The Sanctions Response to Russia's Invasion of Ukraine – Key Lessons Learned Over the Past Year
It has been over a year since Russia first declared the “independence” and “sovereignty” of the non-government controlled areas of Donetsk and Luhansk in Ukraine and the subsequent full-scale invasion of Ukraine. Since that time, Canada and its allies, including the United States, the United Kingdom, and the European Union, have been engaged in an unprecedented campaign to apply punitive economic measures, largely through sanctions, to Russia, Belarus, and the Russian-occupied regions of Ukraine. Given the size of the Russian economy (estimated as the 11th largest in the world in 2021), the integration of Russia and its banks in the international financial system, and the level of commercial trade and investment between Russia and Western nations, these measures targeting Russia constitute the most significant and complex international sanctions regime in modern history.
As we pass the one year mark of Russia’s further invasion of Ukraine, all signs point to continued geopolitical instability in the region and further expansion of aggressive international sanctions and trade control measures. It is therefore an appropriate time to not only take stock of the scope of the measures that have been applied over the last year, but also to highlight the challenges that Canada’s broad sanctions response has created for those doing business abroad, address what can be expected during the balance of 2023, and outline the steps companies can take to mitigate their risk exposure and ensure compliance going forward.
1. Key Lessons Learned
The aggressive rollout of sanctions measures against Russia by the Western allies throughout 2022 provided many challenges and lessons for Canadian companies in the context of sanctions implementation and compliance. Some of the key ones include:
- Multiple sanctions regimes are at play – The activities of any company doing business abroad will likely engage the sanctions regimes of multiple jurisdictions. For Canadian companies this means that in addition to Canada’s sanctions measures, they must also consider the application of US, UK, and EU measures, some of which may be extraterritorial, as well as those of other countries which may apply depending on jurisdictional touchpoints. In some cases, Canadian companies must also consider the risk of exposure to countermeasures threatened or imposed by the sanctions target, i.e. Russia.
- Although the Western allies’ measures are described as being “coordinated”, there are often significant differences in scope - In many cases, Canada’s sanctions are more aggressive than those of its allies such that what may be wholly permissible in the United States or other Western countries is prohibited by Canada. One example is Canada’s sanctioning of certain Russian banks and other parties who are not sanctioned, or not sanctioned to the same extent, by US, UK, or EU authorities or who are subject to winding-down exemptions or general licenses by these countries, which Canada does not employ. Another example is Canada’s services prohibitions which apply to 30 categories of services, in stark contrast to the more limited measures of its allies. Given these differences, in every instance that requires sanctions diligence, Canadian sanctions measures, including listings, should be examined alongside the measures of other jurisdictions, as compliance with foreign sanctions regimes against Russia would not automatically mean that the Canadian sanctions requirements are satisfied.
- Lack of published guidance continues to present significant challenges for risk assessment and compliance – Unlike other Western jurisdictions, Canada has not publicly issued substantive guidance on the interpretation of its sanctions measures. Uncertainties continue to persist on a range of issues, including, for example, the application of sanctions to entities owned or controlled by designated persons, the meaning of “facilitate, directly or indirectly, transactions related to dealings” involving listed persons, the application of sanctions to dealings in publicly traded debt and equity securities of designated Russian and Belarussian entities, the scope of the services prohibitions, and the meaning of “a person in” Russia or Belarus for purposes of supply prohibitions on goods, technology and services. As we’ve previously discussed, this absence of guidance has been noted in at least one judicial decision examining the issue of entities owned or controlled by designated persons, with this decision relying on foreign guidance published by Western allies to attempt to fill the void. Because of this, the Canadian government has been overwhelmed with inquires and sanctions permit requests seeking clarification on the interpretation of these broadly worded prohibitions. Notably, Canada has announced its intention to invest $76 million to strengthen Canada’s capacity to implement and enforce sanctions. This includes establishing a dedicated bureau at Global Affairs Canada to address sanctions issues.
