By Alessandro Guaiana, Sanctions Compliance Officer, European Investment Bank
November 19, 2022
Since the introduction of trade control laws and regulations in the EU, legislation has addressed trade restrictions to industries selling or purchasing tangible items rather than intangible assets. Funds are the primary asset of financial institutions, and have not had such restrictions.
Consequently, few trade control risk assessments have been conducted. This could also be partly attributed to an underestimation of the risks connected to the increasing complexity and interconnections between trade controls and economic sanctions.
While sectoral economic sanctions intensified and world conflicts disrupted globalization’s progress, the EU responded with legislation devised to prevent the development and accumulation of specific tangible and intangible assets and technologies. These took the form of dual-use regulations and, increasingly, specific regulations: EU regulations 833/2014, 267/2012, and 36/2012 as amended, targeting third countries with economic sanctions.
The EU sanctions regulations often contain cross-references to the EU dual-use regulation. What was directly excluded by the EU dual-use legislation is indirectly imposed through EU sanctions legislation. These cross-references have been inserted since the first sanctions package against the Russian Federation issued in 2014, as a consequence of the Russian invasion of the Ukrainian region of Crimea.
Indeed, the “brokering services” definition of EU regulation 833/2014 included the reference to ”financial services” contrary to the EU dual-use regulation and, secondly, article 4 letter d) was explicitly prohibiting “to provide, directly or indirectly, financing or financial assistance related to the dual-use goods and technology, including in particular grants, loans and export credit insurance, for any sale, supply, transfer or export of such items, or for any provision of related technical assistance to any natural or legal person, entity or body in Russia or for use in Russia…”
Reliance on Client Declarations
To face the new restrictions, based on the experiences gained in implementing EU regulation 267/2012 (economic sanctions against the Islamic Republic of Iran), the primary reaction of financial institutions was to rely on declarations provided by their clients. This approach can result in the liability of the financial institution not being discharged should economic sanctions restrictions be breached.
Further, the European Commission, conscious of the difficulties of EU economic operators in implementing such provisions, issued a guidance note on the implementation of EU regulation 833/2014. In particular, FAQ 2 offers the European Commission’s view on the expectations of the financial institutions that seek to apply article 4. “Banks cannot rely on the sole declaration of their customer that the goods and technology concerned are not covered by restrictive measures, and need to exercise due diligence to comply with the Regulation.”
Even the European Banking Authority has inserted trade controls as an increased risk factor in the latest version of the revised guidelines on ML/TF risk factors. “The goods transacted require export licenses, such as specific export authorizations for dual-use items that are goods, software and technology that can be used for both civilian and military applications.”
Even if the European Commission is not the ultimate ruler over the correct implementation of the European legislation – the European Court of Justice is – financial institutions cannot overlook EU guidance. Even if, ultimately, the purpose of the restrictions is clear, financial institutions generally do not have internal expertise in qualifying tangible/intangible items or technologies as restricted by the dual-use EU regulation.
The operator that is closest to the item/technology is always the operator to which the financing is provided. Therefore, the solution most of the time has been to ask the financed operator to obtain a legal memo to “certify” the qualification of the item/technology.
Now, more than ever, the same principle applies in those jurisdictions targeted by sectoral economic sanctions. More such cases are likely as thematic sanctions and protection of human rights through trade controls and financial sanctions restrictions increase.
The new article 2 of EU Regulation 833/2014 prohibits the provision of financing or financial assistance related to dual-use goods and technology for any sale, supply, transfer or export of those goods and technology, or for the provision of related technical assistance, brokering services or other services, directly or indirectly to any natural or legal person, entity or body in Russia, or for use in Russia.
In practice, any financial institution is directly exposed to the violation – and the consequent liability – of EU sanctions triggered by the financing of dual-use goods. That is why financial institutions should put in place the following steps to minimize the risk of violating the prohibitions on financing certain specific items and technologies.
- Perform a risk assessment of the financial operator activities vis-à-vis trade control restrictions (EU, US or other jurisdictions).
- Once the risk level has been identified, set up processes and controls to mitigate and manage the identified risks.
- Perform training and awareness-raising activities within the financial operation.
- Complete performance reviews, audits, reports and corrective actions.
Further and more detailed information can be found in both the EU Recommendations on internal compliance programs and the US export compliance guidelines
Obligation to Perform Risk-Based Due Diligence
Unlike industrial concerns, financial institutions do not have a common practice of implementing trade control measures. Even if – in principle – financial services as a sole provision are directly exempted from the EU dual-use regulation (see the brokering services definition pursuant to regulation (EU) 2021/821), the increasing complexity and cross-references of the EU economic sanctions regulation to the EU dual-use regulation indicate otherwise.
In short, EU financial institutions are required to perform risk-based due diligence on their operations to prevent the prohibited financing of dual-use items.
Alessandro Guaiana is a member of the ACSS Export Controls Task Force and an Italian qualified lawyer and certified fraud examiner working as a sanction compliance officer at the European Investment Bank in Luxembourg. Alessandro advises on a broad range of sanctions and trade compliance requirements affecting international trade and investments.