Sanctions on Securities: Compliance and Global Capital Markets Access

July 14, 2021
By: Alejandro Leáñez, ACSS

Targeted sanctions against securities transactions are common nowadays.

The following table explains some of the common securities transactions challenges for global financial institutions and players affected by these sanctions.

Who is sanctioned? How are securities involved? Compliance Risk Example
Securities may explicitly be designated by sanctioning bodies.

 

Securities themselves are listed. The possibility of trading in a listed securities instrument.

The ban of those securities from trading.

 

A specific list of securities targeted by OFAC.
Securities broker itself is designated. The sanctioned entity issues securities The possibility of engaging in prohibited business with a person or entity subject to sanctions.

Providing services, such as opening a brokerage account for, or executing a trade involving, a blocked person.

 

 

OFAC SDN list includes a securities broker in Gambia: ROYAL AFRICA SECURITIES BROKERAGE CO LTD. The company reportedly affiliated with the Jammeh, the former president of Gambia, is designated under the Global Magnitsky program.
Entity owned 50 percent or more by a sanctioned entity. Investing in foreign securities where the issuer of the security is 50 percent or more owned by a blocked person.

 

Doing business with a sanctions target indirectly, or where the involvement of the sanctioned party is not readily apparent in a securities transaction.

True beneficial owners of the securities may not be known across the tiers of custody and may mask the interest of a blocked person.

 

Blocked Person X owns 50 percent of Entity A, and Entity A owns 50 percent of Entity B. Entity B is considered to be blocked. This is so because Blocked Person X owns, indirectly, 50 percent of Entity B. In addition, Blocked Person X’s 50 percent ownership of Entity A makes Entity A a blocked person. Entity A’s 50 percent ownership of Entity B in turn makes Entity B a blocked person.
Sectoral sanctions on securities investments in certain sectors, governments or companies. These sanctions address the threat from securities investments that finance companies or governments engaged in serious human rights abuses, anti-democratic  behaviors, or other U.S. national security considerations pursuant to the determination of the U.S. Department of the Treasury. Investing in a sanctioned security or company. E.O. 13808 prohibits U.S. persons from purchasing securities of any kind – including debt and equity securities – from the Government of Venezuela.

 

Below we provide a few examples of securities-related sanctions. Then we cover compliance challenges.

U.S. Sanctions Against Venezuelan and Russian Securities

An example of sectoral sanctions on securities investments in certain sectors, governments or companies is the August 2017, Executive Order (E.O.) 13808 issued by the Trump Administration.

It forbids transactions relating to the Government of Venezuela, including Petróleos de Venezuela, S.A. (PDVSA) and other entities owned or controlled by the Government of Venezuela.

The prohibitions target transactions relating to new debt, equity, issuance of bonds, dividend payments or other distributions, and the purchase of securities from the Government of Venezuela and PDVSA.

Similarly, OFAC has imposed similar sanctions against Russia that prohibit U.S. persons from dealing in new debt over a certain maturity and new equity of certain major Russian financial institutions, energy companies, and companies in the defense sector that have been designated within the Sectoral Sanctions Identification (SSI) Lists.

Recently, pursuant to the E.O. of April 15, 2021, OFAC issued a directive that generally prohibits U.S. financial institutions from participating in the primary market for ruble or non-ruble denominated bonds issued after June 14, 2021, by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, or the Ministry of Finance of the Russian Federation. This directive expands upon existing prohibitions on certain dealings in Russian sovereign debt.

U.S. Sanctions on China Securities

Another example of sectoral sanctions on securities investments in certain sectors, governments or companies is the December 2020 E.O. 13959 concerning securities investments that finance Communist Chinese Military Companies (“CCMCs”).

The reasoning of the CMCC measures is to prevent, “U.S. investment from supporting the Chinese defense sector, while also expanding the U.S. Government’s ability to address the threat of Chinese surveillance technology firms that contribute—both inside and outside China—to the surveillance of religious or ethnic minorities or otherwise facilitate repression and serious human rights abuses.”

The sanctions prohibit purchases by U.S. persons of certain securities issued by these CCMCs.

The restrictions apply to financial instruments such as derivatives (including options), ETFs, index funds, mutual funds, and currency, as well as certain notes, drafts, bills of exchange, or banker’s acceptances.

The sanctions apply only to securities from companies that are specifically named in the Annex of the E.O.

In June 2021, President Biden issued a modification of the E.O., that rescinds and supersedes the previous CCMC sanctions regime.

EU Sanctions Against Russian Securities

An example of EU sanctions that affect securities is EU Council Decision 2014/659/CFSP of September 8, 2014.

