Sanctions Against Russia: U.S. Increases Secondary Sanctions Risks For Foreign Financial Institutions, Expands Sanctions And Export Restrictions

On 12 June 2024, the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC) and the U.S. Department of Commerce's Bureau of Industry and Security (BIS) issued new measures to further isolate Russia's ability to access third country financial services, flow of supplies, and international equipment that support its war against Ukraine.¹

Specifically, acting on the basis of Executive Order 14114 (EO 14114) issued by the Biden administration in December 2023, OFAC significantly increased secondary sanctions risks for foreign financial institutions that conduct business with Russia. In addition, in coordination with the U.S. Department of State (State), OFAC imposed blocking sanctions on more than 300 individuals and entities tied to Russia that continually supply Russia with restricted goods and technology and help Russian actors evade sanctions. Concurrently, BIS took action against shell companies, restricted the export of additional items to Russia and Belarus, and introduced a new software export ban to Russia and Belarus.

These restrictions were announced right before the Group of Seven (G7) summit in Italy, where the G7 leaders announced a plan to provide Ukraine with $50 billion in new loans that will be repaid using the interest earned on immobilized Russian sovereign assets held in the European Union (EU) and other jurisdictions. The details on how the funds will be given to Ukraine remain to be published. As a reminder, as part of the 21st Century Peace through Strength Act, the United States has already allowed the use of frozen Russian sovereign assets for assistance to Ukraine and mandated the U.S. President work with partners and allies to pursue a similar use of the assets frozen in their respective jurisdictions.

Expansion of Secondary Sanctions

U.S. secondary sanctions extend the U.S. government's ability to target foreign financial institutions (FFIs) outside the United States' jurisdiction that engage in activities the United States considers contrary to U.S. national security interests. In December 2023, by issuing EO 14114, the U.S. government introduced the secondary sanctions for the Russia sanctions program.² For more information, please see K2 Integrity's policy alert on EO 14114.

At the time, EO 14114 authorized OFAC to impose (i) blocking sanctions or (ii) restrictions on maintaining correspondent accounts in the United States on FFIs that facilitated significant transactions on behalf of some—but not all—persons designated under EO 14024.³ Specifically, it targeted activities involving Specially Designated Nationals (SDNs) designated due to operating in the specified sectors of the Russian economy that were considered to support "Russia's military-industrial base," i.e., the technology, defense, and related materiel, construction, aerospace, or manufacturing sectors (the Specified Sectors).

OFAC has now expanded the definition of "Russia's military-industrial base" to cover (i) all persons blocked under EO 14024 and (ii) any person operating in the Specified Sectors, even if not designated by OFAC. The definition also continues to include persons supporting the sale, supply, or transfer, directly or indirectly, to Russia of certain critical items.⁴

Given this expanded definition, FFIs can be sanctioned if they facilitate significant transactions or provide any service for any person blocked under EO 14024.⁵ In contrast with EO 14114—which referred only to persons in the Specified Sectors "designated" under EO 14024—the new expanded definition refers instead to "blocked" persons, signaling OFAC's intention to include persons blocked by operation of law under the 50% rule. Therefore, FFIs are now exposed to secondary sanctions risks for dealings with all Russian banks, oil and gas companies, trading companies, manufacturing concerns, and several thousands of other companies and individuals that appear on the SDN list, as well as any person considered blocked under OFAC's 50% rule. This also includes hundreds of persons in third countries that OFAC has previously designated for facilitating Russia sanctions evasion or supplying critical military or technology items to Russia.

Concurrently, OFAC updated its guidance to FFIs that further outlines its expectations regarding the expansion of the secondary sanctions (the Updated Guidance).⁶ OFAC also updated 10 FAQs providing further clarifications.⁷

In the Updated Guidance, OFAC provides the following examples of activities it can now target under secondary sanctions:

• Maintaining accounts, transferring funds, or providing other financial services (e.g., payment processing, trade finance, insurance) for any person blocked under EO 14024, including Russian banks, unless involving certain "Permissible Activities" (more on this below);
• Engaging in the same activities for any persons, inside or outside of Russia, that otherwise support Russia's military-industrial base, including those that operate in the Specified Sectors;
• Facilitating the sale, supply, or transfer of certain specified items;⁸ and
• Helping persons evade U.S. sanctions on Russia's military-industrial base, including instances of non-transparency in payments.

