Secondary Sanctions: an Effective Threat

Do Business with Russia's Military or Access the US Dollar; Not Both

Photo by Avinash Kumar on Unsplash

After President Biden last month signed Executive Order 14114, authorizing OFAC to impose sanctions on foreign financial institutions that support or transact with Russia’s military-industrial sector, I figured Treasury would quickly follow up with a list of designations. I wrote at the time that secondary sanctions are an effective tool that designate persons or entities engaging in activities that would normally be subject to US sanctions if US jurisdiction or person was involved.

The United States cannot tell you what to do in your own country, using that country’s currency if no US nexus exists. But it can tell US persons that they’re no longer allowed to transact with you, forcing you to make a choice: either transact with the sanctioned Russian (in this case) entity, or transact with US companies.

That’s a pretty potent threat. I further projected that foreign banks would rather retain their access to the US dollar than make whatever profit they would make by transacting with Russian military entities. And my thought was that banks in China, Turkey, and the UAE must be a little nervous, given their ties to Russia.

I was right.

Media reports last week said that at least two state-owned banks in China have begun reexamining their relationships with Russian entities, and financial institutions in Turkey, which is working to get off the FATF grey list of jurisdictions under increased monitoring for AML regime deficiencies, are also increasing their scrutiny of transactions linked to Russia.

The reports did not name the Chinese banks that are being extra cautious to retain their access to the US dollar, but China's biggest four state banks do have a history of complying with previous US sanctions. In 2022, Industrial & Commercial Bank of China Ltd. and Bank of China Ltd. restricted financing for Russian commodities, even though the Russian energy sector was not impacted by sanctions at the time. So I’m assessing that it may be at least these two banks that are being extra cautious.

In Turkey, the banks involved have not been named either, but the extra scrutiny is resulting in a “slowdown” in transactions by the banks, and exporters have been experiencing difficulties in receiving payments.

The move has led to longer processing times for money transfers and instances where funds are sent back or delayed for days, bankers familiar with the matter said.

Secondary sanctions are often criticized as risky and a jurisdictional overreach, but there’s no denying their effectiveness. Continuing transactions with Russia’s military sector will expose foreign financial institutions to the risk of anything from financing restrictions to full blocks, and working to hide those transactions through webs of shell companies or proxies can be expensive.

Imposing secondary sanctions is a controversial decision because the potential impact is hard to predict and carries the risk of unintended consequences. Wary of violating rules, banks might abandon entire sectors even if they’re not sanctioned. And even some allied countries consider secondary sanctions to be an overreach of US authority.

I, personally, hope we don’t have to use this new authority. We don’t need quarrels with our allies when unity against the aggressive foe that is Russia is paramount. But the new EO turned out to be a wonderful warning shot to those who continue to help build up the Russian war machine: you can do business with the Russians, or you can do business with the United States. But not both.