- Transactional due diligence is more important than ever – Rigorous sanctions and trade controls diligence is now expected and demanded in M&A, corporate finance, as well as regular commercial transactions and relationships, which includes a thorough screening of counterparties and others directly or indirectly involved in the transaction and those who own or control them, understanding the target’s potential exposure to sanctioned jurisdictions and listed persons, and ensuring that targets have effectively implemented sanctions compliance policies and controls. In some cases, because of compliance risks and monitoring costs or the potential reputational exposure, firms have decided to withdraw or refrain from activities involving Russia, Belarus or the occupied regions of Ukraine, regardless of whether they are strictly required to do so under applicable sanctions. In the current geopolitical environment, given both the legal and reputational impact of these concerns, sanctions compliance has become a priority for the boards and senior management of organizations with international operations.
- Sanctions measures are extraterritorial, and apply beyond just imports into and exports from Canada or other activities within Canada – The sanctions prohibitions apply to “persons in Canada” and “Canadians outside Canada”. The activities of a Canadian individual or entity anywhere in the world are subject to the jurisdiction of these Canadian measures. Although frequently announced or referred to as “import bans” or “export bans”, these measures apply more broadly to Canadians located anywhere in the world who may be sourcing items from or supplying items to Russia or “persons in Russia”. This includes Canadians located in countries that have different or more relaxed measures in place when it comes to dealing with Russia or Belarus. Whether it involves a Canadian company operating abroad or a Canadian national employed by a foreign entity or sitting on its board of directors, they fall within the jurisdiction of Canadian sanctions law and are prohibited from engaging in these activities even if the goods, services, or technology at issue have no connection to Canada.
2. The Primary Sanctions and Trade Control Measures
(a) Listed persons
Since the invasion, the number of persons listed under Schedule 1 of the Special Economic Measures (Russia) Regulations (the “Russia Regulations”) that are subject to a broad asset freeze and dealings prohibition has exploded, with over 1,000 individuals and 250 entities being added over the last year, including most significant government and private actors in the Russian economy. Schedule 1 in both the Special Economic Measures (Ukraine) Regulations (the “Ukraine Regulations”), targeting the Russian-occupied regions of Ukraine and their Russian-imposed ‘governments’, and the Special Economic Measures (Belarus) Regulations, in light of Belarus’ support for the Russian invasion, have been greatly expanded as well.
The financial sector has been particularly impacted by the prohibitions. To date, seven out of the top ten Russian banks are listed in Schedule 1, including the Russian financial regulator, the Central Bank of the Russian Federation. Such listings result in a prohibition on dealings in property “owned, held, or controlled” by or on behalf of a listed person, which could in certain cases capture dealings with its subsidiaries. In the context of the financial industry, this could mean not only a prohibition on money transfers or other banking services, but, broadly speaking, on performance of any type of contractual obligations with or through such entities. The chilling effect is exacerbated by the fact that in 2022 several major Russian banks, including Sberbank, Vnesheconombank (VEB) and VTB Bank, were disconnected from SWIFT by the European Union.
Additionally, in June, Canada became the first G7 nation to provide for the forfeiture and redistribution of sanctioned assets. The government’s first use of this power was announced on December 19, 2022, when the Minister of Foreign Affairs reported that Canada would seize and pursue the forfeiture of assets totaling US$26 million held by a company the government asserts is owned by Roman Abramovich, a Russian oligarch who is listed under the Russia Regulations.
(b) Services Prohibitions
As we discussed in a previous legal update, on June 7, 2022, Canada implemented a prohibition of 28 prescribed services (subsequently expanded to 30) in a handful of industries, which, for the time being, includes the oil, gas, mining, and chemical industries, to Russia and persons in Russia. Though these measures were implemented in coordination with its allies, Canada’s services prohibition was much broader than those implemented by the United States, United Kingdom, and European Union. Notably, the relevant categories of services and industries are also worded very broadly and, from a practical perspective, compliance with the services prohibition can present significant challenges for Canadian businesses.
(c) Sourcing and Supply Prohibitions
There are several specific prohibitions on the sourcing and supply of goods and technology as well as certain related services to and from Russia, Belarus, as well as occupied regions of the Ukraine, as noted below.
