Mitigating sanctions circumvention risks and strengthening global compliance

Understanding the need for effective compliance with sanctions regimes

In complex global politics and international relations, sanctions regimes have become an important tool for countries seeking to influence the behaviour of other states without resorting to military actions. These measures can take various forms, from targeted sanctions and sectorial restrictions to comprehensive sanctions, and are often used to address issues such as armed conflicts, humanitarian concerns, or the proliferation of weapons of mass destruction.

The private sector, particularly the financial industry, plays a critical role in the implementation of sanctions as entities within this industry can have a view of the flows of funds which ultimately allow to prevent and detect illicit financial activities. Sanctions regimes continue to grow, along with related obligations and compliance controls required to detect and prevent their violations. In parallel, instances of sanctions violations and circumventions are regularly reported in official publications and the media.

This increases visibility of direct or indirect sanctions breaches naturally raises an important question: Should reported sanctions violations force us to question their effectiveness and how they are implemented?

Why should organizations prioritize compliance with sanctions regimes, detection of sanctions violations and circumvention?

Compliance with sanctions regimes is more than a legal obligation; it is an obligation to achieve a specific outcome, carrying significant consequences. Professionals must possess a thorough understanding of sanctions imposed by entities such as the European Union (EU), the United Nations (UN), the US and the UK, and implement appropriate controls tailored to the scope of their business activities. This emphasizes the importance of establishing an effective sanctions framework. Without it, organizations risk monetary penalties and reputational damage, as professionals remain accountable for any breaches arising from inadequacies in their framework.

The EU Directive 2024/1226 reinforces this framework by introducing criminal accountability for sanctions breaches caused by serious negligence. While Luxembourg has yet to implement this directive, its draft bill aims to broaden the scope to cover all restrictive measures, irrespective of their legal basis - not just the European sanctions regime.

Sanctions regimes should be upheld not only as a legal requirement but also because their historically proven effectiveness.

Economic sanctions played a pivotal role in securing Indonesia’s independence from Dutch rule and were instrumental in the campaign that led to Nelson Mandela’s release from prison. More recently, the economic challenges faced by Russia further illustrate the power of sanctions, as  evidenced by the 2.1% decline in its GDP in 2022 and its comparatively weaker growth relative to other commodity exporters.

Although there are indications that some goods may have been diverted to Russia from other countries, the volume of these redirected goods remains well below pre-war export levels. The necessity for individuals and entities to navigate intricate procedures and adopt convoluted schemes to evade sanctions shows how impactful these measures are. Sanctions circumvention schemes have become so complicated and risky that they could ruin the financial gains they are meant to achieve.

Adapting sanctions frameworks to address emerging sanctions circumvention practices

According to a recent FATF report, the financial system remains highly vulnerable to the financing of prohibited activities. The ability of sanctions evaders to continuously adapt their methods poses a significant threat to the effectiveness of sanctions, enabling targeted individuals and entities to access global markets and fund illicit activities. Three examples include—but are not limited to—the following:

• Russia’s circumvention strategies towards standard financial systems’ restrictions

Russia has developed alternative strategies to sustain its economy and financial system:

1. Physical cash transport: Billions of dollars and euros have reportedly reached Russian banks, with substantial physical cash transported from countries like the United Arab Emirates and Türkiye. This has stabilized Russia's financial system and supported international transactions, often in exchange for precious metals.
2. Currency swap agreements: Russia has entered agreements with countries like China, facilitating trade and access to foreign currencies without relying on Western payment systems. Using Chinese banks, financial messaging systems outside SWIFT and alternative payment infrastructure, Russia has bypassed sanctions while maintaining strong bilateral trade with China.
3. Use of cryptocurrencies and unregulated platforms and intermediaries: In 2022, the Russian defense conglomerate (Rostec) announced a new digital payment system to replace SWIFT network and has since launched a rubble-pegged stablecoin for international transactions. Rosselkhozbank claimed to use cryptocurrency payments for grain settlements. Russia's security services are using crypto in their operations in Europe. A recent Reuters investigation found that crypto wallets were used to pay for intelligence and mis-information operations across Europe.

• Oil cap’s circumvention by Russia and North Korea

Sophisticated tactics are also employed in evading oil cap restrictions placed on Russia and North Korea. Investigative reports reveal advanced smuggling practices, including:

1. Ship-to-ship transfers: The EU-sanctioned oil tanker Unica allegedly conducts ship-to-ship oil transfers in the Taiwan Strait before passing shipments to North Korean vessels within their territorial waters, circumventing the UN’s 500,000-barrel cap imposed by Security Council Resolution 2397.
2. Flag exploitation: A UN report highlighted that North Korea uses flags from countries with lax vessel monitoring (e.g., Panama, Sierra Leone, and Tanzania) to disguise vessels. Cases of identity theft schemes involving blacklisted vessels were uncovered, deceiving commodity traders and obscuring the destination of shipments.
3. Location faking: Russian tankers reportedly falsify their geolocation, appearing west of Japan while shipping oil to China, allowing them to bypass the price cap and sell oil above sanctioned limits.

• Dual-use goods smuggling to Iran
  According to the FATF, intermediaries and front companies have been used to supply dual-use goods to Iranian entities linked to nuclear weapon development. Such methods involve falsified trade documents and using third countries to obscure the final recipient, demonstrating the global reach and complexity of sanctions circumvention.

