U.S., Allies Impose Further Sanctions, New Export Controls on Russia as Military Advances

In response to Russian President Vladimir Putin's continued war operations in Ukraine and military attacks throughout the country, the U.S. government and its allies took "unprecedented" actions to impose severe additional sanctions and new export control restrictions in the past week, specifically targeting Russian financial institutions, Russian elites, Russian state-owned enterprises and several of Russia's critical industrial sectors. These actions follow those imposed on Feb. 22, 2022, which included prohibitions on dealing with the two breakaway regions in Donbas. (See Holland & Knight's previous alert, "U.S. Announces Sanctions in Response to Putin's Action in Ukraine," Feb. 22, 2022.)

President Joe Biden explained that the new measures are designed to "impose severe costs on the Russian economy" to "maximize the long-term impact on Russia" and minimize the impact on the United States and its allies. The U.S. is targeting the core infrastructure of the Russian financial system, including sanctions against Russia's largest financial institutions, restricting the ability of the government of the Russian Federation to raise capital, and cutting it off from access to critical technologies.

New Sanctions from the U.S. Department of the Treasury's Office of Foreign Assets Control (OFAC)

As part of the new tranche of sanctions since Feb. 23, 2022, OFAC announced a series of designations to the Specially Designated Nationals and Blocked Persons List (SDN List), most notably, designating President Putin and Sergei Lavrov, the Minister of Foreign Affairs of Russia; issued new sectoral sanctions; and announced new restrictions specific to certain financial institutions and state-owned enterprises.

Banking and Financial Institutions. In its effort to hinder the Russian banking industry, new sanctions on banks and financial institutions capture approximately 80 percent of all banking assets in Russia.

OFAC designated several Russian banks as SDNs:

• Vnesheconombank (VEB) and Promsvyazbank (PSB) and 42 of their subsidiaries
• Otkritie, Sovcombank and Novikombank (and their subsidiaries worldwide), and
• VTB Bank PJSC (VTB), Russia's second-largest bank, and 20 of its subsidiaries

U.S. persons, including U.S. financial institutions, are generally prohibited from engaging in any transactions with SDNs and are required to block (i.e., freeze) any property or interests in property belonging to SDNs that are or come in U.S. possession. Additionally, under OFAC's 50 percent ownership rule, entities that are owned 50 percent or more, directly or indirectly, by one or more SDNs are also subject to OFAC's sanctions, even if OFAC does not specifically list those entities as SDNs. U.S. persons, therefore, need to conduct due diligence into foreign counterparties to ensure they are not owned 50 percent or more by SDNs.

In addition to the prohibitions applicable to U.S. persons described above, non-U.S. persons may be exposed to secondary sanctions risk, i.e., non-U.S. persons could be designated for property-blocking sanctions in relation to certain activities related to persons subject to property-blocking sanctions under Executive Order (E.O.) 14024. Activities subject to secondary sanctions risk include assisting, sponsoring or providing financial, material or technological support for, or goods or services to or in support of persons blocked pursuant to the Executive Order. Importantly, all of the blocking sanctions issued in connection to Russia's invasion of Ukraine were taken pursuant to E.O. 14024.

OFAC issued a number of general licenses related to the designated entities described above, including 30-day wind-down periods for most of the above banks. OFAC issued general licenses allowing certain energy transactions payments, through June, 24, 2022, with VEB, VTB, Otkritie and Sovcombank, as well as general licenses related to specific bonds, debt and for transactions related to agricultural commodities, medicine and medical equipment exported to Russia.

Correspondent and Payable-Through Account Restrictions. Separately from the SDN designations, Sberbank, Russia's largest bank, and a bank involved in many international transactions was targeted with sanctions (along with 25 of its subsidiaries). These sanctions, issued under new OFAC Directive 2 under E.O. 14024, will require U.S. banks, by March 26, 2022, to sever correspondent and payable through accounts with Sberbank and reject future transactions involving Sberbank. Its assets are not blocked or frozen, but effectively it will be cut-off from being able to wire or otherwise engage in U.S. dollar transactions.

SWIFT. On Feb. 26, 2022, the White House, along with the European Commission, France, Germany, Italy, the United Kingdom and Canada, announced that they will commit to ensuring that selected Russian banks are removed from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) messaging system to ensure that these banks are disconnected from the international financial system and harm their ability to operate globally. On Feb. 27, Japan announced it will also join this measure.

