Leigh Crestohl and Stephanie Limaco outline points to consider and tips to avoid breaching UK financial sanctions in WorldECR

Leigh and Stephanie's article was originally published in WorldECR's Issue 119.

Five points to consider and three tips to avoid breaching UK financial sanctions

It is axiomatic that sanctions intended to freeze assets of targets, or deny them access to the global financial system, expose banks and other financial institutions to significant risk of breaching sanctions regulations. This is especially the case when sanctions are now being imposed with increasing regularity and at unprecedented speed. This article considers various important practical considerations for financial institutions in relation to financial sanctions in the United Kingdom regulatory regime.

1. What are financial sanctions?

Financial sanctions are measures implemented 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 asset 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.

Generally, asset freezing involves prohibitions or restrictions to:

1. Dealing with funds or economic resources owned, held or controlled, directly or indirectly, by a person subject to sanctions.
2. Making funds or economic resources available, directly or indirectly, to or for the benefit of, a person subject to sanctions.

Individuals and entities in possession or control of these assets are required to “freeze” them. This may apply, for example, not only to funds held in bank accounts, but also funds which may be transiting the international banking system.

2. Points to consider by financial institutions
3. Be aware of your reporting obligations

A person is obliged to make a report to the UK’s Office for Financial Sanctions Implementation (OFSI) if any of the following applies: a) knowledge a suspicion that an individual or entity is a “designated person” or b) knowledge a suspicion that a breach of financial sanctions has occurred. If a designated person is a customer and the institution holds frozen assets for them, their nature and amount or quantity needs to be reported. The reporting obligation arises if the knowledge or suspicion arises in the course of business.[1] Note that the Financial Conduct Authority (FCA) should also be notified.[2]

OFSI can request a person to provide information for the purpose of monitoring compliance or detecting evasion of sanctions regulations, or for detecting or obtaining evidence of the commission of an offence, among others.[3] HM Treasury (of which OFSI forms part) also periodically requests persons that hold frozen assets to provide a report with the detail of such assets, in order to carry out its annual frozen asset review.[4]

2. Be careful with 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.[5] It is also prohibited to process a Sterling payment to these persons or entities. A number of Russian banks have been designated under these regulations.

Moreover, correspondent banks, especially in complex transactions that involve a chain of corresponding banking relationships, could be at risk of facilitating illicit payments.[6] It is a good practice for correspondent banks to collect information about the respondent bank’s procedures in relation to sanctions screening and identification and management of Politically Exposed Persons (“PEPs”), among others.[7]

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.[8] Trust services include the creation, operation or management of a trust or similar arrangement and the provision of a registered office, business address, correspondence address or administrative address for a trust or similar arrangement, among others.

Trust services are provided for the benefit of a person where:

1. That person is beneficiary of a trust or similar arrangement,
2. That person is referred to as a potential beneficiary in a document from the settlor relating to a trust or similar arrangement, or
3. Having regard to all circumstances, that person might reasonably be expected to obtain, or to be able to obtain, a significant financial benefit from the trust or similar arrangement.

Financial and other institutions that provide these types of services should carefully consider this recent change. The FCDO recently updated the UK sanctions list to extend the prohibitions against subject persons designated under the Russia sanctions regime to also include trust services sanctions.[9] A General License has also been granted for the wind down of trust services provided to designated persons.[10]

4. Be aware of foreign sanctions regimes

Although there is a certain amount of policy coordination between regulations in many nations, different countries may have divergent sanctions policies and rules. Foreign regimes may also have extraterritorial application or diverse approaches as to whether persons or transactions have a “nexus” with their jurisdictions. Hence, an institution’s internal compliance policies should be tailored to consider not only the sanctions provisions in those countries where it conducts business, but also any other countries which ‘may be relevant’ to that business.

