Worldwide: Sanctions - The Diplomatic Substitute For Military Action?

Sanctions are a growing problem on the desk of every international trading business and bank. The introduction by the European Union (EU) of wide-ranging sanctions against Iran in 2010 signalled the start of a significant growth in compliance concerns. This year the US Iran Threat Reduction and Syria Human Rights Act of 2012 (ITRA) escalated those issues by widening the pool of affected parties and confirming a clear trend for governments to use sanctions as a foreign policy tool and the financial services sector as their enforcement arm.

To facilitate debate around the issues raised by international sanctions and to shed some light on current experience, Clyde & Co's commodities team held a seminar in London on 13 November 2012 attended by around 50 commodity producers, intermediaries, insurers and bankers.

Panellists at the debate, which was conducted under Chatham House rules, included Jonathan Marsh, Head of Legal at Vitol, Andy Wragg, Senior Manager, International Regulatory Affairs at Lloyd's and Clyde & Co's Clare Hatcher, Douglas Maag and Patrick Murphy.

This newsletter provides a brief summary of the discussion and the issues raised. The key topics covered included:

Complexity – recent sanctions regimes have been typified by an absence of consensus in adoption and a rapid introduction

ITRA – the use of sanctions on one sector to impact another has been powerful. Companies are still working through the implications

Enforcement – with sanctions regimes now well established, enforcement is being pursued more rigorously

Operational implications – given the complexity and fluidity of sanctions, companies are still working out how to improve understanding at the "coal face"

We are delighted to provide further advice and insight on request.

Complexity – the nature of the beast

The discussions of issues around sanctions fell into three main categories:

  • speed of introduction, which often creates significant problems
  • different applications in different jurisdictions
  • drafting of the legislation

All of these make for a difficult and complex operating environment.

Speed

When the EU introduced sanctions against Iran in 2010, one panellist had to advise on a review of a major contract portfolio and facilitate rapid service of force majeure notices within a very tight timeframe.

Lack of international consensus

The second complicating factor is the absence of an international consensus. Historically, sanctions have been driven by UN resolutions which then flowed through to the individual countries. What is new today is that each individual power or bloc has decided to run its own regime – often taking unilateral action; or sometimes no action at all. The result is a fragmentary regulatory set up which means that businesses involved in trading, shipping, financing or insuring the international movement of goods need to look at the rules in each jurisdiction to find out what can be done legally.

For example, Clyde & Co worked with an African producer and refiner of oil. They wanted to supply oil to Iran, using an operating subsidiary in one jurisdiction and financing the transaction through a bank in the Middle East. So, even before looking at where the oil was actually going, the company had several jurisdictions in play – all of which had different rules that needed to be reconciled in order to understand what would be permissible.

It was also noted by the panel that additional complexity is derived from the broadly-drafted pieces of legislation from which sanctions are derived, and the absence of any useful commentary either from government or regulators which causes something of a knowledge gap. Other laws have a certain lead-in time and consultation period during which changes can be debated. This generally results in regulation which has been improved by reasoned, pragmatic comments from experts and where all parties have a broad consensus on its interpretation. Sanctions however do not allow time for debate or questions and are often introduced with little or no warning as a direct response to a political event.

ITRA – the perfect secret weapon?

The introduction of ITRA was cited by delegates as a pivotal moment in the development of sanctions policy. By targeting the insurance market – rather than shipping direct – governments hit on a highly effective enforcement strategy.

The short term effect was a complete drying up of the market for Iranian cargoes. The fact that many of the US owners of Lloyd's of London based businesses were no longer able to write the cargo insurance meant that many businesses had legally permissible activity curtailed because they could not buy insurance. Companies as far apart as Switzerland and Asia were forced to rethink their contracts and delivery terms in the hope that they could continue to perform on a varied contract.

This then raised the issue of the availability of transitional relief, and whether it could be lost if an existing contract was varied. Transitional provisions frequently give time-relief before a restriction bites, ensuring that existing contracts can be performed, but several attendees expressed concern about how changes to these rules were affecting their business.

The answer would appear to lie in the degree to which a contract can be varied before it becomes a new contract and the transitional relief disappears. An interesting aspect of this is whether the availability of, or the requirement for, insurance is critical. In a CIF contract, insurance is a necessary function however there is always the option to self-insure. So, the answer – as with so many other aspects of sanctions compliance – is not clear cut.

The panel also noted how significant ITRA is for UK companies that have US parents. Section 218, for the first time, provides for imposition of sanctions liability upon US parent companies for the conduct of their foreign subsidiaries. Section 219 requires companies listed on US stock exchanges to make disclosures of sanctions violations in their public reports. Such companies are compelled to provide the nature and extent of the sanctionable activity, the gross revenues and net profits associated with the activity, and whether the company intends to continue the activity. This has been referred to as a 'name and shame' provision, which allows US law-enforcers to scrutinise international activity.

Enforcement – uneven and unpredictable

The enforcement of sanctions is very variable. The US is probably at the most extreme end of the enforcement spectrum, with some huge fines being imposed and policy makers often taking an even more hawkish line than the enforcement agencies. Delegates commented that, while the Office of Foreign Assets Control (OFAC) has shown some sensitivity in handling the impact of sanctions legislation on businesses, the US Congress does not, and this can be problematic.

The panellists noted that the US effectively delegates the enforcement of asset-freezing measures to banks. US banks automatically freeze funds if a sanctioned party's name appears on a wire transfer, and notify OFAC that it has done so. It has been estimated that 90% of OFAC violations are discovered through these bank reports.

Attendees at the seminar noted that very little has been seen from the EU and UK in relation to the enforcement of sanctions breaches. Delegates observed that there could be a number of explanations for this. Firstly, it was noted that sanctions are implemented within the EU domestically, subject to local legislation, and so are dependent on the activity of each Member State. Secondly, asset freezing units are grossly under-resourced. This often leads to delays, a lack of guidance and little operations transparency.

In other jurisdictions, such as UAE, there is a total absence of any written guidance. When the 2010 Security Council Resolution was passed, the UAE – as a Member State – was obliged to enforce that resolution. However, the approach taken was to enforce it "through executive agencies and customers".

One panellist explained that the only solution was to attempt to extrapolate the UN Resolution and assume it applied in domestic legislation. This means that, unlike the US and EU, there are no economic sanctions in place against Iran but rather hidden roadblocks. For example an Iranian company or an Iranian national cannot incorporate a company in the UAE at the moment. There is nothing in writing, but the application goes nowhere and – if you press enough – you will be told that you have got "national security problems".

Commercial implications

Panellists and audience members also discussed the commercial implications on their business, looking at how their day-to-day operations have been affected by changing sanctions and regimes.

Attendees at the seminar agreed that front office trading personnel are not generally compliance detail-conscious, so it is essential to develop a detail-orientated mindset without stifling commercial activity, or risk-taking – which could jeopardise the business in the longer term.

One panellist commented: "The best approach with front office staff is not to expect them to be legal experts, but to recognise issues effectively and elevate them appropriately. Staff must have an awareness of sanctions and be answerable to compliance and senior management. It is therefore essential that they know when to raise a relevant issue."

Although it is clearly not advisable to have a compliance department larger than the front of office team, some banks are moving towards this. To avoid this scenario it is necessary to rely on a culture of compliance across the whole work force.

A delegate commented: "Educating staff to understand the consequences of not being compliance-aware is also very important. Warning staff about penalties, fines from the US authorities and the risk of the firm's collapse in the event that the bank treats the organisation as a pariah is vital and best explained in simple terms of dollars, profit and loss."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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