These examples demonstrate the need for heightened vigilance from the professionals and of substantial resource allocation, to adapt to complex sanctions circumvention schemes that undermine the effectiveness of the sanction’s regimes.

How can organizations establish robust controls to detect and prevent attempts at sanctions circumvention?

Organizations play a pivotal role in detecting and preventing circumvention. To build a robust sanctions framework, three pillars are essential:

• Sanctions-specific risk assessment: A strong sanctions framework begins with business-wide risk assessments tailored to applicable sanctions obligations and the professional risks associated with sanctions violations. The extent of both is dependent on the professional’s business products and services, counterparties and geographic exposure. It is recommended to make it a specific dimension that can be distinguished from the money-laundering (ML) and terrorism financing (TF) risks which the professional is exposed to.

As per the above-mentioned FATF report, the most common circumvention tactics are the use of intermediaries, concealing beneficial ownership information, the use of virtual assets and the use of the maritime sector. Consideration of FATF and other guidance documents help professionals to remain updated on emerging threats and to implement targeted risk mitigation strategies.

• Counterparty due diligence: Accurate identification of counterparties is critical for identifying sanctioned individuals or entities and understanding their business models. Proper due diligence that allows the identification and evaluation of sanctions must go beyond surface-level assessments, requiring expertise to examine intricate links between counterparties, especially when obscured through complex legal jurisdictions or falsified documentation. A "one-size-fits-all" approach is insufficient—counterparty diligence should be tailored to the risks posed by the business’ activities.

• Name screening processes: Robust name screening mechanisms serve as the cornerstone of a sanction’s framework. Unlike AML/CTF monitoring, screening for compliance with sanctions regimes is rule-based, requiring systems that can detect matches against official sanctions lists with precision and continuously. Professionals should implement:

1. Immediate updates to sanctions lists.
2. Verification procedures to ensure service providers update screening tools promptly.
3.  Second level controls on sanctions alerts.
4. Immediate review and escalation of sanctions-related alerts to prevent detection delays.

Delays in updating sanctions lists or responding to alerts can result in late detection of sanctioned entities, which may trigger violations or breaches.

Lessons from the EU’s comprehensive approach

Sanctions application is a collaborative effort that goes beyond the responsibilities of individual financial institutions. In response to the improvement of circumvention tactics, authorities worldwide are adopting multifaceted strategies to prevent circumvention and safeguard the integrity of sanctions frameworks. The EU’s approach to Russian sanctions offers a prime example of how regulatory authorities are legislating to counter circumvention’s trends effectively.

With 18 sanctions packages, the EU aimed at closing loopholes exploited by sanctions evaders, by targeting organizations beyond Russia, such as Chinese entities for supplying sensitive components to Russia's military, and by tightening export control measures involving companies in Serbia, Iran, India, and the United Arab Emirates for dual-use and advanced technologies. In response to evading the oil price cap, the EU also extended sanctions to specific vessels, an operator of an open flag registry and a captain. The strategic shift to secondary sanctions underscored the EU's commitment to combating sanctions circumvention by adapting its policies to address the complexities of global trade networks.

To combat sanctions circumvention, the EU has implemented extensive reporting requirements that provide national authorities with critical visibility into financial flows connected to Russian entities, such as:

• Reports on fund transfers: Legal entities with a direct or indirect ownership stake of more than 40% by Russian nationals, residents, or entities must report any fund transfers exceeding €100,000 from within the Union. Credit and financial institutions must submit reports on their clients meeting the same ownership criteria, allowing national competent authorities to evaluate risks more effectively and identify funds leaving the EU that might be connected to sanctions violations.
• Reports on deposits: The EU further seeks to close potential loopholes and thwart circumvention strategies that might compromise its regulatory framework by requiring reporting on deposits over €100,000 held by Russian nationals, entities established in Russia, or individuals residing in Russia. This also applies to entities whose proprietary rights are over 50% owned, directly or indirectly, by Russian nationals or residents, and individuals who have acquired citizenship or residence through investor programs in a Member State.

Authorities are sending clear and strong message that detecting and preventing sanctions circumvention is a key responsibility for financial institutions but not limited to these. While financial institutions play a critical role in monitoring and reporting, authorities rely on their cooperation to gain better visibility into transactions—but issues arise due to differing thresholds across sanctions regimes. For instance, the EU’s ownership criteria for reporting (40% ownership stake and 50% proprietary rights) present challenges in aligning these requirements with Know Your Customer (KYC) processes.

This collaborative approach calls for alignment across public and private sectors being necessary to address the ever-evolving tactics of sanctions evaders.

Looking ahead, advancements like the adoption of emerging technologies, such as artificial intelligence, the progressive tightening of regulatory frameworks, enhanced cross-border information-sharing mechanisms, and public-private partnerships are paving the way for more robust and efficient compliance systems.

When designed with clear objectives, precise targeting, and robust frameworks, sanctions can drive positive change, promote accountability, and deter unlawful practices. Effective sanctions implementation is not a one-person job, it depends on the collective will and vigilance of governments, institutions, and professionals worldwide. By investing in robust sanctions frameworks and staying ahead of evolving circumvention tactics, we can ensure that sanctions remain a cornerstone of international justice, accountability, and peace, protecting our financial sectors and economies.