In this case, restrictions on access to capital markets are imposed in relation to state-owned Russian financial institu­tions, certain Russian entities in the defense sector, and certain Russian entities whose main business is the sale or transportation of oil.

The sanctions include the prohibition of the direct or indirect purchase or sale of the brokering or assistance in the issuance of, or any other dealing with bonds, equity or similar financial instruments with a maturity exceeding 90 days, issued after 1 August 2014 by:

  • Major credit institutions or finance development institutions established in Russia with over 50 percent public ownership or control as of 1 August 2014, as listed before.
  • Any legal person, entity or body established outside the EU owned for more than 50 percent by an entity listed before.
  • Any legal person, entity or body acting on behalf or at the direction of an entity referred to in point (b) or listed before.

In this context, there is a prohibition of transactions in or the provision of financing or investment services or dealing in new bonds or equity or similar financial instruments with a maturity exceeding 90 days issued by state owned Russian financial institutions, excluding Russia based institutions with international status established by intergovernmental agreements with Russia as one of the shareholders.

These prohibitions do not affect the granting of loans to or by those state owned Russian financial institutions independently of their maturity.

Risks

The sanctions risk affecting the securities sector varies depending on the clients and product or service offered.

Some risk factors include:

  • International transactions, including wire transfers.
  • Foreign customers/accounts.
  • Foreign broker-dealers who are not subject to OFAC regulations.
  • Risks of investments in foreign securities.
  • Personal investment corporations or personal holding companies.
  • Very high net worth institutional accounts, hedge funds, funds of hedge funds and other alternative investment funds (private equity, venture capital funds) and intermediary relationships.
  • Omnibus accounts/use of intermediaries.
  • Third party introduced business.
  • Confidential accounts.

For example, an investment adviser that manages a private equity fund that has a number of U.S. and non-U.S. investors, including an offshore trust that lacks transparency, should exercise greater scrutiny.

Similarly, an investment adviser that manages a U.S. hedge fund with an offshore related fund where the beneficial owners are offshore investors should be attuned to heightened sanctions risks.

Core Controls and Challenges

OFAC expects investment advisers, both registered and unregistered, and other securities firms, to develop risk-based compliance programs to detect, monitor, and address potential OFAC violations that may arise before they conduct business on behalf of a customer, or prior to the execution of a transaction.

A strong compliance process should have a securities screening solution that identifies securities related to sanctioned entities and monitors for other sanctions-related risk.

Financial institutions operating in securities markets as a market maker, broker or custodian often deal with two key challenges:

  • Identifying the beneficial ownership of assets subject to a transaction or held in custody.
  • Identify specific securities assets subject to OFAC sanctions prohibitions or restrictions.

In order to overcome these challenges, core controls should include:

  • Customer due diligence: Establishing reasonable due diligence procedures to identify customers who do business in or with countries or persons subject to OFAC sanctions. In addition, setting appropriate enhanced due diligence triggers for customers who present a risk that they will use their accounts to hold assets or carry out transactions for third parties subject to U.S. sanctions.

For instance, an OFAC sanctioned company might have other subsidiary companies that also trade securities, these can be detected with specialized software that enhances the scope of the sanctions research.

  • Disclosures: Apprising customers of a financial institution’s OFAC sanctions-compliance obligations.

For example, obtaining formal assertions from customers that they will not use their accounts in a way that could trigger violations of OFAC sanctions in the securities industry. Particularly, that they will not hold to or seek to trade securities that are subject to OFAC sanctions through the company in which the customer regularly trades securities.

  • Account purpose: Developing procedures to document an understanding of the purpose of a customer’s account.

For example, identifying whether third-party assets will be held in a customer’s account and, if so, understanding the OFAC-sanctions risk of the third party and its assets.

  • Account restrictions: Implementing procedures to prohibit customers who present an increased risk, from an OFAC-sanctions point of view, from accessing certain products or services that lack beneficial-ownership transparency.

For example, restricting higher-risk customers from using omnibus accounts. These accounts allow for managed trades of more than one person, and allow for anonymity of the persons in the account.

Due to their anonymity sanctioned OFAC individuals could try to use them to circumvent OFAC sanctions.

Further Guidance

OFAC encourages the securities industry to develop proactive, risk-based compliance programs to ensure that it does not conduct transactions for the benefit of designated terrorists or other sanctions targets.

In 2008 OFAC issued a guidance document on risk factors for compliance in the securities industry. Another useful guidance is the 2012 OFAC Regulations for the Financial Community.

Further, OFAC  has a Financial Sector section on the OFAC Information for Industry Groups with updated information and a Frequently Asked Questions section, to help understand and comply with the U.S. sanctions programs relating to securities.