The Burden of Sanctions Compliance

In recent years much column space has been taken up with trade and economic sanction measures and their effectiveness as a strategy for bringing about desired political change. To stand a chance of succeeding in any such objective, even if that desired outcome is only to get people to engage in meaningful dialogue, they need to have significant economic impact on the territory they are targeted at. That can only be achieved if there is robust surveillance of adherence and regulatory bodies who are prepared to bare their teeth when commercial entities step out of line.

In no country is this demonstrated more highly than in the United States, with the tenacious stance adopted by the Office of Foreign Asset Control (OFAC) to police compliance with sanctions regulations. The significant fines meted out to corporations and financial institutions, headlining to figures in the hundreds of millions of dollars, primarily related to breaches of US sanctions on Iran, have more than succeeded in creating a meaningful deterrent, striking fear into the heart of Wall Street and reverberating around the walls of corporate board rooms.

Legal and compliance departments are swarming all over the risks, particularly in banks where the regulatory burden has, in recent years, become all-consuming. This is bringing about significant change in corporate culture. The entrepreneurial spirit has arguably been stifled under the sheer weight of fear and desperate need to conform and comply.  The consequence of being found to be in breach is not limited to the headline grabbing fines that jeopardize the balance sheet; the associated reputational hit and brand devaluation can have less direct but equally costly results.

Transactional due diligence is multi-faceted, extremely detailed and time consuming to complete, resulting in every deal taking much longer to reach closure. More nimble operators outside of the banking sector, such as commodity traders, are stepping into the breach and leveraging their balance sheets to steal a march on the more lumbering financial institutions. It is not an easy time to be a banker and there is little prospect of a relaxation of regulation anytime soon; the momentum is only heading one way.

Though Iranian sanctions have all but been lifted in Europe as of January 2016, in the US the relaxation has only curtailed the “extra-territorial” application of sanctions with the general trade embargo on Iran remaining in place. Where Russia is concerned, after initial inertia while everyone scratched their heads and grappled with interpreting the new sanctions regulations, it has swiftly become the established norm in the business environment. It seems that where the change in sanctions regulations once (and fairly recently) created uncertainty and unquantifiable risk, it is now almost the acknowledged status quo with the risks being accepted and measured, and the business opportunities slowly resurfacing. Sanctions regulations are now, more than ever before, a prominent fixture on the business landscape and companies are spending considerable time and effort to ensure that they comply with it.

The Cost of Compliance

However, the cost of compliance is not only felt in the form of the wage bill for the swelling cohorts needed internally to implement and police the endless checks and balances. It can also have significant financial impact at the transaction level when new regulations are introduced during the life of an overseas investment or midway through performance of a trade contract or financing.

Timing is everything. If the measures are introduced before you enter into a venture that would be impacted, the solution is fairly straight forward: you don’t proceed. If the signs are there of deteriorating international relations, you form a view and the prudent likely shy away, whereas the more cavalier choose to proceed. It all comes down to your corporate risk barometer and appetite but if the situation escalates without warning and measures are rushed through, even the most cautious may find themselves in a position where to comply with the sanctions regulation they have to beat a swift and financially painful retreat.

How does an organization— be that a bank, commodity trader, exporter or corporate investor—protect itself from the financial consequences at the transactional level of adhering to unanticipated sanctions? In such circumstances, what insurance products could or would provide protection?

The private Credit and Political Risk Insurance (CPRI) market has an extensive history, in excess of 40 years, of providing insurance policies that respond in such circumstances.

Insuring Corporate Investors operating Overseas

Some of the earliest insurance products that provided coverage for loss arising from the application of sanctions appeared in the form of “Forced Divestiture” protection. This is epitomized in the early Lloyd’s standard wordings for investment covers (originating in the late 1970s/early 1980s) and remains a fixture of such policies today. A fairly typical clause reads as follows:

Forced Divestiture means the operation of a law, order, decree or regulation by the government of the Insured’s Country that forbids the Insured from owning shares in the Foreign Enterprise or Assets in the Foreign Country and/or requires the Insured to sell or dispose of such shares or Assets.

Such cover acknowledges that for corporate investors seeking to truly globalize their operations and shift investment overseas on a long term basis, be that in the form of manufacturing capabilities, establishing foreign subsidiaries or investing in infrastructure projects, there is always a risk that relations between an insured’s home nation and the host nation could deteriorate to the extent that the insured’s own government legislates that it must divest itself of its interest in the host country. The insured gets squarely caught in the political crossfire, particularly if it is in a strategic industry, and the impact on the balance sheet could be considerable. Such was the fate of numerous US oil companies over the prior century.

Insurance covering Forced Divestiture is designed to compensate an insured on the basis of either their Net Book Value or Net Investment Value providing the necessary balance sheet protection. In addition, it is also possible to protect the Profit and Loss Account by purchasing Business Interruption following Forced Divestiture. This would then provide compensation for loss of profit, on typically a 6 or 12 month basis, while a business relocates its operations elsewhere.

Though claims activity under such perils has been relatively dormant over the last few decades, in the 1990s it was widely acknowledged (with a wry smile) that the government responsible for generating the largest historic monetary losses to the CPRI market was the United States, largely due to forced divestiture and other impacts of sanctions regulations (though, I would hasten to add, in recent years they are likely to have been overtaken).

