16th October 2020

EU Sanctions, Hong Kong Banks, and US Cryptocurrency Rules

The EU prepares to take action over the Navalny poisoning and Belarusian discontent, the US puts Hong Kong banks on sanctions notice, and the US Justice Department issues a statement of intent on cryptocurrencies.

We share our financial regulatory highlights from the week of 12 October 2020.

EU Prepares Sanctions Against Putin Allies

At a meeting on 14 October, EU member states’ ambassadors are reported to have agreed on new sanctions against Russian officials they believe to be linked to the attempted murder of Russian opposition leader Alexei Navalny.

Navalny became unwell in August 2020 following the suspected poisoning of his tea. After a brief hospital stay in Omsk, he was airlifted to Germany for further treatment, where tests indicated that he had been poisoned with the military nerve agent Novichok – also used in the UK against Sergei Skripal in 2018. Navalny has since recovered, and has accused Russian President Vladimir Putin of complicity in the assassination attempt.

In response to the attack against Navalny, the EU has agreed to impose financial sanctions against six senior defense and security officials with close links to President Putin, including Aleksandr Bortnikov, the head of Russia’s domestic security agency the FSB, Sergei Kiriyenko, Putin’s first deputy chief of staff, and Andrei Yarin, the head of domestic policy. The six will have any EU based assets frozen, and they will be banned from traveling to the EU.

The EU has also imposed institutional sanctions on the Russian State Research Institute of Organic Chemistry and Technology, the agency identified by European intelligence agencies to have been responsible for the production of the Novichok used in the attack.

Earlier in the week, EU foreign ministers were also reported to have agreed on the need for personal sanctions against Belarusian President Alexander Lukashenko, a close regional ally of President Putin, if Belarusian security forces continued to repress protests by domestic opposition groups. Lukashenko – president for 26 years – claims to have won the country’s presidential election on August 9 with 80% of the vote, but his opponents contest the result.

Despite strong German pressure to sanction Lukashenko immediately, the EU agreed to give him more time to restrain his security forces and engage in a dialogue with the opposition, brokered by the Organization for Security and Co-operation in Europe (OSCE). However, Josep Borrell, the EU’s High Representative for Foreign Affairs has made it clear that Lukashenko will be targeted soon if the situation does not improve, stating that the EU had given “their political green light to start preparing the next sanctions package that will include Lukashenko himself.”

In early October, the EU had previously imposed sanctions against 40 other Belorussians individuals believed to be involved in orchestrating electoral fraud and the government’s violent repression of protestors. If Lukashenko is sanctioned, it will be a return to the EU sanctions list from which he was only removed in 2016 following a decision to release some political prisoners.

Although some will be surprised that Lukashenko remains off the list, the overall tone of EU rhetoric on the use of sanctions has been robust. The willingness to impose restrictions on those close to Putin sends a clear signal of EU intent for the future, and one that suggests that further difficulties lie ahead. Leonid Slutsky, the head of the Russian State Duma Committee on International Affairs told the media that the EU’s forthcoming actions were “destructive, deceitful…[and]…delusional.” It is expected that Russia will respond with its own sanctions against EU officials.

This general deterioration in EU relations with Russia and allies suggests that there will be continuing amendments to the EU sanctions regime in the coming months, especially if investigations into the Navalny poisoning identify new suspects or Lukashenko refuses to accede to EU demands. Other potential flashpoints continue to rumble on – Russia is a backer of Armenia in its ongoing clashes with Azerbaijan – and Russia remains under heavy EU and US sanctions for its involvement in the Ukrainian civil war. Businesses – especially those with exposure to Eastern Europe – therefore need to ensure that they keep a close watch on what is likely to be an evolving EU sanctions list.

US Threatens Hong Kong Banks

In a report to the US Congress on 14 October, the Department of State warned that it was preparing to identify and sanction financial institutions operating in Hong Kong which it believed to be doing business with recently sanctioned Hong Kong officials. 

The warning came as part of a report required by the Hong Kong Autonomy Act (HKAA), which passed through the US Congress in July this year following protests in the territory against new security legislation. The HKAA is designed to apply coercive pressure against Hong Kong officials that the US believes are actively collaborating with the Chinese government to erode Hong Kong’s constitution, the Basic Law. The HKAA also provides for secondary sanctions against financial institutions deemed to be facilitating the activities of designated individuals. 

Within the report, the US State Department set out its assessment that 10 individuals, including Hong Kong’s chief executive Carrie Lam, were playing a major role in China’s active dismantling of the territory’s autonomy. All 10 had previously been designated by the US Treasury in early August, and an updated SDN list reconfirmed their status. Presence on the list leads to the freezing of individuals’ assets falling under US jurisdiction, and the restriction of travel to the US. 

