The Russian financial services sector remains a key target of U.S., UK, and EU sanctions. As discussed below, a number of recent such sanctions against Russia and countermeasures by the Russian government have further complicated efforts for investors seeking to divest listed securities from Russia.
As mentioned in our previous alert, on November 21, 2024, the U.S. Department of the Treasury, Office of Foreign Assets Control (“OFAC”) imposed blocking sanctions on a number of Russian financial institutions, including Gazprombank, more than 50 Russian small-to-medium sized banks, and more than 40 Russian securities registrars. The designation of the securities registers in particular follows a months-long exchange between western sanctions authorities and the Russian government relating to the securities infrastructure underlying custody of all Russian public equity securities, including the now-sanctioned Russian central securities depository, National Settlement Depositary (“NSD”). At this time, the Russian government has replaced NSD with local securities registrars in the custodian chains for Russian equities held by “unfriendly” investors, and OFAC has responded by designating the registrars and issued guidance confirming that divestment by a U.S. person of securities held by sanctioned securities registrars requires a specific license from OFAC. Given the changing landscape, such licenses may be subject to uncertain timing or result at this time, notwithstanding the collateral impact of recent sanctions developments on U.S. and other investors.
Designations of NSD
While the European Union blocked NSD in June 2022, the United Kingdom and the United States introduced asset freezes/blocking sanctions on NSD only in June 2024, concurrently with the designations of the Moscow Exchange (MOEX) and the National Clearing Center (NCC), the central counterparty and clearing agent for MOEX. NSD was designated by OFAC pursuant to Executive Order (E.O.) 14024 for operating or having operated in the financial services sector of the Russian Federation economy. Alongside the designation, OFAC issued, and subsequently extended, two general licenses (General License (GL) 99A[1] and GL 100A[2]) authorizing U.S. persons to wind down certain transaction involving NSD, MOEX, and NCC, and the divestment of securities held at NSD.
By the time those general licenses expired on October 12, 2024, a number of investors had not yet been able to divest their holdings, including because of countermeasures introduced by the Russian government and the time required to obtain derogations from EU sanctions authorities for divestment from the Russian financial infrastructure.[3] These developments are discussed in greater detail below.
Russian Presidential Decree No. 840
On October 2, 2024, the Russian President issued Presidential Decree No. 840 (“Decree 840”), which instructed the Central Bank of Russia to implement measures to automatically transfer the holdings of Russian equities by “unfriendly” investors from NSD to other non-sanctioned Russian custodians (which was not possible under the pre-existing regulatory framework that required that NSD be the first-level depositary in the share register of any Russian public company). Based on various media reports,[4] Decree 840 was intended to prevent divestment by “unfriendly” investors without authorization from the Russian government and, possibly, to incentivize such investors to then participate in a Russian government-sponsored “asset swap” as an attempt to allow Russian investors to divest their holdings in foreign securities frozen by Euroclear and Clearstream.
OFAC Response
In response to Decree 840, and several days before the expiration of GLs 99A and 100A, OFAC issued guidance (FAQ 1197) indicating that any securities in the possession or control of U.S. persons that are held at NSD following the expiration of GLs 99A and 100A, as well as dividends or other income received via NSD, should be treated as blocked.[5] OFAC stated that it viewed Decree 840 as an attempt to evade or avoid U.S. sanctions on NSD and cautioned that transfers to other Russian custodians may not be authorized under the general licenses and may be considered null and void.[6] OFAC specifically mentioned that it was investigating the non-blocked local Russian registrars for future designation under E.O. 14024, which ultimately followed on November 21, 2024.
Notably, while, as is often the case, in connection with the November 21, 2024 designations, OFAC also issued GL 113[7] authorizing all transactions prohibited by E.O. 14024 that are ordinarily incident and necessary to the wind down of transactions involving the more than 50 designated Russian banks, the general license does not extend to any of the blocked Russian securities registrars. The difference in treatment between Russian banks and securities registrars may be attributable to the fact that within the Russian custodial infrastructure the accounts of “unfriendly” investors (the so called “type-S” accounts) are essentially blocked by Russian countermeasures, and the wind down of such holdings would be prohibited without authorization from the Russian government.[8]
FAQ 1197 subsequently was updated to provide that any securities in the possession or control of U.S. persons that are held at the sanctioned securities registrars, as well as dividends or any income received via those registrars, should be treated as blocked. Effectively, this means that any investors seeking to divest or engage in any other dealings with or relating to, any securities or related funds held through NSD or other sanctioned Russian custodians, must apply for a specific license from OFAC if such dealings have a U.S. jurisdictional nexus. Because foreign financial institutions (”FFIs”) face the risk of U.S. secondary sanctions for dealing with persons blocked pursuant to E.O. 14024,[1] FFIs may refuse to process any such transactions even when there is no apparent U.S. nexus.
European Commission and UK OFSI Responses
Neither the European Commission nor the UK Office of Financial Sanctions Implementation (“OFSI”) have adopted such broad interpretations of the consequences of a securities custodian being sanctioned. In FAQ 124 issued by OFSI on November 11, 2024,[9] OFSI did not go as far as to suggest that all securities transferred pursuant to Decree 840 are frozen. Instead, OFSI stated that an asset freeze and some financial services restrictions will apply to non-designated entities that are owned or controlled, directly or indirectly, by a designated person. OFSI also cautioned that many of the Russian registrars may be captured by other existing designations, and financial services providers should continue to consider ownership and control and the risks associated with dealing with those assets. This means that assets held by local registrars that are owned or controlled by other designated persons or are themselves designated persons must be treated as frozen.
Similarly, the European Commission has explained in its FAQs[10] that the asset freeze imposed on NSD means that it is not possible to instruct any transaction that may, directly or indirectly, result in any fee payable to NSD or any other funds or economic resources to or for the benefit of NSD. The European Commission also separately stated that, parties may request authorization to release incoming transfers from NSD from the relevant national competent authority under the derogation envisaged in Article 6 of Council Regulation (EU) No 269/2014 (concerning a payment by a listed person under a contract concluded before the date on which that person was listed), because funds received from NSD would be viewed as assets belonging to, owned, held, or controlled by NSD that must be frozen, pursuant to Article 2(1) of Council Regulation (EU) No 269/2014.
[1] https://ofac.treasury.gov/media/933086/download?inline
[2] https://ofac.treasury.gov/media/933091/download?inline
[3] Most of the custodian chains involving foreign investments into Russian securities include both NSD and Euroclear or Clearstream that in practice often require authorizations of the respective Member State authorities for any transactions involving NSD.
[4] https://investfunds.ru/news/169353/
[5] https://ofac.treasury.gov/faqs/1197
[6] See 31 C.F.R. § 587.202, https://www.ecfr.gov/current/title-31/section-587.202
[7] https://ofac.treasury.gov/media/933631/download?inline
[8] The Russian government has only generally authorized “asset swaps” on the terms provided by the Russian regulations. The U.S., EU and UK sanctions authorities have not authorized such swaps.
[9] https://www.gov.uk/government/publications/uk-financial-sanctions-faqs/uk-financial-sanctions-faqs#featured1:~:text=124.%20In%20light,11%20Nov%202024
[10] See FAQs 20 and 21 of the Commission Consolidated FAQs on the Implementation of Council Regulation 833/2014 and Council Regulations 269/2014: https://finance.ec.europa.eu/document/download/66e8fd7d-8057-4b9b-96c2-5e54bf573cd1_en?filename=faqs-sanctions-russia-consolidated_en.pdf