Crisis in Ukraine: How Effective are Sanctions against Russia?

Since Russia’s annexation of Crimea in the first quarter of 2014 Russian net capital outflow has surpassed last year’s annual level of $63 billion. A vast sum of money is leaving the country for safer shores. This in turn has led to reductions in Russia’s growth forecast for 2014. The country’s credit rating has been downgraded to just above junk status, reflecting a high risk investment environment.

The reality of a Russian recession is beginning to set in, and private Russian companies are having trouble re-financing their debts without foreign support. Foreign investors’ confidence in Russia has declined. Russia’s Deputy Foreign Minister Sergey Ryabkov has acknowledged that the country will be hurt by sanctions. The Russian economy is in trouble. Sanctions, used wisely, will have an effect.

Sanctions: The First Line of Defence for the West

On 28 April the US government added seven individuals and seventeen corporate entities to its Russia/Ukraine sanctions list. As a supplement to asset freezes and travel bans, the US is reviewing and rejecting a number of license applications for the export or re-export of high technology defence equipment that could contribute to Russia’s military capabilities.

The US list builds on previous sanctions issued, targeting subsidiaries of Bank Rossiya and corporate interests of Gennadiy Timchenko and the Rotenberg brothers. The EU has closely followed, adding fifteen individuals to their list, including the Director of Russia’s Main Intelligence Directorate (GRU) Igor Sergun and Deputy Prime Minister Dmitry Kozak.

Vladimir Putin and the Russian government have been vocal about Russia’s resilience against sanctions. Putin said that sanctions would in fact help the Russian economy to 'de-offshorise', and he immediately proposed an alternative domestic payment system to replace American providers when Visa and MasterCard blocked certain Russian transactions following Bank Rossiya sanctions in March.

The US sanctions go further than those issued by the EU and EU member states. After all, the UK, Germany, and France have much to lose. The EU has tended towards the more consistent approach, predominantly focusing on individuals who played a role in the annexation of Crimea. They cover a number of career politicians who are unlikely to own significant ‘freezable’ assets. Sanctions will complicate the lives of these individuals, but have few wider implications.

The US has zeroed in on Putin’s inner circle in both the private and public sector in the hope that they will influence Putin’s behaviour, if not put pressure on his own personal corporate interests. Two sanctioned individuals stand out on the new US list: Igor Sechin, the president of Russian state-owned petroleum company Rosneft and a member of the Kremlin’s hard-line siloviki faction consisting of former security agents, and Sergei Chemezov, the deputy chairman of Rosneft's board and CEO of Rostec, the state high-tech exports programme. Both are close associates of Putin and had little to do with the annexation of Crimea.

Following the announcement that they were under US sanctions both were vocally defiant. Sechin responded with assurances to Rosneft’s partners that their cooperation would not suffer but ‘will develop dynamically’. Rostec said the sanctions against Chemezov would 'not impact the company’s activities or be an obstacle for Chemezov in running the company'.

There is some truth in this. It is notable that the US has refrained from placing the powerful state-owned entities these individuals run under sanctions themselves, while the EU has avoided these individuals altogether. This is because by targeting them, the West knows it could seriously jeopardise its own businesses operations. The co-dependent relationship many large UK companies have with Russia shows the limitations even international economic action may have.

BP, which owns almost 20 per cent of Rosneft, has said it remains 'committed' to Rosneft, despite sanctions against Rosneft principals. If Rosneft itself had appeared on the US list and Sechin had appeared on the EU list, this would have had far greater implications for BP’s Russian operations, particularly as BP’s Group Chief Executive, and Rosneft board member, is an American citizen.

Dealing With Vague Guidance on Relevant Assets

The current sanctions are likely to have some effect on the operations and partnerships of large entities but may well be undermined by the lack of guidance from Western governments. The identification of sanctioned assets has been left to US and EU banks and businesses themselves. The lack of direction and guidance from those regulatory bodies issuing the sanctions themselves is diminishing their effect. No attempt at listing relevant assets of sanctioned individuals to aid banks identify liability has been made by either the US or the EU.

The rules are both vague and inconsistent between the sanctioning bodies. The Office of Foreign Assets Control (OFAC) says that freezes apply to assets where a sanctioned individual owns ‘direct or indirect ownership interest of 50% or more’. The British Government says that asset control can be defined as having the power to ‘exercise, or actually exercises, a dominant influence or control over an entity'.

Sechin and Chemezov are mainly known for their directorships, not direct or controlling ownership, of large assets. However, ‘dominant influence’ and ‘control’ are much more relevant forms of ownership in a business environment like Russia. Russian businesses often deliberately hide beneficial ownership through complex and opaque corporate structures, often offshore. Determining this is the problem.

To date, the impact of the sanctions has been met with a degree of international scepticism. The discrepancies between the US and EU sanctions lists have undermined their credibility somewhat, visibly failing to present a united front. But we should not write off sanctions altogether. Sanctions are one of the few tools Western governments have in their declining arsenal of power. Our shrinking military capabilities and diminishing diplomatic weight has left policymakers searching for leverage.

It is true that the importance of global trade to the EU and member states has blunted our financial and economic weapons of choice, but a robust sanctions framework that demonstrates to Putin the West will accept some financial pain in order to maintain peace in Europe must surely be worth it.

Sarah Lain is a Research fellow at RUSI