On 12 September 2014, the EU introduced new sanctions in response to the Ukraine crisis. Later the same day, the US announced that it was deepening existing sanctions against Russian banks and expanding sanctions against Russia’s energy sector, as well as targeting additional Russian entities in the energy and defence sectors. Following our previous update in August, this Client Alert summarises the new sanctions and briefly assesses their impact to date.

EU Sanctions

The new EU sanctions supplement further the existing sanctions issued on 17 March 2014 and 31 July 2014. The latest sanctions significantly broaden the scope of existing sanctions and introduce a number of new restrictions (albeit caveated with the grandfathering provision that enables otherwise restricted contracts entered into prior to 12 September 2014 to be carried out and fulfilled). The new sanctions include:

  1. a prohibition on the (i) provision of any drilling services, well testing services and logging and completion services and (ii) supply of specialised floating vessels necessary for deep water oil exploration and production, Arctic oil exploration and production or shale oil projects in Russia;
  2. an extension of the previous prohibition to provide investment services in connection with raising capital for Sberbank, Vneshtorgbank (VTB), Gazprombank, Vnesheconombank (VEB) and Rosselkhozbank, such that any investment instruments exceeding a 30 day term are now prohibited. (The previous restriction applied to investment instruments exceeding a 90 day term.) This extension conclusively rules out any short term commercial paper financing and is a severe restriction on raising finance. However, funds may be advanced for financing of non- prohibited goods or services other than those in the financial sector or by way of emergency loan for subsidiaries of the sanctioned entities established in the European Union;
  3. an extension of the prohibition on raising capital and provision of investment services to investment instruments exceeding a 30 day term to certain oil companies (Rosneft, Transneft and Gazprom Neft) and certain space, technology and nuclear companies (OPK Oboronprom, United Aircraft Corporation and Uralvagonzavod);
  4. a restriction on the transfer of military and dual-use goods to certain arms, munitions and weapons systems manufacturers and engineers, regardless of whether or not those goods are intended for military use (although dual-use goods can be provided for non-military use and for the aeronautics and space industry); and
  5. an expanded list of persons whose assets, funds and economic resources have been frozen.

US Sanctions

The US Treasury Department’s Office of Foreign Assets Control (OFAC) has widened the scope of the sectoral sanctions announced previously to include more of the Russian defence and energy sectors, as well as deepening existing sanctions against certain Russian financial institutions and adding Russia’s largest lender, Sberbank, to the existing targeted banks. As with the EU sanctions, the latest sanctions apply from 12 September 2014. The new measures include:

  1. an expansion of Directive 1 (see Client Alert of 6 August 2014) which now prevents US Persons from providing or dealing in new debt of longer than 30 days maturity (previously 90 days) or new equity in the targeted banks (Bank of Moscow, Gazprombank, Rosselkhozbank, VEB, VTB and Sberbank) and their 50% or more owned subsidiaries, from 12 September 2014;
  2. an expansion of Directive 2, which prevents US Persons from transacting in, providing finance for or dealing in new debt of greater than 90 days’ maturity and now applies to two additional entities, Gazprom Neft (the oil producing subsidiary of Gazprom) and Transneft (the state- owned pipeline company), and their 50% or more owned subsidiaries;
  3. a new Directive 3, which prohibits transactions by US Persons involving new debt of greater than 30 days’ maturity issued by Rostec, the Russian technology conglomerate active in the defence sector;
  4. a new Directive 4, which expands the restrictions applicable to the energy sector by prohibiting the export of goods, services (not including financial services) or technology for use in deepwater, Arctic offshore or shale oil exploration or production projects by five Russian companies: Gazprom, Gazprom Neft, Lukoil, Surgutneftegas and Rosneft. US Persons have until 26 September 2014 to wind down transactions with the entities affected by Directive 4); and
  5. an addition of five state-owned defence technology firms to the SDN and Blocked Persons List, meaning that US Persons are now prohibited from dealing directly or indirectly with these entities and their property: Almaz-Antey GSKB, Dolgoprudny Research Production Enterprise, Kalinin Machine Plant, Mytishchinski Mashinostroitelny Zavod and NIIP (V.Tikhomirov Scientific Research Institute of Instrument Design).

The Department of Commerce’s Bureau of Industry and Security (BIS) has announced that the defence technology firms and energy companies named above have been added to its Entity List, thereby imposing additional licensing requirements, with a presumption of denial.

Conclusions

Both the EU and US restrictions are significantly broader than the sanctions published in late July. For the energy sector, indications are that the expanded scope is beginning to affect work by EU and US headquartered energy companies on technologically demanding projects in Russia which may lead to project delays and leave EU and US based joint venture partners with no viable exit strategy from an asset that is no longer marketable. As a point to note, the EU sanctions do not expressly apply to natural gas exploration and production. However, under the US sanctions (as clarified by OFAC’s guidance on Directive 4) if, in addition to oil production, a Russian deepwater, Arctic or shale project involving a named entity has the potential to produce gas, the restrictions will nevertheless apply. If a project is unrelated to crude oil and produces gas only, then the prohibition under the US sanctions would not apply.

The shortening of the maturity period for permitted transactions in new debt of Russia’s largest banks imposes yet more complex compliance obligations for EU and US institutions dealing with those banks. Moreover, the inability of Sberbank, VTB, Gazprombank, VEB and Rosselkhozbank to raise finance from EU and US institutions may soon adversely affect Russian citizens looking to access capital from these institutions.

In light of the sanctions, the sanctioned entities will likely look to Asian capital markets to replace sources of capital closed to them in the West. Since the introduction of the latest sanctions, the Russian government has pledged assistance to the ongoing energy projects from the existing reserves and revenue streams from currently producing projects. Reliance on alternative sources of capital will support the affected entities while the sanctions are in place, but the Western partners and suppliers  will need to carefully evaluate their projects and relationships in light of the sanctions to ensure on- going compliance. While to date there has been no enforcement action for a breach of these sanctions, the enhanced restrictions enacted this month indicate that the sanctions regime will be applied rigorously and any EU or US entity found in breach thereof may well find themselves facing serious legal consequences.