Although the State Department report did not name any financial institutions, it specifically restated it would issue a list of those that it believed were involved in ‘significant transactions’ with the designated individuals within 60 days. According to the US Department of the Treasury, ‘significance’ is defined by a range of criteria including nature and frequency of transactions, as well as potential links to activities for which the individuals had been designated. If listed, the financial institutions would also be subject to sanctions, and would be required to disengage from their relationship with the SDNs within a year. Any organizational designations could lead to the financial institutions’ facing restricted access to dollar denominated exchange, commerce and trade, as well as the targeting of corporate executives.

Media speculation about which institutions might be the focus of the State Department’s concerns has focused on two leading UK based banks with dominant roles in the Hong Kong market, HSBC and Standard Chartered. HSBC in particular finds itself in the difficult position of being headquartered in the UK, while its most profitable market remains Hong Kong. The bank has also been focused on expansion in China’s Pearl River Delta region, making a good relationship with the Chinese government essential. In June, HSBC’s Asia-Pacific CEO, Peter Wong, signed a petition supporting new security legislation, leading to criticism from both US and UK politicians, including US Secretary of State Mike Pompeo, who described it as a “corporate kowtow.” 

However matters play out in the next two months, there can be little doubt that the US will continue to use access to the dollar-driven international financial system as a key weapon in its coercive armory. Although President Trump has been highly critical of China with regard to Hong Kong, the status of Taiwan, trade and a host of other issues, it seems likely that any new incoming US administration under Joe Biden would take a similarly hard line in Hong Kong, given his comments about the “death blows” to the city’s freedom in July. 

Much as with the EU’s tense relations with Russia discussed above, the political tensions between the US and China appear set to continue, with increasingly wide effects on the international financial system and the global economy. With further designations pending, businesses in Asia-Pacific also need to remain alert for changes in a fast moving environment. 

US Issues Tough Crypto Enforcement Rules

The release of a new report on 8 October suggests that the US Department of Justice (DoJ) will be taking a strong enforcement line on the potential criminal misuse of cryptocurrencies. The report, ‘Cryptocurrency: An Enforcement Framework,’ is the product of work by the Attorney General William Barr’s Cyber Digital Task Force.

Over the last four years, the Trump administration, especially the Department of Treasury, have made positive statements about the potential economic and financial benefits of Distributed Ledger Technology (DLT) and cryptocurrencies. The newly published report echoes these sentiments, noting that “distributed ledger technology, upon which all cryptocurrencies build, raises breathtaking possibilities for human flourishing.”

At the outset, therefore, the report describes a range of potential positive DLT ‘use cases’ in the federal government, including the Food and Drug Administration’s (FDA) application of blockchain to a new food safety system, and the Federal Reserve’s experiments with digital currencies. It also highlights a range of legitimate commercial benefits from using cryptocurrencies, such as reducing transaction costs by removing intermediaries in payment systems.

Unsurprisingly, however, the majority of the report is devoted to DLT and cryptocurrencies as potential national security and law enforcement threats. As Barr notes in an accompanying statement to the report, it is the DoJ’s role to ensure “that use of this technology is safe, and does not imperil our public safety or our national security, is vitally important to America and its allies.”

According to the report, the criminal misuse of cryptocurrencies falls broadly into three categories: as a method of payment in criminal commerce such as the drugs trade, as an opportunity to launder illicit funds or evade tax laws, and as a target for theft in its own right. As the report notes, cryptocurrency can often be used by criminals as a new method for committing many already well-known financial crimes.

The report not only focuses heavily on the potential crypto activities of criminal networks but also ‘rogue states’ such North Korea and Iran, and terrorist groups such as Islamic State. Case studies provided include terrorist financing via bitcoin donations, the exploitation of cryptocurrencies in sanctions evasion schemes, and their usage as the payment form of choice for Iranian hackers in Ransomware attacks.

A further key area of concern in the report is the advancing use of privacy-preserving cryptocurrencies such as Dash, Monero and ZCash. The DoJ sees these types of assets as particularly dangerous, and goes as far as suggesting that even simply using privacy coins can be seen as “high-risk activity that is indicative of potential criminal activity.”

In response to these threats, the DoJ states it will continue to dedicate increasing amounts of specialist resources into addressing crypto-related threats, while also seeking to tap the knowledge of regulatory agencies within the US and overseas partners. As the report acknowledges, cryptocurrencies are a global phenomenon and enforcement will need an international dimension.

Overall, the tone of the report seems to indicate that for the DoJ, cryptocurrencies remain a more obvious threat than a blessing. Nonetheless, this is probably to be expected given the department’s remit in managing and mitigating criminal risks.

There are positives, moreover in the simple fact that the DoJ has issued the guidelines – suggesting that it is a sector which the US federal government takes seriously and wants to operate without serious criminal penetration. In a sector which has often been condemned as a financial ‘Wild West,’ the DoJ’s statement that ‘the sheriff is in town’ is not necessarily a bad thing for the law-abiding majority.

Disclaimer: This is for general information only. The information presented does not constitute legal advice. ComplyAdvantage accepts no responsibility for any information contained herein and disclaims and excludes any liability in respect of the contents or for action taken based on this information.

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