Substantial Enhancement of Sanctions and Export Controls Targeting Russia and Belarus, Phase II

Earlier this week, following Russia’s aggressive incursion into Ukraine, we reported on the imposition of U.S. sanctions in response — a modest response that reserved the heavier sanctions that have been anticipated. 

On February 24, the U.S. broke the safety glass and substantially escalated that response, imposing new sanctions and other restrictions on a range of Russian and Belarusian financial institutions, persons, and interests, and implementing new export controls designed to deny Russia the benefit of U.S.-origin technology and degrade its military, computing, telecommunications, and other capabilities. Although no steps have been taken to deny Russia’s access to the SWIFT messaging system used by the global financial system (with EU support currently lacking), considered together and over time, these actions will broadly impact financial and other transactions of importance to Russia. All parties with interests involving Russia or Belarus should evaluate their effects.  

Below, we summarize these new measures, which are being implemented by the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) and the U.S. Department of Commerce’s Bureau of Industry & Security (BIS). In reviewing these new restrictions, readers should also recall the prior “Phase I” sanctions discussed here, including the comprehensive embargo of the Donetsk and Luhansk regions of Ukraine.   

1. Specially Designated National (SDN) Designations of VTB Bank, Other Russian Financial Institutions, Certain Oligarchs and Russian Officials, and Certain Belarusian Persons

The U.S. has imposed blocking sanctions on a range of Russian and Belarusian persons by their inclusion on the OFAC Specially Designated Nationals List. Most prominent among these targets is Russia’s second largest financial institution, VTB Bank, and 20 of its subsidiaries. The largest Russian financial institution, Sberbank, was spared the SDN designation but is addressed with separate restrictions detailed in this alert. Also blocked are certain Russian families close to President Putin and certain elites of the Russian financial sector. A list of new SDN designations may be found here. 

As with all SDN designations, U.S. persons (i) are barred from engaging in virtually all transactions, whether direct or indirect, involving SDNs or their direct or indirect property interests, and (ii) must block and report to OFAC any such property within their possession or control. Under OFAC’s 50 Percent Rule, any entity in which one or more SDNs in the aggregate own a 50% or greater interest must also be treated as an SDN, even if the entity does not separately appear on the SDN List.

Recognizing the broad, disruptive effect these SDN designations could have on activities that are otherwise important to U.S. objectives, OFAC has issued a series of General Licenses to mitigate those effects. A General License is automatically available and may be relied upon without specific OFAC authorization, provided compliance with its terms and conditions. 

To mitigate the impact on trade in food and medicine, OFAC has issued: 

• General License 6, authorizing transactions otherwise prohibited and ordinarily incident to (1) the exportation or reexportation of agricultural commodities, medicine, medical devices, replacement parts and components for medical devices, or software updates for medical devices to, from, or transiting the Russian Federation; or (2) the prevention, diagnosis, or treatment of COVID-19.

To assist those reliant upon Russian sources of energy, OFAC has issued: 

• General License 8, authorizing, through 12:01 a.m. EST on June 24, 2022, all transactions “that are related to energy” (defined in the General License) and otherwise prohibited involving (1) State Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank; (2) Public Joint Stock Company Bank Financial Corporation Otkritie; (3) Sovcombank Open Joint Stock Company; (4) Public Joint Stock Company Sberbank of Russia; and (5) VTB Bank Public Joint Stock Company; or entities owned 50% or more by these banks (collectively, the “Covered Entities”).  

To enable U.S. persons to divest debt instruments, equity, and derivative contracts involving SDNs, through 12:01 a.m. EST on May 25, 2022:

• General License 9 authorizes the divestment or transfer (or facilitation of the same), of debt or equity of the Covered Entities, provided that the debt or equity is being transferred to a non-U.S. person; and
• General License 10 authorizes transactions ordinarily incident and necessary to the winding down of existing derivative contracts that (i) include one of the Covered Entities as a counterparty or (ii) are linked to debt or equity of a Covered Entity.

