French Insider Podcast Ep. 13
Additional Sanctions Against Russia: What Businesses Need to Know
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Listen to the original podcast released May, 2 2022 here:
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In this episode of French Insider, Reid Whitten joins host Julien Banquart to discuss the impact of sanctions imposed against Russia in the wake of the Ukraine invasion. Topics addressed include the current and potential impacts of the sanction regime on companies doing business in or with Russia and Ukraine (including French multinationals), factors businesses should bear in mind as sanctions are announced and implemented, and whether or not the sanctions will be effective against Russia.
Guest:
Reid Whitten is the Managing Partner of Sheppard Mullin's London office, practicing in international trade regulations and investigations. He also shares his time serving clients out of the Washington, D.C. office and is the Leader of the firm's CFIUS Team. In the areas of economic sanctions, export and defense exports, CFIUS, anti-corruption, and tariffs, Reid supports clients in detecting and addressing potential compliance issues, conducting investigations, and defending against enforcement actions. He also advises on U.S. anti-dumping, anti-money laundering, and anti-boycott regulations.
Host:
Julien Blanquart is an International Trade associate in the Government Contracts, Investigations & International Trade Practice Group in Sheppard Mullin's Brussels and London offices. His practice focuses on compliance counseling, training, and investigations in the areas of export controls, economic sanctions, anti-corruption (FCPA and Sapin II), customs, and foreign investment reviews (CFIUS). Julien advises clients on all aspects of European and French competition law, including mergers, cartels, abuse of dominance, as well as State aid across all sectors and industries.
Transcript:
Julien Blanquart:
Bonjour à toutes et à tous et bienvenue dans ce nouvel épisode de notre podcast "The French Insider". Je serai votre hote pour cette épisode. Je m'appelle Julien Blanquart et je suis avocat aux Barreaux de Paris et de Bruxelles et collaborateur au sein du bureau de Bruxelles de Sheppard Mullin. Depuis quelques années, je travaille sur les problématiques ayant trait au contrôle aux exportation (export controls) et les sanctions (aussi bien américaines qu'européennes) et j'assiste nos clients à faire face aux difficultés résultant de ces règles et à répondre aux problématiques qui en résultent dans leurs affaires internationales.
Je serai ravi de continuer cette intervention en Français, mais notre invité aujourd'hui me lancerait probablement quelques regards noirs. Pour cette raison et parce que je tiens à mon travail, je vais basculer en anglais pour entrer dans le vif du sujet!
On today's podcast, we are going to discuss the recent sanctions taken by the US, EU and the UK against Russia, following its invasion of Ukraine and the impact of those new trade restrictions on companies operating with or in Russia and Ukraine. In order to discuss those issues, I am really pleased to welcome my mentor and former professor at the university, Reid Whitten.
Reid is the managing partner of the firm's London office, practicing in international trade regulations and investigations. He shares his time serving clients out of the Washington DC office and specializes in international trade law, all of those US regulations that really sneak outside the borders of the United States to affect international transactions. Thanks for joining, Reid.
To start off, could you please describe some of the sanctions that are currently in place since the beginning of the conflict and maybe tell us the way those sanctions have impacted some of our clients' operations?
Reid Whitten:
Yeah, sure, of course. Thank you very much for taking the time and for doing the interview, Julien. It's good to talk to you in this format. As you know, and as we've been doing work on for the last six, seven weeks, there have been incredibly broad sanctions against Russia. And now we won't call them comprehensive because comprehensive sanctions have a distinct meeting. Those are the sanctions that are imposed on a geographic region. You'd think sanctions against Iran or Cuba, North Korea, Syria. No jurisdiction has put comprehensive sanctions on Russia. That is, no jurisdiction has banned all interaction with Russia but they have done a lot of other things to restrict trade with Russia. The US, the EU and the UK are all generally aligned and they're close enough in the level of their sanctions that we can talk about them as sort of a single set of sanctions.
The major things that they have done are to restrict exports to Russia, to restrict dealings with a number of the biggest Russian banks, including the Central Bank of Russia. We'll talk a little bit more about that, and to target a long list of individuals and companies related to Putin and his efforts to invade Ukraine or support the invasion or the military. Those are the efforts that have been made and those are affecting, I don't know, hundreds of our clients, I think these days. If you think about it, there must be thousands of companies. Just two months ago, Russia was leasing aircraft from Ireland. They were selling oil and gas to Europe. They were financing projects throughout Eastern Europe and in Asia and all of that business was being done more or less lawfully.
And now most of that business is prohibited and it is a shock to the economic system, the global economic system and our clients are all scrambling to figure out what they can and can't do, how they can continue to do their business but also how they can continue to do business without supporting an illegal invasion of Ukraine by Russia.
