Dr. Justine Walker, Head of Sanctions Policy, UK Finance
Our last blog dealt with how we are entering unchartered territory following the US withdrawal from the Joint Comprehensive Plan of Action (JCPOA). As set out in our webinar yesterday, the Trump administration has geared up for a significant diplomatic campaign to convince companies to exit Iran. The re-imposition of secondary sanctions is a key card that the US has played. The assessment is that allied governments and foreign companies will eventually comply with the new US approach.
In response, the European Commission have set out their aspirations for mitigating the impact of the US JCPOA withdrawal. This includes an enhanced focus on the European Investment Bank to finance activities in Iran and a strong political will to strengthen assistance to Iran in the energy and SME sectors. Furthermore, EU Member States have been encouraged to explore new possibilities for payment channels involving the Iranian Central Bank.
A central feature of the European Commission’s response was the 18th May announcement that the Commission had launched the formal process to update the 1996 EU Blocking Regulation (also referred to as the Blocking Statute). In brief, the Blocking Regulation prohibits ‘EU persons’ – a very broad term – from complying with certain US extraterritorial sanctions.
The driving force for this update is clearly an exceptionally strong desire by EU Member States to protect the Iran-related business interests of European companies and individuals following the US JCPOA withdrawal. The update process is following a rapid implementation timeframe. The Commission has begun drafting amendments for adoption by 6th June. Unless there is any unexpected delay, the new Regulation will enter into force by 6th August.
Whilst the EU Blocking Regulation has been in place for over two decades, it has rarely been enforced. In its current shape, the financial sector and other sectors perceive the Regulation as ineffective in providing tangible protection against US secondary sanctions; a simple update to it is therefore unlikely to change this. The impact it will have, however, is to add a further dimension of legal complexity and cross-border compliance challenges in an already complex geopolitical sanctions landscape. The potential of civil legal action will also intensify.
Previously, EU Member States had little appetite to draw upon the tools offered by the Blocking Regulation. Whether this appetite has now changed will determine the true impact of the updated Regulation. Financial institutions would be well advised not to automatically assume that the updated Regulation will have little to no impact. Much will depend on how it is implemented and enforced.
US secondary sanctions – EU banks caught in the cross fire.
Secondary (or extraterritorial) sanctions are those sanctions that apply to non-US persons for conduct that occurs entirely outside US jurisdiction, i.e. the proscribed conduct does not involve any US person. The aim of secondary sanctions in the Iran context is to apply pressure on third parties (i.e. EU banks and corporates) to stop their dealings with designated Iranian entities, individuals or associated activity. It does this by prohibiting US financial institutions from transacting with any third party designated under the secondary sanctions.
The threat of the imposition of secondary sanctions was an effective tool under the US Iran-related sanctions prior to the JCPOA, due to many EU banks and EU corporate entities experiencing numerous touchpoints with the US financial system. Such touchpoints for an EU institution can be considerable and range from offering US dollar transactions (therefore needing access to a US correspondent bank), employing US natural persons, being listed (either directly or indirectly) on US exchanges, having US shareholders, raising capital through US dollar-denominated bonds listed in the EU and so forth. The prospect for being denied access to the US financial system is a major consideration for many EU banks.
As a result, banks operating in the EU face being caught in the crossfire of the growing transatlantic sanctions rift. There are many questions that will need detailed and urgent consideration. For instance, how will the Blocking Regulation impact customer agreements which prohibit engagement in Iranian activities prohibited under US sanctions requirements. Will these agreements leave banks open to being sued by customers or other interested parties? Additionally, many European banks, due to their US exposure have set global group sanctions policies that may include external statements on willingness to undertake business in Iran. Will such statements trigger enforcement action under the Blocking Regulation?
A further facet to the debate is the impact on US persons operating within the EU. Under the JCPOA the US maintained its primary sanctions, including those applying to non-US incorporated subsidiaries of US entities, but removed the threat of secondary sanctions for non-US persons wishing to trade with Iran. The US also introduced a General License – ‘GL H’ – which permitted non-US subsidiaries of US entities to trade with Iran. However, this was permitted under strict conditions (including a prohibition on any touchpoint with the US financial system) which many non-US subsidiaries could not meet. Even when the US was party to the JCPOA, it was always the case that US natural and legal persons, including non-US incorporated subsidiaries, were prohibited by primary sanctions from engaging with Iran unless licenced by OFAC under very stringent conditions. The Blocking Regulation will create a considerable conflict of law for US natural and legal persons operating in the EU or EU incorporated subsidiaries of US entities. Some may even argue that it is disproportionate to require these persons to support trade relationships with Iran when they were prevented from doing so even when the US was an active partner in the JCPOA.
Within the 1996 Regulation a little-known procedure exists for an EU person to apply to the European Commission for authorisation to comply with US sanctions. Whilst it is not clear whether this mechanism has ever been utilised, it is likely to be a critical route many will wish to explore. Equally, the European Commission intends to issue guidance to accompany the new Regulation. This new guidance will require detailed thought and consultation.
For now, at least, EU Member States have chosen a different path of engagement with Iran. Supporting trade, securing payment channels and protecting EU companies who trade with Iran from US extraterritorial sanctions are key components of the European strategy. However, given the globalised nature of international finance, dusting off the Blocking Regulation may not be the most effective way forward in advancing those aspirations.