Financial institutions are grappling with an increasingly complex network of international penalties as geopolitical tensions rise. The stakes for individuals navigating this perilous landscape are higher than ever, as regulators tighten their grip.
These organisations have been thrust into the forefront by the global spike in geopolitical instability over the past ten years. Due to their lack of preparation, many have suffered significant penalties and harm to their reputation. This has put the industry in a war posture, and armies of new specialists have been brought in to help them navigate the increasingly complicated world of international sanctions.
The severity of some of the fines is staggering, and there are signs that they will continue to grow and delve deeper into the complex fields of banking, insurance, trade finance, and investment.
According to Oliver Brifman of Miami-based card payments company eMerchant Authority, the number, scope, and variety of sanctions make this a delicate area.
“The main risks for financial institutions about sanctions are regulatory complexity, third-party risks, geopolitical uncertainty, indirect exposure, and reputational risk,” he said.
The regulatory landscape is complicated, and institutions must carefully manage it to avoid penalties, as there are 5,935 companies and over 11,632 sanctioned individuals throughout the US, EU, Canada, and Australia.
The inefficiency of some sanctions, particularly the ways Russia circumvents the oil price cap, has stung regulators worldwide, even though there are thousands of sanctions in place. However, the renewed determination to tighten sanctions against Russia extends beyond the issue of Russian oil.
The fact that so many manufactured goods from the West are entering Russia through nations that support the Putin administration is raising serious concerns. Banking, insurance, foreign exchange management, and trade finance are all under attack.
Financial institutions can anticipate some challenging questions from regulators as the emphasis shifts from following the oil to following the money.
Sir William Browder, the head of the Global Magnitsky Justice Campaign and a longtime critic of Putin’s Russia, recently criticised the UK Treasury and its Office of Trade Sanctions Implementation (OTSI) for its poor record in prosecuting sanctions breaches.
Global police
Negotiating sanctions against Russia is by no means the only region of the world that poses a complex sanctions challenge, even though it has pushed its way into the daily monitoring of transactions in a variety of financial institutions since Russia’s invasion of Ukraine in February 2022.
The swift development of sanctions and the extraterritorial character of US actions are what make them complicated. Penalties have traditionally been used to isolate governments like Iran in the Middle East, and a new round of penalties is expected to be triggered by the fast-intensifying war between Israel, Iran, Hezbollah, and Hamas.
An illustration of how the sanctions war might confront the harsh realities of military combat is Israel’s October 20 attacks on branches of Al-Qard Al-Hassan, a banking institution that the United States has sanctioned since 2007 due to its ties to Iran and Hezbollah, in Beirut. Even though it is an extreme example, it serves as a reminder of the complexity and interdependence of geopolitical dangers.
As friendly and unfriendly administrations change, the US occasionally imposes and relaxes the strict sanctions it has had against some of its neighbours in Latin America. The United States is also aggressively combating organised crime, particularly the global drug trade.
When HSBC was forced to pay $1.3 billion in 2013 for handling transactions on behalf of clients in Cuba, Iran, Libya, Sudan, and Burma—all of which were on the sanctions list—the bank realised how serious they are about this.
Additionally, according to federal investigators, HSBC assisted in the laundering of around $881 million in narcotics revenues via the US banking system.
China comes next. The sanctions that have already been put in place against China, by the US but also by the EU, are insignificant in comparison to what might befall financial institutions that facilitate trade with China if aggression against Taiwan intensifies or the territorial disputes in the South China Sea become unmanageable.
China has firmly established itself in the global economy as a result of the Chinese government’s resolve under Xi Jinping to make this the Chinese century. The swift imposition of sanctions following Russia’s invasion of Ukraine causes global corporations and their financial backers to shudder. In addition to being harsh and disruptive, it would harm sanctioning nations as much as China.
In response to concerns about the potentially disastrous outcomes of intensifying sanctions wars, David Chmiel, managing director of Global Torchlight, a geopolitical analysis and advisory firm, emphasises the importance of understanding why sanctions are currently the most powerful tool available.
The first is purely geopolitical. According to polling data, people worldwide continue to be extremely hesitant to see military responses to problems involving foreign policy. Take, for instance, the polls conducted in the US, Europe, the UK, and other countries regarding direct engagement with Russia over Ukraine.
Chmiel went on to add that, although globalisation may be unravelling, numerous economic and financial ties still exist. These ties provide governments with tools to exert pressure on other states, particularly when they face demands to act but encounter resistance to using kinetic military force. For this reason, sanctions have recently gained attention.
