Russia's relationship with the international community has in recent years often been strained to the breaking point; arguably never more so than when Russia annexed Crimea from Ukraine in March 2014. The response from the international community was immediate and unified. Both the U.S. and E.U. put into place a web of complicated sanctions regimes. With the recent change of administration in the U.S. and continued instability across Europe, it appears that the U.S. and E.U.'s relationship with Russia will remain complicated throughout 2017.
Background to Crimean / Ukraine Sanctions
In the aftermath of the 2014 Ukrainian revolution, Russia increased its military presence in the region. This culminated with the annexation of Crimea by the Russian Federation on 18 March 2014. Since then, the peninsula has been administered as two de facto Russian federal subjects — the Republic of Crimea and the city of Sevastopol which, until 2016, were grouped in the Crimean Federal District. The reaction from the international community to Russia's actions was largely to condemn the Russian government and to impose economic sanctions on those involved. The initial Ukraine sanctions imposed by the U.S. were somewhat limited, targeting Russian officials and imposing limited “sectoral sanctions” restricting U.S. investment in certain sectors of the Russian economy. As the situation in Crimea escalated, so too did the sanctions by the U.S. and EU, culminating in sweeping sanctions targeting government officials and entities connected with the Russian annexation of Crimea, denying them access to E.U. and U.S. banking facilities and freezing any assets they held within those jurisdictions. In essence, the Crimean sanctions essentially blocked all economic contact between U.S. and E.U. persons and entities with Crimea; essentially imposing on Crimea the same sweeping sanctions that those jurisdictions maintained towards Iran and Syria.
Broadly speaking, the stance of the international community has been that these sanctions would be lifted once peace returns to the region and democratic elections take place. There have been two attempts at peace - the Minsk Protocol and Minsk II Protocol - but progress has been, at best very slow. In November 2016, local elections were postponed until further notice. Thus, at this time there is no clear end to the Ukrainian/Russian dispute and the resultant sanctions seem likely to remain in place for some time, absent a drastic change in position from the U.S. or E.U. The question is whether the ascension of the Trump administration and/or alterations in the political landscape in the E.U. will lead to such policy changes and an immediate or near-term cessation or relaxation of the Crimean sanctions.
The signs of a possible sea change were foreshadowed in the differing responses to the Crimea annexation by the Obama administration and by Donald Trump, who at that stage was still fifteen months away from announcing his candidacy for President. The Obama administration immediately reacted by issuing executive orders imposing stringent economic sanctions against certain officials in the Government of the Russian Federation. In contrast, Mr Trump's response at the time was to tweet that he believed Putin would continue to "re-build the Russian Empire".
Cyber Attack Sanctions
Away from the tanks and guns in Crimea, 2017 has also brought to the forefront friction between Russia and the U.S. played out on a 21st century battlefield.
The 2016 presidential campaign gave rise to credible allegations of Russian hacking and interference in the U.S. election. In early 2017, during the final weeks of his administration, President Obama issued an executive order imposing economic sanctions against those engaged in what it termed “significant malicious cyber-enabled activities.” The designated individuals and entities included Russian intelligence officers, a Russian hacker believed to be employed by Russian intelligence agencies, as well as the Russian Main Intelligence Directorate, the Federal Security Service (more commonly known as the FSB) and various companies suspected of assisting with this state sponsored cyber-attack such as the Professional Association of Designers of Data Processing Systems and Zorsecurity / Esage Lab. President Obama also expelled 35 Russian diplomats from the U.S.
Imposing sanctions on Russian officials, the Russian intelligence services, and expelling from America 35 Russian diplomats sent a very clear message. Again, this was in contrast to then President-elect Donald Trump's response, which was to say it was time to move on – and there were initial signs that the new administration wanted to do just that. On 2 February 2017, the Department of the Treasury issued a general licence to authorise certain transactions with the Russian FSB, thereby watering down some of the effects of these sanctions. However, stringent sanctions remain on the exportation, re-exportation or provision of any goods, technology or services to the FSB in connection with the Crimean region of Ukraine.
Whilst we may be witnessing the early stages of the new U.S. administration eroding Russian sanctions, could President Trump really rescind them in their entirety?
The initial thought was that this was likely to happen early in the Trump administration, given President Trump’s pro-Russian posture throughout his campaign. The President has authority both to issue and rescind executive orders, meaning that President Trump has legal authority to rescind the Obama executive orders at any time. However, the political situation is more nuanced. Republican Senator John McCain has led a charge to maintain the Russian sanctions regime. Senator McCain went so far as to state that if President Trump were to rescind the executive orders imposing sanctions regarding Russia/Ukraine, then the Senator would introduce the same sanctions via congressional legislation.
