The UK’s financial sanctions over the Ukraine invasion fall well short of cutting Russia off SWIFT, maxing out on the usual self-congratulatory hyperbole whilst opening up significant risk. When we should be distinguishing our PR approach from that of the Kremlin, we instead get big-sounding phrases masking deficiencies in the respective Statutory Instrument that will be recognisable only to cognoscenti.
This is dangerous for UK financial institutions, who could find themselves on the wrong side of the line described in our first article on this matter. Indeed the UK appears to have swung towards the approach that the article warned Olof Scholz not to adopt. US sanctions are in place, are more specific and are backed up by the power of the US$. If UK financial institutions find that they are having continued dealings with Russian market actors, even if at two or three steps removed, they could themselves become a target for US sanctions, at colossal cost to the City of London and the UK economy.
The first article warned of this risk to EU financial institutions; the UK government seems to have walked into the same thing with its eyes wide shut.
Concerns focus on paragraph 7 of Statutory Instrument 2022 No. 194 about payments.
Firstly its scope is limited to ‘establishing Correspondent banking relationships’, excluding mention of membership of ‘Financial market infrastructures’.
Secondly, while there is a block on processing payments in £pounds, there is no mention of a block on processing payments in other currencies like US$ or Euro, as long as this is not done within the context of the ‘Correspondent banking relationships’.
These factors go exactly to the issue discussed in our earlier article. If UK institutions are directly addressable in TARGET2 – as many are – there is no block to their sending and receiving Euro payments with a bank like VTB Bank (Europe) SE, because the payments are exchanged in a Financial market Infrastructure and not via Correspondent banking.
Thirdly, UK institutions should not deal with sanctioned entities ‘directly or indirectly’ within ‘Correspondent banking relationships’. Direct relationships are overt, but indirect ones can be unwitting: a UK institution can claim ignorance and innocence in the absence of a ‘reasonable cause to suspect’. This permits a significant degree of passivity to where a non-UK institution has established arrangements in which message flows do not disclose that a sanctioned entity is at the other end of the chain. Active enquiry by the UK institution is not required.
The problem is that this ‘reasonable cause to suspect’ test may protect the UK institution when payments are in Euro but processing a US$ payment in the UK inevitably requires a settlement payment to be made through New York, in either the Fedwire or CHIPS system. Then the payment (all of it) falls within the purview of US sanctions. These sanctions do not contain a carve-out for the absence of a ‘reasonable cause to suspect’.
It is not that difficult to disguise the endpoint of a payment chain if you are so inclined. As everyone now knows (since the weekend) SWIFT traffic runs between Business Identifier Codes (BICs) that have a stem of eight characters (a BIC-8). SWIFT members can add a three character extension to form a BIC-11, through which to identify their own department or branch. However, a non-sanctioned bank can create BIC-11s without their being their own departments or branches, and actually identifying (but not to the outside world) sanctioned entities. This would be in contravention of regulations on Anti-Money Laundering and Countering the Financing of Terrorism, but some jurisdictions see this circumvention as all part of the service. These are the ‘sunny places with shady people’. The BIC-11 might be published as belonging to ‘Reconciliations’ or ‘Forfaiting’. Since dealings are driven off the BIC-8, and neither off the BIC-11 or the name of the owner of the BIC-8, other participants in the chain may be none the wiser.
The UK (and no doubt also the European) sanctions offer participants in the payment chain the ‘reasonable cause to suspect’ safe harbour; the US ones do not.
The questions are then what considerations have played a role in the UK’s approach falling short of the Gold Standard, who has been involved in the deliberations about what to do, and what is their relevant experience and agenda. The public, in such a situation, has a right to be apprised of the government’s workings-out, not just its conclusions.
UK Finance, the banks’ trade body, has been vain-glorious about its influence on the drafting of these sanctions. ‘Just the kind of critical and complex decision… our CEO and our comms, payments and wholesale banking teams are good at ensuring politicians understand the real and technical implications of’. This is the same UK Finance that arranged the UK’s continued membership of the Single Euro Payments Area, or SEPA, as well as the planned adoption of ISO20022 XML, the SEPA payment data standard, for the UK’s payments. It’s almost as if they haven’t heard of the British people’s decision to leave the EU.
ISO20022 XML will be adopted by the UK’s CHAPS system under the ‘RTGS Renewal’ project, and by the BACS and Faster Payments systems under the ‘New Payments Architecture’ project. A major claimed benefit is that ISO20022 XML is a more capacious data format, thus including more data that can be screened for financial crime.
The lie is given to this claim by SEPA payments being processed based only on the IBANs of the payer and payee; no name is needed, nor any accompanying information.
The UK’s financial sanctions against Russia contain numerous loopholes and the most serious are that Russian money can still circulate in and out of the UK in Euro and US$. This may suit those who want the UK to remain close to the EU – with SEPA Area membership and ISO20022 XML as their ideological bridgeheads – but it is bought at the price of a huge risk to US banking licences and access to US$ payment services for UK institutions. US authorities take a simpler view: if you handled sanctioned funds, you are guilty of sanctions busting, with or without a ‘reasonable cause to suspect’.
The UK government, no doubt under advice, has failed to match its Gold Standard rhetoric with Gold Standard actions. It has steered towards the European approach and away from the US one. The consequences of that for UK financial institutions, the City of London and indeed the entire country could be severe.
 https://home.treasury.gov/news/press-releases/jy0608 accessed on 28 February 2022
 Many BICs are of 11 characters, but that is always a 3-character suffix after the stem of the 8-character BIC; a typical suffix is XXX, which means the head office of the bank. Banks may also have suffixes for a branch, or for an operations centre supporting a group of branches
 https://www.linkedin.com/feed/update/urn:li:activity:6903490080984702976/ accessed on 1 March 2022
 IBAN – International Bank Account Number