Foreign Adversaries Threaten Critical U.S. Manufacturing Sectors

Sanctions: What Can We Expect to See in 2023?

March 8, 2023

White Paper | Article

Increased Number of Fines
Increased Spend on Sanctions Compliance
Multi-Jurisdictional Alignment on Sanctions
Crypto Firms in the Sanctions Spotlight
Increased Regulatory Focus on China
Western Push for Increased Iran Sanctions
How Can Firms Prepare for Sanctions?
Conclusion
How Exiger Can Help

2023 Sanctions Trends at a Glance

2022 will go down in history as a watershed year for sanctions. Spearheaded by the Russian invasion of Ukraine, governmental and international bodies, fronted by the Office of Foreign Sanctions Implementation (OFSI), European Union (EU) and Office of Foreign Assets Control (OFAC), hammered Russia with an unprecedented volume of sanctions in the hope of thwarting Russian aggression towards Ukraine.

While it is hard to look past Russia when considering the sanctions landscape in 2022, there was a notable increase in sanctions targeting Belarus, China, Myanmar and Iran, imposition of “strict liability” under the Economic Crime Act of 2022 introduced by OFSI, and a crackdown on crypto entities who provide money laundering services to criminals and help others evade sanctions.

What Does This Mean as We Look at 2023 Sanctions Trends?

Increased Number of Fines

OFSI’s introduction of “strict liability” under the Economic Crime Act of 2022, means, for breaches of sanctions committed after June 15, 2022, OFSI may impose civil monetary penalties on a strict civil liability basis. What this means is that as a result, the previous requirement for OFSI to prove that a person had knowledge or reasonable cause to suspect that they were in breach of sanctions will be removed, but OFSI will still bear the burden of proof to establish that there was a breach of financial sanctions prohibitions. Accordingly, firms must be cautious of sanctions evasion methods with respect to Russia. As Russia attempts to minimize the impact of Western sanctions (with support from countries such as Kazakhstan, China, India, Turkey, UAE etc.) strategic circumvention tactics are becoming increasingly common and OFSI (in addition to OFAC and the EU) will be paying increasing attention to firms that are still doing business with Russia and may be facilitating sanctions evasion.

OFSI’s strict liability approach resembles that of OFAC’s and lowers the threshold for OFSI to issue a fine. This, combined with the huge rise seen in the number of designations across 2022, the complexity in sanctions introduced as a result of the Russian invasion of Ukraine and increasingly complex Russia circumvention methods, may catch many firms out in 2023 as they battle what is a fast-paced and everchanging regulatory landscape.

OFSI doubling its workforce from 45 at the beginning of 2022, to near 100 by the end, signals a busy year ahead.

Increased Spend on Sanctions Compliance

The tsunami of sanctions designations following the Russian invasion of Ukraine meant that many firms were not staffed to deal with the number of resultant sanctions escalations. To handle the increased workload, many sanctions teams immediately borrowed resource from internal financial crime teams (AML, KYC, QA etc.) and provided them with training on relevant sanctions processes so they could process increased volumes. This is, however, a short-term solution and given it is apparent these sanctions will not be disappearing any time soon, sanctions teams will need to consider a longer-term resource solution. Examples include using machine learning and AI-enabled software to reduce false positives, and leveraging trained resources provided by trusted third parties to effectively and sustainably manage sanctions risk and enable other internal financial crime teams to meet their own obligations.

In 2023 sanctions trends, we can expect to see firms continuing to add sanctions expertise to compliance teams to ensure they are well positioned to deal with changing regulatory obligations.

[Assess your sanctions risk with AI technology and industry expertise. Learn more about Exiger’s sanctions screening and compliance services.]

Multi-Jurisdictional Alignment on Sanctions

What we have seen in the response to the Russian invasion of Ukraine is OFSI, the EU and OFAC creating independent, comprehensive regimes, which, while being thematically aligned, contain many variances which can make compliance efforts hugely challenging. To add to the mix there are also other sanctions imposed by countries such as Canada, Japan, and Australia, which must be considered by some firms.

Misalignment between regulators has long been a point of frustration for compliance professionals, with ownership and control being no exception to this. OFAC applies the “50% rule”, an objective rule based on ownership alone, whereas the EU and OFSI, also consider “control” to be a factor in considering whether a non-listed entity is de-facto designated.

