Financial sanctions: “connected with” Russia
Gavin and Merry explore recent developments in the financial sanctions deployed against Russia with a particular focus on the expanded scope of those measures and the meaning of “connected with” Russia in the context of securities, loans and other instruments.
(This article was submitted for publication on 21 April 2022, just weeks after the invasion of Ukraine, and first appeared in the June issue of Butterworths Journal of International Banking and Financial Law, inevitably some things have changed in the meantime …)
As a result of the Russian invasion of Ukraine on 24 February 2022, the UK, along with the EU, U.S. and many other countries, has imposed further sanctions on Russia to supplement those originally imposed, in 2014, for Russia’s invasion and ongoing occupation of Crimea. The Russia Guidance, first published by the Office of Financial Sanctions Implementation (‘OFSI’) in June 2020, was updated on 31 March 2022 and further Statutory Guidance, has been published (last updated on 14 April 2022). (It should be noted that the FAQs within the Russia Guidance have not been updated to reflect the 2022 amendment regulations and at present continue to “reproduce relevant guidance from the ‘European Commission guidance note”.)
On an almost daily basis, individuals and entities are being designated in relation to asset freezes; on 13 April 2022 alone, 206 individuals were so designated. The names of the 11 entities listed in Schedule 2 as Investment Ban Targets will be familiar to those involved in financial sanctions, however, a great number of other entities, including financial institutions, have also been designated. At the time of writing (21 April 2022), 1224 individuals and 115 entities are on the Consolidated List of Financial Sanctions Targets under the Russia regime.
Importantly, there have also been significant amendments to the scope of the UK regime under the Sanctions and Money Laundering Act 2018 (’SAMLA’) and the Russia (Sanctions) (EU Exit) Regulations 2019 (‘the Regulations’); since 10 February 2022, eight separate amending statutory instruments have been brought into force. Further sanctions have been imposed on Belarus in response to its involvement in the aggression and to ensure even more effectively that Russian sanctions cannot be circumvented, including through Belarus.
This article does not set out to deal comprehensively with changes to the UK Russia Regime and does not touch on measures in relation to: sterling clearing payments; transactions with the Russian Central Bank, Ministry of Finance or National Wealth Fund; and, trade, shipping and aviation.
Extended prohibitions on transferable securities and money market instruments
As before, Regulation 16 provides that a UK person (The Regulations also apply to British Overseas Territories under The Russia (Sanctions) (Overseas Territories) Order 2020/1571, as amended) must not, directly or indirectly, deal with a transferable security or money-market instrument (‘TS/MMI’; the definitions of those terms are unaltered), if it has a maturity exceeding 30 days, and was issued after 12 September 2014, by any of the entities listed in Schedule 2, or by any person acting on behalf or at the direction of such a person.
However, the prohibition now extends:
Under 16(4D), to a person who, directly or indirectly, deals with a TS/MMI if it has a maturity exceeding 30 days, and was issued on or after 1 March 2022, by:
- A person connected with Russia (this is defined in regulation 19A(2), and is subject to the exclusions in Regulation 16(4D)(a));
- An entity owned by such persons; or
- An entity acting on behalf or at the direction of any of the above;
Under 16(4F), to a person dealing directly or indirectly with a TS/MMI issued on or after 1 March 2022 by the Government of Russia (as defined in Regulation 6).
Regulation 16(9) provides a broad definition of “dealing with”:
“… a reference to “dealing with” a [TS/MMI] includes a reference to purchasing or selling the security or instrument, providing investment services relating to the security or instrument or assisting in the issuance of the security or instrument”.
Extended prohibitions on loan and credit arrangements
Similarly, the prohibition in relation to loan and credit agreements has been extended to prevent a UK person from directly or indirectly granting or entering into any arrangement to grant a new loan or credit arrangement (‘L/CA’), after 1 March 2022 and with a maturity exceeding 30 days, to a person connected with Russia (albeit subject to the exclusions in regulation 17(5)).
There are a limited number of exceptions to the L/CA prohibition; that is, the prohibitions are not breached in circumstances including (but not limited to):
- A relevant loan that makes emergency funds available to meet insolvency or liquidity criteria for a relevant subsidiary;
- A relevant loan consisting of a drawdown or disbursement under an arrangement that was entered into before either of the relevant dates.
“Connected with Russia”
Regulation 19(2) provides that “a person is to be regarded as “connected with” Russia if the person is:
- An individual who is, or an association or combination of individuals who are, (a) ordinarily resident in Russia; or, (b) located in Russia;
- A person, other than an individual, which is: (c) incorporated or constituted under the law of Russia, or (d) domiciled in Russia.”