The political situation for the Trump administration has been further complicated by allegations of illegal or improper communications between Trump advisors and Russian officials during the campaign. These allegations came to a head earlier this month, when President Trump’s National Security Advisor, Michael Flynn, was forced to resign amidst allegations that he prematurely discussed Russian sanctions with the Russian Ambassador and later misled senior members of the Trump administration, including the Vice President, about that conversation. Congressional pressure and these early missteps by the Trump administration make it difficult for President Trump to exercise unilaterally his executive prerogative to rescind Russian sanctions.
All of this adds to the uncertainty around the Russian Sanctions and to what actions the administration will ultimately take. We advise our clients to take a wait-and-see approach with regards to any changes in the Russian Sanctions.
On the other side of the Atlantic, E.U. countries have outwardly maintained their political objections to Russia's actions in Ukraine and recently renewed the E.U.'s Russian/Ukrainian sanctions for a further six months. However, the E.U. is far from united on this issue. Italy has been calling for the re-establishment of business ties with Russia, and Germany's vice chancellor, Sigmar Gabriel, has voiced opposition to sanctions. Most notable is France, where in April 2016 a non-binding vote in France's lower house went against continuing sanctions.
In the current shifting E.U. political landscape, there can be no guarantee that when the E.U. next considers the issue of sanctions against Russia they will be extended.
The U.K.'s position is also far from certain. President Trump and Theresa May are reportedly at odds over Russian sanctions. The U.K.'s position has been that sanctions against Russia should continue until the Minsk II peace deal is properly implemented by Moscow. Whether that will remain the case in a post-Brexit United Kingdom is unclear. The U.K. may have to look further afield than Europe to find its international allies, and whilst the U.K. government will be keen to encourage the special relationship with America, further international friends out of political necessity may include Russia.
How This Impacts You
There is a huge amount of insecurity on the future of Russian/Ukrainian sanctions (coupled with further uncertainty regarding sanctions imposed against Iran – of which more in a follow up article). As a result of this constantly changing political landscape, the list of those countries and individuals with whom corporates and individuals are able to conduct business changes monthly and it has never been more important to ensure that adequate protections are in place. These can include:
- Counterparty risk and due diligence: if sanctions against Russia are lifted, a substantial amount of investment will return to the U.K. However, there are likely to be a number of entities which will remain blacklisted by the U.K. and the E.U. To ensure compliance, it will still be necessary to check that all counterparties and the Ultimate Beneficial Owner of corporate entities are not still on the sanctions lists. This may not be straightforward in circumstances where complex ownership structures are in play.
- Simultaneously tracking E.U., U.K. and U.S. sanctions: if the political perspectives of the E.U., U.K. and U.S. continue to diverge we may begin to see the various sanctions regimes become less harmonised requiring more extensive due diligence.
- Contractual protection: full and robust contractual protections should be negotiated to address the residual sanctions risk, as well as the risk of sanctions "snapback". The future of Russia's relationship with the rest of the international community looks turbulent, which carries with it an inherent risk of revolving door sanctions policies.
- Finance: banks and other financial institutions have spent recent years "de-risking" and stopping all business with high-risk/sanctioned countries, and are likely to remain cautious when dealing with those recently removed from any sanctions list. At least in the short term, they are likely to remain reluctant to handle Russian-related transactions and may require proof which demonstrates that the transaction is not caught by U.K., E.U. or U.S. sanctions.
- Wider compliance risks: many of Russia's key businesses and assets are subject to state control and the use of intermediaries is common place. This, along with the fact that Russia is ranked as high risk according to Transparency International's Bribe Payers Index, means that the corruption risk (e.g. U.K. Bribery Act/ U.S. Foreign and Corrupt Practices Act) in Russia remains significant. Businesses should remain vigilant and ensure proper procedures are in place and that they are followed.
2017 is likely to see major developments in the existing sanctions landscape as international allegiances are tested with new administrations and shifting political agendas. During President Trump's first call with President Putin, reports indicate that the issue of U.S. sanctions against Russia was not discussed, but that does not mean it is not an issue they are both keen to talk about. Sanctions may well be the subject of their next call.
This article was co-authored by Adam S Kaufmann and Aaron Wolfson of Lewis Baach Kaufmann Middlemiss PLLC.