In October 2022, OFSI and OFAC issued a joint statement announcing a strategy to align on sanctions implementation and enforcement, with the statement also talking to broader collaboration with additional global partners to make the sanctions more impactful, remove loopholes and make compliance easier.

“We have decided to deepen OFSI-OFAC co-operation further, to enhance both our own capabilities and the support we provide to those at the forefront of effective sanctions implementation.”

Joint OFSI and OFAC statement
Enhancing the US—UK Sanctions Partnership

Important partnerships like this are key in progressing how sanctions are implemented and enforced.

Crypto Firms in the Sanctions Spotlight

Crypto’s success thus far has been built on the promise of privacy and the freedom to transact, but with 2023 being dubbed as “Crypto Sanctions Season”, this may well change.

2022 highlighted the importance of sanctions compliance for crypto firms, with OFAC announcing its first ever crypto enforcement action against Bitrexx for apparent violations of multiple sanctions programs against Iran, Sudan, Syria, Cuba, and the Crimea region of Ukraine.

In similar fashion to what the banking industry went through approximately a decade ago, 2023 sanctions trends will see the crypto industry react to increased attention from regulators with firms looking to strengthen their AML and sanctions controls as a result.

The UK’s Financial Conduct Authority (FCA) identified several steps for crypto firms to consider, including:

Updating business-wide and customer risk assessments to account for changes in the nature and type of sanctions measures
Ensuring that customer onboarding and due diligence processes identify customers who make use of corporate vehicles to obscure ownership or source of funds
Ensuring that customers and their transactions are screened against relevant updated sanctions lists and that effective re-screening is in place to identify activity that may indicate sanctions breaches
Identifying activity that is not in line with the customer profile or is otherwise suspicious and ensuring that these are reported quickly to the nominated officer for timely consideration

To drive the increased sanctions compliance efforts, many crypto firms are hiring sanctions compliance professionals from the more mature banking industry, to provide support in building an effective sanctions compliance program.

“Cryptocurrency has presented a potentially attractive method for sanctions evasion.”

UK FINANCE
The Cyber-Crypto-Sanctions Nexus

The crypto space is often exploited by criminals looking to use crypto platforms to evade sanctions. The Digital Asset Task Force (DATF) is an expert committee comprising of industry leaders across digital assets and financial crime, formed in 2022 with the purpose of preventing sanctions circumvention by promoting compliance. DATF’s key objective in 2023 is to crackdown on criminals, and firms who let criminals use their platforms and services as a method for evading sanctions through identifying weaknesses in compliance frameworks and developing more effective controls against the movement of dirty money.

Increased Regulatory Focus on China

In late 2022, China sent military jets into Taiwanese airspace and fired missiles into the sea around the island, with China’s president, Xi Jinping, promising to bring Taiwan under China’s control and not ruling out the potential further use of violence.

China has also shown continued support for Russia, through increased trade, which has damaged Western efforts to hurt the Russian economy. China has been supplying Russia with goods, such as smartphones, vehicles, computer chips, ships, and aircrafts. Whilst there is no evidence of China supplying technologies and weapons to support Russian war efforts, Western leaders fear circumvention methods through use of front companies, may facilitate this. Russia has also been supplying China with a significantly increased volume of crude oil, coal, pipeline gas and liquefied natural gas, with Russian oil and gas exports to China rising by over 50% since pre-war times.

Many large Chinese businesses are cautious of secondary sanctions and as a result are reluctant to trade with Russian entities. We can expect to see continued sanctions against Russian oil and gas playing a key role in Western efforts to devastate the Russian economy, with additional sanctions on entities that support Russian oil and gas production, shipping, and logistics.

Sino-American relations are descending to an all-time low. Further to China’s strong relationship with Russia, the U.S. recently shot down what was believed to be a Chinese “spy balloon” encroaching U.S. airspace, and China added U.S. defense company Lockheed Martin to the “unreliable entities list”, following the sale of weapons to Taiwan.

China’s relationship with the West is further complicated by the introduction of Anti Foreign Sanctions (AFS) law by China in 2021 which (a) states that individuals and organizations cannot implement or assist in the implementation of discriminatory measures taken by a foreign country, and such entities can be sued by Chinese citizens and organizations, and (b) empowers the relevant Chinese authorities to issue countermeasures against individuals and entities that directly or indirectly participate in the formulation, decision and implementation of discriminatory restrictive measures, and such lists may be extended to spouses, relatives and entities with which they are associated. 2023 sanctions trends takeaway: this puts corporates that are operating or have exposure to both the U.S. and China in a very challenging spot.