The list does not include Russian nationals, wherever located, however, this provision must be read together with those relating to ownership and control and particular care should be taken in relation to complex ownership structures. Further detail as to the statutory definitions in relation to “ownership and control” can be found in Regulation 7 (the 50% rules and disguised mechanisms of control) and Schedule 1 at paragraphs 3(1) and 9(2) (‘joint arrangements’ and ‘chains of persons’).
Sanctions law and interpretation generally
Given that the amended regulations are only weeks old, there is no decided case on the ambit of “connected with” Russia, however, OFSI’s General Guidance of December 2020 makes clear that it:
“… interprets prohibitions widely. This means that while we will not seek to draw in activities that clearly fall outside of a prohibition, OFSI will consider a wide range of actions when assessing if a breach of financial sanctions has taken place.”
The UK courts have also held that:
“financial sanctions measures were to be construed as a consistent whole, in a way which enabled all the articles or regulations in question to have effect” (R v R  EWCA Civ 796).
EU guidance and decided cases have repeatedly asserted that financial sanctions provisions will be given a broad and purposive interpretation in order to be swift and effective in the maintenance of international peace and security. See, for example, Mollendorf C117/06 (a case involving terrorist assets) and Afrasiabi C/72-11 (where a raft of different financial sanctions interpretation issues were considered, including: “indirectly making available”, “economic resource”, “circumvent” and “knowingly and intentionally”). Although, post-Brexit, any decision of the General Court is only of persuasive authority, and some divergence between the UK and EU regimes is already obvious, the UK government has declared its intention to continue to harmonise its sanctions regime with the EU regime.
“Connected with” in UK law
In general terms, in the law of England and Wales, “connected with” is: closely defined, context specific and prescriptive. By way of example, see:
- Financial Services and Markets Act 2000, s.55R, “connected with” in the context of Financial Services;
- Corporation Tax Act 2010, ss.1062 and 1122, connected persons;
- Income Tax Act 2007, s. 993, meaning of “connected” persons;
- Value Added Tax Act, s.69C, transactions connected with VAT fraud;
- Sentencing Act 2020, s.69, terrorist connection.
What if the connection is very loose?
Given the broad interpretation to be applied to financial sanctions concepts generally, “connected with” is likely to be given as wide a meaning as possible to ensure compliance with expressed foreign policy objectives. On 7 March 2022, the FCDO Blog stated that, “The UK … will make Putin and his regime pay the highest price for this reckless and illegal action … Those who aid and abet Putin’s aggression … will also face the consequences.” The spectres of criminal liability and reputational harm are likely to feature heavily in any assessment and, in any event, a careful case-by-case analysis of the circumstances, using a risk-based approach, is required (particularly where there may be less than perfect visibility in relation to Ultimate Beneficial Owners).
In Europäisch-Iranische Handelsbank AG T-434/11 the court held that (paragraph 193):
“… in so far as the applicant maintains that the Council’s obligation to designate an entity on the basis of assistance provided to designated entities does not take account of the fact that the assistance may be minimal or provided inadvertently, it should be borne in mind that … the Council is required to make a case-by-case assessment in order to determine whether such assistance has been provided … it will, if necessary, be able to take into account the minimal nature of the support provided … a bank cannot reasonably claim that it has inadvertently provided assistance …”.
UK persons must consider the possibility of contravening U.S. primary and secondary (notoriously difficult to plan for) sanctions and U.S. dollar denominated transactions and instruments add a further layer of complexity.
What is the position for trading ETFs where the bucket of securities contains only a very small Russian component?
Since 24 February 2022, the London Stock Exchange has published six Russia notices, including those suspending trading in certain instruments for the purpose of maintaining orderly markets, noting, “the deterioration of market conditions in respect to the ETF market for products with substantial Russian exposure”.
Current OFSI Guidance does not provide any clear answers in relation to aggregation and/or the ‘tainting’ of funds and is not expressed in the same terms as that issued either by the EU or the U.S.. Any difference in approach means that ownership and control, particularly across multiple jurisdictions and with complex ownership structures, is becoming increasingly difficult to navigate.
On 3 June 2021, the U.S. Department of the Treasury published an important FAQ following the November 2020 Trump administration Executive Order prohibiting U.S. persons from engaging in transactions in the publicly traded securities of certain Chinese companies in the military industrial complex:
“861.Does Executive Order (E.O.) 13959, as amended, prohibit U.S. persons from investing in U.S. or foreign funds, such as exchange-traded funds (ETFs) or other mutual funds, that hold publicly traded securities of a Chinese Military-Industrial Complex Company (CMIC)?
