Lynn Strongin Dodds looks at what some firms are doing to help financial institutions stay on the sanctions roadmap
Navigating the world of sanctions is never easy and the financial services industry is no exception. However, a new handbook – ‘Compliance: Guide to Sanctioned Securities,‘ from BIGTXN, Dow Jones Risk & Compliance, Baker McKenzie, and the Association of Certified Sanctions Specialists (ACSS), aim to help it unravel the complexity.
A new handbook
The handbook addresses the specific challenges faced by financial institutions in ensuring regulatory compliance and is tailored to compliance professionals in investment banks, hedge funds, asset managers, and related sectors. Based on case studies and data, it offers actionable insights and a best practice guide.
The handbook also notes that although sanctions are far from new – the US has placed restrictions on Cuba and North Korea – for years, the ones against Russia are much more complex. This is because the country is more closely integrated into the global economy with many Russian companies and individuals having close connections to western markets.
Government recommendations
It is not of course the only tool on the market and law firms have released a steady stream of information on the latest regulatory changes and recommendations on how to comply. Governments have also been busy and this month saw the US departments of state, treasury, commerce and labour issued advice for financial institutions as well as other businesses and individuals regarding the range of heightened risks such as sanctions associated with doing business in or engaging in transactions involving the Russian Federation or Russia-occupied territories of Ukraine. The government made it very clear that businesses across the board will face severe civil and criminal penalties if they circumvent or do not adhere to the rules.
The US as well as the UK and European Union imposed sanctions on Russia in the wake of its invasion of Ukraine in 2022. Last September, the UK watchdog, the Financial Conduct Authority (FCA) published a review from its assessment of the sanctions systems and controls in over 90 UK financial services firms across a range of sectors. The aim was to determine whether they were adequate and effective at not only addressing sanctions risk but also appropriately responding to any changes in the country’s regime system.
On the positive side, the FCA identified three examples of good practice such as horizon scanning and scenario planning, sanctions screening systems and tool calibration. Most firms had incorporated “fuzzy logic” into their systems to assist in detecting name variations for sanctioned persons.
However, the list of areas that needed improvement was much longer. It ranged from senior management needing better oversight of sanctions risks to over reliance on third party tools as well as weak know your customer and customer due diligence. The review also uncovered substantial backlogs in the assessment, escalation, and reporting of alerts related to the sanctions screening of names and payments. In addition, some firms had not adequately tailored the calibration of their sanctions screening tools, resulting in the tools being too sensitive and returning high numbers of false positive hits.
Derivatives world
In the derivatives world, specifically, there were and have been different challenges. One of the main concerns in the wake of the sanctions in 2022, was the state of the credit default swap (CDS) market. There were fears that new Russian CDS trades would potentially become illegal while existing CDS trades might be unable to settle following a credit event. Figures from JP Morgan showed at the time, there were approximately $4.5 bn in CDS tied to Russian government debt and another $1.5 bn in derivative indices (https://www.proskauer.com/alert/russian-sanctions-how-will-they-impact-credit-default-swaps).
The initial step was to remove Russia from the CDX.EM index followed by the International Swaps and Derivatives Association (ISDA) publishing its 2022 Russian Sanctions Additional Provisions Protocol. This enabled parties to amend the terms of their outstanding credit derivatives agreements, and exclude CDS contracts that reference sanctioned Russian entities as well as any index that includes the sanctioned Russian entities. It identified these entities as the Russian Federation, including any of its government ministries, agencies or instrumentalities, and Gazprom Public Joint Stock Company (Gazprom).
The trade group also prepared a list of frequently asked questions (FAQs) which covered the sanctions, the requirements, impact and how to assess if the firm or counterparty has been affected.
