On 22 June 2015 the EU announced it was extending the current Russian sanctions until January 2016 at the earliest. Sanctions generally are a key tool to pursue diplomatic goals on a global basis, at least this is how they are used by the EU and the US. These sanctions have been used by the EU to penalise Russia and Russian entities for their perceived involvement in destabilising the Ukraine.
The EU sanctions target Russia's state finances, energy and arms sectors. Russian state banks are now excluded from raising long-term loans in the EU, exports of dual-use equipment for military use in Russia are banned, future EU-Russia arms deals are banned and the EU will not export a wide range of oil industry technology. The financial sanctions could potentially lead to, amongst other things, cutting Russian state banks off completely from any financial and payment transactions with the EU and US. So how do these work?
What sanctions are in place?
There are two types of sanctions – those against designated individuals or entities and country wide sanctions. As to be expected from the name, the countrywide sanctions restrict all US and EU entities from dealings with any nationals or entities in that country and/or entities doing business in those countries.
The Russian sanctions are the former; they apply to certain designated individuals and entities and do not apply geographically across Russia. The upshot of this is that there are still Russian banks that an EU bank could trade with – care just needs to be taken to ensure such Russian banks are not subject to sanctions and consideration given as to the implications if such Russian banks were to be subject to sanctions in the future.
How do sanctions affect EU banks?
Put simply, the sanctions could prohibit EU banks from doing a financial transaction.
More specifically, sanctions can negatively affect EU banks in respect of:
- revenue (particularly for EU banks that historically have a strong customer base in Russia, which may be now subject to sanctions, or EU banks that have relationships with sanctioned banks)
- reputation (as noted above, sanctions are essentially a modern day manner in which nation states can "shun" entities and persons with whose political agendas they do not agree - the reputation of EU banks associated with such entities could be tarnished by association)
- ability of the bank to recover debts (eg. if the customer's accounts and other assets are subject to asset freeze sanctions)
- internal overheads (additional manpower needs to be expended in conducting the relevant due diligence and ensuring KYC/ AML policies are fulsome enough to pick up sanctioned customers)
So how do EU banks comply?
Be up to date (or ensure your KYC/AML department is up to date with) the latest sanctions from both the US and the EU (and any other jurisdiction in which you may trade) or get your lawyers to do it. Each time new sanctions are released, review existing borrowers and fellow syndicate members to ensure you are not caught out.
It's ultimately a question of diligence (and degree of diligence having regard to risk). For example:
- Are your existing or new borrowers on a sanctions list (and if so, what are you restricted from doing in relation to them)?
- Are your existing or new borrowers controlled (directly or indirectly) by a person on a sanctions list (and if so, what are you restricted from doing in relation to them)?
- Are you a member of (and/or an agent in respect of) a syndicate where a syndicate member is on a sanctions list (including as a result of a transfer or potential transfer by a syndicate member of its commitment or participation)?
Expect to do due diligence on the people and entities you are dealing with and where they are based or operate. Expect to do a lot of it. Even then, you are likely to have to "take a view" at some point in the process – if only there was a "white" list.....
Remember, a breach of sanctions can have criminal consequences.
Can you engage with regulators to ensure compliance?
A tricky one, this is a big challenge, particularly in the EU where guidance in documentary form has been extremely tough to procure. Unfortunately a perceived lack of transparency on interpretation of sanctions gives rise to uncertainty and uncertainty breeds the killing of deals.
So how do loan documents deal with the issue?
Assuming the bank can lend to the entity in the first place under applicable sanctions and other laws, such banks will want to ensure its borrowers and fellow lenders don’t inadvertently trip up the bank's ongoing compliance with sanctions. There is no LMA standard language for European loans but the LSTA in the US has some broadly acceptable representation and covenant language which is becoming quite common. In addition to this one thing to watch out for is ensuring you think about the "use of proceeds" language in the purpose clause of the loan agreement.
That said, many banks have their own policies on sanctions and these are required to be in that bank's loan documents – this can make for some interesting discussions on syndicated loans and typically result in adoption of the language from the bank that has the "tightest" sanctions language mandated from on high. Borrowers do try to push back in terms of what the banks are requiring them to do as part of their day to day operations and we have seen some compromise in this regard.
Whilst some sanctions have "grandfathering" provisions (i.e. deals signed and funded before the sanctions came into force) meaning existing deals can be fine, be careful about amending/waiving provisions under them – you could lose your grandfathering rights……take advice.
What about enforcement and recovery of debt?
An interesting question. This is always going to be fact specific and determined on a case by case basis. If there is an asset freeze in place you may not be able to receive proceeds of enforcement - the money could be locked away until sanctions are lifted.
If you are doing new syndicated deals, think laterally about potential future sanctions issues. On the occurrence of certain "bad" events, instead of going for an outright event of default which could cause the full debt to become due, consider instead having a mandatory prepayment event (along the line of the LMA "illegality" clause). This could be is exercisable by each syndicate member individually so that on the occurrence of such event those banks who are able to receive proceeds from a potentially sanctioned obligor can stay "in the game" enabling those who want out (assuming of course that they can get out under applicable sanctions) to do so.
If you have any questions about this article please contact the authors or your usual Fieldfisher contact.
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