Answer: Yes … any purchase or sale of publicly traded securities, or any publicly traded securities that are derivative of such securities or are designed to provide investment exposure to such securities … is prohibited, regardless of such securities’ share of the underlying index fund, ETF, or derivative thereof.”
On 24 February 2022, in relation to the Russian invasion of Ukraine, the U.S. Treasury announced that it was:
“imposing severe economic costs that will have both immediate and long-term effects on the Russian economy and financial system … including all of Russia’s largest financial institutions and the ability of state-owned and private entities to raise capital …”
On 2 March 2022, the U.S. Department of the Treasury published an FAQ that does not take the same approach as previously in relation to China:
“982. Are U.S. funds allowed to buy or sell debt or equity of blocked Russian financial institutions? Are U.S. investors allowed to invest in a fund that holds debt or equity of a blocked Russian financial institution?
Except as authorized … U.S. persons may not buy or sell debt or equity of the Russian financial institutions blocked in February 2022 … However, a U.S. fund that contains such blocked holdings generally is not itself considered a blocked entity as long as the blocked holdings represent less than a predominant share by value of debt or equity of blocked persons. As a result, U.S. persons may continue to invest in the fund and the fund may continue to operate …”
On 8 March 2022, a further FAQ was published:
“1019. For the purposes of Executive Order (E.O.) of March 8, 2022, “Prohibiting Certain Imports and New Investments With Respect to Continued Russian Federation Efforts to Undermine the Sovereignty and Territorial Integrity of Ukraine,” what is meant by the terms ‘Russian Federation origin’ …
For purposes of this interpretation, a loan or extension of credit is any transfer or extension of funds or credit on the basis of an obligation to repay, or any assumption or guarantee of the obligation of another to repay an extension of funds or credit, including: overdrafts, currency swaps, purchases of debt securities, purchases of a loan made by another person, sales of financial assets subject to an agreement to repurchase, renewals or re-financings whereby funds or credits are transferred or extended to a borrower or recipient described in the provision, the issuance of standby letters of credit, and drawdowns on existing lines of credit.”
The banking and financial services industry’s response to the globally co-ordinated measures adopted in relation to the 2022 Ukraine invasion already appears to be similar to that in relation to the U.S./China 2020 EO, when China-focused ETF providers sold their positions in the target companies. Whether or not expressly required under any particular regime, the prospect of different interpretations and enforcement responses in different jurisdictions is likely to cause the industry to adhere to compliance with the most onerous measures.
Although there is no decided UK case, further assistance may again be gleaned from the Opinion of the Advocate General in Mollendorf, in the context of “making funds available” to designated persons through the sale of an asset (real property) owned by a partnership where only one partner had been designated (paragraphs 98 and 99):
“ … the fundamental right to property, protected in the Community legal order on the basis of the principles common to the constitutions of the Member States … is not an absolute right and its exercise may be subject to restrictions justified by objectives in the general interest … any restrictive measure of an economic nature has, by definition, consequences which affect the right to property, thereby causing harm to persons who are in no way responsible for the situation which led to the adoption of those measures.”
OFSI Guidance reminds us that:
“Breaches of financial sanctions are a serious criminal offence … OFSI is responsible for monitoring compliance with financial sanctions and for assessing suspected breaches. It also has the power to impose monetary penalties for breaches … and to refer cases to law enforcement agencies for investigation and potential prosecution.”
Licences in relation to securities, loans and credits may be granted in certain circumstances but the list of such circumstances is more limited than the lists relating to Asset Freezes, Foreign Exchange Reserves and Asset Management and, other than under a broad heading of humanitarian assistance and related activities, a licence will only be granted in “extraordinary situations”. Importantly, it does not include, the “maintenance” of any asset and/or, “the safety and soundness of a firm”.
As ever, caution must be exercised.
This article suggests the following practical pointers for navigating the Russia sanctions regime:
- The spectres of criminal liability and reputational harm are likely to feature heavily in any risk assessment and a careful case-by-case analysis of all the circumstances is required.
- Licences in relation to securities, loans and credits may be granted in very limited circumstances and, for these purposes, only in “extraordinary situations”.
- Ensure you are up to date with the fast-developing sanctions regimes in all relevant jurisdictions. The UK Regulations are being amended with unprecedented frequency; in particular the number of designated entities and individuals changes on an almost daily basis.