Julien Blanquart:
Could you be maybe a bit more specific on the additional sanctions that we have been looking at recently taken by the allies basically?
Reid Whitten:
Sure. When a sanction is put on target, there's no actual restriction on the target. The United States puts the sanction on, let's say Sovcombank, a big Russian bank. That designation of Sovcombank as an SDN, does not actually change what Sovcombank can or can't do. The restriction is actually on all US people. No US person may do business with that bank. And what that does is effectively cut that bank off from the US economy because the US person includes US banks. That means that any of those targeted Russian banks not only can't do business with anybody in the US, they also can't use the US dollar.
They more or less are severed from the use of the US dollar because that requires the use of a US correspondent account. Even if that's only sort of a microsecond that it passes through an electronic account, it still has to pass through the United States. The US has jurisdiction there and the US says, "You may not pass your funds through our jurisdiction." And that effectively blocks the use of the US dollar by those banks, which means that they can't do business in so many different international ways because so many currencies are pegged to the US dollar and so many commodities are priced in US dollars, so many contracts are written and priced in US dollars.
Julien Blanquart:
Excellent. And in light of all of what you have described now, what should businesses bear in mind when they look at the news and they see that those sanctions are being discussed or being implemented by the allies?
Reid Whitten:
That's a really good question. What we are recommending to our clients is to check their Russia exposure. Are they doing business in Russia? And what type of business are they doing? We have some companies that are exporting products to Russia. They're simply making an arms’ length agreement to sell products into Russia. Not all of the sales of those products are prohibited but many of the items that are controlled, which are called for dual use reasons, that is they have some civil purpose as well as a potential military or security purpose, those items are controlled and they're controlled at a pretty low level. That is you could have a fairly commercial off the shelf item that has a control on it and now you may no longer send that item to Russia.
Another thing that we're advising them to do for instance in that case, is to also look out for red flags that there are persons trying to evade or avoid the restrictions on Russia. We have one client who is sending some equipment to Russia and the distributor said, "Hey, where's my equipment?" And they said, "Well look, we can't send it to you anymore. There's an export band." And the distributor said, "Could you send it to my operations in Kazakhstan?" A country that shares a very porous border with Russia. And to their credit they said, "Well yes, but you could not re-export it from Kazakhstan to Russia." And the distributor said, "How would you track that?" And he wrote that in an email. And that email is exactly the type of email that the Department of Justice will put in their charging documents. That is considered a red flag and we would not recommend that you respond to that by saying, "Oh yes, here's a bunch of equipment to Kazakhstan," because that person has indicated that it is a possibility that he will re-export that in violation of the US restrictions and EU restrictions on Russia.
Julien Blanquart:
Thanks. You told us that those new sanctions were really affecting the whole industry but would you have any particular industry that has been particularly affected by the sanctions? And do you think of any other to be affected in the near future?
Reid Whitten:
The major industries that are affected, top one is oil and gas. Russia's economy is more or less a second world economy but it's propped up by a very thin veneer of these oligarchs who have all kind of plundered the wealth of the country. And that wealth of the country is largely in carbon based resources. There is a lot of oil and gas extraction. The sanctions on companies that do that extraction, on banks that support that extraction and projects that are related to that and the oligarch individuals who own the companies that do work in oil and gas have really not quite shuttered the oil and gas industry. Certain sales of oil and gas are still being allowed but they have crippled long term projects in that industry.
The other two industries that I can think of are finance, that is the banking sanctions we touched on. It is going to be very difficult to move money in or out and we can talk a little bit about that in a little while, outside of Russia. The financial industry's struggling. I don't think there's going to be a lot of M&A deals or projects financed anytime soon. And the last one's probably space because one of the things that Russia has been cooperative with the West about has been space programs, has been launched and a lot of that work has come under fire.
Oh, I should probably go into one more, which is the aviation industry because my aviation colleagues we're probably jumping up and down going, why not talk about the aviation industry? Russia has taken, I think it's 450 aircraft that are owned or financed by Western parties and they have nationalized them effectively. They said, "Nope, these things stay in Russia." That means that the parties that have leased those aircrafts into Russia, don't have aircraft anymore but they still kind of do and it's unclear whether or not the rent's going to be paid. That means that they're going to turn to their insurers and there's going to be some payout and it's going to be the biggest kerfuffle in the airline industry maybe that it's ever seen because I've seen estimates between one billion and four billion in insurance payouts that may be due. But again, they may be due so there's going to be a heck of a scrap between the insurance companies and the aviation lessors about whether or not the clauses in their contract have been triggered because Russia has effectively nationalized their assets in the country.
