Thursday, February 22, 2024

The first round of U.S. secondary sanctions on Russia is working

Turkish banks halted transactions with Russian banks last month and are only slowly reintroducing payments for a narrow range of products that are on a so-called "green list," reports Ragip Soylu. This broad debanking of Russia by Turkey is part of the fallout from President Biden's first round of secondary sanctions, announced on December 22. 

Ukraine/sanctions watchers around the world are breathing a sigh of relief. At last the cavalry has arrived! While the Russian sanctions program has often been described by the press as the "world's strictest", in actuality it has been (till now) alarmingly light-touched due to its lack of the toughest tool of financial warfare: secondary sanctions.

Primary sanctions vs secondary sanctions

Secondary sanctions, especially when applied to foreign banks, are far more damaging than primary sanctions, which to date have been the dominant type of sanction levied against Russia. 

With primary sanctions, it is the "primary" layer  U.S. citizens and companies  that are cut off from dealing with the designated Russian target(s). However, primary sanction don't prevent non-U.S. individuals or non-U.S. companies, say a Turkish bank, from filling the void left by departing American counterparts, often acting as a re-router of the very U.S. goods that can no longer be moved directly to Russia by U.S. firms. So rather than reducing the amount of Russian trade, primary sanction often lead to little more than a displacement of trade from one route to another. That's a nuissance for the targeted country, but hardly a game changer.

Secondary sanctions are an effort to combat this displacement effect. They do so by extending the trade prohibitions placed on the primary layer, U.S. actors, to the second layer, that is, to non-U.S. actors. In the case of Biden's December order, foreign banks can no longer facilitate certain Russian transactions that have already been off bounds to Americans for several years.

So far, Biden's secondary sanctions appear to be working. In addition to halting all transactions with Russia for a month, Turkish banks have completely stopped opening accounts for Russian customers. According to Reuters, Turkish exports to Russia fell 39% year-on-year in January. In China, reports say that banks have "heightened scrutiny" of Russian transactions, in some cases going so far as to cut off Russian banks. UAE banks have also begun to restrict linkages to Russia.

Why comply with the U.S.?

Why do non-U.S. actors bother complying with U.S. secondary sanctions? After all, if you're a Turkish banker in Istanbul, Biden has no jurisdiction over you. America can't put you in jail, or fine you.

The way that the U.S. is able to sink a hook into non-U.S. actors is by threatening to take away access to the U.S. economy. Foreign banks, for instance, are told they will be exiled from the all-important U.S. banking system if they don't severe or constrict their Russian relationships. Since access to the Ne York correspondent banking system is so important relative to the small amounts of sanctioned Russian business they must give up, foreign banks are quick to fall into line.

Biden's secondary sanctions on foreign banks only apply to a narrow range of transaction types, specifically those that support Russia's military-industrial base. In short, any foreign bank that is found to be conducting transactions involving military goods destined for Russia can be penalized. Those foreign banks that deal in, say, Russian food imports needn't worry.

In addition to obviously prohibited military items, like missiles and fighter jets, the U.S. Treasury has provided a list of not-so obvious items, such as oscilloscopes and silicons wafers, that it deems fall under the category of military-industrial goods. I've appended this list below. The Treasury suggests that these additional items might be used for, among other things, the production of advanced precision-guided weapons.

Source: OFAC

That's quite an extensive list.

Turkish banks appear to have overcomplied by dropping any transaction that even has a whiff of Russia. This de-risking effect is a common by-product of various banking controls, both sanctions and anti-money laundering, whereby banks cease dealing not only with prohibited customers but certain legitimate customers that are superficially similar to prohibited customers that they are deemed too risky and expensive to touch.

According to reports, Turkish banks have reintroduced transactions for green-listed products such as agricultural products, which aren't actually targeted by the U.S. secondary sanctions.

