Written by Stephen Platt
Secondary sanctions are an essential tool used by countries, notably the United States, to enforce foreign policy objectives. Unlike primary sanctions, which directly target individuals, businesses, or countries with prohibitions, secondary sanctions aim to deter third-party entities from doing business with those already sanctioned. For financial institutions, the implications of secondary sanctions are particularly significant, as violations can lead to severe repercussions, including exclusion from the U.S. financial system.
Understanding Secondary Sanctions
Secondary sanctions extend the reach of sanctions regimes beyond the borders of the issuing country. These sanctions penalize foreign entities, individuals, or governments that engage in transactions with a sanctioned entity. For instance, the U.S. can impose secondary sanctions on non-U.S. companies that engage with designated targets, such as entities linked to North Korea, Iran, or Russia. The aim of secondary sanctions is twofold:
- Economic Leverage: By threatening penalties, secondary sanctions can exert pressure on third-party countries and businesses to refrain from engaging with the primary sanctioned targets.
- Political and Diplomatic Influence: They serve to align global economic activities with the foreign policy objectives of the sanctioning country.
Key Examples of Secondary Sanctions
- Iran Sanctions: The U.S. imposed secondary sanctions on entities that engage with sectors like Iran’s oil industry, with the goal of preventing companies from facilitating financial transactions or trade with Iran.
- Russia-related Sanctions: The U.S. imposed secondary sanctions under the Countering America’s Adversaries Through Sanctions Act (CAATSA), targeting non-U.S. businesses that engaged with Russian military and intelligence sectors.
- North Korea Sanctions: Secondary sanctions target non-U.S. entities aiding the financial networks supporting North Korea’s weapons programs.
Challenges and Risks for Financial Institutions
- Ambiguity and Lack of Clarity: Secondary sanctions often have broad wording, leading to ambiguities in terms of who might be targeted and for what activities. This creates challenges in risk assessment and compliance management.
- Cross-Border Compliance: Financial institutions operating globally must be compliant not only with domestic regulations but also with foreign sanctions policies. Aligning operations to avoid secondary sanctions can be daunting.
- Reputational Risk: A violation, or even the perception of one, can severely harm a financial institution’s reputation and client trust.
- Cost of Compliance: Mitigating the risks associated with secondary sanctions requires significant investment in compliance programs, due diligence, and employee training.
Effective Risk Management Approaches for Financial Institutions
To manage the risks of secondary sanctions effectively, financial institutions should adopt a proactive, multifaceted strategy. The following approaches can significantly strengthen an institution’s resilience:1. Robust Sanctions Screening Programs
Financial institutions need to maintain robust sanctions screening systems to monitor and screen transactions against lists of sanctioned individuals and entities. A key focus should be on identifying indirect exposure to sanctioned entities, such as through third-party suppliers or clients of sanctioned companies.
- Adopting Automated Solutions: Automation and AI-based monitoring can enhance the accuracy and efficiency of sanctions screening, reducing the risk of missing connections to sanctioned entities.
2. Comprehensive Risk Assessment Framework
Institutions must develop a risk-based approach to their sanctions compliance program. This involves understanding and regularly assessing their exposure to sanctioned jurisdictions, sectors, and entities.
- Country-Specific Risk Analysis: Assess risks associated with specific countries or regions with a high likelihood of secondary sanctions exposure, and implement specific controls for business in those jurisdictions.
3. Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD)
Financial institutions should prioritize robust due diligence measures, both at the onboarding stage and throughout the customer relationship. High-risk customers or transactions require enhanced due diligence (EDD), including detailed scrutiny of ownership structures and counterparties.
- Ownership and Beneficiary Mapping: Effective CDD should include mapping the ownership structures of business clients to determine connections to sanctioned entities or countries.
4. Training and Awareness Programs
Employees at all levels must be equipped with knowledge about secondary sanctions risks and the financial institution’s responsibilities. Training should focus on understanding the broad implications of secondary sanctions and the steps to take when a potential issue is identified.
- Scenario-Based Training: Conducting scenario-based training can help employees recognize potential indirect sanctions exposure and understand how to escalate such situations.
5. Transaction Monitoring and Reporting
Financial institutions need an effective transaction monitoring system that flags suspicious or unusual activity. Automated monitoring solutions can help in detecting red flags indicating potential indirect dealings with sanctioned entities.
- Suspicious Activity Reports (SARs): Institutions must have clear procedures in place for filing SARs when transactions suggest possible indirect exposure to secondary sanctions violations.
6. Independent Audits and Reviews
Conducting regular, independent audits of the institution’s sanctions compliance program is crucial. This allows for the identification of weaknesses and ensures that controls are functioning effectively.
- Internal and External Audits: Engage both internal audit teams and third-party auditors to conduct thorough reviews of sanctions compliance efforts.
Staying up-to-date with evolving sanctions regulations and interpretations is vital. Financial institutions should establish open communication channels with regulators and seek advice from legal and compliance experts regarding complex sanctions-related matters.
- Proactive Dialogue: Proactively engaging with regulators can help clarify ambiguities and ensure alignment with current sanctions expectations.
Conclusion
The risks posed by secondary sanctions require financial institutions to adopt a proactive and comprehensive approach to compliance. From establishing robust screening systems to engaging in ongoing dialogue with regulators, managing the complexities of secondary sanctions demands attention to detail and constant vigilance.
By implementing robust compliance frameworks, financial institutions can not only protect themselves from the legal and financial consequences of sanctions violations but also build resilience and trust with their clients. In a globalised financial system, where economic policies intersect with international politics, maintaining a solid understanding of secondary sanctions and their risks is indispensable for financial institutions aiming to remain competitive and compliant.
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