- Energy Sector: The Russia Regulations explicitly target the Russian oil and gas industry. Canada has implemented import and export bans on a variety of goods, equipment, and technology for use in the oil and gas industry, including offshore, arctic and shale oil exploration and production, as well as a prohibition on the provision of a wide range of services to Russia or to any person in Russia in relation to petroleum and natural gas products. There is a similar restriction on purchase of petroleum products exported from Belarus.
In addition, Canada along with the other G7 nations and Australia have imposed price caps on Russian-origin crude oil and petroleum products. The price cap measure prohibits Canadians from providing specified services in relation to maritime transport, including ship-to-ship transfers, of Russian crude oil and petroleum products, unless the products are sold at or below the established price cap.
- Restricted Goods and Technologies: There is a prohibition on the supply or transfer of goods and technology listed in the Restricted Goods and Technologies List to Russia or Belarus or to persons in Russia or Belarus. As discussed in detail in our legal update, the List covers a broad range of goods and technologies in the areas of electronics, computers, telecommunications, sensors and lasers, navigation and avionics, marine, aerospace, and transportation.
- Goods for manufacture of weapons: There is a prohibition on the supply of certain goods that can be used in the manufacturing of weapons to Russia or Belarus or to any person in Russia or Belarus, which covers a very wide variety of chemical elements, metals, articles thereof, and specific goods, including most electrical machinery and equipment. Notably, these items need not be designed for or intended for use as or with weapons – as long as they are identified in the relevant list, they are prohibited.
- Steel and aluminum products: On March 10, 2023, the Canadian government prohibited the import, purchase, or acquisition anywhere in the world of most steel and aluminum products from Russia or any person in Russia.
- Shipping and aviation: The Russia Regulations prohibit Russian ships from docking in or passing through Canada. A similar measure was introduced under the Aeronautics Act with respect to Russian aircraft such that Canada’s airspace is now effectively closed to all Russian aircraft.
- Luxury goods: There are also prohibitions in place with regards to importing and exporting luxury goods from or to Russia and Belarus. We note that the list of ‘luxury goods’ that cannot be exported to Russia or Belarus covers a wide variety of consumer products, including items that may not be traditionally considered luxury items such as motor vehicles and their parts, as well as footwear.
- Embargo on dealing with Occupied Regions: There are also broad prohibitions, effectively amounting to embargoes, in the Ukraine Regulations on dealing with certain areas of the country that are subject to Russian control. These prohibitions currently cover Crimea as well as four other regions of Ukraine that are occupied by Russia: the Donetsk, Luhansk, Kherson and Zaporizhzhia oblasts of Ukraine (the “Occupied Regions”). The embargoes establish blanket prohibitions on investments, financial services, import and export of goods, technical assistance, and services related to tourism.
(d) Export Controls and Customs Tariffs
In addition to economic sanctions, there have been other significant measures put in place by Canada to restrict trade with Russia, including:
- the cancellation of all existing export and brokering permits and a ban on issuance of new permits thereby prohibiting the export or transfer of any controlled goods, services or technology to Russia; and
- the withdrawal of MFN tariff treatment for goods from Russia and Belarus, resulting in a duty rate of 35% being applied to any Russian or Belarusian goods being imported into Canada.
The withdrawal of MFN treatment applies to all goods from Russia and Belarus and goods that originate in Russia and Belarus, regardless of where the good is being shipped to Canada from. Canadian importers therefore have to be diligent to ensure that they are properly identifying the country of origin for these goods to ensure they are paying the appropriate duty. As we’ve noted, the Canada Border Services Agency has indicated that it is a priority for it to ensure that goods from Russia and Belarus do not enter Canada under the MFN tariff treatment.
3. What to Expect For The Rest of 2023
As the conflict in Ukraine persists, we expect 2023 will see continued focus on expansion and implementation of the relevant trade restrictions.