Turkish financial institutions may be particularly sensitive to U.S. sanctions given the fact that an executive of Halkbank, a Turkish government-owned bank, was sentenced to 32-months in U.S. jail in 2018 for helping Iran evade U.S. sanctions and money laundering. One of his evasion routes was the notorious gold-for-gas trade, which I wrote about here. Halkbank itself was indicted in 2019 for sanctions evasion; the case against it is ongoing.

An unforgiving legal standard

An important element of any alleged crime is the mental state of the alleged criminal, or their "intent." This gets us to another reason for the rapidity and breadth of the debanking of Russian trade. Biden's secondary sanctions have a novel legal feature. The legal standard on which they rely, strict liability, does not require that the prosecution prove intent.

Up till now, U.S. secondary sanctions have not deployed this sort of a strict liability standard. To demonstrate that a foreign bank has engaged in evading secondary sanctions on Iran, for instance, U.S. prosecutors have been required to show that the foreign bank did so knowingly. If the banker conducted prohibited Iranian transactions unknowingly (i.e. inadvertently or unintentionally), then they couldn't be found guilty of sanctions evasion.

Under the strict liability standard set out in Biden's December 22 order, there is no onus on U.S. sanctions authority to show that a foreign bank has knowingly conducted transactions linked to Russia's military-industrial complex. Even an unintentional transaction can be punished. Because this strict liability standard makes it so much more likely that foreign banks run afoul of sanctions and get cut off from the U.S. banking system, bankers are rushing to comply.

What's next?

When the U.S government asked domestic entities to stop dealing with Russia a few years ago, many of these transactions were quickly displaced to third-parties like Turkey. By deputizing foreign banks to be equally vigilant, secondary sanctions will likely crimp the original displacement effect, resulting in a big and permanent decline in Russian trade.

To get an idea for what might happen to Russia's military-industrial goods trade, take a look at how Iran's oil exports were halved after Obama imposed secondary sanctions on Iran in 2012, leapt when they were lifted in 2016, and crumbled again when Trump reimposed them in 2018.

The lesson is that secondary sanctions on foreign financial institutions can be very effective.

Evasion efforts will begin very quickly. When secondary sanctions were first placed on Iran in 2012, Turkish bank Halkbank introduced a forged document scheme in an effort to disguise trade in sanctioned crude oil shipments as legitimate food transactions. The U.S. will have to step up its enforcement efforts to plug these holes. Without proper enforcement, the effect of the secondary sanctions will remain muted.

Using the secondary sanctions on Russia's military-industrial complex as a model, there are many more sectors of the Russian economy on which secondary sanctions might be placed. The next round could extend to Russian automobile imports, its central bank, or the diamond industry.

Secondary sanctions to strengthen the oil price cap 

Even more useful would be to use secondary sanctions to strengthen the most important piece of financial artillery heretofore deployed against Russia: the $60 oil price cap

The price cap endeavors to force Russia to accept a below-market price for the oil that it ships, thus hurting its ability to finance its invasion of Ukraine. The cap is currently underpinned at the primary level by threatening banks, insurers, shippers and other businesses located in the EU, U.S., and other G7 countries ("the Coalition") with penalties if they trade in Russian oil above $60. Because Russia has historically been dependent on Coalition service provides for shipping oil, it has been getting less revenue for its oil then it would otherwise receive. 

However, over time a growing chunk of Russia's oil exports has been diverted away from Coalition service providers to third-parties in jurisdictions like Turkey and UAE that are not subject to the cap. This has allowed Russia to sell at prices in excess of $60 and thus recover much of its forgone revenues. If the cap were to be applied not only at the primary Coalition layer, but also at the secondary layer by requiring foreign financial institutions to join in via the threat of secondary sanctions, then much more Russia oil would brought back under the $60 ceiling, and Russia's ability to finance its war against Ukraine would be significantly crimped.