China has been subject to mounting sanctions over the last few years, which has been largely aimed at slowing the growth of the technology industry and restricting investing in securities of Chinese military companies. The UK, EU and U.S. have been threatening further sanctions, should China continue on its current path, however it is not clear what those sanctions may look like. Given the global dependency on the Chinese economy and the collateral damage that will be felt worldwide, it is anticipated that the sanctions will target specific sectors such as frontier technologies (e.g., quantum computing, blockchain, artificial intelligence, bioprinting etc.) and next generation infrastructure, as opposed to broad-based sanctions intended to cripple the economy.

Western Push for Increased Iran Sanctions

In 2023, OFSI, EU and OFAC have already imposed new sanctions on Iran, following the Islamic Republic’s brutal responses to anti-government protests and its supply of drones to Russia for use in their war against Ukraine, which contravenes a Joint Comprehensive Plan of Action (JCPOA) clause barring the transfer of certain weapons to and from Iran.

Biden in December 2022 was caught on camera admitting the Iran nuclear deal is “dead” and will not be renegotiated, and with the UK and EU looking to recognise the Iranian Revolutions Corps Guard as a terrorist entity, all hope of western diplomacy with Iran may be eroded.

With the demise of the JCPOA, an alternative approach will need to be sought and as a 2023 sanctions trend, it looks likely that sanctions against Iran will ramp up.

How Can Firms Prepare for Sanctions?

There is no one size fits all approach. Each firm’s sanctions risk exposure will differ based on factors, including risk-appetite, size, geography, product offerings and legal structure, and firms must take a risk-based approach in responding to new sanctions. To assess sanctions exposure, firms must complete a risk assessment, which will subsequently enable the firm to implement a plan to mitigate such risks.

At the core of being able to effectively respond to sanctions, is the maintenance of up-to-date and accurate customer due diligence (CDD) records, including accurate data on customers, ultimate beneficial owners, third parties, counterparties, and participants in the overall supply chain. The effectiveness of a firm’s screening process is largely dependent on the accuracy of the data being screened. Understanding and addressing exposure to new sanctions enables firms to adequately consider commercial decisions in the context of sanctions risk and develop policies and procedures consistent with the firm’s risk exposure.

2023 Sanctions Trends Conclusion

2023 promises to be another busy year for regulators and compliance professionals. The world has fast acknowledged sanctions as a critical risk to their business through the impact of Russia sanctions and with the threat of enforcement looming, firms will need to be able to demonstrate to regulators they have key controls in place to effectively manage sanctions risk.

Russia-Ukraine will continue to be a focal point for 2023, as demonstrated by the new Russia sanctions packages introduced by OFSI and the EU, and what was described as OFAC’s “most significant sanctions actions to date” on the anniversary of Russia’s war against Ukraine.

There is hope of broader collaboration on sanctions implementation and enforcement through the OFAC-OFSI partnership, with work already in progress to address priorities such as misuse of virtual assets, improved information sharing and alignment on key definitions.

Looking beyond Russia, we can expect to see regulators place more focus on the often-exploited crypto firms, particularly given the weaknesses uncovered through the demise of crypto exchange FTX, whilst Iran and China are already moving further away from the West through increased support for Moscow.

All in all, 2023 looks to be another turbulent year in the world of sanctions.

Author Dan Younan is a Managing Consultant for Exiger’s Financial Crime Advisory team.

How Exiger Can Help

Exiger can support firms to effectively manage sanctions risk through.

Risk Assessment

Evaluate entity sanctions risks against regulatory requirements and risk appetite, review current controls and identify gaps
Conduct product-based sanctions risk assessments

Due Diligence

Understand who ultimately owns and controls your clients or third parties
Screening your vendors or clients to identify potential hidden sanctions nexus using DDIQ, our AI-powered engine that helps to illuminate material sanctions risks

Program Assessment and Enhancement

End to end sanctions program reviews, from conceptual framework to alert review output

Alert Review and Backlog Remediation

Provide staff augmentation/co-sourcing to enable timely review of both name and transaction screening alerts for sanctions nexus on an ongoing basis
Conduct targeted lookbacks of legacy alerts to identify breadth and scope of historical sanctions risks

Model Validation

Deep dive model assessment to review configuration settings/general governance, data quality, exact and fuzzy matching performance and appropriateness of tuning