On July 16, 2014, the US Office of Foreign Assets Control (OFAC) escalated Russian sanctions by issuing "Sectoral Sanctions" — prohibitions on certain finance related transactions with certain entities, including two major Russian banks and two oil and natural gas producers. OFAC also designated and blocked the assets of an additional 11 entities (and five individuals), including Kalashnikov, Uralvagonzavod, Bazalt, and various JSC companies. In orchestrated fashion, the US Department of Commerce's Bureau of Industry and Security (BIS) also added these same 11 Russian parties to its Entity List on that same day.
The new OFAC Sectoral Sanctions were issued under the authority of Executive Order (EO) 13662 "Blocking Property of Additional Persons Contributing to the Situation in Ukraine." This move came after US President Barack Obama and German Chancellor Angela Merkel's Tuesday call to coordinate the imposition of this new round of Russian sanctions. The European countries also intend to levy their own next round of Russian sanctions; however, those sanctions are expected to be less hard-hitting as the EU countries are far more dependent on Russia than the United States.
Sectoral Sanction Prohibitions Are Not Blocking Sanctions But Yet Another List to Check
These sanctions prohibit US persons or individuals within the United States from "transacting in, providing financing for, or otherwise dealing in new debt of longer than 90 days maturity or new equity for these persons (listed below), their property, or their interests in property" with those listed on OFAC new "Sectoral Sanctions Identifications List" (SSI List). The persons named in the SSI List were determined to be operating in the sectors of the Russian economy identified in EO 13662. The complete list is provided below, but the notable additions are Rosneft, the state-owned oil company and largest oil producer; Gazprombank, the financial arm of Gazprom, the giant state-controlled natural gas producer; Novatek, Russian natural gas producer; and Vnesheconombank, the state economic development bank.
This means that the listed Russian companies will be banned from the US financial markets for loans and other forms of debt with a maturity of over 90 days and, in some cases, also equity markets. This is reportedly intended to allow day-to-day business with overnight loans, but penalize medium to long-term financial support founded in debt or equity.
In contrast to other OFAC designated entities (specially designated nationals [SDNs] and blocked entities), however, the assets of the Russian companies listed on the Sectoral Sanctions Identifications List are not blocked (unless, of course, the companies are separately listed on the SDN List).
Directives 1 and 2, or "Thing 1 and Thing 2?"
To complicate matters, there are two different "flavors" of the Sectoral Sanctions — known as Directive 1 and Directive 2. This may entertain economic sanctions lawyers fond of Dr. Seuss, but is likely to confuse companies trying to comply with US laws.
Directive 1 of EO 13662 prohibits transacting in, providing financing for, or otherwise dealing in:
- New debt with a maturity of longer than 90 days; or
- New equity;
- All financing in support of such new debt or new equity; and
- Any dealing in, including provision of services in support of, such new debt or new equity for the persons listed under Directive 1.
Directive 2 of EO 13662 prohibits transacting in, providing financing for, or otherwise dealing in:
- New debt with a maturity of longer than 90 days;
- All financing in support of such new debt; and any
- Dealing in, including provision of services in support of, such new debt for the persons listed in Directive 2.
In other words, for Directive 1 listed entities, certain debt and equity transactions are prohibited; for Directive 2 listed entities, only certain debt transactions are prohibited.
Directive 1 (90+ days debt & new equity transactions prohibited):
- Bank for Development and Foreign Economic Affairs (Vneshconobank) State Corporation (a.ka. Bank Razvitiya I Vneshneekonomicheskoi Deyatelnosti (Vneshekonombank) Gosudarstvennaya Korporatsiya; Vnesheconombank; VEB)
- Gazprombank OAO (a.k.a. Gazprombank Gas Industry OJSC; Gazprombank OJSC; Gazprombank Open Joint Stock Company; Gazprombank Otkrytoe Aktsionernoe Obshestvo; GPB, OAO; GPB, OJSC)
Directive 2 (90+ days debt transactions prohibited):
- Novatek (a.k.a. OAO Novatek; Finansovo-Investitsionnaya Kompaniya Novafininvest OAO)
- Rosneft (a.k.a. OAO Rosneft Oil Company; Oil Company Rosneft; Open Joint-Stock Company Rosneft Oil Company; Rosneft Oil Company; OJSC Rosneft Oil Company)
50% Rule Still Alive and Well
It should be noted that the prohibitions apply NOT ONLY to the named persons, their property, and their interests in property, but also to entities owned 50 percent or more by the listed persons.
