New Secondary Sanctions Heighten Risks For Foreign Financial Institutions, IT-Related Service Prohibitions, And Export Restrictions

On June 12, 2024, the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) announced new sanctions targeting Russian entities, guided by G7 commitments to intensify the pressure on Russia. The key points of the announcement include:

• Designation of New Entities and Individuals;
• Export Restrictions;
• IT-Related Services Prohibitions;
• Secondary Sanctions; and
• Amended Frequently Asked Questions (FAQs).

I. Designation of New Entities and Individuals

OFAC has added numerous Russian entities and individuals to its List of Specially Designated Nationals and Blocked Persons (SDN List). These designations target individuals and entities involved in sectors such as technology, defense, and financial services. The U.S. Department of State also targeted over 100 entities and individuals engaged in developing Russia's energy, metals, and mining production and export capacity, sanctions evasion, and supporting Russia's war efforts. Collectively, over 300 new sanctions were issued across the Departments of Treasury and State.

Significant entities included in these sanctions are:

• The Moscow Exchange (MOEX): Russia's largest public trading markets for equity, fixed income, derivative, foreign exchange, and money market products, as well as Russia's central securities depository and the country's largest clearing service provider.
• The National Clearing Center (NCC): The central counterparty and clearing agent for, and a subsidiary of, MOEX. NCC is supervised by the Central Bank of the Russian Federation.
• The Non-Bank Credit Institution Joint Stock Company National Settlement Depository (NSD): Russia's central securities depository and a subsidiary of MOEX. NSD provides bank account services, registration of over-the-counter trades, and liquidity management services. The European Union (EU) previously sanctioned NSD in June 2022.

Concurrently, OFAC issued General Licenses No. 98, 99, and 100, which authorize specific transactions involving sanctioned Russian entities. Specifically, General License No. 98 authorizes the wind-down of transactions involving certain blocked entities through July 27, 2024; General License No. 99 authorizes the wind-down of transactions and certain transactions related to debt or equity of, or derivative contracts involving, MOEX, NCC, or NSD until August 13, 2024; and General License No. 100 authorizes transactions related to the wind-down of debt or equity or the conversion of currencies involving MOEX, NCC, or NSD until August 13, 2024. Additionally, OFAC amended General License No. 8J, which authorizes certain transactions related to energy involving NCC and other entities, through November 1, 2024. OFAC also issued FAQ No. 1183 to provide guidance on the authorizations in place concerning MOEX, NCC, and NSD.

The designation of MOEX, NCC, and NSD, among others, aim to disrupt Russian financial infrastructure, networks designed to evade sanctions, Russia's future revenue from liquefied natural gas, and Russia's domestic war economy.

II. Export Restrictions

On the same date, the U.S. Department of Commerce's Bureau of Industry and Security (BIS) issued a press release announcing the imposition of new export controls to prevent the transfer of sensitive technologies to Russian military and intelligence services.

Furthermore, BIS stated that it has been cracking down on diversion through shell companies, cutting off exports of business software to Russian and Belarusian defense industries, restricting trade items to Belarus and Russia, tightening license exceptions, cutting off trade to foreign companies through the Entity List, issuing Temporary Denial Orders which halt participation in exports and re-exports of items subject to the Export Administration Regulations (EAR), and restricting distributors and transhippers supplying Russia's defense industrial base.

III. IT-Related Services Prohibitions

In coordination with BIS and G7 efforts, the Department of the Treasury has restricted the Russian military-industrial base's access to certain software and IT-related services. To implement this policy, the Department of the Treasury, in consultation with the Department of State, has issued a new determination under Section 1(a)(ii) of Executive Order (E.O.) 14071, which prohibits the supply to any person in the Russian Federation of (1) IT consultancy and design services; and (2) IT support services and cloud-based services for enterprise management software and design and manufacturing software. This determination takes effect on September 12, 2024.

Concurrently, OFAC issued General License 25D (replacing and superseding General License No. 25C), which authorizes transactions necessary for the receipt or transmission of telecommunications and certain internet-based communications involving the Russian Federation.

OFAC also issued FAQs No. 1184, 1185, 1186, 1187, and 1188 to provide additional guidance on the IT-related services prohibitions. Specifically:

• FAQ 1184: Describes the June 12, 2024 determination. The FAQ clarifies that the aim is not to prohibit all IT and software-related services to Russia, as the U.S. supports global information and communications flow which is reflected in OFAC's issuance of General License 25D
• FAQ 1185: Explains the type of activities considered prohibited "IT consultancy and design services" under the determination and the "prohibition on certain IT technology and software services" pursuant to E.O. 14071.
• FAQ 1186: Defines activities considered prohibited "IT support services" and "cloud-based services" for enterprise management software and design and manufacturing software under the determination, and the "Prohibition on Certain IT and software services" pursuant to E.O. 14071.
• FAQ 1187: Clarifies the interpretation of terms used in the prohibition such as "enterprise management software," "design and manufacturing software," "cloud-based services," "IT support services," and "information technology consultancy and design services."
• FAQ 1188: Addresses whether the prohibitions extend to providing services to persons located outside the Russian Federation but owned or controlled by Russian persons. It states that such services are prohibited if the benefit of the services is ultimately received by a person located in the Russian Federation. This includes indirect provisions where the service benefits a Russian parent company through a third-country subsidiary.

