Amid continued unrest in parts of Ukraine, the US and EU have moved to impose additional sanctions on Russia and on Russian and Ukrainian persons. These sanctions build on the prior rounds of sanctions, summarized in our March 7, March 17, March 21, April 15 and April 29 updates.
The new US sanctions include the first, limited implementation of “sectoral sanctions” on Russia, a long-anticipated step that reflects US government concern with the situation in Ukraine and US perception of Russia’s role in current events. These sanctions may impact the issuance of new debt or equity by two major Russian banks and of new debt by two major Russian energy companies.
The new EU sanctions include a range of measures including the potential for broader targeting of Russian companies, but fall short of following the US in imposing even limited “sectoral sanctions.”
There remains significant space for the US and EU to expand the sanctions on the Russian energy and financial sectors, or other sectors of the Russian economy, if the conflict escalates further.
New entities subject to financing restrictions under US sanctions
The Obama Administration has creatively interpreted the broad authority set out in an Executive Order issued by President Obama earlier in 2014, to impose limited sanctions on four major Russian companies. Executive Order 13662 of March 20, 2014 provides for the addition to the primary US sanctions list (the list of specially designated nationals or “SDN list”) of entities active in specific sectors of the Russian economy, to be designated in future.
Rather than imposing the very broad penalty of SDN listing, on Wednesday July 16, the US Office of Foreign Assets Control (“OFAC”) created the Sectoral Sanctions Identifications List (“Sectoral Sanctions List”) and issued two Directives to impose limited, specific sanctions on four major Russian companies. Directive 1 targets two major Russian banks, Vnesheconombank (“VEB”) and Gazprombank, and Directive 2 targets two major Russian oil and gas sector firms, Rosneft and Novatek.
The sectoral sanctions prohibit US persons from engaging in transactions relating to debt “with a maturity of longer than 90 days” or equity issued by, on behalf of, or for the benefit of, any of these companies, on or after July 16, 2014 (“new debt or equity”). The term “debt” is defined in the website guidance to include “bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers acceptances, discount notes or bills, or commercial paper”. The term “equity” is defined to include “stocks, share issuances, depositary receipts, or any other evidence of title or ownership.” The aim of the sanctions is to restrict the medium- and long-term access to US sources of funding for these entities.
The sanctions include some confusing language referring to the property or interests in property of any of these four companies. OFAC has explained in guidance on its website that this language is intended to refer to any company in which one of the four Russian companies directly or indirectly owns 50% or more of the equity interests. Thus it appears the sectoral sanctions prohibit “transacting in, providing financing for, or otherwise dealing in”:
- “new equity” issued by or for the benefit of VEB, Gazprombank or any entity in which either has a direct or indirect 50% or greater equity interest; and
- “new debt of longer than 90 days maturity” of either of these two banks, Rosneft or Novatek, or of any entity in which any of them has a direct or indirect 50% or greater equity interest.
We understand “transacting in, providing financing for, or otherwise dealing in” debt or equity of such companies to involve, among other things, purchasing, selling, arranging or underwriting, or acting as a trustee or agent for a group of banks, for covered issuances of debt or equity (as applicable) by the four Russian companies or their direct or indirect subsidiaries.
OFAC has emphasized that the sectoral sanctions only apply to new debt and equity issued on or after July 16, 2014, that all other transactions involving the covered Russian companies or their property are permitted unless prohibited by other sanctions, and that the sanctions do not block any of the covered entities, meaning US persons are not required to block (freeze) funds or other assets of these entities. OFAC has also issued a general license for trading in derivatives products the value of which is “linked to” underlying new debt or equity covered by the sectoral sanctions.
OFAC indicates that US banks “can continue to maintain correspondent accounts and process US dollar-clearing transactions” for these companies, “so long as those activities do not involve transacting in, providing financing for, or otherwise dealing in” new debt or equity. OFAC does note that when US banks refuse to engage debt or equity issuances as a result of the sectoral sanctions, they may be required to report the matter to OFAC within 10 days.
New entities blocked by US sanctions
Also on July 16 the US added to the SDN list 5 Russian individuals, 9 Russian or Russian-owned companies and 2 breakaway Ukrainian regional governments, in addition to listing a number of individuals on June 20. Unlike the companies targeted under the limited sectoral sanctions, US persons must block (freeze) any funds or other property of these SDNs and of any entity in which they directly or indirectly own 50% or more of the equity interests, and US persons are generally prohibited from entering into any transactions with such companies and individuals.
The US Treasury has stated that 8 of the 9 companies targeted on July 16 (including Kalashnikov Concern) were selected because they manufacture small arms, mortar shells and tanks, and one company for its involvement in the handling of Ukrainian state assets. Three of the targeted individuals, and one of the targeted companies, were previously designated under EU sanctions. This continues the gradual consolidation of the EU and US lists – almost all of the individuals targeted by the US on June 20 had previously been designated by the EU.
Application to non-US companies
The US sanctions relating to Ukraine and Russia are primarily directed at US persons. Non-US persons are not directly required to comply with the sanctions, so long as the relevant transaction and parties involved do not have any US nexus.
On the other hand, if US individuals or companies, or any person within the United States is involved in a transaction, or there is another sufficient nexus to the US, the US sanctions may be applicable even to non-US persons involved. In other contexts the US government has interpreted broadly the key phase “by US persons or within the United States” that is used in the sectoral sanctions to describe covered transactions.
New EU sanctions
On July 11, the EU broadened its sanctions by designating 11 more individuals on the basis of their responsibility for undermining or threatening the territorial integrity, sovereignty and independence of Ukraine, banning them from entering the EU and freezing their assets. The EU has now designated 72 individuals as sanctioned. In addition, the assets of the two companies listed on May 12 2014 by the EU, PJSC CHERNOMORNEFTEGAZ and FEODOSIA, remain frozen.
Also, on June 23, the Council of the European Union adopted Regulation (EU) No 692/2014 which prohibits the import into the EU of goods originating in Crimea or Sevastopol and the provision, directly or indirectly, of financing or financial assistance as well as insurance and reinsurance related to the import of such goods. The prohibition entered into force on June 25.
In a move that could bring the EU sanctions closer to the US position, the European Council announced on July 16 that it has agreed a “six step” plan to further expand sanctions, in view of Russia’s failure to de-escalate the situation in eastern Ukraine. These broader measures will target entities, rather than individuals, with further designations expected by the end of July. Targeted entities would be those determined to be materially or financially supporting actions undermining or threatening Ukraine’s sovereignty, territorial integrity and independence. Additional designations of individuals or entities determined to be actively providing material or financial support to the Russian decision-makers responsible for the annexation of Crimea or the destabilization of eastern Ukraine may also follow. The Council has further requested the European Investment Bank to suspend new financing operations in Russia, and called on EU Member States to coordinate their positions within the European Bank of Reconstruction and Development with a view to also suspending new financing. In addition, the European Commission will reassess bilateral EU-Russia cooperation programs with a view to their suspension. Finally, the Council has called for restrictions on new investment in Crimea, requesting international financial institutions to refrain from financing projects that explicitly or implicitly recognize the occupation of Crimea.