Russia Foreign Reserves. The White House and allied nations also announced restrictive measures that will prevent the Central Bank of Russia from deploying its international reserves (estimated at approximately $650 billion) in ways that undermine the impact of the sanctions. On Feb. 28, 2022, OFAC implemented new restrictions with respect to the Central Bank and published Directive 4 under E.O. 14024, which generally prohibits any transaction involving the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation or the Ministry of Finance of the Russian Federation, including any transfer of assets to such entities or any foreign exchange transaction for or on behalf of such entities.

Sovereign Debt. Under new OFAC Directive 3 under E.O. 14024, OFAC imposed new sectoral sanctions prohibiting U.S. persons from providing new debt or equity to a number of Russian state-owned entities including Sberbank, Gazprombank, Russian Agricultural Bank, Gazprom, Transneft, Rostelecom, RushHydro, Alrosa, Sovcomflot, Russian Railways, Alfa-Bank and Credit Bank of Moscow. While generally "new debt" means a loan or other extension of credit, OFAC takes the position that payment terms, or allowing an entity to not pay for the relevant period (14 or 30 days depending on the entity) would constitute "new debt" and require an OFAC license. This measure will impede the ability of these entities to operate and invest in their respective business sectors (for example, the designation of Alrosa, a global player in diamond exploration, mining, sales of rough diamonds and diamond manufacturing, will have an impact on the diamond sector).

Senior Russian Officials, Russian Elite and Family Members. In addition to sanctioning the above entities, OFAC sanctioned President Putin and Minister of Foreign Affairs Sergei Lavrov, as well as other members of Russia's Security Council, and family members of individuals in Putin's inner circle. The list includes high-level government officials, senior officials of some of the designated banks and their family members.

Energy, Maritime and Sovereign Debt. Other OFAC measures implemented in response to the Russian invasion of Ukraine include:

• Designation of Nord Stream 2 AG and Matthias Warnig as SDNs, with a short wind-down period ending March 2, 2022, as outlined in General License 4
• Designation of five Russian-flagged oil tankers and container ships owned by PSB as SDNs
• Expansion of existing sovereign debt restrictions imposed by Directive 1A under E.O. 14024. Specifically, the action prohibits U.S. financial institutions from participating in the secondary market for bonds issued by the Central Bank of Russia, the National Wealth Fund of Russia or the Ministry of Finance of Russia after March 1, 2022. (Prior restrictions only applied to the primary market, as well as lending restrictions).

As discussed above, a number of state-owned enterprises, such as Gazprom and Transneft, are prohibited from issuing new debt in the U.S., which will also affect their ability to invest in the energy sector. Of importance, however, is that certain energy payments are authorized until June 24, 2022, to alleviate some of the impact the sanctions will have globally.

The maritime industry could be another sector seriously affected by the designations. It is likely there are hundreds, to maybe thousands, of cargoes on order, now awaiting loading or in transit aboard vessels that are being financed with documentary letters of credit (DLCs) issued, confirmed or advised by sanctioned financial institutions for the benefit of exporter sellers. In other instances the beneficiary of the DLC, or the applicant (i.e., the issuer's customer) may be sanctioned entities.  Even on cargoes not financed by DLCs, the bills of lading and dock receipts or other negotiable instruments and non-negotiable sea waybills issued by the ocean carriers for all sorts of shipments might present a problem when goods arrive and have to be released to consignees at destination. The normal transactions for a negotiable bill of lading include transfers of title by endorsement, as well as surrender to the carrier or a financing bank at destination. It may be that if a transport document has a sanctioned party as the shipper or consignee, or even notify party, or the shipper, consignee or notify party is shown as being an agent for a sanctioned party, the routine endorsement or surrender of the instrument could be affected by sanctions. Additionally, if any intermediary (e.g., a forwarder or non-vessel operating common carrier) is involved, they may be affected. There might also be complicated situations such as where a vessel is arriving at a U.S. port to discharge or load cargo, and then proceeding to another foreign port, if the vessel has cargo remaining on board (CROB) that is reported on its Automated Manifest filing with U.S. Customs and Border Protection, if the CROB is associated with a sanctioned entity. There are reports of a Russian cargo ship that was seized in the English Channel because it was suspected of belonging to a Russian company that is currently on a sanctions list by the EU¹ and this is likely to become more common.

New Export Control Restrictions from the U.S. Department of Commerce Bureau of Industry and Security (BIS)

Separately, on Feb. 24, 2022, BIS issued a fact sheet and pre-publication version of a new rule (the Rule) effective Feb. 24. This rule significantly limits exports of sophisticated goods, software and technology to Russia affecting, in the words of President Biden, Russia's ability to develop its aerospace and defense sectors and compete globally.