- Continued expansion of sanctions and trade controls and related compliance expectations – Persisting geopolitical tensions point to continued escalation in sanctions measures, as we have already seen in the first few months of 2023. It is unlikely that we will see any abatement in the trade restrictions related to the conflict in Ukraine this year. Businesses should continue to closely monitor the developments in the Canadian and Western ally sanctions programs targeting Russia, Belarus, and the Occupied Regions. Businesses will also be facing increasing expectations regarding the implementation of effective compliance policies and procedures – not just from enforcement authorities, but also stakeholders such as their investors, financial institutions, customers, vendors, business partners, acquirers, underwriters and other counterparties. As was recently noted by the US Deputy Attorney General, “what once was a technical area of concern for select businesses, should now be at the top of every company’s risk compliance chart”.
- Increasing effort to address sanctions evasion – As over this past year there has been a massive expansion of sanctions and trade control measures in response to Russia’s further invasion of Ukraine, evasion has become a growing concern for Canadian and other Western governments. Enforcement authorities have been warning the business community to watch out for evasion behaviour, especially regarding sanctioned Russian elites and their financial networks. On March 9, 2023, the multilateral Russian Elites, Proxies, and Oligarchs (REPO) Task Force, whose membership includes Canada and other Western nations, issued a Global Advisory on Russian Sanctions Evasion identifying the following key typologies for Russian sanctions evasion tactics:
- use of family members and close associates to ensure continued access and control;
- use of real estate to hold value, benefit from wealth;
- use of complex ownership structures to avoid identification;
- use of enablers to avoid involvement, leverage expertise; and
- use of third party jurisdictions, false trade information to facilitate sensitive goods shipment to Russia.
- Sanctions measures adopted in 2022 may lead to increased jurisprudence – Given the expansion in sanctions measures in 2022 and the broad impact these measures are having, we expect more judicial decisions to arise from these measures, if not in Canada, at least in the jurisdictions of its Western allies. This will likely be the result of increased enforcement as discussed below. One area where there will likely be at least some judicial developments in Canada during 2023 is the new asset forfeiture mechanism described above. It appears likely that Canada will be engaged in proceedings pursing a forfeiture order for the US$26 million assets alleged to be indirectly owned by Roman Abramovich.
- Continued focus on coordinated sanctions efforts of Western countries - Given the scale and complexity of the sanctions programs targeting Russia, Belarus, and the Occupied Regions, coordinated actions of the Western countries continues to be an issue of significant importance for the sanctions efforts to reach their full potential. The G7 countries, including Canada, have recently announced the establishment of an Enforcement Coordination Mechanism to bolster compliance and enforcement. Further, the United States announced the launch of Task Force KleptoCapture, an interagency law enforcement task force dedicated to enforcing the sanctions, export restrictions, and other economic countermeasures imposed on Russia. It is expected that the coordinated enforcement actions of Canada and its Western allies will intensify during 2023.
- Increased focus on enforcement efforts - To date, Canadian authorities appear to have engaged in limited public enforcement actions with regards to these new Russia sanctions measures. However, there are signs that this may change moving forward. As noted above, in November 2022, Canada announced its intention to implement a package of measures to strengthen its sanctions response and the investment of $76 million to bolster Canada’s capacity to implement and enforce sanctions, including such measures as asset freezes. The enforcement will be carried out through a dedicated bureau at Global Affairs Canada. Additional support will be provided to the RCMP to investigate and identify assets belonging to sanctioned persons and gather evidence. These increased resources may provide support for Global Affairs Canada to issue much needed guidance on the interpretation of the sanctions measures. In the United States, the message on increased enforcement is very clear - the Deputy Attorney General has declared that “sanctions are the new FCPA” and recently announced the dedication of significant new resources to enforcement, including “25 new prosecutors who will investigate and prosecute sanctions evasion, export control violations and similar economic crimes”.
In light of all the foregoing, organizations with any possible direct or indirect exposure to the region must continue to be vigilant. The McCarthy Tétrault International Trade and Investment team will continue to monitor these developments and shifting economic measures as the Russian invasion of Ukraine continues into its second year.