Julien Blanquart:
We've been talking about sanctions on Russia since the beginning but are there restrictions that have been put in place on trade with Ukraine now? And can we expect further restrictions against Ukraine to come?
Reid Whitten:
That's a really good question. Yes, there have been some restrictions. And in fact, remember at the top of the podcast, I talked about comprehensive sanctions. There are actually comprehensive sanctions not against all of Ukraine but against certain territories of Ukraine. We have had sanctions against the territory of Crimea, which Russia annexed in 2014, since that time. And to that, we have now added Donetsk and Luhansk regions in the east of the country. They're collectively known as the Donbas bus region. And all of those regions are subject to comprehensive sanctions. That is no US person may do business with parties in those regions.
It is possible that if the Russians, if Putin takes Kyiv and sets up some sort of public government, at least ostensibly run Ukraine, that the US and the EU would sanction that government and kind of all of the territory of Ukraine. That would be a difficult one to do because of the potential increased hardship on an already suffering population of Ukraine. But at the same time, if Russia managed to get the keys to the kingdom, we would want to take away that resource from them so that they couldn't abuse it to get money into Russia. It would be interesting to see how they mold and shape those sanctions but it would very likely be an entire comprehensive sanction against the country of Ukraine.
Julien Blanquart:
We have seen, and you have reminded us, that the US has really coordinated its sanctions efforts with its allies, so the EU and the UK. Are the sanctions adopted by the EU and the UK, similar to the ones adopted by the US? Is there any specificity you can think about that businesses should bear in mind with regards to those sanctions?
Reid Whitten:
That's a good question. By and large, they are all the same. If the company has a specific set of facts, they may be able to see that there's daylight between the sets of sanctions but largely the list of the parties sanctioned, the restrictions on trade with Russia are similar as between the US and the UK and the EU. I think the US and EU have gone beyond the US sanctions, which is not usually the case in a couple of ways. I know that certain encryption products that may be allowed to be exported to Russia from the US are not allowed under UK or EU law. And that the EU and UK have implemented a ban on trade with state owned enterprises. And I don't think the US has that ban and many of the Russian enterprises are state owned. That's a pretty sizable restriction that's not in the US law but O other than that, there's not much daylight between sets of sanctions from the various jurisdictions.
Julien Blanquart:
Thanks, Reid. And maybe now more on the forecasting, how the things could happen and looking forward. Aside from expanding your military action beyond Ukraine, how could Russia retaliate against those sanctions being imposed by the allies?
Reid Whitten:
Russia's options in this are pretty limited. What's interesting to see is that we saw a lot of reports before the invasion into Ukraine about how Russia had built this thing, it was called Fortress Russia, that the country had insulated itself by gathering an enormous amount of foreign currency reserves. But what we saw in actual fact was that the foreign currency reserves that Russia had were not piles of dollars or euros or pounds sitting in the Central Bank of Russia. They were notes in a ledger in the banks, in the US Treasury, in the Bank of England, in the Bank of Europe that said, "Oh, the Central Bank of Russia has the right to this number of pounds or dollars or euros." And as soon, the US, EU and UK put sanctions on the Central Bank of Russia, those notes in those ledgers got a line slashed through them and all of a sudden Russia had zero foreign currency reserves.
And in fact, the US prohibited Russia from paying its bonds, paying interest on its bonds in dollars that it had it in foreign currency reserves, in fact to force its hand, not let it use those foreign currency reserves. It has really shown just how deep the impacts are going to be on Russia and I think that continues. Because the other part of Fortress Russia was that they had stockpiled gold and that's not understanding the fact that companies can't do business with Russia so the sanctions prevent the movement of that gold. If a major world power starts selling a bunch of gold, the gold market is thin. There's not a lot of room there.
And so as soon as you start selling it, the price will crash. You're selling your first ton of gold for whatever the current price is and the next one for a dollar, if you can even sell it. That leaves the gold as almost useless as a hedge against sanctions and their impacts or I suppose Russia could try to borrow against it but imagine, Putin comes to you Julien and he says, "Okay Julien, I need a billion dollars in cash. You give me a billion dollars in cash and you, you Julien, can have the right to $1.2 billion, 20% return in gold that I keep in the Kremlin in Moscow." I'm not sure you're going to take that deal, Julien. I don't know. I think you're pretty financially savvy and I'm not sure anyone else is. And that's really what the problem is here is that Russia has lost international credibility. I don't think it's going to be able to finance much of anything. And this goes to the long term impact.
