International sanctions pose challenges in the industrial sector

12.4.2021

Recently, the monitoring of sanctions risks, especially in industrial companies, has reared its head. Several fines imposed by OFAC (Office of Foreign Assets Control) in particular have targeted the industrial sector, such as companies active in the chemical, oil and gas industries. International sanctions also have a major impact on the raw materials market. Sanctions against the Venezuelan Government affected the operations of oil companies around the world since their largest oil company is state-owned by Venezuela and is therefore subject to sanctions regimes. US sanctions against the world’s leading aluminium company also caused a major crisis in the global aluminium market in 2018, increasing the price of aluminium by up to 40%.

The management of sanctions risks poses a wide range of challenges as, nowadays, sanctions are increasingly being used as a political tool. International sanctions are constantly updated in response to the political situation in the world, which has recently been somewhat unstable due to the Covid-19 pandemic, the US presidential election and the poisoning of Alexei Navalny. Although sanctions risks are often lumped together with money laundering and terrorist financing risks, it is important to understand that the controls created to prevent money laundering and terrorist financing alone are not sufficient for managing sanctions risks.

The consequences of sanctions violations can be diverse

Sanctions violations may cause reputational damage and serious economic impacts on the activities of companies. For example, adding the world’s leading aluminium company to the sanctions list caused a dramatic plunge in the price of the company’s shares. Nowadays, attention is also increasingly paid to the responsibility of operations, and thus, sanctions violations can have a negative impact on customer and collaboration relationships. In extreme cases, breaches of sanctions can even lead to prison sentences.

Secondary sanctions imposed by the US also cause significant consequences. In the worst-case scenario, a company or a person violating US sanctions may be added to the sanctions list itself, even when it has no link whatsoever to the US. For example, in 2020, a small Finnish logistics company was added to the US sanctions list after conducting business with a Russian company sanctioned by OFAC. Being added to a sanctions list naturally harms or at least hinders the company’s business as the purpose of sanctions is to limit trade and other financial activity with the sanctioned company.

The importance of organising an effective sanctions monitoring process

In our experience, sanctions risks are often managed in the compliance, legal or import and export units in industrial organisations. A background check is carried out for new business partners and suppliers at the beginning of the collaboration to investigate different types of potential risks – such as corruption and bribery risks, credit risk and money laundering risk – related to the business partner. As part of the background check, the counterparty is often also screened against existing sanctions lists. Once a counterparty has been accepted as a business partner, the counterparty’s customer data is periodically checked (for example, once a year), ensuring that the risk rating has not changed. However, it is important to understand that annual sanctions monitoring of counterparties is not sufficient – sanctions monitoring must be continuous and real time.

When planning sanctions monitoring, it is a good idea to consider at least the following:

• In addition to identifying and monitoring suppliers and business partners, it is also necessary to identify their owners and beneficial owners and screen them against sanctions lists. This sometimes poses interpretation issues since, for example, OFAC’s sanctions policy defines entities owned 50% or more by a sanctioned entity or individual as sanctions subjects themselves. According to the European Union definition, a sanctions subject is any entity where the sanctioned entity or individual has the majority ownership or control. Particularly when applying the latter definition, an additional challenge is that it is often not known how much control the sanctioned entity or individual can actually exercise. It is also worth noting that, although a sanctioned entity or individual in the ownership or control structure does not necessarily contaminate the entity, it notably increases the risk scoring of the counterparty since it is possible that it will be added to sanctions lists if the political situation changes.
• It is good practice to also screen contracts and export documentation against sanctions lists to ensure that there are no sanctioned entities in the supply chain. Special attention must be paid to the intended use of goods since several industrial goods are considered dual-use goods which may be used not only for civil and military use but also for weapons of mass destruction, nuclear weapons and the manufacture of explosives or otherwise used for terrorist purposes. The problem may be that product identification as products and components that are classified as dual-use items are not always obvious.
   

Risk-based optimisation pays off

The accuracy of sanctions monitoring not only depends heavily on the company’s operating environment but also depends on its risk appetite, which must be defined in the company’s risk assessments. For example, the ‘fuzzy matching’ method can be used to determine the accuracy with which different spelling variations of names trigger an alert. On one hand, fuzzy matching takes into account situations where, for example, translating the Cyrillic alphabet or Chinese alphabets into the Latin alphabet causes variations in spelling, but the downside is that the lower the accuracy percentage, the more false alerts will be triggered.

It is also advisable to optimise monitoring so that the customer base is always screened against sanctions lists when there is a change in either the sanctions list or the business partner data. It also makes sense to match the scope of sanctions monitoring to the size of the company and other risk factors in accordance with a risk-based approach.

Each company must take into account the sanctions risks in its operations, but it is also important to understand that risks should be controlled in a company-specific manner. The risk classification depends, for example, on the company’s industry and location as well as the location of its business partners. Thus, it is important for every actor in the industrial sector to identify the sanctions risks present in their business by using proportionate controls in order to avoid the unpleasant consequences of sanctions violations.