Shipping faces a sanctions compliance crisis
Ill-equipped shipping companies have found themselves navigating a maze of international enforcement that is riddled with contradictions
Banks have invested billions of dollars on sanctions compliance capabilities over the past decade, but the shipping industry has not kept pace. With Russian sanctions reaching across the corporate spectrum like never before, a compliance crisis looms
LAWYERS with sanctions expertise have not been getting much sleep of late.
Such is the round-the-clock demand from shipping companies struggling to navigate the morass of rapidly evolving financial trade restrictions that the 3am finish has become a bleary eyed standard for many of the industry’s compliance experts.
Economic measures to cut Russia off from the world’s financial arteries are the most extensive seen since the Second World War.
Yet as governments fire out near daily amendments, clarifications and legalese-laden ‘FAQs’ to patch the hastily issued legislation, large sections of the shipping industry working without in-house compliance teams have struggled to keep pace.
The Western response to Russia’s invasion of Ukraine may be broadly aligned in terms of political objective, but the detail differs significantly, regimes often overlap and inconsistencies are acknowledged across the board.
Add in the mercurial mix of enforcement appetites, jurisdictional grey areas and calculations of blocking statutes being employed as the financial world fractures in line with regional political alliances, and it becomes clear that a global sanctions compliance minefield is being laid in the path of an industry that, with minimal exceptions at the top, has not kept pace with the compliance monitoring forced upon other sectors.
In the wake of a series of compliance scandals and record fines, the financial sector has invested heavily over the past decade.
Banks have built an industrial-scale operation just to digest all the regulatory changes, with compliance costs now representing 15% of a bank’s total annual spend in some cases.
According to LexisNexis’ Global True Cost of Compliance report, the projected total cost of financial compliance across financial institutions worldwide is $213.9bn, up from $180.9bn the previous year.
That rise mirrors the expansion of sanctions being meted out as the foreign policy tool of choice for successive regimes, even before Russia vaulted past Iran and North Korea to become the world’s most-sanctioned nation.
Since 2000, the number of individuals and entities on the US sanctions lists has risen more than tenfold, to more than 10,000.
While oil majors, some traders and charterers and a handful of listed shipowners have invested in compliance teams, technology and expertise, the vast majority of shipping companies have not kept pace.
The fact that law firms have, in some cases, set up round-the-clock hotlines for worried clients is no mere brag on their part.
Compliance chiefs may exist within energy majors, but in most shipping companies, compliance risk management has fallen to general counsel, where they exist — or, more often, the overstretched chief financial officer.
“That’s going to work day to day, I guess, but when the proverbial hits the fan, that means everyone runs to external legal counsel — and, let’s face it, there’s only so much expertise in this sector,” said one regulation compliance specialist working inside a major firm.
“It’s well understood that a significant portion of the sector has just never proactively invested in resources to manage this risk.”
The increasing complexity is not just an issue for under-resourced or laggard operators; even at the top end of the marine insurance sector, where oversight and expertise has arguably been the most advanced, experts are feeling the heat.
Addressing a Treasury Committee hearing earlier this month, Lloyd's Market Association head of marine and aviation Neil Roberts said the impact of Russian sanctions on the London insurance market had been “profound”.
“The complexity of it has been difficult for people to manage. Even very well-resourced compliance teams have found it troublesome. Insurers are not as well-resourced as banks and they are also finding it difficult,” Mr Roberts said.
Part of the problem beyond the unprecedented pace of change is that Russian sanctions have involved a much broader coalition of legislatures than ever before, all seeking to achieve a common, but not particularly well-defined political goal.
The result is that companies find themselves navigating a maze of international enforcement that is riddled with contradictions.
The UK and US sanctions are targeting Russian-controlled and beneficially owned vessels, but the EU rules only block Russian-flagged vessels, with multiple caveats in place across all regimes, carefully balancing individual state interests.
Exemptions and wind-down periods on all sides have created confusion, while general licences issued to clarify hastily prepared legislation have seen ships occupying a grey area where they may or may not be subject to sanctions — but any number of import exclusion orders, insurance or financial services restrictions may apply.
While the shipping headlines have focused on the key US, UK and EU jurisdictional changes, Russia is now subject to more than 5,000 different targeted sanctions globally from 45 countries — more than Iran, Venezuela, Myanmar and Cuba combined.