To mitigate the immediate impact on the banking industry, OFAC has issued two temporary authorizations that expire after 12:01 a.m. EST on March 26, 2022: 

• General License 11, authorizing otherwise prohibited transactions incident and necessary to the winding down of transactions involving Public Joint Stock Company Bank Financial Corporation Otkritie, Sovcombank Open Joint Stock Company, VTB Bank Public Joint Stock Company, and entities owned 50 percent or more by these Russian banks.
• General License 12, authorizing, in lieu of the blocking obligations described above, the rejection of transactions involving these same three Russian banks and their 50% or greater subsidiaries. After expiration of this authorization, U.S. persons must block the property of these SDN banks and report that action to OFAC.  

In addition, General License 5, and General License 7 of the Belarus Sanctions Regulations, authorize otherwise prohibited activities with specific international organizations (e.g., the International Committee of the Red Cross); transactions for the official business of the United Nations exempt from these restrictions. General License 7 (related to the Russia sanctions) authorizes certain overflight payments, emergency landings, and air ambulance services. 

2. Barring Sberbank from the U.S. Financial System — Prohibitions on Correspondent or Payable-Through Accounts and Processing of Transactions 

Sberbank is Russia’s largest financial institution and holds nearly a third of Russia’s banking-sector assets. U.S. financial institutions are required to close Sberbank correspondent or payable-through accounts and to reject any future transactions involving Sberbank or its foreign subsidiaries — substantially restricting the processing of payments denominated in U.S. dollars, which typically must be routed through the U.S. financial system for clearing purposes. 

To implement this measure, OFAC issued Directive 2 under Executive Order 14024, which, beginning at 12:01 a.m. EST on March 26, 2022, will prohibit U.S. financial institutions (as defined in the directive) from:

• Opening or maintaining correspondent or payable-through accounts for or on behalf of Sberbank or 25 of its foreign subsidiaries, or their property or interests in property; and 
• Processing transactions involving Sberbank or 25 of its foreign subsidiaries, or their property or interests in property.

Additional foreign financial institutions may later be subject to the directive’s prohibitions. 

Here is a List of Foreign Financial Institutions Subject to Correspondent Account or Payable-Through Account Sanctions (CAPTA List); however, any foreign financial institution owned 50% or more by CAPTA-designated parties are also covered by the prohibitions of Directive 2, even if not identified specifically on the CAPTA List.

3. Debt- and Equity-Related Restrictions on Certain Russian Entities

The U.S. will expand Russia-related debt and equity restrictions to additional key actors in Russia’s economy, an action intended to restrict Russia’s ability to finance its malign activities through the U.S. market. 

Under E.O. 14024 Directive 3, U.S. persons are prohibited from engaging in transactions in, providing financing for, or otherwise dealing in new equity or new debt of longer than 14 days maturity, issued on or after 12:01 a.m. EST on March 26, 2022, by 13 specific entities. These entities, which include six of Russia’s largest banks and companies in its energy, utility, and transportation sectors, are listed in Annex 1 to the Directive. OFAC’s 50 Percent Rule applies to E.O. 14024 Directive 3, meaning these restrictions also impact dealings involving any entity in which one or more listed entity owns a 50% or greater interest. 

These are not the SDN/blocking sanctions imposed on other Russian banks and companies, and transactions involving these entities remain permissible, provided that they are not prohibited by Directive 3 or another law (including those detailed in this alert). As some of these entities were already subject to certain sanctions and/or export restrictions implemented in response to Russia’s 2014 annexation of the Crimea region of Ukraine, companies should carefully review the full scope of sanctions that may apply to a given entity. 

Additional Russian entities may later be made subject to E.O. 14024 Directive 3. 

