Compliance with sanctions regimes has become a hot topic this year as the rapid expansion of sanctions against Russia, a country well integrated into the global economy, coincides with aggressive enforcement and the imposition of a record-setting penalty against BNP Paribas. Here, we provide a quick primer for private equity firms and their portfolio companies to help them understand key aspects of the new sanctions against Russia and the steps they can take to mitigate potential risks. More in-depth coverage of U.S. and E.U. sanctions on Russia can be found at The Sanctions Resource, a collection of Debevoise & Plimpton’s sanctions-related Client Updates.
Sanctions Against Russia Are Complex and Expanding
Beginning in March 2014, the United States and the European Union have imposed progressively harsher sanctions on Russia in response to events in Ukraine. Both the United States and the European Union have attempted to tailor their sanctions regimes in a manner that recognizes Russia’s interconnectedness with the global economy. This tailoring has created complexity, which presents its own set of compliance challenges for many firms.
Blocking Sanctions. The United States and European Union maintain “blocking” sanctions, which prohibit most business dealings by U.S. and E.U. companies and persons (including U.S. private equity firms and funds and their U.S. portfolio companies), and in some cases their affiliates, with a large number of Russian government officials, businessmen and companies.
Financing and Capital Markets Restrictions. The United States and European Union have also instituted so-called “sectoral” sanctions, targeting certain Russian financial, defense and energy companies. These sectoral sanctions restrict U.S. and E.U. companies and persons from providing long-term financing to, or dealing in new long-term debt instruments (including loans) of, designated companies and, in some cases, dealing in new equity of designated companies. For this purpose “long-term” debt is debt payable more than 30 days (or more than 90 days) in the future (depending on the company and the circumstances).
Oil-Related Restrictions. U.S. and E.U. companies and persons are also prohibited from providing many goods and services to support most Russian oil exploration or production projects.
U.S. Sanctions Can Apply to Non-U.S. Portfolio Companies
Private equity firms may not be aware that a non-U.S. portfolio company is also required to comply with U.S. sanctions if the private equity firm or fund is deemed to control the management of the portfolio company. In such cases, the private equity firm or fund could face liability for sanctions violations by the portfolio company. And while many U.S. private equity firms have in place sanctions compliance programs, their non-U.S. portfolio companies may not.
Risk Assessment Is Key
Private equity firms should monitor sanctions developments and conduct regular risk assessments with respect to their operations, both at the fund level and at their portfolio companies. Sanctions on Russia substantially increase compliance risks faced by U.S. and E.U. companies because, unlike many more “traditional” sanctions targets, Russian companies are frequent counterparties to U.S. and E.U. companies, both within Russia and in international financial markets.
Due Diligence Is More Important Than Ever
Private equity firms should conduct comprehensive sanctions-related due diligence when considering new investment opportunities or add-on acquisitions. Among other things, private equity firms should ensure that they understand the ownership structures of their counterparties. Under both U.S. and E.U. sanctions regimes, prohibitions and restrictions apply not only to listed Russian companies and persons but also, in many cases, to entities that may be owned or controlled by sanctioned persons. Know who you’re dealing with!
Compliance Programs Mitigate Sanctions-Related Risks
In many cases, even an inadvertent violation of sanctions can result in significant penalties. However, regulators may give meaningful credit to firms that have in place good compliance programs, training and oversight. Firms should adopt risk-based sanctions compliance plans that provide appropriate controls for investor intake (e.g., screening potential fund investors and co-investors against sanctions lists); encourage comprehensive sanctions-related due diligence on new investment opportunities pursued by the firm’s funds; and require, where appropriate, portfolio companies to implement compliance programs as well.
Employees and Directors Can Be Liable
Employees and directors of private equity firms or their portfolio companies may be held liable in their personal capacities for their violations of sanctions laws.
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