Currency of trust
“The massive lack of trust is a third factor to consider. The public still has a great deal of mistrust for institutions, whether they be government or industry. Due to the public’s lack of trust in financial institutions during the global financial crisis, there is very little political capital to be lost by imposing sanctions on businesses. Governments can transfer risk and expense to the private sector in foreign policy crises by imposing sanctions,” Chmiel noted.
Unintentionally enabling transactions that breach sanctions is a major concern for financial institutions.
The message is straightforward. Financial institutions are under attack and probably will be for some time to come. The main actor is the Office of Foreign Assets Control (OFAC) of the US Treasury Department, which maintains extensive databases of individuals and firms that are sanctioned and, more importantly, uses extraterritoriality to reach entities outside of the US.
Dennis Shirshikov, the head of growth at the US property management company Gosummer.com, states that many institutions have been caught off guard over the past ten years due to rapid changes in regulations. The complexity of sanctions arises from their extraterritorial nature, meaning they can impact institutions located outside the US as well.
The enormous number of cross-border transactions puts banks and asset managers in particular at risk. As we have seen with major banks in recent years, one of the biggest risks for financial institutions is unintentionally enabling transactions that violate sanctions, which can result in fines of billions of dollars.
“The problem is just as big for insurers, since doing business with sanctioned businesses can result in retroactive fines. As an illustration, consider the $9 billion penalties imposed on BNP Paribas for processing transactions for Iran, Cuba, and Sudan in violation of US sanctions. This illustrates how banks are susceptible to harsh enforcement measures even when they try to operate in third-party nations,” Shirshikov added.
According to Michael Feller, a former Australian diplomat who now advises multinational corporations on geopolitical risks, “All those banks in Europe and the UK who are providing trade finance to Turkish exporters selling into Kazakhstan are on notice, and so they will be having serious talks about de-risking from that exposure.”
However, the broad scope of US sanctions can occasionally be confused with locally imposed sanctions and even conflict with local laws, potentially creating a complex situation for businesses.
Risking criticism
To assist its members in recognising and avoiding such risks, the International Underwriting Association of London (IUA), a trade association for the insurance industry, regularly updates its members.
Director of public policy, Helen Dalziel, said, “I have been working at the IUA for 12 years, and these updates have changed drastically over the last ten years, highlighting the growing exposures insurers face.”
“Every month, we update our members’ sanctions spreadsheet with all the new sanctions. As a result, we closely monitor events, and we have never seen as much activity around sanctions as we do now,” she added.
Getting insurers to look beyond the proximate companies they are insuring, which is what the regulators are now doing, is the largest problem, according to Dalziel.
“All of these financial facilitators aren’t always authorised organisations. The US and UK enforcement agencies understand that they must pursue the funds to try to stop profit from evading sanctions. What effect does that have on insurance? Following the money is not always simple, since insurance is clearly multi-layered and you have complicated reinsurance agreements,” Dalziel added.
“There is a real risk there that we might inadvertently breach sanctions and then find ourselves, as a relatively small insurer, with an existential sort of sum of money that we have got to hand over,” said David Langran, a specialist aviation underwriter at Hive Underwriting in London, who added that this risk is recognised by many firms and is further complicated by the lack of detail when so many new sanctions are imposed in rapid succession, like after the Russian invasion of Ukraine.
Secondly, Langran highlighted the political risk that sanctions pose to his clients, potentially putting them in a difficult position.
“The issuance of sanctions against Russia was hasty and largely generic. You are left to try to understand how they affect us and our clients, since they were not explicit, and they were most definitely not specific to aviation insurance. You wind up wondering what this means and corresponding with the US Treasury, the UK Treasury, or the EU. What does that signify, then? Could you also explain that and this? There is a mismatch, especially when there are several jurisdictions involved, and they are not all imposing the same penalties on the same individuals or organisations,” Langran noted.
“We had a claim for a trading client in Switzerland who, when Belarus was not sanctioned, was doing some metals trades there. But when it came to responding to a claim after Putin’s camping exercise turned into something more serious and sanctions were imposed, we hit problems,” explained Finn McGuirk, political risk underwriter at Mosaic Syndicate Services in London.
“We were making payments to a Swiss customer who had lost money as a result of prepaying for steel that was leaving Belarus. Paying the Swiss client for that loss shouldn’t have presented any problems. However, it was a complete nightmare to get a satisfactory response from the UK authorities that would help persuade the several banks engaged in the money transfer and other activities that everything was legal,” McGuirk added.
Sanctions are divided into two main categories. The prominent one implements asset-freezing policies that impact the distribution of money and other resources to specific organisations or people (designated persons).
