Living in a world of increasing geopolitical uncertainty, as recently witnessed with the upheaval in various Middle East and North African countries, threats to world peace such as the threat of terrorism continue to be a concern.
Since diplomacy has not always worked in reconciling disparate interests and ideologies in the international political scene, individual countries or the wider international community have utilised other means, such as the threat or use of sanctions, to protect their interests and often the interests of the citizens of other states.
Sanctions may simply be defined as restrictions upon international trade and finance that one or more countries impose against another country or targeted entities and individuals for political or humanitarian reasons.
As the United Kingdom Treasury notes, sanctions are used by the international community variously to encourage a change in the behaviour of a target country or regime, to apply pressure on a target country or regime to comply with set objectives, as an enforcement tool when international peace and security has been threatened and diplomatic efforts have failed, or to prevent and suppress the financing of terrorist acts. Similarly, the United States government through the US Treasury’s Office of Foreign Assets Control (OFAC) uses sanctions to accomplish foreign policy and national security goals.
In addition, the United Nations and European Union may impose sanctions regimes. Under Chapter VII of the UN Charter, the Security Council may take measures, including the imposition of sanctions, to maintain or restore international peace and security.
However, this article will focus on sanctions imposed by the US government through OFAC, whether imposed unilaterally or with the backing of other countries. Historically, due to its economic status and as the holder of the world reserve currency, the US has had the greatest ability to impose biting economic sanctions and in recent years has enforced these vigorously.
OFAC publishes details of all the sanctions programmes enforced by the US on its website, and they may broadly be divided into two categories: sanctions targeted at specific countries and sanctions targeted at certain illegal or otherwise undesirable activities.
Country specific sanctions include sanctions against Cuba, Iraq, Iran, Burma, Somalia and others, all of which have different implications for permitted and prohibited activity, whereas activity specific sanctions include Counter-Terrorism, Non-Proliferation of Weapons of Mass Destruction and Counter-Narcotics Trafficking sanctions.
Some of these sanctions programmes define lists of parties to whom the sanctions apply. These parties are known as Specially Designated Nationals (SDNs). For other regimes such as Cuba and Iran that are more comprehensive in scope the SDN list is not a complete list of entities and individuals with whom doing business is prohibited.
Recently, new sanctions have been imposed on regimes in Syria and Libya amongst others, and the US has been prepared to tighten sanctions already in force. Both the US and EU have implemented additional sanctions relating to Iran (and in particular its energy sector) that tighten and strengthen pre-existing sanctions.
Further, Iran-related sanctions previously included a provision termed the “Iranian U-turn” allowing the US banking system to process certain Iranian-related transactions, but the US Treasury banned Iranian U-turns effective November 2008.
A sizeable proportion of all world trade takes place in US Dollars and since dollar denominated transactions clear through the US banking system, they fall under the purview of the US Treasury. It is also important to note that the world oil trade is conducted in US dollars, and Iran is a significant oil producer against whom sanctions have recently been strengthened.
US sanctions are an issue for all financial institutions that conduct transactions in US dollars and not just those domiciled in the US or with US operations. This issue is of particular significance to Cayman and other Caribbean financial institutions since a large proportion of their business is US dollar denominated and is cleared through the US.
To comply with these sanctions, financial institutions need to have a sanctions compliance framework in place to enable them to identify and avoid dealing with the SDNs or being involved in prohibited activity.
In addition to having a robust governance and reporting process, such a compliance framework needs to consider the data being screened, the lists being used to screen, how screening is conducted, the review of matches and the reporting of those matches.
The penalties for violating US sanctions are punitive. OFAC criminal penalties include fines of up to $10,000,000, and imprisonment of up to 30 years. Civil penalties range from $250,000 or twice the amount of each underlying transaction up to $1,075,000 per violation. If a bank processes a wire transfer on behalf of a sanctioned party or is any one of the correspondent banks in the chain, it could potentially be liable. In recent years enforcement actions have seen several US authorities jointly investigate non-US banks.
These US authorities include OFAC, the Department of Justice and the Manhattan District Attorney. A number of major international banks have recently been penalised for sanctions violations with the reported fines ranging from $90m to over $500m.
Much of the Department of Justice focus to date has been on the conduct of non-US banks in processing payments through the US and the practice of SWIFT message “stripping”. Stripping is when a bank removes references to originators and beneficiaries from a SWIFT message involving sanctioned parties before forwarding the message to US correspondent banks, which may then unwittingly process the transactions.
While deliberate stripping activity has been at the heart of a number of fines that we have recently seen for non US banks, it appears that in addition to simply fining banks there is now a desire on the part of the US authorities also to identify and enforce against individuals involved in this type of activity; we are likely to see actions against individuals being initiated in the future.
While the majority of very significant enforcement actions have been focused on banks, it is also important to bear in mind that sanctions can affect almost any industry, and within the financial services sector risk is not limited to banks but also extends to insurers, asset managers, brokers, fund administrators and other service providers.
In conducting investigations, the US government also has the power to instigate a detailed review of a bank’s transactions with the cost of such review being borne by the bank. Typically, the authorities request that an independent expert (such as Deloitte) conduct the review to identify any transactions conducted by the bank during the period which might constitute potential sanctions violations.
In summary, banks and other financial institutions are operating in an environment of heightened scrutiny in relation to their adherence to US sanctions legislation. One consequence of this is that financial institutions that deal in US Dollars must pay attention to sanctions risks and ensure that they have been appropriately considered and are being mitigated.
Since the penalties for contravening sanctions can be substantial, it is important that financial institutions have a robust sanctions compliance framework in place to identify customers, counterparties and transactions that may be subject to the sanctions.