February 07, 2022

Russian Sanctions/Export Controls Update

The following alert will be updated as events change. Last Updated: 2/7/2022

Below you will find an overview of a package of economic sanctions and export control measures the U.S., U.K. and EU are reportedly considering in a collective effort to compel the Russian government to de-escalate its military activities on the Ukrainian border.

Specifically, in this alert, you can read more about:

  • Proposed Sanctions
    • Additional sanctions on financial institutions: The package will likely affect multiple sectors of the Russian economy, with an emphasis on financial services.
    • Additions to Specially Designated Nationals (SDN) and Sectoral Sanctions Identification (SSI) lists: Aside from financial services, potential targets include a host of individual and entities connected to key sectors of the Russian Russia’s economy, including aerospace, defense, technology, and oil and natural gas. Moreover, momentum appears to be building for sanctions targeting individuals and entities affiliated with the Nord Stream 2 pipeline.
    • Restrictions/prohibitions on SWIFT: Russian financial institutions could be restricted (or even prohibited) from accessing the Society for Worldwide Interbank Financial Telecommunication (SWIFT) messaging system.
    • Congress: The “mother of all sanctions” bill that is building bipartisan momentum in Congress.
  • Proposed Export Controls
    • Country Group Changes: Placement of Russia in Country Group E in the Export Administration Regulations (EAR), meaning that the export or re-export of “Anti-Terrorism” (AT)-controlled items would likely require a license for any end-user in Russia.
    • Foreign Direct Product Rule: An expansion of the foreign direct product rule to target Russia, which could provide that any products manufactured outside the U.S. based on certain U.S. technology or in a plant containing certain U.S. manufacturing equipment are subject to the EAR if bound for export or re-export to Russia.

Recommendations

  • Companies operating in potentially affected industries should identify and assess exposure to:
    • Business relationships with named or likely named parties to these measures.
    • Potential expansion of the direct product rule for end users in Russia with respect to crucial chips, integrated circuits and microprocessors, as well as other advanced technologies needed to support key industry sectors in Russia, such as defense, civil aviation, maritime and artificial intelligence, among others.

I. Overview

Since the buildup of Russian troops on the Ukrainian border, the United States and its key allies have engaged in diplomatic efforts to de-escalate the ongoing crisis, threatening Russia with “massive consequences” and the infliction of “significant costs on the Russian economy and financial system” in the event of a Russian military invasion.

As it stands, the U.S., U.K. and EU possess broad legal authority to impose new (and severe) economic sanctions and export controls on any given sector of the Russian economy. In the U.S., for example, President Biden exercised this authority last year by issuing an Executive Order imposing targeted sanctions on persons operating in the defense and technology sectors of the Russian economy. Per the EO, the sanctions are based, in part, on Russia’s “violat[ion of] well-established principles of international law, including respect for the territorial integrity of states.” The EU and the U.K. have imposed similar measures, many of which stem from the Russian annexation of Crimea in 2014.

Providing a window into the measures under consideration, Democrats and Republicans in Congress are coalescing around a separate legislative proposal that has been dubbed as “the mother of all sanctions[.]” It would require the Biden administration to impose, among other items, mandatory sanctions on Russian political and military leadership, financial institutions, extractive industries and entities affiliated with the Nord Stream 2 pipeline.

The potential trigger for such measures, however, remains a sticking point — both in Congress and at the international level — with some key officials arguing that any package should be imposed preemptively (i.e., prior to a Russian military invasion); while others support a more reactive approach (i.e., in direct response to a Russian military invasion), primarily due to concerns that preemptive sanctions and export controls will lead to further escalation.

Although the imposition and severity of future measures are dependent on Russian actions in the coming days and weeks, companies should be aware of — and preemptively assess their exposure to — the following measures reportedly under consideration.

II. Economic Sanctions and Export Controls Under Consideration

A. Sanctions

1. Blocking/List-Based Sanctions

The most severe option under consideration is the imposition of so-called “blocking” or “list-based” sanctions that would prohibit virtually any transactions with targeted Russian individuals and/or entities. Although the U.S., U.K. and EU have refrained from officially naming potential targets, it is widely believed that any blocking sanctions will focus on individuals and entities (including state-owned enterprises) operating in key sectors to the Russian economy, including aerospace, defense, oil and natural gas, finance and technology.

As noted above, recent statements from U.S. and European officials indicate that Russia’s financial services sector remains a prime target. Notably, the aforementioned legislative proposal in Congress — the Defending Ukraine Sovereignty Act of 2022 — would require the Biden administration to impose blocking sanctions on three or more Russian financial institutions from a list of 12, including Sberbank, VTB, Gazprombank, VEB.RF, The Russian Direct Investment Fund, Credit Bank of Moscow, Alfa Bank, Rosselkhozbank, FC Bank Otkritie, Promsvyazbank, Sovcombank and Transkapitalbank.

Another potential “list-based” target is Swiss-based Nord Stream 2 AG (NS2AG), the current operating company of the Nord Stream 2 pipeline, as well as key executives of NS2AG. Although the EU has previously been reluctant to take such measures — primarily due to its reliance on Russian natural gas, particularly within Germany — the tide appears to be shifting as of late. On January 28, 2022, President Biden and EU Commission President Ursula Von der Leyen issued a joint statement noting their work “towards continued, sufficient, and timely supply of natural gas to the EU from diverse sources across the globe to avoid supply shocks, including those that could result from a further Russian invasion of Ukraine.” Moreover, German Minister for Foreign Affairs, Annalena Baerbock, has now publicly acknowledged that Nord Stream 2 sanctions are, in fact, on the table with German support.