Trade Embargo and Export License Cancellation

Where investments are wholly reliant on overseas inputs to be productive, or overseas sales markets to be profitable, any introduction of regulatory barriers to trade can result in an equity investor’s overseas operation ceasing to function. These barriers can take the form of new trade embargoes or the cancellation or non-renewal of existing export/import licenses. Protection for these events can be provided under fairly traditional private investment insurance policies and have been regular features of market template policy wordings for decades.

Bank Investment Insurance

Those same insurance covers of Embargo and Export/Import License Cancellation are also available to lenders particularly in relation to project finance risks in the extractive industries where revenue from exports is paid into off-shore collection accounts primarily to provide debt service. If those trade flows are interrupted due to the aforementioned named perils resulting in default in scheduled payments under the project loans, then these lenders’ policies are structured to respond. Indemnity is provided on the basis of the value of the resultant outstanding loan repayments, typically on a principle plus contractual interest basis.

Contract Frustration Insurance

In addition to political risk insurance for overseas investments, the CPRI market provides policies covering cross-border trade contracts against frustration due to named political and commercial perils.

Where the Insured is the seller under the contract: These covers indemnify on the basis of “costs incurred” if the frustration occurs before the insured has delivered the goods and services to meet their contractual obligations, typically referred in the market as “Pre-shipment” cover. Should the frustration occur due to the failure of the counter-party to meet its payment obligations after the insured has performed, then indemnity under the policy is simply based on amounts contractually due to the insured under the contract. This latter cover has traditionally been referred to as “Post-shipment.”

Protection against the impact of sanctions regulations is provided under both of these sections, just more overtly in the former. Pre-shipment cover, in line with investment insurance policies discussed previously, includes named perils of “Embargo” and “Export License Cancellation or Non-renewal” and responds when the sales contract is frustrated due to the fact the Insured is unable to deliver the goods or services in accordance with the contract. Typically this will fall within the force majeure provisions of the contract and if regulation remains in place the contract will likely be terminated. The insurance policy will step in and compensate the insured for its costs, including those of obligations to third party suppliers and a small element of lost profit (typically 10%).

On the “Post-shipment” side, cover responds when the buyer defaults in payment in accordance with the contract terms. The policy doesn’t typically seek to limit the causation of that non-payment. Therefore, if sanctions restrict the buyer’s access to markets or finance resulting in liquidity crises this wouldn’t normally be excluded from cover.

Where the Insured is the purchaser under the contract: Contract frustration policies in these circumstances indemnify to the value of any prepayment made by the insured to a supplier in advance of delivery. If sanctions regulations prevent the supplier from delivering under the contract or the insured from taking delivery under the terms of the contract, then this should trigger the contract force majeure clause. As long as the contract is drafted so that force majeure situations lead to termination, and upon that termination the supplier is under a contractual obligation to return the advance payment to the insured, then the policy will respond if the supplier fails to make that repayment.

Comprehensive Non-Payment Insurance for Banks

Much time has been devoted recently in the CPRI market to developing a clause for banks that determines the treatment of the policy if the parties to the insurance, or the transaction being insured, become subject to sanctions during the life of the policy. This has been a long drawn out and, at times, surprisingly heated debate. By way of explanation, as comprehensive non-payment insurance policies can be utilized for capital relief (if drafted to meet the definition of a guarantee under the Basel II/III banking regulations), any clause that adds conditionality which is outside the bank’s control jeopardizes that treatment. Therefore, drafting a clause to recognize the positions of both insured and insurer, while retaining the benefits of capital relief from the policy, requires treading a very careful and considered line.

Given the focus of this section is on coverage for sanctions as opposed to compliance with them, you could be forgiven for querying the relevance of the preceding paragraph. However, during the process of reaching a landing on the market sanctions clause (LMA 1865), it served to highlight the fact that in complying with sanctions regulations, an insured may well exacerbate the probability of a default under a loan and increase the likelihood of a claim under the policy. This would arise if, in fear of being found guilty of “facilitating” trade with a sanctioned entity and breaching regulations, the banks activated the sanctions provisions in the loan agreement, giving them the right to terminate the loan agreement. At that point, any amounts drawn down under the loan would become immediately due and payable.  If the obligor couldn’t meet the requirements to pay the accelerated amount, the obligor would be in default and any insurance policy providing non-payment cover would be in line to respond.

What the market sanctions clause recognized contractually in the policy was that an insured taking action to abide by sanctions could increase the likelihood of a loss but that action should not in itself prejudice the insured’s rights to claim under the policy. Insurance policies have always contained obligations on an insured to “minimize loss” and act with “due diligence.” The market sanctions clause recognised the potential contractual conflict that sanctions compliance could create with the other terms of the policy and made it clear that in such circumstances, coverage would be preserved. Therefore, inclusion of the clause in any comprehensive non-payment policy for a bank removes any possibility for alternate interpretation by insurers and potential for dispute on the issue at point of claim.

As I hope this piece has demonstrated, many insurance products are available to provide protection for entities financially caught out when sanctions regulations get unexpectedly implemented. Many of these products have been available for decades and merit dusting down and re-highlighting. Others are more subtle and less obvious in the scope of protection they afford in such circumstances and are worthy of a little explanation. What is clear, for the prudent overseas investor or entity involved in cross-border trade, is that insurance products exist to ensure adherence to sanctions won’t leave compliant entities exposed to financial loss.

Sian Aspinall



Sian Aspinall is Managing Director of BPL Global, the specialist trade credit and political risk broker. She has over 25 years market experience in this sector as broker, senior underwriter and as independent consultant to various insurers and legal firms.