In particular, note that US sanctions may have extraterritorial effect, affecting companies around the world. In some cases, countries have established mechanisms to counter the effects of US secondary sanctions, such as the EU Blocking Statute and the retained Blocking Regulation in the UK.[11]

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 that a defence is no longer available where the person or entity who committed the breach did not know, or had no 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.[12]

The Economic Crime Act also allows OFSI to publish the name of persons that have breached financial sanctions, even if a monetary penalty has not been imposed against them.

3. Tips to avoid breaching sanctions

1. Review the tools and resources provided by OFSI and the FCA, in relation to sanctions:
2. OFSI provides extensive guidance and alerts to help with compliance responsibilities. Businesses should regularly check that compliance screening procedures and platforms are up to date with the UK sanctions lists and the list of financial sanctions targets.[13] For cases that may be less obvious, it may be worthwhile to use the OFSI’s Financial Sanctions Search (which has a “fuzzy search” tool)[14]  and to subscribe to the UK Treasury’s e-alerts (which alerts subscribers when there is a change to existing financial sanctions).[15]

However, be aware that some persons or entities may be subject to sanctions restrictions despite not being included in these lists, such as persons connected with a particular country (for instance, Russia), an entity owned or controlled directly or indirectly by a designated person, specified groups (such as groups of persons connected to a specific country in a certain way) and entire sectors of the economy of a country or specified activities in relation to a particular country.

2. Chapter 7 of the Financial Crime Guide (“FCG”)[16] 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 nature, size and risk of 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.[17] Good practices include screening potential sanctions-matches at several key stages of a transaction and adequately focussing sanctions resources by considering and analysing previous sanctions alerts.

2. Institutions should retain evidence to show that the rules are being followed and implementation of good practices in relation to sanctions compliance. Having proof of procedures, decisions and actions in relation to sanctions compliance, including risk assessment, could be very helpful. 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 contracts with clients, customers and suppliers, in order to regulate the risk of sanctions being imposed on them, and to have more control of the consequences if they were to become sanctioned. For instance, a provision might be included to allow termination of the contract should the counterparty (or its shareholders or subsidiaries) become a designated person or otherwise subject to sanctions, or contravenes any sanctions, and suspend any contractual obligation (including payments) in that case. Consequences of the termination or suspension should also be considered. A broader provision might be incorporated to safeguard the position in case continuing a contract with the counterparty could expose the institution to a risk of being sanctioned. These clauses could considerably reduce the scope of potential disputes in the future.

It is advisable to define the term “sanctions” and “sanctions authority” – does it only include sanctions imposed by the UK? Or is it intended to cover sanctions imposed by other jurisdictions such as the United States, the European Union, any relevant country where business is conducted or that is relevant to the institution’s business, or the United Nations? Further, contracts could include an express representation that the counterparty is not subject to sanctions.

4. What are the consequences of not complying with sanctions regulations?

A sanctions breach could lead to fines, restrictions and even criminal liability punished with imprisonment, as well as reputational damage. A person could commit a criminal offence by breaching sanctions rules if it knows, or has a reasonable cause to suspect, that the relevant transaction or activity is prohibited. As noted, for financial penalties, there is no defence available. Even where no prosecution is taken, the real “name and shame” procedure of a Disclosure by OFSI concerning an institution may cause reputational damage.

Enforcement of UK sanctions has become tougher in recent times. In 2021 to 2022, OFSI considered 147 reports of suspected financial sanctions breaches, which is slightly more than the period from 2020 to 2021.[18] Between the beginning and the end of 2022, OFSI has doubled its number of staff.[19]

Further, 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.[20] The FCA can impose restrictions and/or take enforcement action when it detects deficiencies in the financial crime systems and controls.[21]

The FCA has also called for persons and entities to self-report sanctions evasion issues, or those from another financial firm or individual.[22] The FCA is particularly interested in suggestions that firms have poor sanctions controls and suspected and actual breaches of the sanctions regime, and maintains a whistleblowing team.[23]

5. Conclusion

It is important to keep up-to-date with the continuous changes in international sanctions provisions. Banks and financial institutions should ensure that their systems and processes are updated in accordance with the fast-moving sanctions developments. 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.