What qualifies as "debt" or "equity" in trade transactions?
Clearly, a key question is what constitutes "debt" and "equity" for purposes of the Sectoral Sanctions Directives.
According to OFAC's FAQ:
The term debt includes bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers acceptances, discount notes or bills, or commercial paper.
The term equity includes stocks, share issuances, depositary receipts, or any other evidence of title or ownership.
The reference in the definition to extensions of credit and letters of credit indicate that trade transactions could potentially violate the Sectoral Sanctions if they involve extensions of credit or letters of credit made after July 16, 2014 that exceed 90 days. However, OFAC has yet to address this issue. The FAQs also state that prohibitions extend to rollover of existing debt, if such rollover results in the creation of new debt with a maturity of longer than 90 days.
Thus, until OFAC provides greater clarity, the most prudent approach would be to ensure that extension of credit for new trade transactions, and extensions of credit for outstanding accounts receivable, are less than 90 days and this lesser date is specifically stated in writing in the documentation. Personnel should also be instructed not to agree to any credit extensions beyond the 90 day period.
General License for Derivative Products
At the same time as it imposed the Sectoral Sanctions, OFAC created an exception for derivatives trading by issuing General License 1 authorizing certain transactions involving derivative products. Specifically, General License 1 authorizes:
[a]ll transactions by U.S. persons, wherever they are located, and transactions within the United States involving derivative products whose value is linked to an underlying asset that constitutes (1) debt with a maturity of longer than 90 days or equity issued on or after July 16, 2014 by a person identified in Directive 1 pursuant to Executive Order 13662 or (2) debt with a maturity of longer than 90 days issued on or after July 16, 2014 by a person identified in Directive 2 pursuant to Executive Order 13662, are authorized.
General License 1 does not, however, authorize the holding, purchasing, or selling of underlying assets otherwise prohibited by Directive 1 and Directive 2.
What Happens Next?
In its FAQs, OFAC provides the following reassurance to US financial institutions:
U.S. financial institutions may continue to maintain correspondent accounts and process U.S. dollar-clearing transactions for the persons identified in the directives, so long as those activities do not involve transacting in, providing financing for, or otherwise dealing in prohibited transaction types identified by these directives.
This is not a blocking action, nor will persons identified in Directives 1 and 2 be added to the Specially Designated Nationals (SDN) list, and the action does not require U.S. persons to block the property or interests in property of the entities identified in today's directives. U.S. persons should reject transactions or dealings that are prohibited by today's directives, and to the extent required by Section 501.604 of the Reporting, Procedures and Penalties Regulations (31 C.F.R. part 501), U.S. persons must report to OFAC any rejected transactions within 10 business days.
In other words, to comply, for all transactions involving the entities listed in the Sectoral Sanctions Identifications List, US financial institutions will have to assure themselves that the transactions do not involve debt with a maturity of 90 days or more or other prohibited actions.
If the past is any indication, US financial institutions may simply decide not to bother with transactions with listed entities given the level of risk, or to require onerous proof from all parties to the transaction. We anticipate that US dollar denominated transactions involving the listed entities, and transactions involving a US entity or financial institution will rapidly become much more difficult.
Commerce's BIS Expands Russian Sanctions
In conjunction with this new wave of sanctions, the US Department of Commerce's Bureau of Industry and Security (BIS) added the same 11 new OFAC designated SDNs to its Entity List. This announcement was also made on July 16, 2014.
The following 11 parties were added to the Entity List based on a determination that they are "involved, or pose a significant risk of becoming involved, in activities contrary to the national security and foreign policy interests of the United States." Designation on the Entity List imposes a license requirement for the export, re-export or foreign transfer of items subject to the Export Administration Regulations to the designated Entities, with a presumption of denial.
Additions to the Entity List:
- Donetsk People's Republic
- Feodosia Enterprise
- JSC Concern Radio-Electronic Technologies
- JSC Concern Sozvezdie
- JSCC Almaz-Antey
- Kalashnikov Concern
- KBP Instrument Design Bureau
- Luhansk People's Republic
- MIC NOP Mashinostroyenia
- Research and Production Corporation "UralVagonZavod"
- State Research and Production Enterprise "Bazalt"