United States: Russian Against Time: New Sanctions And Lowered Expectations As Ukraine Crisis Continues

There's no end in sight for the turmoil in Ukraine. And there's no end in sight for international sanctions against Russia for causing that turmoil. As sanctions escalate, so will the collateral damage. New sanctions announced on April 28, 2014 will not only affect Russia and Ukraine, but will affect U.S. business too. But while the United States and its allies continue to double down on their sanctions efforts, no one in Washington seems very confident in the end game.

Asset Freeze. On April 28, 2014, the Obama administration announced new economic sanctions on Russian officials and companies. Specifically, pursuant to Executive Order 13661, entitled "Blocking Property of Additional Persons Contributing the Situation in Ukraine," the U.S. Department of Treasury, Office of Foreign Assets Control has frozen the assets of seven Russian officials. They include Putin's Deputy Chief of Staff and his Deputy Prime Minister, and Russia's Chairman of the State Duma Committee on International Affairs.

Also targeted is Igor I. Sechin, President of the state-owned Rosneft oil company and a trusted Putin advisor. Not only is Mr. Sechin a close ally of Putin, Rosneft has multiple joint ventures with major U.S. companies. The impact on the U.S. joint venture partners remains to be seen. Rosneft itself is not sanctioned. But one thing is clear, Mr. Sechin will no longer have access to any of his assets that may come under U.S. jurisdiction. Further, since the April 28 sanctions also place a travel ban on the named individuals, Mr. Sechin will not be permitted to travel to the United States.

And although the sanctions do not target Rosneft, seventeen other Russian companies saw their assets frozen by the new sanctions, and thirteen of those companies will face even tighter restrictions on their ability to import American-made goods due to a "presumption of denial" of license applications for export to those companies. Those companies, including some Russian banks and energy companies, are all affiliated with the oligarchs that were designated by the U.S. Department of Treasury, Office of Foreign Assets Control (OFAC) on March 20, 2012, which we reported on here. These measures come after an initial wave of U.S. sanctions in early March that we outlined here.

Separately, on April 3, Mr. Obama signed into law the Support for the Sovereignty, Integrity, Democracy, and Economic Stability of Ukraine Act of 2014. That act requires the President to impose sanctions on persons determined to be responsible for violence, human rights abuses, instability in Ukraine. The effect of that act is discussed in this article by our Sheppard Mullin international trade colleagues Thad McBride, Fatema Merchant, and Cheryl Palmeri.

Multilateral Sanctions. By adding more Russian individuals and companies to the list of U.S. sanctions targets, the April 28 sanctions represent an attempt to increase pressure on the Russian economy. The United States is not acting alone. The EU has announced its own sanctions, which can be reviewed online here. Those sanctions add 15 new names to the list of persons subject to EU sanctions such as asset freezes and travel bans.

But the attempt to impose multilateral sanctions has had paradoxical effects. On the one hand, acting together sends a strong message and helps minimize end runs around the restrictions, as an Obama administration official argued in this statement issued April 28, 2014. On the other hand, it's very hard to coordinate policy among sovereign governments with different sanctions programs and divergent interests. For example, the Obama administration official conceded in the April 28 statement that the U.S. and EU designation lists are not congruent, saying, "I expect there to be a divergence in the lists.  They have not in the past matched up exactly, and it will continue to be the case given the different nature of our sanction regimes that we hit different targets."

U.S. Export Restrictions. In addition to freezing assets, the United States is imposing some tough export restrictions that will have a substantial impact on exports to Russia, as follows:

  1. Effective immediately, the State Department Directorate of Defense Trade Controls (DDTC) and the Commerce Department Bureau of Industry and Security (BIS) will deny all export license applications for high-tech items that could contribute to Russian military capabilities.
  2. All other pending applications and existing licenses with DDTC and BIS will be evaluated to determine their contribution to Russia's military capabilities. Any existing export licenses that meet these conditions will be revoked.

