Mitigating Russian risk(2)

Now the EU and the US have tightened their sanctions against Russia, there’s even more danger of GPs getting into hot water.

Since March, private fund advisors with possible ties to Russia and the Ukraine have been regularly monitoring government lists of people and businesses restricted from conducting business in the US and EU. But after the both the US and the EU strengthened their sanctions last week, the compliance burden for fund managers has stepped up a notch.

Some fund managers will pull out altogether. The Blackstone Group has recently decided to stop hunting for deals in Russia, according to today’s Financial Times.

For those that choose to persist, the first step is to seek advice and clarification from your local regulator on what is and isn’t permitted, lawyers tell pfm. This might seem obvious, but sources say not all GPs have been doing it. And it’s important – because while EU sanctions are effective at the European level, their interpretation and enforcement occurs at the national level. Some countries may also choose to ‘gold-plate’ the sanctions, for instance by putting a larger number of individuals on the blocked persons list.

Sanction compliance also needs to go beyond box-ticking, legal sources say. It is not enough to simply check the blocked person and company lists for familiar names; GPs must dig into the ownership structures of the firms’ business partners, separating webs of holding companies, subsidiaries and affiliates as well as calculating each owner’s economic interest. Under the US sanctions, any entity that is more than 50 percent owned, directly or indirectly, by a blocked person becomes a blocked company.

This won’t be easy. Ownership of Russian businesses can often go through several holding companies, and legal sources say it is incredibly difficult to work out who owns what. It is also relatively straightforward for sanctioned entities to disguise their ownership or control of offshore entities or shell companies, the sources add. GPs can’t rely solely on public disclosures; they should also seek representations and warranties by third parties, or demand statements that the parties are not subject to sanctions and thus safe to deal with.

“Public information can only take you so far. We have had situations in the past few weeks where we have gone through all available public information but we wanted more detail. Then you have to go to the party you are dealing with and they might not always be forthcoming with that information,” said Caroline Hobson, competition partner at law firm CMS.

Firms are also being advised to get into the weeds of their counterparty agreements – for instance, reviewing portfolio companies and scrutinising their companies’ business partners, including vendors, suppliers, customers, co-investors and joint venture partners. Again, sources say that getting statements from counterparties confirming that they are compliant with the sanctions, and that their systems and controls are up to scratch, is a good practice to follow.

What’s more, with nobody really sure what Russia’s next move will be, tougher sanctions are always a possibility. By increasing the compliance legwork now, GPs that inadvertently break a sanction may be protected – if they can prove they had robust systems and controls in place.

Failure to do so has severe ramifications. French bank BNP Paribas agreed to pay a whopping $9 billion in damages back in July, after violating US sanctions by failing to stop senior officials at the bank breaking embargoes with Iran, Sudan and Cuba. And what’s particularly problematic for smaller groups is that there’s no proportionality of punishment: because violating sanctions is a criminal matter, firms with a part-time compliance officer will get hit just as hard as those with a ten-strong compliance team. 

As an SME, if you have less robust systems and controls than a much larger firm, you will have to provide evidence that they still were effective (not an easy undertaking if a serious violation at the SME has been established),” said Benno Schwarz, corporate partner at law firm Gibson Dunn & Crutcher.So extreme caution has to be the order of the day.