Financial Institutions – Five Points to Consider and Three Tips to avoid Sanctions Breaches by Leigh Crestohl and Stephanie Limaco

December 20 2023

Banks and other financial institutions are particularly exposed to the risk of breaching sanctions regulations, especially nowadays when sanctions are being imposed at an unprecedented speed. We will focus in this article on financial sanctions, given their importance for these entities.

I.            What are financial sanctions?

Financial sanctions are measures put in place by governments and multinational bodies (such as the UN) that constrain the ability of a person or entity to carry out financial transactions or access to financial services, funds and economic resources. They include assets freezing, investment bans, restrictions on access to capital markets, directions to cease banking relationships and activities, restrictions to provide financial services (including banking), among others.

II.           Points to consider

1.           Be aware of your reporting obligations

You are obliged to make a report to the UK’s Office for Financial Sanctions Implementation (OFSI) if any of the following applies: a) you know or suspect that an individual or entity is a designated person or b) you know or suspect that a breach of financial sanctions has occurred.  If a designated person is a customer and you hold frozen assets for them, you need to report their nature and amount or quantity. The reporting obligation arises if your knowledge or suspicion comes to you while carrying out your business.  Note that you should also notify the Financial Conduct Authority (FCA). 

2.           Be careful with your correspondent banking relationships

Under the Russian Sanctions Regulations, UK credit or financial institutions are prohibited from establishing or continuing correspondent banking relationships with a designated person or a credit or financial institution which is owned or controlled by a designated person. You are also not allowed to process a Sterling payment to these persons or entities.

Moreover, correspondent banks, especially in complex transactions that involve a chain of corresponding banking relationships, could be at risk of facilitating illicit payments.

3.           Note the recent changes in relation to trust services

The Russia (Sanctions) (EU Exit) (Amendment) (No. 17) Regulation, which came into force on 16 December 2022, included a prohibition against: (i) providing trusts services to, or for the benefit of, a designated person; and, (ii) providing new trust services to, or for the benefit of, a person connected with Russia. If you provide these types of services, consider this recent change carefully.

4.           Be aware of the other countries’ sanctions regimes

Different countries have divergent sanctions policies and rules, and could have extraterritorial application or diverse approaches as to whether people or transactions have a “nexus” with their jurisdictions. Hence, you should consider the sanctions provisions not only in all of the countries where you are conducting business, but also any other countries which ‘may be relevant’ to that business. In particular, note that US sanctions could have extraterritorial effect, affecting companies around the world.

5.           Monetary penalties are subject to strict liability

The UK’s recently enacted Economic Crime (Transparency and Enforcement) Act 2022 allows OFSI to impose monetary penalties for breaches of financial sanctions by applying a strict liability test. That means it no longer matters whether the person or entity who committed the breach knew, or had a reasonable cause to suspect, that they were in breach of sanctions. This model, which is more similar to the US enforcement system, came into effect on 15 June 2022.

III.          Tips to avoid breaching sanctions

1.           Review the tools and resources provided by OFSI and the FCA, which could help you with your compliance checks in relation to sanctions:

  1. OFSI provides extensive guidance and alerts to help with compliance responsibilities. Businesses should regularly check the UK sanctions list and the list of financial sanctions targets (available here and here). It may be worthwhile to use the OFSI’s Financial Sanctions Search (which has a “fuzzy search” tool) here and to subscribe to the UK Treasury’s e-alerts (which alerts subscribers when there is a change to existing financial sanctions) here.

    However, be aware that some persons or entities may be subject to sanctions restrictions despite not being included in these lists, such as a person connected with Russia, or an entity owned or controlled directly or indirectly by a designated person.
     
  2. Chapter 7 of the Financial Crime Guide (“FCG”) (available here) provides guidance on firms’ governance, risk assessment, screening and procedure in case of breaches related to financial sanctions, including examples of good and poor practices. For instance, the FCG advises commercial parties to have measures in place for appropriate escalation of actual target matches and breaches of UK sanctions, to be aware of the areas of business most at risk of sanctions’ breaches and to have an effective and up-to-date screening system appropriate to the business.
     
  3. For banks, Chapter 15 of the Financial Crime Thematic Reviews contains in section 15.3.7G examples of good and bad practices in relation to sanctions procedures.  Good practices include screening potential sanctions-matches at several key stages of a transaction and focussing sanctions resources by considering previous sanctions alerts.

2.           You should keep evidence to show that you are following the rules and have implemented good practices in relation to sanctions compliance. These obligations, such as screening, should be conducted on an ongoing basis and not only at the start of the business relationship. Note that more careful KYC checks will be required when the customer or client is a Politically Exposed Person (“PEP”).

 

3.           Include comprehensive sanctions clauses in your contracts with clients, customers and suppliers, so you can regulate the risk of sanctions being imposed on them, and have more control of the consequences if they were to become sanctioned. For instance, you could include a provision establishing that you are entitled to terminate the contract should your counterparty (or its shareholders or subsidiaries) become a designated person, and that you are entitled to suspend any contractual obligation (including payments) in that case. You could also include a broader provision to safeguard your position in case continuing a contract with your counterparty could expose you to the risk of being sanctioned. These clauses could considerably reduce the scope of potential disputes in the future.

IV.          Conclusion

Enforcement of UK sanctions has become tougher in recent times. The FCA indicated in February 2022 that it expects firms to have established systems and controls to reduce the risk that they might be used to commit financial crimes. Ensuring compliance with financial sanctions obligations is a key example of those systems and controls.  The FCA has also called for persons and entities to report sanctions evasion issues, emanating from themselves or another financial firm or individual. 

It is important to keep up-to-date with the continuous changes in international sanctions provisions. A breach of sanctions could lead to fines, restrictions and even criminal liability punished with imprisonment, in addition to reputational damage. Remember, all transactions are subject to the financial sanctions regime, there is not a “de minimis” rule with regards to the breach of a sanction.

 

Article featured in Financial Regulation International on 20 December 2023 and can be found here https://www.financialregulationintl.com/financial-crime/financial-institutions-and-sanctions-155398.htm?origin=internalSearch.

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