High-Tech Exports Will Require a License, with a Policy of Denial. BIS will require a license, with a policy of denial, for the export, reexport or transfer (in-country) of products, software and technology controlled on the Commerce Control List (CCL) in Categories 3-9 to Russia (15 C.F.R. § 746.8(a)(1)). Certain of these items, in 58 Export Control Classification Numbers (ECCNs) with unilateral controls, were not previously controlled to Russia and include microelectronics, telecommunications items, sensors, navigation equipment, avionics, marine equipment and aircraft components. BIS restrictions are calculated to significantly impact Russia's ability to acquire items it cannot produce itself. The rule provides for certain limited exceptions, which will be reviewed on a case-by-case basis. The scope of these exceptions includes flight safety, maritime safety, humanitarian needs, government space cooperation, civil telecommunications infrastructure, government-to-government activities and support of limited operations of partner country companies in Russia.

Significant Restrictions on the Use of Export Administration Regulations (EAR) License Exceptions for Russia Exports, Reexports, and Transfers (In-Country). BIS also significantly restricted the availability of license exceptions for Russia exports, reexports and transfers (in-country). Under 15 C.F.R. § 746.8(c), only limited license exception provisions remain available for exports, reexports or transfers under § 746(a)(1), including among others: License Exception TMP (temporary imports) for items for use by the news media; License Exception TSU (technology and software unrestricted) for software updates for civil end users that are subsidiaries or joint ventures of U.S. companies or companies of allied countries in the EAR's Country Groups A:5 or A:6; License Exception ENC (encryption commodities), but excluding Russian government end users and Russian state-owned enterprises; and License Exception CCD (consumer communication devices), which previously was limited to Cuba, and which now authorizes exports and reexports to Russia of certain consumer communications devices and software to and for the use of individuals and independent nongovernmental organizations in Russia.

Near Total Embargo of U.S. Items to Russian Military under Expanded Military End Use/End-User Rule (MEU). The Rule expands the MEU rule to apply to all items subject to the EAR (items located in the U.S., U.S.-origin items located anywhere and foreign manufactured items containing above a de minimis U.S.-origin controlled content). This essentially prohibits exports of any item subject to the EAR to such entities. The only exceptions are for food and medicine designated as EAR99; and certain mass-market encryption commodities and software classified as ECCN 5A992.c or 5D992.c, provided that they are not for Russian government end users or Russian state-owned enterprises. BIS also added a number of Russian aviation, shipbuilding and other industrial base entities to the MEU list and Entity List, and transferred 45 Russian entities that were previously listed on the MEU List to the Entity List.

Significant Expansion of Foreign Direct Product Rule. BIS established two new foreign direct product (FDP) rules with respect to Russia under 15 C.F.R. § 734.9 of the EAR, which will impact a large number of foreign-made products. These new rules will significantly limit Russia's access to foreign-made products that are the direct product of U.S. software or technology, or the direct product of plants or major components of plants that are themselves the direct product of U.S. software or technology. Thus, foreign-made products that are produced with or incorporate U.S. technology or software will become subject to the EAR and would require a U.S. export license to ship to Russia.

Expanded and Revised Restrictions on Crimea to Cover Donetsk and Luhansk Regions. The Rule expanded 15 C.F.R. § 746.6 to cover these regions and prohibit the export or reexport of items subject to the EAR, except food, medicine and certain software for personal communications.

Partner Country Exclusion from Russia and Russia-MEU FDP rules. Certain partner countries that are adopting or have expressed intent to adopt substantially similar measures are not or will not be subject to the Russia and Russia-MEU FDP rules. Exports, reexports and transfers (in-country) from the following countries are not subject to these rules: Australia, Austria, Belgium, Bulgaria, Canada, Croatia, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Japan, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, New Zealand, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the United Kingdom.

In President Biden's address to the nation on Feb. 24, 2022, he noted that restrictions on Russia's imports of key technology, including semiconductors, would squeeze its "access to finance and technology for strategic areas of its economy and degrade its industrial capacity for years to come." He said the sanctions would hurt Russia's ability to modernize its military, its aerospace industry, and its space program and would be a "major hit to Putin's long-term strategic ambitions." The far-reaching sanctions and export controls described above will impact a range of U.S. and non-U.S. businesses with customers, suppliers, partners, vendors and other business dealings in Russia.

