. Moreover, analysts warn that Western governments must be clear about what the sanctions are expected to achieve. The aim is to convince Putin that de-escalation is preferable to continuing aggression, which means it must be clear under what circumstances the sanctions will be lifted. Permanently crippling the Russian economy may satisfy ‘righteous’ punitive instincts, but is ineffective as a bargaining tool.
What does this mean for compliance?
Evidently the vast array of measures outlined above pose a challenge for compliance professionals. The first stage has to be ensuring that their firms have a robust sanctions screening process in place. Any organisations still using manual processes need to urgently look at switching to automated, ongoing screening. Firms that do use screening tools need to interrogate the lists on which the tools are based to ensure they are up-to-date and fully comprehensive. They should obtain granular details on how associated parties, e.g. subsidiaries of designated institutions, are identified. All firms should ensure they understand how aggregated ownership is calculated by the relevant regulators (the UK, US and EU all take a different approach).
In many ways, ensuring compliance with sanctions against designated entities is the easy part. The second thing to consider is how to ensure compliance with the broader range of measures discussed in this article against specific types of financial transactions, goods and services, sectors etc. Here compliance professionals must engage with the business teams to fully understand the nature of services being offered or goods forming the subject of transactions, and should be prepared to ask for additional information, conduct their own enhanced research, or seek external advice where necessary. There can be no one-size-fits-all approach, as every firm will have a different level of exposure based on its individual products and services, and its customer base.
Finally, it is also clear that financial institutions should consider the reputational impact of any Russia-associated business as well as their regulatory obligations. Certain types of business or certain Russian customers or counterparties may remain permissible, but the risk of any business activity undermining sanctions measures or causing reputational damage to the firm should be considered. This must be weighed up carefully against heavy-handed ostracising of all Russian-related companies and individuals, which could amount to deliberate and potentially even unlawful exclusion.
How FINTRAIL can help
At FINTRAIL, we combine deep financial crime risk management with geopolitical expertise to help you keep your anti-financial crime and sanction programmes in step with current events. Please get in touch if you would like support with refining, enhancing or testing your sanctions or transaction monitoring programmes. We’re here to support you in conducting due diligence on higher-risk situations, providing context-based training to your analytical team, and helping you navigate the situation as it unfolds. Please email us at contact@fintrail.com.