IV. Secondary Sanctions

The most critical aspect OFAC's aforementioned new measures is the introduction of secondary sanctions. Secondary sanctions impose penalties on persons and organizations not having a U.S. nexus that are engaged in the same dealings prohibited under U.S. primary sanctions. This is true even when there is nothing in the transactions that triggers a U.S. nexus, such as the use of U.S. dollars or the involvement of a U.S. person. Though secondary sanctions vary across jurisdictions, most secondary sanctions are triggered upon a determination that a non-U.S. person has "knowingly" engaged in a "significant transaction" with an SDN.

Previously, on December 22, 2023, President Biden issued E.O. 14114, amending E.O. 14024, authorizing OFAC to impose sanctions on foreign financial institutions aiding Russia's military-industrial base. Section 11(a)(ii) of E.O. 14024, as amended, allows the Secretary of the Treasury, in consultation with the Secretaries of State and Commerce, to prohibit or impose conditions on maintaining correspondent accounts or payable-through accounts in the U.S., or to block all property and interests in property of foreign financial institutions that conduct or facilitate significant transactions with Russia's military-industrial base.

Russia's military-industrial base was originally defined by OFAC to include any person operating in the technology, defense and related materiel, construction, aerospace, and manufacturing sectors of the Russian Federation economy (and other sectors as may be determined pursuant to E.O. 14024). Russia's military-industrial base may also include individuals and entities that support the sale, supply, or transfer, directly or indirectly, of critical items identified pursuant to subsection 11(a)(ii) of E.O. 14024 to the Russian Federation.

Importantly, as of June 12, 2024, OFAC updated the definition of "Russia's military-industrial base" to include all persons blocked under E.O. 14024. In conjunction, OFAC issued FAQ No. 1181 stating that the agency has updated its definition of Russia's military-industrial base to include all persons blocked pursuant to E.O. 14024.

Updating the definition of "Russia's military-industrial base" to include all persons blocked under E.O. 14024 heightens the risks of secondary sanctions for foreign financial institutions that deal with Russia's war economy. Accordingly, OFAC also issued a sanctions advisory with updated guidance to assist financial institutions in identifying sanctions risks and implementing controls. The advisory provides examples of activities that could expose foreign financial institutions to sanctions risk under E.O. 14024, which include:

• Maintaining accounts, transferring funds, or providing financial services to blocked persons, including Russian financial institutions under E.O. 14024.
• Providing financial services to persons supporting Russia's military-industrial base.
• Facilitating the transfer of specified items to Russian importers.
• Helping evade U.S. sanctions by setting up alternative payment mechanisms, altering payment details, or hiding transaction purposes.

Furthermore, the advisory provides guidance on identifying and mitigating risk; enhancing due diligence and compliance measures for financial institutions; conducting thorough reviews of transactions involving Russia; updating risk assessments regularly; and monitoring for red flags associated with sanctions evasion.

The advisory also identified permissible activities that do not violate sanctions such as those that relate to the production, manufacturing, sale, transport, or provision of agricultural commodities, agricultural equipment, medicine, medical devices, replacement parts and components for medical devices, or software updates for medical devices. Consistent with the above, OFAC issued FAQ No. 1182 which states that foreign financial institutions may continue to conduct or facilitate any transaction or provide any service related to activities that are otherwise authorized or exempted under the Russian Harmful Foreign Activities Sanctions Regulations (31 C.F.R. Part 587).

V. Amended FAQs

In addition to the issuance of the new and previously discussed FAQs No. 1181-1188, OFAC also amended existing FAQs No. 976, 1040, 1068, 1122, 1128, 1146, 1147, 1148, 1151, and 1152. See below a brief summary of each of these FAQs:

