Banks face complex compliance risks as they attempt to exit Russia

The two resulting wars—one fought with tanks and bombs, the other with sanctions and asset seizures—have created a humanitarian crisis in Ukraine, devastated Russia’s economy, and roiled the world’s financial system.

“The coordination of sanctions has been effective and really unprecedented,” said Aaron Hutman, partner at law firm Pillsbury and an expert in international trade. “Usually it’s much more fractured.”

Equally notable has been the response of the U.S. and international business community, with an ever-expanding list of companies pulling out of Russia.

After some initial hesitation, big banks have joined the exodus. Goldman Sachs, JPMorgan Chase, and Deutsche Bank announced plans to leave the Russian market, while other financial institutions like Citi and Germany’s Commerzbank have pledged to stop accepting new business in Russia and reduce their exposure by winding down product lines, closing branches, and moving Russia-based employees to other countries.

Banks and other organizations doing business in Russia are also attempting to gauge whether their decisions need to be temporary or permanent, depending on the political situation and the progress of the invasion, said Tom Firestone, partner at law firm Stroock & Stroock & Lavan. Firestone served eight years as resident legal adviser at the U.S. embassy in Moscow.

“They constantly need to ask themselves, ‘Where is this going?’” he said. Things are changing so fast and so dramatically day-to-day that “it is making life difficult for companies to do business in Russia,” he said.

Winding down Russian operations is not as simple as turning off a tap. The biggest risk is a bank’s exposure—that is, the amount of loans and deposits it has committed in Russia—will either be paid in rubles as the currency plummets or forfeited to a Russian government unconcerned with the rule of law. The Russian government has announced plans to pay its sovereign debt to so-called “hostile countries” in rubles, which leaves the thorny question of whether doing so places those loans in default. Private sector loans might follow suit.

If a bank has physical assets in Russia, like branches and offices, those are at risk of being seized by the Russian government. And then there are the employees of these banks who, in addition to looming unemployment, also face potential threats within Russia.

“Governments are issuing new rules every day. But sanctions are not the only factor, and banks likely are leaving Russia in part for the same reason McDonald’s is leaving Russia: They don’t want to be perceived as contributing to a war,” said Hutman. “They also don’t want to lose or compromise their global business or correspondent relationships just to take on a small amount of business in Russia.”

For foreign banks, the bulk of their customers are in their home countries and the West. That means the risks posed by keeping their Russian operation afloat is outweighed by the reputational harm staying in Russia would cause them with the bulk of their customer base.

Once a bank decides to withdraw or wind down its Russian operations, there are a host of thorny compliance issues to navigate in a compressed timeframe.

Sanctions and asset seizures

One major risk is compliance with sanctions, which the United States and its allies have continued to build on weekly since Russia invaded Ukraine on Feb. 24. Early sanctions targeted Russian banks, with subsequent actions largely focused on Putin and the wealthy oligarchs who have benefitted from their association with him.

The Department of Justice has established “Task Force KleptoCapture,” which will be investigating and prosecuting sanctions violators, combating efforts to undermine restrictions placed on Russian financial institutions, and targeting the use of cryptocurrency to evade U.S. sanctions.

In the United Kingdom, the government is preparing to seize real estate belonging to Russian oligarchs. Italy and France have begun seizing yachts belonging to Russian elites and government officials, including one that might belong to Putin himself.

But perhaps even more difficult to navigate for foreign banks in Russia is how to deal with new laws and sanctions being considered by the Russian government, Firestone said. In 2018, Russian parliament considered a bill that would make it a crime to comply with Western sanctions against the country, and a similar bill might be introduced soon, he said.

Russian prosecutors have also threatened to seize the assets of Western companies that leave the country, according to a report from the Wall Street Journal. And the government has already begun suspending some intellectual property rights for “hostile countries” like the United States and United Kingdom, Firestone said.

Another potential risk for banks navigating withdrawal from Russia is violation of the Foreign Corrupt Practices Act (FCPA). Russian government officials might solicit bribes to help companies keep their assets or avoid costly litigation, Firestone said.

“The more dealings you have with Russian government officials, the more risk you have” of being asked for bribes and running into potential FCPA issues, he said.

AML/CFT risks

One financial trend occurring in Russia since its invasion of Ukraine began is a “flight to quality,” as ordinary Russians attempt to move their money into unsanctioned Russian banks and foreign banks and convert their rubles to euros or dollars to preserve their value. Of course, oligarchs and corrupt politicians who are under U.S and other Western sanctions are doing this as well. Banks handling Russian-based accounts must be acutely aware of the money laundering risks associated.

“Banks likely are leaving Russia in part for the same reason McDonald’s is leaving Russia: They don’t want to be perceived as contributing to a war.”

Aaron Hutman, Partner, Pillsbury

“There is an enhanced risk that legitimate assets, as well as crony and corruption money, will be brought to unsanctioned banks,” Hutman said. “Banks will have to be very careful about taking on new clients in Russia and in watching for unusual activity that might indicate an existing client is acting for a hidden party.”

The Financial Crimes Enforcement Network (FinCEN) said in guidance released earlier this month that red flags of money laundering attempts in Russia include transactions issued by nonsanctioned banks and financial institutions within Russia and Belarus, particularly if there is a recent increase in new company formations or sudden influx of funds without any clear economic or business rationale. Another potential warning sign might be contained in nonroutine foreign exchange transactions, which might be an attempt by the Central Bank of Russia to use third parties to obfuscate its involvement.

Financial institutions must pay particular attention to sanction evasion attempts using digital assets, FinCEN said. Transactions initiated from or sent to IP addresses from nontrusted sources; locations in Russia, Belarus, jurisdictions with anti-money laundering/countering the financing of terrorism/counter proliferation deficiencies flagged by the Financial Action Task Force, or comprehensively sanctioned jurisdictions; or IP addresses previously flagged as suspicious warrant additional attention. Financial institutions should also be wary of convertible virtual currency transactions connected to individuals on sanctions lists or from a CVC exchange located in a high-risk jurisdiction.

“If you’re hosting a (digital asset) wallet or in the cryptocurrency ecosystem, your regulators expect you to be on high alert right now,” Hutman said.