Intensifying geopolitical tensions and the US government’s focus on enforcing sanctions and export controls are reshaping how debt markets approach complying with these regimes.
Banks, lenders and borrowers have been cognizant of the risks of non-compliance with sanctions and export controls since the early 2010s when several banks incurred sizable fines for violating US sanctions.
However, during the past 24 months, the US government has raised the stakes. The Biden administration has expanded the US sanctions and export control regimes, and authorities have adopted a more comprehensive approach to the enforcement of export controls.
Expansion of US sanctions
On April 24, 2024, the US government passed legislation extending the statute of limitations for violations of certain sanctions administered by the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) from five to ten years. It will apply the new statute of limitations to any violations occurring after April 24, 2019, based on guidance issued by OFAC on July 22, 2024.
Additionally, on June 12, 2024, OFAC expanded the basis upon which the US government can impose “secondary sanctions” on foreign financial institutions (FFIs) that are engaged in services or transactions beyond the US’ jurisdiction to include certain sanctioned persons, particularly those involving Russia’s military-industrial base. The sanctions that can be imposed on FFIs include restrictions or prohibitions on correspondent and payable-through accounts, up to blocking (i.e., “asset freeze”) measures.
This expansion of US sanctions among other measures issued during the past several years (in particular, targeting Russia in connection with the conflict in Ukraine) have significantly heightened compliance risks.
Export control risks intensify
The large fines incurred by some banks in the US during the early 2010s have made sanctions compliance a key gating issue in borrower due diligence. Recently, the focus has expanded to US export control compliance due to changes in the US government’s policies and enforcement approach.
Although complementary to sanctions—which generally prohibit certain types of activities and conduct involving the US or US persons with sanctioned countries and persons—export controls generally target the movement of items (such as commodities, software or technology) rather than the activities of persons. Export controls typically restrict where items are going, what they are being used for and who is using them.
Historically, export control compliance was largely viewed as an issue affecting entities engaged in exports, such as manufacturing and logistics companies, rather than financial institutions, as export control compliance typically requires a technical understanding of the items that financial institutions may not have.
However, during the past two years, US regulators have gradually broadened expectations for compliance to include financial institutions. In June 2022, the US Department of Commerce’s Bureau of Industry and Security (BIS) and the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued a joint alert on Russian and Belarusian export control evasion attempts. This was the first time that FinCEN and BIS, which are responsible for enforcing export controls, jointly issued an alert focused on export control issues. By creating an export control-focused key term for financial institutions to use in filing Suspicious Activity Reports (SARs), US regulators sent a clear message to financial institutions that they now share the burden of monitoring for export control violations.
This shift in burden coincides with BIS’s intensified enforcement of export control violations, including violations of “General Prohibition Ten” (GP10). GP10, which has been a longstanding part of US export control regulations, prohibits anyone from engaging in certain activities, such as financing, with knowledge that a violation of export controls has or will occur with respect to the transaction.
Although GP10 has been in place for a long time, it has been invoked more frequently during the past few years, including when Russian aircraft that have flown in violation of US export controls. Since then, the aircraft have been included on a list of aircraft in violation of US export controls.
Moreover, the US government has widened export control programs for certain jurisdictions to include a broader range of foreign goods, specifically non-US items made using US software or technology.
Collectively, these measures have put export controls under a brighter spotlight than ever before, with the penalties for export-control violations commensurate with those for sanctions breaches.
Increased US government enforcement pressure
In recent years, the US Department of Justice (DOJ) has increased its efforts to enforce criminal violations of US economic sanctions and export controls. One of the most critical developments in this effort was the creation and appointment of the first chief counsel and deputy chief counsel for corporate enforcement in September 2023. As part of their mandate, both attorneys are responsible for coordinating and overseeing the National Security Division (NSD)’s investigation and prosecution of corporate crimes relating to the national security of the US, including criminal violations of US economic sanctions and export controls. Prior to their appointments, in March 2023, US Deputy Attorney General Lisa Monaco announced that NSD would hire more than 25 additional prosecutors to investigate and prosecute sanctions evasion, export control violations and similar economic crimes. Collectively, these efforts signal to the private industry that the DOJ is resolute in its commitment to police sanctions and export controls more robustly and that combatting national security threats will remain a cornerstone of the DOJ’s mission.
The risks for lenders and borrowers that fail to comply with sanctions and export controls can be severe. Fines and penalties vary across sanctions programs, though in most cases, penalties will fall under the International Emergency Economic Powers Act (IEEPA) that was enacted in 1977. The IEEPA provides for a maximum civil penalty not to exceed the greater of US$368,136 (as adjusted for inflation) per violation or an amount that is twice the amount of the transaction that is the basis of the violation for which the penalty is imposed. The latter penalty could end up being very high, particularly if compounded by penalties for violations of other laws such as anti-money laundering regulations, wire fraud and criminal false statements. Criminal violations of IEEPA and the Export Control Reform Act (ECRA) may result in a fine up to US$1 million and/or imprisonment of up to 20 years per violation. Administrative monetary penalties of the ECRA may also reach up to US$364,992 per violation or twice the value of the transaction, whichever is greater.
Banks adapt processes
Banks, lenders and borrowers have had to adapt their syndication and risk assessment processes to account for the changing sanctions and export controls environment.
Lenders and borrowers are conducting extensive due diligence, including closely cross-checking all parties in loan syndicates against restricted party lists. Auditors, agents and legal advisers are scrutinizing internal company compliance procedures and systems even more strictly.
Moving forward, loan documentation is expected to include more detailed covenants and representations and warranties confirming that no part of the loan proceeds provided by lenders will be distributed to, or involve, any country or territory that is the target of any comprehensive sanctions; and that borrowers, their subsidiaries and their respective management teams and employees are not sanctioned persons or otherwise the target of sanctions. Regarding export controls, parties are adopting a pragmatic approach, taking a lighter touch on due diligence for domestically-focused borrowers that do not trade items subject to export controls.
However, borrowers that produce and export restricted items, such as semiconductors or software, will have to navigate more granular, technical due diligence by banks and other lenders. Moreover, borrowers are increasingly expected to disclose whether they are under investigation or have any outstanding disclosures with the US government that could lead to an enforcement action.
As US watchdogs fortify their enforcement efforts and the risks of incurring large fines intensify, banks, lenders and borrowers cannot afford to leave even one stone unturned when it comes to sanctions and export controls.