In the Updated Guidance, OFAC also listed several practical examples of what an FFI should consider as high-risk customers or activities.

Narrow Scope of Permissible Activities Not Targeted under Secondary Sanctions

OFAC clarified in the Updated Guidance that FFIs do not risk imposition of secondary sanctions for engaging in activities involving Russian blocked persons that are either exempt from the Russia sanctions program or are authorized for U.S. persons under general licenses (GLs) issued by OFAC. Examples of such permissible activities include:

• Production, manufacturing, sale, transport, or provision of agricultural commodities, agricultural equipment, medicine, medical devices, replacement parts and components for medical devices (see GL 6D);
• Certain transactions related to energy (see GL 8J);
• Certain transactions in support of non-governmental organizations (see GL 27), official business of third-country diplomatic or consular missions located in Russia (see GL 20), or official business of certain international organizations (codified in 31 CFR 587.510);
• Telecommunications and internet-based communications (see GL 25C); and
• Travel and dealings in information and informational materials (exempt under the International Emergency Economic Powers Act (IEEPA)).

Traditionally, OFAC maintains the position that an activity is permissible only to the extent it conforms to all requirements and conditions of the relevant general license. Therefore, FFIs will need to carefully assess the applicability of such licenses if they wish to continue to engage in any business with Russian blocked persons. Such an assessment may need to include the risks of non-transparency, document falsification, or diversion by a Russian client or their proxies, as commonly used evasion tactics.

Targeting Russian Banks' Operations Abroad

Following its invasion of Ukraine in 2022 and being cut off from the Western financial system or the use of stable currencies such as the dollar or the euro, Russia sought out new currencies to support cross-border transactions, turning to the Chinese yuan and Indian rupee.⁹ The risk of secondary sanctions, however, resulted in Chinese banks avoiding processing transactions or supporting trade with Russia.¹⁰ These initial concerns of secondary sanctions resulted in Russian banks, including VTB, VEB, and Promsvyazbank, opening branches or expanding their footprint in China and India to facilitate cross-border trade.¹¹ In order to counteract this activity, OFAC listed as SDNs the following banks:

• Promsvyazbank's branches in China, Kyrgyzstan, and India;
• VEB's branches in China and India;
• Sberbank's locations in China and India; and
• VTB's locations in India and China (including Hong Kong).¹²

These banks already have been blocked persons as majority-owned subsidiaries of SDNs. By explicitly naming these branches in foreign jurisdictions, however, OFAC is signaling to FFIs that their risk of being subject to secondary sanctions is much more prevalent if they continue to deal with them. Accordingly, OFAC's action is designed to further curtail Russia from finding new avenues to conduct proscribed trade.¹³

Targeting Russia's Public Trading Markets

In the same action, OFAC also designated the three key companies that form and operate Russian public markets in order to further curb Russia's efforts to raise capital from persons from "friendly countries." The newly designated entities include:

• The Moscow Exchange (MOEX), which operates Russia's largest public trading market for equity, fixed income, derivative, Foreign Exchange (FX), and money market products, and serves as Russia's central securities depository and the largest clearing services provider;
• The National Clearing Center, a clearing agent and subsidiary of MOEX; and
• The National Settlement Depository, Russia's central securities depository and provider of liquidity management services, and also a subsidiary of MOEX.

This may cause significant disruptions in trading and settling of Russia-related securities, derivatives, and other similar products that continue to be held by persons in third countries. By designating these entities under EO 14024, OFAC is signaling to third country FFIs that persons who continue to engage in business with MOEX or its subsidiaries will run the risk of secondary sanctions. Reportedly, MOEX has already halted all trading in securities, over-the-counter (OTC) derivatives, FX, and other instruments with settlement in dollars or euros.¹⁴

Software and IT-Related Services Prohibitions

Additionally, OFAC, in coordination with State and the U.S. Department of Commerce, issued a new determination under EO 14071 to prohibit U.S. persons from providing the following to Russia:

• IT consultancy and design services; and
• IT support services and cloud-based services for enterprise management software and design and manufacturing software.¹⁵

The effective date of the prohibition is 12 September 2024. This action aligns the United States with similar EU and United Kingdom (UK) prohibitions that were implemented in December 2023 and December 2022, respectively. OFAC issued new FAQs 1184–1188, which define key terms such as IT support services, enterprise management software, cloud-based services, and others, and provide examples of activities that are now prohibited.¹⁶ The cited prohibited examples include indirect exports to Russia, such as instances where a U.S. person provides services or software to a third country company or re-seller that are then supplied to a Russian company.

Concurrently, BIS published the final rule imposing additional export control measures against Russia and Belarus by imposing a license requirement for any export or re-export to or within Russia or Belarus of certain types of EAR99-designated software, such as business intelligence, enterprise management, or supply management software (including any updates to previously exported software).

Targeting Russian Sanctions Evasion Networks

Both OFAC and State sanctioned more than 100 individuals and entities in third countries that bolster Russia's ability to evade sanctions and backfill sanctioned technology and equipment from third countries to support its war effort.¹⁷ These include, for example, networks of logistics and trading companies that continue to facilitate Russia's procurement of defense equipment, military-related electronics, and other technology and equipment items, allowing the country to maintain its weapons systems.¹⁸ The sanctioned entities include persons in China, Hong Kong, Kyrgyzstan, Türkiye, the UAE, Serbia, Moldova, Thailand, and other countries.

Moreover, for the first time, BIS added eight addresses (not companies) in Hong Kong to the Entity List as part of its new rule targeting shell companies. BIS noted that shell companies can easily be dissolved, have their name changed, or be reinstated at the common addresses used by service providers for registration purposes. Thus, by designating these addresses, BIS noted that they represent a high risk of involvement in unlawful diversion, no matter the name of a company registered there. Any company that uses the addresses identified in this new rule (or any future addresses BIS may add to the Entity List) is now subject to a license requirement. BIS also added five entities to its Entity List.¹⁹

Commerce Tightening the Scope of Permissible Trade

BIS introduced controls on more than 500 additional six-digit Harmonized Tariff System codes for export, re-export, or transfer (in-country) to Russia and Belarus. BIS is also adding controls on several additional riot control agents to Russia and Belarus. Additionally, BIS narrowed the scope of commodities and software that may be authorized for export, re-export, or transfer (in-country) to or within Russia or Belarus under License Exception Consumer Communications Devices.²⁰ Most remaining trade with Russia is limited to the agricultural or medical sectors.

Key Implications of Recent Actions

Treasury's new actions targeting Russia's war economy significantly expand the scope of secondary sanctions and continue to uncover and target vast networks of companies in third countries that supply goods and technology that Russia needs. Accordingly, FFIs should take immediate steps to identify, assess, and mitigate their exposure to new secondary sanctions. These steps include:

• Assess the FFI's exposure to clients, their ultimate beneficial owners, or counterparties that are OFAC SDNs or that could be considered blocked persons under OFAC's 50% rule;
• Once identified, consider suspending provision of services to such persons until and unless the bank is certain they are only engaging in the narrowly defined permissible trade;
• Assess the FFI's exposure to Russian financial institutions, including MOEX and its subsidiaries;
• Assess the institution's exposure to customers that deal directly or indirectly with or on behalf of any person in Russia's defense and technology, construction, aerospace, or manufacturing sectors;
• Implement the necessary mitigating measures, which could potentially include customer exit;
• Ensure customer due diligence and anti-money laundering policies, procedures, and controls are sufficiently developed to prevent and detect sanctions evasion; and
• Conduct training on the U.S. secondary sanctions so that the FFI's officers are aware of their scope.

U.S. persons operating in the IT, software development, and other adjacent sectors should also consider their direct or indirect exposure under the new IT-related services prohibition from OFAC and BIS. While OFAC and BIS provided a 90-day window for the prohibition to become effective, a company's assessment can take considerable time and should include, for example, a review of automatically pushed updates and of the company's supply network in third countries that may be unaware of new sanctions and export controls restrictions.