These moves are aimed at inhibiting Russia's military capabilities in Ukraine and occupied Crimea. But they will have a substantial impact on American defense and technology companies doing business with Russia. If your company is involved in business in those sectors, you need to take immediate steps to identify current and future exports covered by the new rules. You also need to be prepared to navigate the revocation of standing export licenses. In short, the newly imposed export restrictions may prove to be costly for some American exporters.

An Elusive End-Game: Q&A With Our Sanctions Gurus.

As the Ukraine crisis moves into its third month, many in the international community are raising reasonable questions about the endgame for the United States, Europe, and Russia. According to President Obama, "these sanctions represent the next stage in a calibrated effort to change Russia's behavior ... [but] we don't yet know whether it is going to work."

Sheppard Mullin's Russia / Ukraine sanctions team has been fielding lots of questions about whether the sanctions are going to work, and what to expect next. Here is a summary of our analysis of those questions:

Q1. Do sanctions work (global geopolitical version)?

We don't think sanctions will ever force Putin out of Crimea. The Obama administration (along with all available world security apparatus) seems to have been caught off guard by the annexation of Crimea. As far as our group's history majors are aware, it is the first territorial annexation in Europe since the end of WWII. Such things are not undone easily, as evidenced by the 7 years of war that followed Hitler's 1938 annexation of Austria. And over 50 years of total economic embargo of Cuba hasn't caused regime change there.

Q2. Do sanctions work (modern expectations version)?

That said, modern economic sanctions are very different from the blunt economic embargoes of old. A very good case can be made that targeted sanctions such as the Russia sanctions are a much better instrument of economic warfare. A person or company designated by U.S. sanctions is denied all access to the U.S. financial system. That system is more pervasive than most people think. So the companies and persons designated by OFAC (and especially when also designated by the EU) can find themselves to be financial pariahs. This Op-Ed in Forbes makes that case, arguing that the Russia sanctions "will destroy Vladimir Putin." We're not going that far, but we do think the named oligarchs and the companies they own are going to feel a lot of pain in the next few years. Moreover, the sanctions appear to be causing some capital flight from Russia. The State Department estimates that there has been $60 billion in capital outflows from Russia this year, which would exceed outflows for the entirety of 2013. State says this factor has "contributed to sharp declines in the value of Russian equities, which are down almost 15 percent this year, and the Russian ruble, which has depreciated almost 9 percent against the dollar since January 1."

Q3. Will sanctions increase?

Yes. Putin does not scare easily, as President Obama observed in his April 28 press conference announcing the sanctions. So more rounds of sanctions are a near-certainty in our view.

Q4. Will future sanctions be better coordinated among Europe and the United States?

Likely not. Russia's trade relationship with Europe is an order of magnitude greater than with the United States. And in particular, Europe is much more dependent on Russian energy resources than the United States is. For that reason, as JP Morgan Chase Asset Management strategist Michael Cembalest has argued, as long as Europe remains so reliant on Russian energy and trade, the EU will be reluctant to hit hard.

Q5. What should U.S. and European businesses do to deal with these sanctions? We recommend the following steps:

  1. Be sure to screen customers, suppliers, joint venture partners, and other third parties against the OFAC Specially Designated Nationals List.
  2. And the EU lists here and here.
  3. Understand the 50% ownership rule. Under the U.S. sanctions, the property of any entity owned 50% or more, directly or indirectly, by designated Russian individuals or entities is frozen. It is unlawful to have any dealings with entities that are so owned. Even when non-designated persons are in the ownership chain between a designated person owner and another entity, the property of that entity – ie, the entity that is ultimately 50% or more owned by a designated person –  and the property of that entity's majority-owned affiliates, is frozen. We have this from OFAC's presentation at this conference.
  4. Be ready for counter-sanctions by Russia. With a tip of the hat to a competitor of ours for this idea. Whenever one country imposes sanctions, no rule says the sanctioned country can't consider those sanctions to be an illegal boycott. So don't be surprised to see Putin's government trying to make an example of some big U.S. companies.

We hope this information proves useful in charting a course through the rough and changing seas of international sanctions.

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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