Per recent reporting, other potential “list-based” targets include top Russian government officials, including, notably, Russian President Vladimir Putin.

On the U.S. side, it’s important to remember that if individuals or entities are added to the Department of Treasury’s Office of Foreign Assets Control SDN list, any entities that are owned, either directly or indirectly, 50% or more by a listed individual or entity (or in the aggregate by several listed individuals or entities) are also deemed to be SDNs. There has been talk that this “50 percent rule” could be modified to automatically include immediate family members of blocked individuals with respect to designated Russian individuals.

2. Sectoral or Transaction-Based Sanctions

A narrower alternative to blocking sanctions is the imposition of sectoral or transaction-based sanctions that would prohibit specific types of transactions involving targeted parties. In the U.S., sectoral sanctions have been in place since 2014, targeting, for example, equity transactions involving specific entities in the defense, energy and financial sectors as well as certain Russian energy projects.

Here, too, it is likely that any sectoral sanctions imposed will target Russia’s key economic sectors and could apply generally to all Russian entities or end-users. Alternatively, sectoral sanctions could be targeted at specific Russian entities (including the Russian government). A concrete example of a sectoral sanction reportedly under consideration is the expansion of existing prohibitions on the purchase and holding of Russian sovereign debt.

Currently, U.S. financial institutions are prohibited from engaging in transactions involving Russian sovereign debt on the primary market. New measures could include prohibitions on secondary market transactions involving Russian sovereign debt (or, potentially, certain state-owned entities). Depending on the inclusion of a preexisting provision or other forms of mitigation, such measures could result in U.S. financial institutions being forced to sell affected holdings at substantial losses.

Another example of a potential sectoral sanction is a restriction on specified transactions involving Nord Stream 2 AG and other related entities. This option is being viewed as a less heavy-handed alternative to blocking sanctions, which, again, would impose blanket prohibitions on transactions involving these entities.

3. Society for Worldwide Interbank Financial Telecommunication (SWIFT)

At points over the past few weeks, a prohibition or restriction on the ability of Russian financial institutions from accessing the global SWIFT messaging system was suggested. However, it has recently been reported that such measures are unlikely. Such a prohibition would effectively exclude Russian financial institutions from the global markets and could have a significant effect on other economies, including the U.S. and EU.

However, the Defending Ukraine Sovereignty Act of 2022, in its current form, would require the Biden administration to report on efforts to terminate SWIFT access for Russian financial institutions subject to U.S. sanctions.

B. Export Controls

1. New Licensing Requirements

On the U.S. side, a significant measure that is reportedly under consideration is the placement of Russia in Country Group E in the U.S. Department of Commerce’s Export Administration Regulations (EAR), meaning that the export or re-export of “Anti-Terrorism” (AT)-controlled items would likely require a license for any end-user in Russia. Currently, the only countries in Group E include Cuba, Iran, North Korea and Syria. Because AT-controlled items include a host of key manufacturing components, the effect of such a measure would likely be substantial.

Alternatively, it has been discussed that the U.S. may choose to impose a formal policy of denying licenses for the export of any items subject to the EAR to Russia for commercial applications.

2. Foreign-Produced Direct Product Rule

Another high-profile measure under consideration is an expansion of the EAR’s foreign-produced direct product rule, an extraterritorial export control rule that was expanded under the Trump administration. The rule prohibits the re-export and export from abroad of certain foreign-produced direct products of U.S. technology and software or products produced in plants containing certain equipment to specified countries considered to pose risks to U.S. national security.

The U.S. Commerce Department’s Bureau of Industry and Security (BIS) has previously demonstrated its willingness to expand the direct product rule based on foreign policy considerations. For example, on May 15, 2020, BIS announced that it was amending the EAR to further restrict the ability of Huawei and its affiliates from transactions involving foreign-produced products of U.S. technology or software or produced in plants containing certain U.S. equipment or equipment based on certain U.S. technology.

If BIS expands the direct product rule to target Russia, it could provide that any products manufactured outside the U.S. based on U.S. technology or in a plant containing U.S. manufacturing equipment, are subject to the EAR if bound for export or re-export to Russia. Here, too, the potential effect on the Russian economy could be significant, given that such an expansion would effectively prohibit Russia from importing a host of key manufacturing components, with Taiwanese-origin semiconductors at the top of the list. It’s worth noting, however, that in the recent BIS measures directed at Huawei, the restrictions were imposed narrowly (i.e., on specific, high-technology products).

III. Looking Ahead

In light of these developments, we highly recommend that companies proactively assess their global trade activities to assess their potential exposure. This is especially prudent for companies operating in the aerospace, defense, energy, financial services and technology industries, which face heightened risks in the event of further escalation on the Ukrainian border.

Please note that we’ll continue to closely monitor this situation and provide timely updates, as warranted. In the meantime, please do not hesitate to reach out to a member of the Faegre Drinker customs and international trade team if you have any questions.

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