US SANCTIONS AND RUSSIA : CONSIDERATIONS FOR INVESTORS

 

With the political situation in Ukraine continuing to deteriorate, and Moscow seeking to deepen its regional influence, an expansion of the sanctions regime imposed by the United States and the European Union against Russian officials and business interests close to Putin should be expected. At the time of writing, five rounds of sanctions have been introduced, along with revised export restrictions, and there appears to be an evolving strategy in the White House increasingly focused on targeting commercial entities in Russia close to the Kremlin, rather than just political figures.

 

With the West’s weapons of choice in response to Moscow’s blustering looking primarily economic, Western companies with commercial interests in Russia are likely to face two sets of related economic and business concerns:

 

Compliance: As new entities are added to the evolving sanctions list, a significant challenge to business managers is the need to continually ensure compliance by determining on an ongoing basis if entities or individuals they deal with are being reprimanded

 

Russia’s potential response: While the Kremlin is yet to reveal the full extent of its response to sanctions, it has warned that it will be “painfully felt in Washington”. The possible sanctioning of Western assets, particularly in the energy sector, as well as likely local market discrimination, have the potential to significantly impact the local operations of Western businesses. 

 

Compliance

 

The evolving sanctions regime poses a growing compliance risk for Western firms active in Russia. While the companies most recently added to the US Specially Designated Nationals list are owned or controlled by Bank Rossia, Boris or Arkady Rotenberg, Genaddy Timchenko or Yuri Kovalchuk (all of whom already face sanctions), the strong indication is that this list is going to widen.

 

Adding to this compliance risk is the lack of transparency in local corporate structures in Russia. It is not uncommon that influential local Russians are not explicitly affiliated with a company, preferring to be represented by nominees, who register as directors and/or shareholders on their behalf. This opacity of ownership means the need for due diligence and local partner screening is significant, and complicates the process of ensuring that local partners are not compromised.

 

R₂G notes that the extent to which sanctions will preclude Western companies from engaging with Russian partner companies whose senior managers have been added to the sanctions list remains unclear. In announcing that sanctions would be levied against both Igor Sechin, chairman of the Russian state oil firm Rosneft, and Sergei Chemezov, the director general of Rostec, the US administration emphasized that neither Rosneft nor Rostec themselves were to be treated as if on the list.

 

Russian response

 

Moscow is yet to make clear its response to Western sanctions, and Putin has proved keen to cast himself as resistant to making countermeasures. In the specific areas of space, military and technology, which have faced specific and significant export bans, it is likely that cooperation will cool substantially. However the wider implications for Western firms operating in Russia, and the associated difficulties, are less clear. Adding to the uncertainty, the rouble has fallen approximately 8% since sanctions were imposed.

 

With this recent wave of sanctions however, it looks increasingly likely that Putin will start to increase the pressure on foreign companies whose governments have implemented sanctions.

 

While the seizing of assets is unlikely for now, one possible area Putin might respond will be to freeze access by Western interests to hydrocarbon investments in Russia. It is notable that BP’s share-of-earnings from its substantial stake in Rosneft has fallen from $1.1bn to $271m over the last quarter. Shell has been keen to reaffirm its relationship with Moscow. However the impact of the most recent sanctions are showing, and while in mid-April Chief Executive Ben van Beurden personally assured Putin that the company was committed to expansion in Russia, on 1^st May it announced a U-turn, that it had frozen all future investments in the country.

 

Putin’s comments suggest that outside energy, other sectors might well be targeted by a Russian response. Pepsi earned 7.5% of its 2012 revenue from its Russian business, while Alcoa earned almost 3%. Western companies such as Boehringer Ingelheim and Bayer MateriaScience, have signaled that they remain committed to the Russian market. However there are already indications of market discrimination against their activities locally, a situation likely to worsen if relations between Moscow and the West sour further.

 

Conclusion

 

In summary, given the growing friction between Moscow and the West, and the expanding nature of the sanctions regime, the risks to Western companies operating in Russia are rising.

 

In combating the possible implications of this, monitoring sanction lists, understanding the full ownership structures of local partners, and having visibility on local risk and reputations by conducting enhanced due diligence into partners in Russia is essential.

 

To conclude, the impact of current events on Western businesses in Russia is significant, and given the ongoing political developments in Ukraine, for the short-to-medium term is likely to remain. While it is still possible to conduct successful business in Russia, vigilance is required to ensure associated risks are mitigated.

 

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R₂G is strongly positioned to assist companies seeking to safeguard themselves from the legal and reputational risk of non-compliance with Western sanctions, and the evolving business climate in Russia. R₂G conducts partner screening, enhanced due diligence and dispute management investigations in Russia and throughout Eastern Europe, and can help develop visibility on new and existing partners, and conduct dispute-focused investigative work when relationships fail. 

 

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Risk Resolution Group

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