Several notable implications for technology-focused companies include:

• For U.S. companies that export products, software or technology to Russia that are controlled on the CCL in Categories 3–9, a license is now required to any entity in Russia. BIS estimates that these new controls will result in an additional 350 license applications being submitted to BIS annually. Notably, the new restrictions exclude deemed exports and deemed reexports. This means that companies that employ Russian national employees in the United States would not have the same licensing requirement under the new rule for sharing controlled technology with such employees that would be required for exports of the same technology to Russia.
• The software and technology covered by the Russia FDP rule includes that which is specified in any ECCN in product groups D (software) and E (technology) in Categories 3-9 of the CCL. This includes a broad array of software and technology, which will result in many more foreign-made products being subject to U.S. export control jurisdiction. BIS explained the concept of "destination" is used to address situations involving multistep manufacturing processes that occur in more than one country and in which the parties involved have "knowledge" that the foreign-produced item being produced will ultimately be reexported or exported from abroad to Russia. BIS estimates new license requirements under the Russia FDP rule will result in an additional 2,000 license applications being submitted to BIS annually.

The BIS Rule will also have a direct impact on aviation with many yet to be answered questions on flying U.S.-origin aircraft out of and back to Russia, supplying repair parts, temporary sojourns and other matters affecting safely operating aircraft.

Coordination with Allies

For weeks, the Biden Administration has been stressing that actions taken against Russia would be taken in coordination with U.S. allies to maximize the intended effect. Over the past week, such coordination has been on display.

• The European Union (EU) froze President Putin's and Russian Foreign Minister Lavrov's European assets; sanctioned 351 members of the Russian State Duma (and further restrictions are expected); has agreed to implement sanctions on Russia's financial, energy and transport sectors, and visa policy; committed to restricting Russia's access to SWIFT; closed its airspace to Russian aircraft; banned Russian media outlets Russia Today and Sputnik; and plans to institute increased export controls and an export financing ban.
• Germany halted certification of the Nord Stream 2 pipeline, meaning it cannot commence operations. Germany also announced that it would be sending Ukraine 1,000 anti-tank weapons and 500 stinger missiles, representing a total shift in the country's arms export policy.
• Australia announced sanctions that will target more than 300 Russian government officials; barred several top Russian banks from transacting with Australian financial institutions; and extended current Crimea-related sanctions to include the Donetsk and Luhansk regions.
• Canada canceled all export permits to Russia; banned new transactions in Russian sovereign debt; sanctioned more than 400 entities and individuals (including many of the banks targeted by U.S. sanctions); and announced that it will impose sanctions on President Putin and supports removing Russia's access to SWIFT.
• Japan prohibited the issuance of Russian bonds, freezing several Russian individuals' assets, committed to restricting Russia's access to SWIFT, and restricted travel into the country.
• The United Kingdom sanctioned all of Russia's major banks, and more than 100 individuals, entities and subsidiaries; agreed to prohibit flights by Russian airline Aeroflot from landing in the U.K.; suspended all dual-use export licenses to Russia from the U.K.; closed its airspace to Russian aircraft; and announced that it will impose sanctions on President Putin.
• Turkey recognized the Russian invasion as "war" and announced it will apply the 1936 Montreux Convention that regulates naval passage through the Bosporus and the Dardanelles straits. This allows Turkey to block passage to warships of a belligerent state unless the ship is returning to its naval base in the Black Sea.²
• At least two of China's biggest state-owned banks announced that they will not support transactions with Russia.³
• Switzerland announced that it is freezing Russian assets and adopting the EU's sanctions on Russia, setting aside its tradition of neutrality.
• Two non-NATO countries, Finland and Sweden, attended a NATO leaders summit, prompting threats from Russia. In addition, Sweden announced that it was sending substantial funding and weapons directly to Ukraine's military.
• Israel indicated it would vote in favor of a United Nations resolution condemning Russia's invasion of Ukraine, a shift in policy for the country, which until now has maintained good relations with Russia and Ukraine.

Takeaways

As the sanctions and restrictions outlined in this alert come into effect, and additional sanctions are announced and implemented worldwide, U.S. entities should anticipate any business with Russian entities will be increasingly limited. It is expected that even if a transaction is not subject to sanctions, major financial and insurance institutions may decide not to support it. Now is the time to conduct thorough diligence of all operations and counterparties to determine where Russian touchpoints exist and take steps to address those points by halting certain operations, winding down within the specified periods, or considering alternative or backup operations in the face of additional sanctions that are being announced hourly.

Holland & Knight continues to closely follow developments in this area and assess impact on U.S. and non-U.S. businesses operating in Eastern Europe generally and the Russian Federation and Ukraine specifically. Reach out to the authors or another member of the firm's International Trade Group to understand impact on your business.

Notes

¹ See Russian cargo ship seized in the English Channel, CNBC.com, Feb. 26, 2022.

² See Russia-Ukraine News, CNN.com, Feb. 27, 2022.

³ See China State Banks Restrict Financing for Russian Commodities, Bloomberg.com, Feb. 25, 2022.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.