4. New Export Control Restrictions Targeting Russia’s Reliance Upon U.S.-origin Technology

While OFAC is responsible for implementing the various sanctions discussed above, a range of amendments to the Export Administration Regulations (EAR), administered by BIS of the Commerce Department, impose new export license requirements and licensing policies targeting Russia. When considered together with the sanctions discussed above, the new export controls will cause many to treat Russia as a comprehensively embargoed destination under U.S. law; however, many items (for instance, certain mass market software items) are still authorized for export to most Russian end users.  

Applying to certain exports, reexports, and transfers to or within Russia, the new restrictions are highly technical and sweep across industry sectors. Fidelity to these new restrictions will demand a close review of all dealings involving U.S.-origin items destined to Russia (including items made abroad in reliance upon U.S.-origin technology), including correct Export Control Classification Numbers for items and the equipment used to manufacture those items, and familiarity with the nature of the Russian end user. 

In summary: 

• All items controlled in Categories 3-9 of the Commerce Control List (“CCL”) will require an export authorization prior to any export, reexport, or transfer to or within Russia. The expanded scope, in Section 746.8 of the EAR, includes all items and technologies in the CCL Categories, covering electronics/microelectronics, computers, telecommunications and information security, sensors and lasers, navigation and avionics, marine equipment, and aerospace and propulsion. Included are scores of items not previously controlled for export to Russia. Some License Exceptions — including a narrowed version of License Exception ENC for most software items, discussed below — remain available to overcome the new license requirements. 

(The expanded license requirement does not extend to deemed exports or reexports to Russian nationals located outside of Russia.)

• A new Russia Foreign Direct Product (FDP) Rule expands the export license requirement for items listed in Categories 3-9 of the CCL to include certain foreign-produced items, shipped to any destination, that meet product scope and destination scope requirements. 
  • o An item is within the product scope if it is a foreign-produced item that is (i) the “direct product” of U.S.-origin “technology” or “software” controlled under Categories 3-9 of the CCL, or (ii) produced by any plant (or major component of a plant) that itself is a “direct product” of such technology or software. 
  • Destination scope means knowledge that the foreign-produced item (i) is destined to Russia, or (ii) will be incorporated into, or used in the production or development of any part, component, or equipment produced in or destined to Russia. 

Exempt are foreign-produced items that would be designated as EAR99 (i.e., not specifically described on the CCL) or items shipped from certain partner countries. ¹

• Export license applications will be reviewed under a policy of denial, with important exceptions; and the use of license exceptions is significantly restricted. Software companies may still rely upon License Exception ENC for the export of certain encryption items, but not if the software items are destined for Russian “government end users” or Russian state-owned enterprises (and see below concerning “military end uses” and “military end users”).

New restrictions applying to Russian “military end uses” and “military end users” will require enhanced diligence to determine whether counterparties may fit within one of those categories or are designated on the Entity List.

• Existing Russian “military end use” and “military end user” restrictions (formerly directed at a subset of export controlled items) now extend to all items subject to the EAR, imposing an export license requirement with limited exceptions. ² These end use and end user restrictions require careful diligence to understand the nature of the ultimate consignee as well as the item’s intended end use.
• A new Russia-Military End User FDP rule expands the export license requirement to a wider range of foreign-produced items for designated military end users. Unlike the Russia FDP rule described above, the Russia-MEU FDP rule applies to all foreign-produced items, including those designated EAR99, ³ that are the “direct product” of, or produced by a plant (or major component of a plant) that itself is a direct product of, any technology or software listed on the CCL. But the broad product scope only restricts transactions involving a military end user on the Entity List with a so-called “footnote 3” designation, or where there is knowledge that the item will contribute to the production or development of anything produced, purchased, or ordered by a footnote 3-designated entity. 
• BIS added 49 Russian “military end users” to the Entity List with a special “footnote 3” designation. The Entity List generally imposes an export license requirement for all items subject to the EAR destined for listed entities, with limited eligibility for license exceptions. Footnote 3 identifies entities subject to the expansive Russia-Military End User FDP rule.

If you would like additional information about the issues addressed in this client alert, please contact Rich Matheny or Jacob Osborn, or the Goodwin lawyer with whom you typically consult.