Right now, Russia's going to feel crippling sanctions because it can't move money or get foreign currency. In the future, and I think this goes on for decades, the cost of doing business in Russia, if there's not a significant change in the nature of the government, is going to increase incredibly. Can you imagine a major oil company starting a project, financing a project, going into Russia now or let's say Putin withdraws as troops, the war ends and Russia tries to get back in the good graces of the international markets. Any party considering a major operation in Russia, financing a major project in Russia is going to have to add a risk premium, a huge amount of extra cost because there's a possibility that Russia does something like this again and becomes a pariah.
You think about it, it'd be like investments in unstable states that might nationalize your assets at any time, you add a risk premium. And the price of that risk of doing business as in Russia is going to be incredibly burdensome and it's going to be that way for years to come, unless and until the Russian government can change. And I don't see how that happens because their Russian government currently is one person.
Julien Blanquart:
Right. Another question Reid, my tech-side of things now takes over. You have told us that the regulations also prohibits persons to evade US sanctions. Do you think that crypto could provide a means for some individuals or persons to evade US sanctions?
Reid Whitten:
We hear this a lot. Oh, people can launder their money through cryptocurrencies and they can bring money out of the country through cryptocurrencies. And that is possible but there are a couple of problems with that theory. One, access to the blockchain and cryptocurrencies is not, crypto evangelists pride themselves on the fact that the system is anonymous and decentralized but there are five ways to get in. You have five companies that'll sell you some crypto and that's how you get it. Those companies are in countries and they are regulated by governments and those companies do what they can to identify the parties who are on their blockchain.
Second, it's not hard to identify wallets. All of this wallet switching and ways of trying to hide it, the FBI's pretty good at following that. And it happens on immutable records that are open to the public. All of the trail that you leave is there and cannot be hidden. I suppose it could be anonymous but once they recognize there's one bad guy's wallet, everything that follows from that is clearly there and it's a trail that's open to anyone to investigate. That's problematic as well. And the size of the transactions it would require would raise red flags and would be easily spotted. I think at the margins, sure, some people will get money out through cryptocurrencies, through buying and selling NFTs, through washing and wallet swapping and other ways of hiding money but not at any scale that would save a world economy.
Julien Blanquart:
Okay. Now, and this is more a theoretical question to end our great discussion, Reid, what makes sanctions effective? How sanctions in the past have been effective and could we expect those sanctions imposed against Russia to be effective?
Reid Whitten:
Now Julien, as you know, from my classes, I would like to have a whiteboard right now. There is a lot of international relations theory on this and it is international relations theory that I bore my students with. But some of the things that make sanctions effective are international unity. If many parties can get together and put the same sanctions on one target, that makes them incredibly powerful. One of the difficulties the EU has had in the past is that it can't get all 27 member states to get together on sanctions and it's much easier for the US to put sanctions on a country because it's a function of the executive branch so it doesn't get mired in US politics as much. But in this case, you've got the UK, the EU and the US all aligned. And that makes for a very powerful, combined effort to put sanctions on Russia.
One of the other things that we discussed though, is how much of an effect can the sanctions have on the party it's targeting? If you're targeting a country and you make life difficult for the population and the government is responsive to that population, then the difficulties of the population become the government's problems. That is they can vote out the person that is causing the problem that you, the sanction sender, don't like. If sanctions are a way of manifesting your national security and foreign policy on other state actors, you can cause pain for the country and the country can then change its leadership. Great. But if there is an autocratic leader that is not responsive to the population, that wins quote unquote, 99% of the vote every election, then you have a harder time. Because even if the Russian population is miserable because of the ruble's collapse and it's difficult to get items in from outside the country, et cetera, et cetera, they the people, may not be able to change the government.
I think a couple years ago, Putin won Russia's sexiest man competition. If he's fixing those elections, he did look good on that horse but I suspect that that was a rigged one as well. And if he's rigging those, then his control of the country's absolute. What's interesting about these sanctions though, is that they are impacting a lot of his inner circle. And I think that that may be the means to effectuate the change. If there are enough of his oligarchs that support him that are tired of having to hide their yachts in the Maldives and not being able to go to Monaco and having their kids kicked out of London because they're sanctioned, then they may effectuate change and push for a change in the leadership or a change in the leadership's policy. And I think that's the idea behind these sanctions. I don't know whether or not it works but I think it gives the sanctions the best chance of being effective in this case.
Julien Blanquart:
All right, Reid, well thank you very much for this great talk. I really appreciate you taking the time to discuss with us on those very topical subjects and that was great. Thanks.
Reid Whitten:
It was my pleasure, Julien. Great interview.
Contact Information:
Reid Whitten: https://www.sheppardmullin.com/rwhitten
Julien Blanquart: https://www.sheppardmullin.com/jblanquart
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