Demand for sanctions compliance recommendation rises sharply | USAEMALL.com

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The war in Ukraine sparked a sharp rise in demand for sanctions screening and compliance advice, with industry figures now closely monitoring Donald Trump for unexpected additions to the list.

The SIX Sanctioned Securities Monitoring Service, an offshoot of the SIX financial services and stock exchanges group, has reported a sharp increase in the use of its services. It assesses more than 10,000 ETFs and its latest data indicates that 7.7 per cent of them included securities sanctioned by one or more government, and that there has been a 700 per cent increase in the number of sanctioned securities over the past two years.

“With sanctions, to some extent, you have to try to predict the future,” said Sara Nordin, partner at law firm White & Case.

SIX SSMS said that the majority of the ETFs holding sanctioned securities are domiciled in China, the US and Ireland, in that order, but this statistic does not mean that the ETFs are in breach of any domestic regulations.

For example, the recent decision by the US to add to the blacklist of sanctioned Chinese companies deemed to have links to Beijing’s military resulted in the removal of a group of telecoms companies from global indices, but that does not mean that domestic Hong Kong or Chinese investors cannot invest in them.

“Assessing exposure in ETFs is complex, and vigilance is just as paramount for issuers as it is for brokers and other investors,” said Oliver Bodmer, senior product manager, at SIX Financial Information.

The complexity deepens because of the different rules applied by different jurisdictions.

“[ETF] Issuers need to stay on top of securities sanctioned in their jurisdiction, but also in the jurisdictions of the investors they intend to target for the instrument,” Bodmer said.

“Similarly, investors must ensure they are not investing in funds that hold sanctioned securities beyond the prescribed thresholds — which varies by jurisdiction and sanctions regime,” he added.

Sanctions imposed by successive US administrations already include pages of orders limiting trading or other dealings with, for example, corporations identified as being involved in the Chinese military industrial complex as well as entities connected to Iran and Russia.

The EU has its own list that focuses strongly on Russia. The UK too has its own sanctions list.

But those working to advise the industry point out that risk assessment for fund managers and investors requires more than simply referring to a list.

“The chain of exposure to sanctions could potentially be endless, for example if a sanctions measure prohibits ‘indirect’ transactions, through one or more third parties, with sanctioned persons,” said Nordin, who has also seen a jump in demand for its sanctions-related advice.

“Whether a company would be liable for any sanctions violation that may arise as a result of indirect transactions with sanctioned persons generally comes down to diligence and risk management,” she added.

Risk management also depends on how likely a violation will be identified and pursued by authorities, as well as whether there can be any defence of an alleged violation and what the likely penalty will be.

Lawyers said that in the EU there are legal principles that mean that if you can show you have made reasonable efforts to carry out due diligence, such as by using a reputable screening service, then the regulator might accept this as a reasonable defence.

In contrast, the US Office of Foreign Assets Control operates on a so-called strict liability basis, which means that “a person subject to US jurisdiction may be held civilly liable even if such person did not have knowledge that it was engaging in a transaction that was prohibited under sanctions laws and regulations”, Ofac explains on its website.

Ofac also pursues so-called secondary sanctions, which can target non-US entities engaging in activities with sanctioned parties, even if those activities have no direct connection to the US.

The penalties can be severe. Last year EFG International, a Swiss private banking group, agreed to pay $3.7mn to settle an “apparent violation” of the US’s Cuban Asset Control Regulations. Ofac said the amount reflected the fact that EFG’s “apparent violations were voluntarily self-disclosed and were non-egregious” — in other words, the penalty could have been much higher.

Navigating possible exposure to sanctions risks falls heavily on asset managers and can affect the value of investments held by retail investors too.

However, Kenneth Lamont, principal at Morningstar, said there should be no surprises for end investors. “I would argue the very real potential for investment restrictions is less of a compliance issue and more of an investment risk baked into investing in some emerging markets,” he said.

“Broadly speaking, if we see a new wave of sanctions on companies Chinese or otherwise, this will increase compliance costs,” he added, though he pointed out these increased costs would “still pale in comparison” when compared with compliance costs around environmental social and governance factors and consumer duty.