  1. These secondary sanctions with strict liability will only work for a short period of time, say half a decade.
    What will start to happen, purely due to operational reliability and to draw down compliance costs, is that non-USA banks and others will derisk from using USA financial systems and USA customers.
    The result of which could be sort of air-gapping of USA financial systems from the rest of the world.
    How would that work? Lets say Bob is an USA importer of Turkish wares from Amid's Emporium.
    Before air-gapping he could transfer USA Dollars to Amid's business bank account via a 'wire'.
    After air-gapping Bob can only transfer USA Dollars to himself at a Turkish financial institution that only allows such 'sender is recipiant' wires, cash deposits and withdrawls by same. Then Bob has to actually travel to Turkey to do the cash withdraw to go pay Amid.
    You see how much hassle that is but it is one all the other Turkish banks and financial institutions are willing to offload onto USA (dealing) folks so they (aforesaid banks and such) do not have to deal with strict liability secondary sanctions risks.
    Is that what the USA politicans and their voters want?

    1. Nah, that analysis is flawed, because non-US banks in places like Turkey are not going to separate themselves from the US.

      It's very important for Turkish banks to be able to offer their Turkish customers the ability to make US dollar wire transfers through the New York correspondent banking system, much more important than conducting military-industrial transactions for a relative backwater like Russia. And so banks will almost always choose to drop Russia in order to stay on the U.S.'s good side.

    2. You are making two assumptions here.
      One is that USA Dollar wires will continue to through the New York correspondent banking system. (Heard that quite a lot of South American banks have statarted to route around that system.)
      Two is that long term cost projections by Turkish and other bank wont take the massive uncertainity of USA politics regarding sanctions into account. That is who knows what other convoluted and costly compliance rules will they, USA politicans, dream up next?

      Businesses will divest from juristictions/regimes that generate too much regulatory uncertainity or chaos. Good example of such are manifacturing companies moving from China due to Xi and CyberCoin exchanges moving from USA due to Gary Gensler.

    3. Ultimately, it's not possible to make US dollar wires that avoid New York. Take the example of Turkey. Turkish banks need to make dollar transfers between each other (or to banks in places like Europe), and that requires going through their New York banker. Two Turkish banks might be able to use a larger Turkish bank where they both have U.S. dollar accounts to conduct a bank-to-bank transfer with each other, temporarily avoiding a direct New York connection, but eventually that larger Turkish bank will be asked to send those dollars elsewhere, and that requires invoking its connection to New York.

      The big apple can't be evaded.

    4. To be more technically accurate US Dollar wires have to go through the US at some point. Most of them are processed through New York because that is where most non US banks have there US branch or presence and where most large US banks conduct there correspondent banking operations(even if technically based somewhere else like Wells Fargo or Bank of America are. Hell on paper JPMorgan is based in Ohio and Citibank in South Dakota). However, there are exceptions Bank of Montreal's main US branch is located in Chicago(where BMO's US subsidiary Harris Bank is also headquartered) so a US dollar wire transfer involving BMO will inevitably touch Chicago instead of just New York. BMO also has it's primary US Treasury trading desk in Chicago which also makes BMO one of the few US Treasury Primary Dealers not located in NYC.

      More broadly the only way to avoid US jurisdiction is to avoid using US Dollars and to use a different currency instead Canadian Dollar, Euro, Japanese Yen, etc. More non Canadian banks than you might think actually do have Canadian correspondent account domiciled in either Toronto or Montreal(BMO has it's intl correspondent unit in Montreal unlike the other Big 5 banks) but the volume of international CAD wires is very small.

    5. So one way to avoid the Big Apple is just use BMO.

    6. Great points, Tim.

      Just one comment on this:

      "...the only way to avoid US jurisdiction is to avoid using US Dollars and to use a different currency..."

      With the new secondary sanctions, using a different currency is not necessarily a way to avoid US jurisdiction.

      See here:

      For example, under primary sanctions, a Turkish bank can still deal with a sanctioned Russian using Turkish lira or some other foreign currency, like yuan. They may even be able to do U.S. dollar transactions for sanctioned Russians, being careful to conduct those on their own books rather than invoking their New York (or Chicago) correspondent bank.