And it is worth noting the speed at which these measures have been implemented. The crippling economic sanctions that targeted Iran were adopted over the course of 10 years; the majority of Russian sanctions have been implemented in just 10 days.
So, while the management of sanctions complexity is not a new phenomenon for shipping, lawyers, insurers and the few industry compliance chiefs point out that with unprecedented sanctions come unprecedented compliance challenges.
Prior to Russia, the noose of financial regulation had been tightening for several years in the wake of successive financial crises and a US-led upgrading of sanctions enforcement, courtesy of the Trump administration’s ‘maximum pressure’ campaign against Iran and, latterly, Venezuela.
That tightened scrutiny and denial of the waivers previously granted under the Obama administration saw the emergence of a subterfuge fleet of around 220 veteran tankers operating under the radar, with increasing levels of often state-sponsored sanctions-evasion tactics.
That trend, in turn, forced banks, insurers and traders to up their game in terms of vessel tracking, turning to AI and machine learning tools to flag risk that was evading traditional tracking methods.
Despite the sanctions imposed by US and Europe, most of Russia’s energy shipments have remained legal as governments seek energy security over sanctions.
However, the ability to track Russian oil shipments, ship-to-ship transfers and unpick the opaque matrix of Russian beneficial ownership and control in international commodity shipments has now become the number one priority of compliance departments globally.
“Technology can certainly help, but no tool is perfect because we’re now dealing with grey areas that require interpretation and human intelligence to understand the regulation and political context,” explained Louie Vargas, the principal compliance officer on the sanctions controls and technology team at Danske Bank in Copenhagen.
For the banks with entire compliance teams at their disposal, such a forensic approach to compliance risk is a basic business requirement. For the vast majority of the shipping industry racing to catch up, the rapid onslaught of Russian restrictions has proved more problematic.
When the UK government tweeted its intention to ban Russian-controlled ships before legislation had even been written, UK ports were put on notice that the responsibility for identifying the Russian-controlled entities and ownership links would fall to them.
That process initially saw several authorities resort to basic Google searches to protect themselves against potential sanctions breaches.
“Right now, there is no need for Russian tankers, or companies transporting Russian oil, to employ the sanctions-evasion tactics that Iran has — but it doesn’t mean that they won’t in the future,” said Claire Jungman, chief of staff at the lobby group and sanctioned vessel tracker, United Against Nuclear Iran.
“And we know the maritime industry is slow to adopt new measures to enhance their due diligence or compliance procedures because we see it with Iran and Venezuela. If the industry is not able to stop oil that is actually sanctioned, how are they going to be able to deal with Russia?”
Given the evolving nature of the sanctions, the inevitable mis-steps from shipping to date have been overlooked by governments, but any grace period on enforcement is likely to be short-lived.
Law enforcement and regulatory agencies are preparing to enforce a raft of new export control rules and initiatives as part of the US government’s response to the invasion of Ukraine.
Officials from the US Justice Department, US Commerce Department and other federal agencies have been advertising the coming changes at every opportunity.
“The way that multinational companies have to think about how these sanctions regimes are going to be affecting their businesses is critically important, and something we should be having conversations about,” deputy attorney general Lisa Monaco said at a New York City Bar Association event in late April.
In the UK, the snappily titled Economic Crime (Transparency and Enforcement) Act 2022 enters into force in May.
One of the less well-publicised amendments of this legislation removes the requirement that people must have known or suspected that they breached sanctions law to receive a monetary penalty for such breaches.
In effect, the excuse that you were unaware of the fact that your customer’s customer had loaded sanctioned crude is no longer a mitigating excuse in the eyes of UK law.
Russian sanctions have effectively weaponised financial services and trade like never before and, regardless of whether the shipping industry is ready, enforcement is about to come knocking.
Even those sleep-deprived lawyers racking up their billable hours cannot rest easy. Britain’s Solicitors Regulation Authority said on March 15 that it will police law firms’ sanctions compliance with spot checks just to be sure they were not providing advice to the wrong side.
This article is part of Lloyd’s List’s special report on Risk & Compliance. Click here to access or download a PDF copy of the report.