What might be the business implications of Western sanctions on Russia

What do we mean by "Western sanctions"?

In response to recent Russian troop build-ups around Ukraine and currently unsuccessful negotiations, the US, EU, UK, Canada, Australia and others are discussing a joint and coordinated series of possible sanctions to use if any incursion into Ukraine takes place. Unlike other sanctions coordinated by the West, which have been mostly designed after an event occurs, the current discussions appear to be an attempt to head off any such incursion by allowing the Russian leadership (and the global business community) to see that the West stands united and that the price of any incursion would be potentially devastating.

Western states already have a complicated and far-reaching set of sanctions targeting Russia for: (i) its annexation of Crimea; (ii) issues in Eastern Ukraine; (iii) tampering with democratic election processes; (iv) cyber-attacks; etc. These sanctions were coordinated as of 2014 but have since diverged slightly. Critically, there is legislation in place to allow swift new sanctions, including US "secondary" sanctions which will apply to any transaction with designated Russian entities regardless of any US nexus. 

Broadly the current sanctions on Russia include:

• sanctions on individuals (both politicians and selected oligarchs) in Russia and in Ukraine;
• controls on oil and gas, with the EU and UK focusing on oil as opposed to gas;
• sectoral sanctions restricting access to Western capital markets by Russian SOEs, including banks and energy companies; and
• increased Western export controls in relation to Russian aerospace and defence.

If there are further Russian incursions, the expectation is that these regimes would be expanded dramatically to new strategically chosen entities or even entire sectors of the Russian economy.

Timing\trigger

The exact trigger might be the crossing by Russian troops into Ukraine or another act of perceived aggression from the Russian side. However, Russia may use provocations, proxies or unidentified military groups. There has been some discussion in the West about pre-emptive use of sanctions, particularly in light of recent cyber-attacks on Ukrainian and Canadian governments, linked to Russia. Therefore the precise trigger for sanctions is unclear.

Content

We expect that any measures will be highly coordinated between Western countries. This was done in respect of Iran in 2012 and Crimea in 2014. We expect that Western partners will want to show a high degree of cooperation and coordination around sanctions, with any lack of unity likely being seized upon by Russia and its allies. So, as an example of such cooperation and coordination, both the US and Germany have recently suggested that the Nord Stream 2 gas pipeline would be a primary target. This is an important development as the US appeared to be thinking of acting unilaterally and on an extraterritorial basis, potentially running the risk of a division on Nord Stream 2 with the EU or Germany. However the German Foreign Minister has echoed the US position suggesting strongly that Germany\the EU will takes measures against Nord Stream 2.

The substance of potential new sanctions is also currently uncertain. There has been public discussion of the following:

• Designating senior Kremlin officials and/or major Russian contributors to the Russian economy, particularly in the energy, industrial and infrastructure areas, as sanctioned entities. This can be achieved on the basis of the existing sanctions regimes with secondary sanctions elements (e.g. the United States Countering America's Adversaries Through Sanctions Act (CAATSA)) or under sectoral sanctions (which would have much smaller impact). No specific names have been floated thus far, and this is normal to avoid "tipping off" the targets.
• Removing Russian access to the SWIFT clearing system. This action is not unprecedented as Iranian access to SWIFT was removed in 2012, reconnected in 2015, and then some banks removed it in 2018. However it is seen as a "nuclear" option. As Belgian based, US has no direct control over SWIFT, other than to sanction SWIFT itself if it refuses to comply. Belgium/EU do have direct control. Would Russia use any EU-level appeals process to try to block this?
• Extending prohibitions on access to the Western debt market for some or all Russian entities, not just banks and energy SOEs.
• Borrowing from the recent menu of options targeting Chinese military entities, the US or others could impose targeted sanctions and export controls restrictions on corporations directly or indirectly involved with the Russian military.
• Taking other financial measures, e.g. restrict Western access to Russian companies' equity or bonds, place limitations of access by Russian entities to the Western insurance and re-insurance markets.
• Placing limitations on all dual use items to Russia, either a complete embargo or presumption of denial.
• Extend oil and gas controls to all end-users not just deepwater, Arctic and shale – be clear that gas is covered in the same way as oil, or potentially expand the list of so-called Annex I items to or for use in Russia.
• Extend controls to other non "dual-use" areas. It is hard at the moment to see what these other areas might be. However, Western economies are, to some extent, reliant on certain Russian minerals.
• Import restrictions into the West for Russian items – an obvious one is gas, but that may be too sensitive, at least in winter. Nothing comes close to oil and gas as revenue generating exports for Russia. Russia cannot sell its oil and gas to third countries, as all current pipelines face West, and much of eastern Russia is not connected to any gas grid. There are no obvious alternative markets yet for Russian gas, potentially making restrictions a powerful tool.
  
  It should not be forgotten that Russia has shown some limited appetite to put in place sanctions on the West (e.g. food imports), and has considered some form of blocking measures. It is of course the case that Russian courts will not give effect to any Western sanctions and so that stance will impact dispute settlement raised by any Russian counterparty affected by Western sanctions. Russian legislation specifically provides for the jurisdiction of Russian courts in disputes involving targets of Western sanctions, even if the parties have previously agreed on international arbitration outside Russia.

Current reaction\possible future reaction

• There is already flight from Russian assets and business, and this is likely to accelerate. Businesses do not want frozen funds or assets, or face significant losses.
• Clients will want support understanding their exposure, particularly in relation to contractual positions. For example, do payments made by Western parties into blocked accounts discharge obligations under the law regulating the contract? Do contracts have specific “sanctions” clauses, and can they be triggered now, or do parties have to wait until sanctions are in fact imposed? Where would disputes be heard? If in Russian courts, clients can expect a poor outcome.
• Regulators appear to be asking EU and UK businesses to "war game" certain sanctions, and there may be regulatory concerns associated with the results of these “war games”.
• Any crisis may present business opportunity to "risk tolerant" investors who see asset prices dropping – but note again Russia may retaliate against the West, and punish Western investors.
• Clients should know what their position in Russia is (e.g. expat employees in Russia, exposure to Russian investors already or likely to be targeted by Western sectoral sanctions, shareholdings that might be difficult to exercise, debt positions, levels of import or export business at risk, etc).
• If the confrontation lasts (which it likely will), Russia may even try to nationalise companies or otherwise take away ownership by companies from jurisdictions which imposed sanctions. Based on the recent Russian laws (and judicial interpretation), domestic litigation can trump arbitration clauses if sanctioned entities are involved.
• Assess what new or enhanced restrictions might mean to those positions.
• Balance possible loss against likelihood of sanctions.

Our global sanctions team, which has experience of dealing with all major sanctions regimes, can help clients triage issues now, or when sanctions are imposed.

Authors: Ross Denton, Ruby Hamid, Alexander Dmitrenko, Olivier Dorgans, Tom Cummins, Sophie Law and Neil Donovan