Some of these could be rules against giving money to or helping designated people with transactions that aren’t allowed, as well as rules about how designated people can use assets and receive and send money to certain groups of people. There are more than 4,800 people and corporate entities on the UK Treasury’s current list alone.
Then there are trade sanctions. These can be more extensive and forbid the sale of certain products from impacted nations, typically weapons and commodities like gold, diamonds, lumber, and oil; they also forbid the sale of equipment used in the petrochemical, nuclear, or oil and gas industries. This type of trade may prohibit numerous activities, including construction and transportation.
One of the biggest challenges facing any financial institution is monitoring sanctions. While some rely on outside consultants to keep them informed and highlight the warning signs when they may be in danger of violating sanctions, many have grown their own internal compliance teams.
“For banks, insurers, and asset managers, keeping up with frequent changes to sanctions lists and regulations across multiple jurisdictions can overwhelm compliance teams,” Mosaic said.
Frequently, the tools employed are fairly crude. The high percentage of false positives in sanctions screening is a noteworthy problem that leads to time and resource waste as well as increased operating expenses.
Austin Rulfs, a director of the Australian investment and real estate advice business Zanda Wealth, said, “This is especially problematic in cross-border payments, where each institution in the chain might repeat the same screening processes, causing delays and inefficiencies.”
The sanctions’ ever-expanding reach throughout the banking sector is affecting every component of the global financial infrastructure. In 2021, the European Central Bank fined Clearstream, a Luxembourg-based international central securities depository, which is a member of the Deutsche Börse Group, €9 million for handling payments involving sanctioned Russian businesses. Russia and Iran, two of the main targets of sanctions, have been progressively removed from SWIFT, the global payments system.
“Although some of these countries do not have much affinity with Russia, they looked at what was happening in the wake of the war in Ukraine and said, ‘I do not want that to happen to me next time I do something bad in my neighbourhood,’” Feller says, highlighting how some of the BRICS economies have banded together to protect themselves against the impact of sanctions.
This has led to the establishment of parallel payment systems, which he says is one example of the perverse way sanctions can work. Therefore, the solution to being banned from SWIFT is to simply create a new SWIFT and include the most vibrant rising markets in the world.
Crackdown on cryptocurrency
Regulators are closely monitoring cryptocurrencies. As a means of bypassing the US dollar, Chmiel argues, “There have been attempts to start targeting cryptocurrency organisations that were allowing the financing of weapons procurement and terrorist financing.”
US officials have previously targeted Tornado Cash, a company that anonymises normally recorded cryptocurrency transactions. The United States slapped sanctions in 2022 after alleging that these so-called “mixers” were being used to launder bitcoin that had been stolen and illegal money that was being sent to countries like North Korea.
The novel aspect of this was that Tornado Cash successfully generated code that was hosted on multiple cryptocurrency platforms, and the use of the code was authorised. For the first time, software code was sanctioned instead of just placing people or organisations on the sanctions list. It made it possible that, even if it wasn’t immediately apparent, employing the code would violate sanctions.
Maximillian Hess, the principal of Enmetena Advisory and the author of Economic War: Ukraine & the Global Conflict Between Russia and the West, asserts that these service providers are encountering a challenging learning curve.
“We are trying to upskill and implement policies that require, for instance, technology and intellectual property owners to bring in the same kind of compliance departments as banks,” Hess says of the fines now in place.
He observes that other participants in the financial system, such as Euroclear, find themselves in a precarious situation where they must freeze assets from Belarus and Russia due to fear of Russian retaliation. When politicians begin discussing the use of frozen Russian assets to rebuild Ukraine, the problem becomes very delicate.
Unpacking China
China remains a vast and uncertain region. Nobody can predict how Xi Jinping’s ambition to retake Taiwan and his belief that this is the Chinese century would turn out. How the West will respond is a mystery. Without a doubt, the US will set the example, but it will even need to carefully consider the effects that severe sanctions, let alone a military response, would have on both its own and its allies’ economies.
“Since any kind of extensive sanctions on China would have a cascading effect on our own economies, and the fundamental principle of sanctions is that you want to hurt the target more than you harm yourself or your allies, it is difficult to imagine that the US and other nations could take the kind of action we have seen with other nations. If the necessity ever arose, it would be difficult to find a method to do that to a country like China without hurting the economies of the United States and its allies as much as China might,” Smith continued.
It would be irresponsible for any financial institution not evaluate its exposure to China and that of its clients, as the West will not tolerate China’s persistent violations of international law; eventually, it will draw a line. It will happen as quickly and with as much disruption as when the West sanctioned Russia and Belarus in February 2022.