US sanctions on Russia are a compliance task for everyone

The case of ABLV

On 14 February 2018, the US Financial Crimes Enforcement Network (FinCEN) formally accused Latvia’s third-largest lender, ABLV, of money-laundering and of facilitating financial transactions with North Korea. Although its notice was only a “proposed rulemaking … to prohibit the opening or maintaining of a correspondent account in the United States for, or on behalf of, ABLV Bank”, other banks got the message loud and clear and withdrew dollar funding from the Latvian institution.

Because the dollar dominates international transactions, a bank banned from correspondent banking relationships in the US is effectively shut out of the global financial network.

Depositors panicked (rightly) and there was a run on ABLV. On February 24, just 10 days after FinCEN had put ABLV on notice, the Latvian bank was wound up.

The ECB could in theory have propped up ABLV, just as it had supported many European banks struggling with liquidity in the aftermath of the financial crisis, but there wasn’t any point. A bank that cannot get its hands on US dollars is a doomed bank.

This makes any intervention by OFAC the business and responsibility not just of US banks, but of every participant in the global financial system. It also means that the US sanctions on Russia need to be taken seriously by every financial institution.

How is this working out in practice now that fresh waves of economic sanctions have been imposed on Russia and Russian individuals in retaliation for the invasion of Ukraine?

Why transaction monitoring is needed to uphold sanctions

Although the agreement to expel Russia from the SWIFT system of international settlements was reached with surprising speed, it is incomplete as it does not extend to the banks that handle payments for Moscow’s energy exports: Gazprombank and Sberbank, the country’s largest lender.

In other words, the financial blood supply to Russia has not been cut off.

Blocked entities and individuals, as well as money launderers who were using SWIFT to move their funds, are redirecting their efforts to institutions with the weakest compliance – and that is probably the banks in Eastern Europe.

US sanctions on Russia are further complicated by OFAC ramping up its program of sectoral sanctions. These sanctions do not impose blanket prohibitions on blocked entities but are more granular, targeting sector-specific transactions. The Ukraine-related sectoral sections are directed specifically at the Russian energy and financial sectors.

The four directives setting out these sanctions are primarily concerned with limiting the provision of financing through either the issuance of debt or equity to “specified persons operating in the Russian economy”. Directive 4 prohibits the export or re-export of goods, services, and technology that could in any way support the search or production of Russian energy resources for deep-water, Arctic offshore, or shale projects.

It is up to businesses and financial institutions to understand the finer detail of OFAC’s blocking and sectoral sanctions and to put in place systems of compliance that pre-emptively identify transactions that may be prohibited. It is no good being wise after the event because US regulators will not hesitate to hit sanction-busters, even unwitting sanction-busters, with the full force of US law – and, more pertinently, of the US dollar.

Banks know it is naive to assume they cannot be affected just because they do not transact with Russia or with sanctioned individuals directly. Money-launderers are already exploiting the incredible inter-connectedness of the global financial system to move their money around, in the hope that if they do this often enough, or fast enough, nobody will notice.

Finding the path of least resistance

Transactional monitoring is the best tool banks have to detect unusual and perhaps illicit flows of money – and the effectiveness of sanctions depends in part on the strength of compliance technology and practices in place to spot where they are being breached. This is a potential headache even for banks with advanced compliance workflows; processing and flagging thousands of transactions that were previously fine obviously means more work – while the political and moral dimension of the sanctions ramp up the pressure even further.

The Achilles heel is probably Eastern Europe, as we mentioned earlier. The partial ban on SWIFT is forcing “Russian” money to seek transactional paths of least resistance. The US sanctions on Russia will likely see blocked entities targeting banks in nearby jurisdictions where compliance is most vulnerable as they attempt to get round OFAC and other sanctions.

Eastern European banks relying on spreadsheets to monitor transactions are likely to be overwhelmed. It's vital that to avoid the fate of ABLV by failing to ignore the US sanctions on Russia these banks need to update their AML systems. They should act now to automate TM, or appeal to the global financial community to help them build advanced systems of compliance. This cannot happen overnight, but financial sanctions are a long-term weapon.

The hope is that over time sanctions will choke the Russian economy or motivate some of the powerful “blocked entities” to intervene politically. For financial sanctions to work, banks need to know where they are being breached – and to have the expertise and the technology that enables them to know.

This is where transaction monitoring is an important weapon against sanction-busting, and ultimately, against tyranny and war.