In addition, exporters and intermediaries facilitating global trade should consider the best methods to incorporate BIS's decision to list addresses on its Entity List. While screening against addresses remains challenging, exporting or re-exporting to any companies listed at these addresses could be in violation of U.S. export controls. In addition, BIS signaled that it would consider adding new addresses to the Entity List in the future.

Footnotes

1 U.S. Department of the Treasury, "As Russia Completes Transition to a Full War Economy, Treasury Takes Sweeping Aim at Foundational Financial Infrastructure and Access to Third Country Support," https://home.treasury.gov/news/press-releases/jy2404.

2 Executive Order 14114, "Taking Additional Steps With Respect to the Russian Federation's Harmful Activities" (22 December 2023), 88 FR 89271, https://www.federalregister.gov/documents/2023/12/26/2023-28662/taking-additional-steps-with-respect-to-the-russian-federations-harmful-activities.

3 Executive Order 14024, "Blocking Property With Respect to Specified Harmful Foreign Activities of the Government of the Russian Federation" (15 April 2021), 86 FR 20249, https://www.federalregister.gov/documents/2021/04/19/2021-08098/blocking-property-with-respect-to-specified-harmful-foreign-activities-of-the-government-of-the.

4 Sanctions Advisory, Updated Guidance for Foreign Financial Institutions on OFAC Sanctions Authorities Targeting Support to Russia's Military-Industrial Base, 12 June 2024, https://ofac.treasury.gov/media/932436/download?inline.

5 Id.

6 Id.

7 See OFAC Frequently Asked Questions # 976, 1040, 1068, 1122, 1128, 1146, 1147, 1148, 1151, and 1152.

8 See K2 Integrity's policy alert on EO 14114. Specified items include, among others, certain machine tools, manufacturing equipment or materials for semiconductor manufacturing; certain electronic test equipment; and other items.

9 Atlantic Council, "Russia and China Have Been Teaming Up to Reduce Reliance on the Dollar. Here's How It's Going," 22 February 2023, https://www.atlanticcouncil.org/blogs/new-atlanticist/russia-and-china-have-been-teaming-up-to-reduce-reliance-on-the-dollar-heres-how-its-going/.

10 Reuters, "Exclusive: Banking Bottleneck Causing Six-Month Delays for Russia-China Payments, Sources Say," 4 April 2024, https://www.reuters.com/business/finance/banking-bottleneck-causing-six-month-delays-russia-china-payments-sources-say-2024-04-04/.

11 Id.

12 U.S. Department of Treasury, "As Russia Completes Transition to a Full War Economy, Treasury Takes Sweeping Aim at Foundational Financial Infrastructure and Access to Third Country Support," https://home.treasury.gov/news/press-releases/jy2404.

13 Id.

14 Bloomberg, "U.S. Sanctions Force Moscow Exchange to Halt Dollar, Euro Trading," 12 June 2024, https://www.bloomberg.com/news/articles/2024-06-12/moscow-exchange-halts-dollar-euro-trading-on-new-us-sanctions?sref=Pw1Mp35R.

15 U.S. Department of Treasury, "As Russia Completes Transition to a Full War Economy, Treasury Takes Sweeping Aim at Foundational Financial Infrastructure and Access to Third Country Support," https://home.treasury.gov/news/press-releases/jy2404.

16 See OFAC FAQs 1184–1188, available at https://ofac.treasury.gov/faqs/added/2024-06-12.

17 U.S. Department of State, "Taking Additional Measures to Degrade Russia's Wartime," 12 June 2024, https://www.state.gov/taking-additional-measures-to-degrade-russias-wartime-economy/.

18 Id.

19 The U.S. Federal Register, Docket No. 240610-0156, Implementation of Additional Sanctions Against Russia and Belarus Under the Export Administration Regulations (EAR) and Refinements to Existing Controls, https://www.bis.gov/sites/default/files/Public%20display%20version%20of%20Russia%20and%20Belarus%20Sanctions%20rule%20on%20public%20display%20and%20effective%206-12-24%20and%209-16-
24%20for%20intruction%2014%20and%20published%206-18-24.pdf.

20 Id.

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