• FAQ No. 976: Clarifies that General License No. 8J authorizes foreign financial institutions to process certain transactions "related to energy." Importantly, FAQ No. 976 states that GL 8J provides authorization solely under E.O. 14024; as such, U.S. financial institutions that rely on the authorization provided in GL 8J to process transactions related to energy must also comply with the prohibitions of E.O.s 14066, 14068, and 14071.
• FAQ No. 1040: Clarifies that General License 25C authorizes certain transactions necessary for telecommunications and internet-based communications involving Russia. This includes transactions ordinarily incident and necessary to the receipt or transmission of telecommunications and the exportation or re-exportation of services, software, hardware, or technology related to internet communications, provided they are authorized for export by the Department of Commerce. However, it explicitly excludes transactions with specific designated entities, such as Joint Stock Company Channel One Russia, Television Station Russia-1, and Joint Stock Company NTV Broadcasting Company.
• FAQ No. 1068: Clarifies that "accounting services," for the purposes of the determination made pursuant to Section 1(a)(ii) of E.O. 14071 (Prohibitions Related to Certain Accounting, Trust and Corporate Formation, and Management Consulting Services), include tax preparation and filing services, and are prohibited unless otherwise authorized.
• FAQ No. 1122: Explains that General License No. 25D authorizes transactions ordinarily incident and necessary to the receipt or transmission of telecommunications involving Russia, as well as the exportation or re-exportation of services, software, hardware, or technology related to internet communications, provided they are authorized for export by the Department of Commerce. This license excludes transactions with designated entities such as Megafon PAO and Limited Liability Company Digital Invest.
• FAQ No. 1128: Details and defines the categories of services U.S. persons are prohibited from providing to persons located in the Russian Federation under E.O. 14071, including architecture, engineering, and IT consultancy services, among others.
• FAQ No. 1146: Outlines how E.O. 14114 amends E.O.s 14024 and 14068 to further address the Russian Federation's continued use of its military-industrial base to aid its effort to undermine security in countries and regions important to United States national security and to further counteract the Russian Federation's continued evasion of U.S. sanctions.
• FAQ No. 1147: Explains that E.O. 14114 amends E.O. 14024 to authorize the imposition of sanctions on foreign financial institutions that have engaged in certain transactions involving Russia's military-industrial base, including all persons whose property and interests in property are blocked pursuant to E.O. 14024.
• FAQ No. 1148: Provides examples of activities that could expose foreign financial institutions to sanctions under E.O. 14024, including significant transactions for blocked persons and providing financial services to sectors critical to Russia's military.
• FAQ No. 1151: Defines terms in E.O. 14024, such as "foreign financial institution," "Russia's military-industrial base," and "significant transaction."
• FAQ No. 1152: Confirms that foreign financial institutions can be sanctioned for significant transactions in any currency under Section 11(a)(ii) of E.O. 14024.

VI. Implications for Non-U.S. Persons

Foreign financial institutions that conduct or facilitate significant transactions or provide services involving persons blocked under E.O. 14024 now risk OFAC sanctions unless facilitating permissible transactions related to food, agriculture, medicine, energy, and telecommunications. ^[50] The expanded scope of secondary sanctions significantly broadens the U.S. sanctions regime, necessitating vigilance from non-U.S. persons, businesses, and financial institutions in their interactions with Russian entities on the SDN List. Non-compliance can result in severe penalties, including blocking sanctions or being cut off from the U.S. financial system.

Non-U.S. persons and entities must be particularly cautious in their dealings to avoid unintentional breaches of U.S. sanctions laws. Activities that could expose foreign financial institutions to sanctions include maintaining accounts, transferring funds, or providing other financial services for blocked persons, providing financial services to persons supporting Russia's military-industrial base, facilitating the transfer of specified items to Russian importers, and helping evade U.S. sanctions by setting up alternative payment mechanisms, altering payment details, or hiding transaction purposes. Enhanced due diligence, updated risk assessments, and monitoring for red flags associated with sanctions evasion are critical compliance measures.

OFAC's updated guidance emphasizes the importance of identifying and mitigating sanctions risks. Financial institutions must ensure they have robust compliance programs to avoid inadvertently violating these sanctions. The advisory also identifies permissible activities, such as transactions related to the production, manufacturing, sale, transport, or provision of agricultural commodities, agricultural equipment, medicine, medical devices, and related software updates, which remain authorized under the Russian Harmful Foreign Activities Sanctions program.

VII. Conclusion

The new sanctions announced by OFAC mark a significant escalation in economic pressure on Russia, primarily aimed at restricting Russia's military and technological capabilities. The updated secondary sanctions significantly expand the U.S. sanctions regime, posing new challenges for international businesses and financial institutions. Non-U.S. entities must ensure robust compliance mechanisms are in place to navigate these expanded sanctions effectively.

Including all persons blocked under E.O. 14024 within the definition of Russia's military-industrial base heightens the stakes for non-U.S. financial institutions, increasing the risk of secondary sanctions. Non-compliance can lead to severe consequences, such as exclusion from the U.S. financial system, underscoring the need for comprehensive compliance strategies. International businesses must stay informed of regulatory changes and adapt their operations to ensure compliance with evolving sanctions laws.

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