Complex compliance: Companies face challenges of Russia sanctions

On 24 February 2024, it is two years since Russia’s full-scale invasion of Ukraine. On that day, the EU is expected to issue its thirteenth package of sanctions. Against this backdrop, we take a critical look at what the sanctions have achieved. The Russia sanctions lack both a long-term plan and flexibility. Accordingly, the collateral damage to EU companies is significant. The EU would be well advised to learn the lessons of the last two years and reach a consensus that bridges Member States’ special interests and eliminates the contradictions and conflicting aims in the sanctions.

Asymmetry and special interests

On the one hand, twelve packages of sanctions have placed financial sanctions on over 1,900 Russian individuals and companies, frozen their assets in the EU, and prohibited any transactions with them. On the other hand, sectors of the EU’s trade with Russia have been incrementally sanctioned by prohibiting exports and imports of goods as well as the provision of services. Taken together, these measures seem to amount to a total embargo of Russia.

EU sanctions aim to have an asymmetrical effect, i.e. to hurt the Russian economy more than the EU’s. It is doubtful whether this aim has always been achieved. For one thing, sectors that could provide significant leverage against Russia – e.g. the nuclear industry, the real estate sector and, for a long time, the diamond trade – have remained untouched. One of the reasons for this is special interests of certain Member States. Because each Member State has a de-facto veto power, it has been impossible to place sanctions on important sources of Russia’s income, and this has seriously undermined the effectiveness of the sanctions. For example, Hungary was able to obtain an exception for a nuclear power plant that is to be built by Rosatom. Similarly, due to Belgium’s efforts, trade in Russian diamonds went untouched for a long time although it would have had a disproportionally strong impact on Russia. It also seems questionable that Russian citizens are not permitted to have deposits of more than EUR 100,000 at any EU financial institution, but are basically free to invest large amounts in European real estate.

On the other hand, substantial bureaucratic requirements and indirect detrimental effects of the sanctions place a heavy burden on European companies. It is doubtful whether the EU has been or is completely aware of the serious consequences for companies of all sizes. Notable examples include documentation obligations in the iron and steel industry and the requirement under the twelfth package of sanctions to include a “No-Russia clause”. This means that for certain exports to non-EU countries, EU companies must contractually prohibit the re-exportation to Russia or for use there. This causes significant administrative work and expense for the companies, as such clauses must typically be added to hundreds of existing contracts. It remains at least questionable whether this requirement can really prevent sanctions circumvention and transfers to Russia, especially in light of the fact that many clauses frequently used in foreign trade contracts already contain obligate parties to comply with EU sanctions. In general, it can be observed that the efforts to enforce sanctions significantly lengthen the list of companies’ due diligence obligations and place a large chunk of the administrative burden on the companies.

These challenges are exacerbated by the fact that compromises on new sanctions packages are often reached at the last minute. This has resulted in deadlines for licenses, for example for withdrawing from Russia, not being extended until two weeks before they expired. One possible argument for this is that it increases the pressure on EU companies to withdraw. However, given how complex exits from Russia already are, companies’ legal departments would rightly frown upon this argument.

Lack of flexibility and guidelines for companies

The sanctions inadequately reflect the complexity of economic reality, as they often prove to be too rigid and sweeping. Welcome changes for companies would be additional licensing options and faster assistance. After all, companies are required to comply with new measures immediately.

The EU Commission and the German federal government routinely issue FAQs to clarify specific questions. While providing essential guidance, the FAQs are often not published until significant measures such as the “No-Russia clause” have long entered into force and companies have already been forced to act.

EU sanctions would better reflect the complex reality if they offered more room for specific licenses. This would make it possible, for example, to diverge from prohibitions on a case-by-case basis. A weighty argument against additional licensing options is based on mistrust among the Member States. It is the Member States that are responsible for implementing the sanctions, and their authorities are responsible for issuing licenses. This gives rise to the concern that some Member States could be lax for the benefit of their domestic economies. On the other hand, some authorities have shown little flexibility and applied excessive standards. The result has been that some activities that serve the purpose of the sanctions have been permitted too late or not at all. One example of this is withdrawing capital and investments from Russia after missing the deadline for import into the EU by just a few days due to the complicated situation in Russia.

Compliance in stormy seas

Considering how broad the EU sanctions have become, implementing them and preventing their circumvention is now increasingly gaining significance.

For example, several investigations by the German attorney general regarding embargo breaches have become public. In Germany, two sanctions enforcement laws expanded investigatory powers as early as in May 2022. But also at the EU level, consensus has been reached on criminalizing sanctions violations in all Member States.

In addition, sanctions regulations are increasingly being used to put pressure on non-EU countries that do not fall under the scope of applicability of the EU sanctions. One example of this was listing citizens of Iran and the United Arab Emirates. The EU has also created an “anti-circumvention tool”, a mechanism to prohibit certain exports to non-EU countries where a risk of diversion to Russia has been ascertained. Although this mechanism has not yet been used, the EU seems to be heading towards extraterritorial sanctions, which claim applicability even beyond the traditional territorial scope of application of EU sanctions, for example to non-EU countries and their citizens. Up to now, sanctions with extraterritorial effect have come primarily from the USA and have often been met with loud criticism from the EU. The fact that the EU is now singing a similar tune only illustrates how difficult it is to counter sanctions circumvention and how effective secondary sanctions are.

The erratic course of the EU sanctions and their inconsistencies will continue to pose substantial challenges to companies. EU companies are exposed to unprecedented regulatory uncertainty arising from legal uncertainty, a lack of interpretation aids and a lack of licensing options coupled with increasing investigatory pressure and efforts to expand the territorial scope of EU sanctions. Companies therefore often resort to overcompliance with sanctions. They miss out on potential room for manoeuvre for fear of a presumed sanctions breach and damage to their reputation. This has given the EU sanctions a previously unknown influence over and impact on completely harmless areas. They have taken on a life of their own, and it remains to be seen how far this will carry them. The only thing that is certain is that change in sanctions law will be a constant companion and that legal advice on it will remain crucial.