Second Shoe Drops on US Chem-Bio Sanctions on Russia: Did Anyone Hear It?

The sanctions follow the President’s Executive Order (EO) 13883, issued August 1, 2019, delegating implementation of CBW Act sanctions to the Secretary of the Treasury.

However, this second round of sanctions is unlikely to affect most US companies doing business in Russia. The sanctions may impact US banks – but only with respect to transactions involving non-ruble bonds and funds of the Russian sovereign issued after August 26, 2019.

The sanctions also make it next to impossible to obtain a license to export items controlled for chemical and biological weapons (CB) reasons on the Commerce Control List to the Russian Government and state-owned companies. But because companies exporting CB controlled items to Russia already needed to get a license (and might have had trouble already in the past for exports to the Russian Government and state owned companies), it is hard to assess the impact.

So companies that export items controlled for CB reasons and banks need to review this alert: the rest of you can go back to lounging at the pool.

1. First Round of Sanctions Issued August 27, 2018

As described in our previous alert of August 10, 2018, the US Administration announced the imposition of sanctions against the Russian Government under the CBW Act, which requires implementation of five initial sanctions. On August 27, 2018, Department of State issued the first round of sanctions under the CBW Act, waiving several of them, as we reported in our August 29, 2018, alert.

The CBW act required additional sanctions unless within three months of the initial round of sanctions the Executive Branch determined and certified that the Russian Government had made certain reassurances, including not using chemical and biological weapons against its own nationals or in violation of international law, not engaging in such activities in the future, and allowing onsite inspections by U.N. observers or other internationally recognized impartial observers. The Administration did not make such a certification last November 2018, which ensured a second round sanctions, and we have been waiting nine months for the other sanctions shoe to drop.

2. Second Round of Sanctions Issued August 2, 2019 – Licensing Policy for CBW Items Affected

The US Administration waited for the dog days of summer to issue its second round of sanctions on the Russian Government. After one year, the sanctions can be lifted if the Executive Branch can certify to Congress that Russia has met the conditions described in the CBW Act set forth above.

The three new sanctions are:

• The US will oppose the extension of any loan or financial or technical assistance to Russia by international financial institutions, such as the World Bank or International Monetary Fund.
• US banks will be prohibited from participating in the primary market for non-ruble denominated bonds issued by the Russian sovereign and lending non-ruble denominated funds to the Russian sovereign.
• Licenses for exports to state-owned or state-funded entities of dual-use chemical and biological items controlled by the Export Administration Regulations will be subject to a “presumption of denial” policy.

A comparison with the export restrictions set forth in the CBW Act is informative. The CBW Act provides that “[t]he authorities of section 4605 of title 50 shall be used to prohibit exports to that country of all other goods and technology (excluding food and other agricultural commodities and products).” To reduce the export sanctions from the broad based export restrictions set forth in the CBW Act, the US Administration “determined that it is essential to U.S. national security interests to partially waive the restrictions on bank loans and exports.”

In addition to limiting export restrictions to CB controlled items, the US State Department also noted that some export license applications will continue to be considered on a case-by-case basis. Specifically:

• Exports for space flight activities, including those involving government space cooperation and commercial space launch;
• Exports needed to ensure the safe operation of commercial passenger aviation;
• Exports to commercial end-users in Russia for civil end-uses;
• Exports to wholly-owned subsidiaries of US and other foreign companies in Russia; and
• Deemed export licenses for Russian nationals working in the United States.

The US Government noted the same categories for case-by-case review for the restrictions imposed in the first round of sanctions relating to items controlled for National Security (NS) on the Commerce Control List. The first two waivers make more sense for NS-controlled items than CB items, which are not as likely to be used in space or aviation.

The US State Department also noted that export licenses issued by the US Commerce Department, Bureau of Industry and Security (BIS) would continue to be available to US companies fulfilling existing contracts with Russian customers. This likely confirms that licenses already issued will not be revoked, and it may even include a case-by-case review policy for new applications relating to an existing contractual obligation. BIS has yet to issue separate guidance on licensing policy.

If your company exports items subject to CB controls on the Commerce Control List to Russia, it would be a good idea to assess your current customer base to determine if the change in licensing policy will impact your ability to obtain an export license. All other US exporters (except for the ones exporting NS- controlled items hit with the first shoe drop) can order a pool-side drink with a small umbrella.

3. OFAC Issues Directive Prohibiting US Banks from Engaging in New Russian Sovereign Non-Ruble Denominated Bond Market

The Office of Foreign Assets Control (OFAC) issued the Russia-Related Directive under EO 13883 (CBW Act Directive), which implements the CBW Act sanction related to US banks. OFAC has clarified the scope of the sanctions in the Directive, as well as in newly published Frequently Asked Questions. Pursuant to the Directive, US banks are prohibited from participating in the primary market for non-ruble denominated bonds issued by the Russian sovereign after August 26, 2019, and are prohibited from lending non-ruble denominated funds to the Russian sovereign after August, 26, 2019.

As in the export context, the US Administration decided it was essential to US national security interests to water down the bank loan sanction to these non-ruble denominated bond and fund transactions. The CBW Act stated that “[t]he United States Government shall prohibit any United States bank from making any loan or providing any credit to the government of that country, except for loans or credits for the purpose of purchasing food or other agricultural commodities or products.” The Directive limits this to new non-ruble denominated bonds issued by Russia and new non-ruble denominated funds loans to the Russian Government after August, 26, 2019. This leaves untouched transactions in pre-August 26, 2019, non-ruble currency bonds and transactions in all ruble-denominated bonds and loans of the Russian Government.

OFAC’s definition of US banks also departs from OFAC precedent to exclude foreign branches. “US banks” is defined to include depository institutions, banks, savings banks, trust companies, securities brokers and dealers, commodity futures and options brokers and dealers, forward contract and foreign exchange merchants, securities and commodities exchanges, clearing corporations, investment companies, employee benefit plans, and US holding companies, US affiliates, or US subsidiaries of any of the foregoing. “US bank” also includes branches, offices and agencies of non-US financial institutions that are located in the United States. However, according to the Directive, the definition of US Bank does not extend to non-US financial institutions’ branches, offices, or agencies located outside of the United States. According to OFAC’s FAQ, the CBW Act Directive also does not prohibit US banks from participating in the secondary market for Russian sovereign debt.

Finally, OFAC has defined “Russian sovereign” narrowly. “Russian sovereign” means any ministry, agency, or sovereign fund of the Russian Federation, including the Central Bank of Russia, the National Wealth Fund, and the Ministry of Finance of the Russian Federation. Critically, “Russian sovereign” does not include state-owned enterprises of the Russian Federation, unlike the BIS export license restrictions discussed above. In other words, US banks can still loan money to Russian state-owned enterprises.