      Under secondary sanctions, however, our Turkish bank cannot conduct even foreign currency transactions for sanctioned Russians. If they do so and are caught, they could lose their correspondent banking account, and thus their ability to conduct U.S. dollar transactions for the rest of their customers.

  2. Given that the primary sanctioned boomeranged so badly, isolating USA and Europe from the rest of the world, e.g. Germany industry is collapsing for lack of Russian gas. Won't the boomerang effect of secondary sanctions be even more damaging to USA and the rest of the world?

  3. You know, may seem off-topic, but when it comes to financial sanctions, I am reminded of Iraq where children were dying from a shortage of medicines due to sanctions, Iraq whose regime was financed by the US to fight Iran, until some kind of misunderstanding happened over Kuwait. Now the "enemy of the free world" is Russia for its illegal invasion. But I am also reminded that the US has illegally invaded five countries in the last 20 years and no one has dared to cry scandal or call for sanctions. So let's understand what financial sanctions are: they are another tool of soft power of the US Empire. I think we can agree on that.
    Now beyond the whining propaganda the reality is that the war in Ukraine could have been prevented, cause Russia's recriminations over those territories were understandable, even today there are videos of civilians welcoming Russian soldiers in Adviinka - they may be minorities but the fact remains that the country is much more divided than the Western media says - instead the US empire wanted to unilaterally annex Ukraine and Georgia in 2008 to achieve its old strategic plans of closing the Black Sea to Russia and the rest is history.
    So today you say that finally sanctions "are working" but I see another problem, from Iran to Cuba sanctions have hardly killed any regime. Why is that?
    Well the americans believe that if the world, spontaneously wants to become part of the USA, that sooner or later a pakistani or a vietnamite would want to admire Beyonce or Taylor Swift - how can you not? - and therefore sanctions would make them revolt against their regime. Well, that is blissful ignorance.
    Now, there are 5 billion people who use US dollars very little or not at all, so chances are that sanctions will shift the focus of the search for exchange or reserve assets to something else, be they the Dirham, Bitcoin or gold. Truth is, that the world can live without the American empire, while the opposite, the empire of good with its military bases on 5 continents and its currency printed on monopoly paper... may not survive

    1. You're right, most of that is off topic. A few comments on the on topic stuff:

      "...let's understand what financial sanctions are: they are another tool of soft power of the US Empire."

      Every advanced nation has a sanctions program. The EU does, as do Canada, Korea, Japan, and China. Even Russia has one too. The difference is that the Americans have the most evolved and effective program.

      "...but I see another problem, from Iran to Cuba sanctions have hardly killed any regime. Why is that?"

      I think the best example of a sanctions program working is how they brought Iran to the negotiating table for the JCPOA.

      "...shift the focus of the search for exchange or reserve assets to something else, be they the Dirham, Bitcoin or gold."

      There may be some minor substitution into exotic media of exchange. But ultimately the US economy is so dominant, its capital markets so advanced, and the dollar so liquid that there's no escape. Foreign banks will always need a New York correspondent banking account, and that'll always give the US government a tremendous amount of global leverage.

    2. Thanks for your answer.

  4. btw, for the skeptical, take a look at this 2019 study from RAND corporation to understand how empires and politics are way more important than economy..
    (it's called extending, but the real meaning is 'killing')

  5. Terrific, highly illuminating post, JP.

  6. Do secondary sanctions prevent large non-Russia dealing Turkish bank A clearing dollar transactions internally for small, secretly Russia-dealing Turkish (or otherwise) banks B and C? Turkish bank A remains clean (unless the concept of strict liability is so expansive it includes indirect participation) and retains dollar access.

    Or would those be tertiary sanctions?

    Asking for a friend. :-)

    1. What you're describing is a potential way for banks to get around primary sanctions.

      But not secondary sanctions, since by clearing dollar (or non-dollar) transactions for Bank B and C, Bank A could potentially lose its access to the New York banking system if caught.