The resurgence of sanctions

Read the article in the Cayman Financial Review Magazine 

Although “sanctions” may be levied for a number of reasons, the term is most commonly used nowadays to describe the international embargo of finance and trade in relation to either specified persons, or in more serious situations, entire jurisdictions.

In terms of legal effect, sanctions are promulgated at the level of the United Nations, usually through a Security Council Resolution, and are then either directly adopted by a jurisdiction through domestic legislation, or are extended to the jurisdiction by some form of sovereign or communal enabling legislation.  

For example, EU members are bound by, and adopt legislation implementing, EU regulations. Similarly, the Cayman Islands, as a British Overseas Territory, have their sanctions legislation enacted by a statutory instrument that is extended to them from the United Kingdom.

Historically, sanctions were applied (sparingly) against oppressive regimes (eg Rhodesia, South Africa, Former Yugoslavia and Iraq). More recently, the Arab Spring has caused an escalation in the issuance of resolutions by the UN Security Council, and consequent sanctions legislation in each jurisdiction. In the last two years alone, the Cayman Islands has had sanctions legislation effected for Belarus, Libya, Egypt, Syria, Tunisia, Sudan and Iran.

These are in addition to the longer standing sanctions put into effect after 9/11 in relation to terrorism and those linked to Al-Qaida, Iraq and/or Afghanistan.

Sanctions have now cemented themselves as the third pillar in the anti-money laundering/combating of terrorist financing (AML/CFT) regime (the other two pillars being AML and Anti-Bribery/Corruption). 

Cayman sanctions

Sanctions legislation in the Cayman Islands (a “sanctions order”) largely mirrors the UK regulations, which put the EU regulations and UN resolutions into effect. Depending on the urgency, there is usually a one to three month delay between the enactment of the UK regulations and the extension of the sanctions order. However, further amendments to those sanctions orders may come into effect immediately upon changes to the EU or UK regulations, where references are made to such legislation in the body of the Cayman sanctions order.

The sanctions orders apply to:

  • Any person in the Cayman Islands
  • A British citizen, a British overseas territories citizen, a British Overseas citizen, a British subject, a British National (Overseas) or a British protected person, ordinarily resident in the Cayman Islands; or
  • A body incorporated or constituted under the law of any part of the Cayman Islands

Almost all sanctions orders will have similar fundamental financial prohibitions. These include:

  • Dealing with funds or economic resources owned or controlled, directly or indirectly, by a designated or listed person, or persons acting on their behalf, or at their direction, or by persons controlled by them, unless authorised by licence; and
  • Making funds or economic resources available, directly or indirectly, to, or for the benefit of, a designated or listed person unless authorised by licence.

The licence referred to above, is an authorisation issued by the governor, or his delegate, to allow an affected party to continue with certain types of business activity that may be caught by the above-mentioned prohibitions, as long as no funds or economic resources are made available to a designated person. 

Although most sanctions orders refer to a prescribed list of designated or listed persons (usually maintained at the level of EU Regulations), which includes both natural and legal persons, certain sanctions orders go beyond specific lists and more broadly prohibit any form of trade with certain jurisdictions (eg Iran).

Like other AML/CFT legislation, the sanctions orders mandate reporting of potential breaches of the legislation and/or the identification of a designated or listed person. Where a relevant institution (ie the Cayman Islands Monetary Authority, a Cayman licensed bank or credit unions) knows or suspects that a relevant person is a designated person, or has committed an offence under the sanctions order, they must disclose such information to governor as soon as reasonably practicable.

The disclosure must include information on which knowledge or suspicion is based, as well as information relating to the identity of the designated/listed person and the nature/quantity of funds/economic resource.

The penalties for non-compliance under the sanctions orders can be significant. Where a person may have dealt with, or made available, sanctioned funds or economic resources, they may face a term of imprisonment for two years and/or a fine on conviction on indictment. The penalty for failing to report could also lead to imprisonment for up to three months and/or a fine not exceeding £5,000. The value of the specified fine is in pounds sterling as it is applied across all British Overseas Territories.

In order to avoid prosecution, the sanctions orders provide a defence where you did not know and had no reasonable cause to suspect that you (or a third party counterpart) were dealing with funds or economic resources, owned or controlled, directly or indirectly, by a designated or listed person, or persons acting on their behalf, or at their direction or by persons controlled by them. The evidential burden will be on the defendant to prove that such knowledge or suspicion did not (or should not) exist.

The Cayman sanctions are of obvious importance to the financial services industry. Cayman corporate entities have long been used to support international trade and development transactions. Cayman domiciled entities are involved in a range of finance transactions including infrastructure projects (eg real estate, roads, bridges and ancillary services such as telecommunications and sanitisation), oil, gas and other energy projects, as well as aircraft and vessel financing. Cayman insurance vehicles can often be used to underwrite the transportation of certain cargo including oil and gas, as well as the ships, pipelines and equipment that carry them.

Such Cayman entities will have been incorporated by Cayman trust companies or company managers and may have Cayman directors and Cayman bank accounts. The sanctions orders should give these Cayman service providers cause to seek more information about the nature and scope (as a transactional and geographical matter) of the business of the Cayman entity to which they are providing services.

To add to the complexity, if any Cayman entity has been involved with the financing of foreign government projects, in sanctioned jurisdictions or otherwise, Cayman service providers to such entities should be minded to become familiar with the foreign bribery provisions under the Cayman Islands Anti-Corruption Law.

Reach of US sanctions

As noted in an article by Stephen Platt in a prior issue of the Cayman Financial Review (see issue no.26 “Why Sanctions Compliance is an Imperative”), non-US financial service providers should also be concerned with the potential extra-territorial reach of the US sanctions regime, enforced by the US Treasury Office of Foreign Assets Control (OFAC).

Although the OFAC sanctions, as US legislation, are not technically applicable in the Cayman Islands, there is every chance that a Cayman financial service provider will be operating within the remit of the extensive range of its provisions. As certain non-US banks have learnt, arguments of sovereignty and ultra vires mean little in modern commerce when most transactions are conducted either in US dollar currency or through US banks.

Although OFAC sanctions only apply to US persons and US dollar transactions, they have a much wider effect on international finance. For example, the OFAC sanctions also apply to any non-US person operating in the US (eg by branch or agency).

They also apply to any non US dollar transaction being cleared through a US bank operating outside of the US. More worryingly, it is a breach for any non-US person to conspire to cause a US person to violate the OFAC sanctions.

“It shall be unlawful for a person to violate, attempt to violate, conspire to violate, or cause a violation of any license, order, regulation, or prohibition issued under this chapter.” 50 U.S.C. §1705

This was the provision that was used by the US Department of Justice (and OFAC itself), following a massive investigation, to bring actions against a number of global (non-US) banks who had deliberately stripped out or falsified identifying details on wire transfer documentation to get around the OFAC sanctions when using US dollar correspondent accounts for transactions involving Iran, Libya, Sudan, Burma and Cuba.

Since 2009, the likes of Lloyds TSB (over US$550 million), Credit Suisse (over US$530 million), ABN AMRO N.V (US$500 million), Barclays (US$298 million), ING NV (US$619 million) and Standard Chartered (US$340 million) have been fined by the US authorities for the above-mentioned violation of the OFAC sanctions.

As there currently appears to be no other valid solution to the growing US budget deficit, do not be surprised to see more hefty fines imposed by the US authorities on non-US banks, as well as those entities that may have been used to facilitate the transactions. Cayman service providers need to remain vigilant to ensure that they do not inadvertently become members of what is now affectionately known as the “Strip Club”.