Sanctions Against Russia: Evasion, Compensation, and Overcompliance
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13 2015 Elena Ignatyeva/AP/SIPA Elena Sanctions against Russia: Evasion, compensation and overcompliance by Cameron Johnston In the popular imagination, sanctions are akin only displace it onto others, exacerbating ten- to arrows at an archery range: fired by archer sions between competing factions. Therein lies A, they fly in a regular arc to hit ‘target’ B with the danger. varying degrees of accuracy. Attractive as this model may be, however, it does scant justice Some sanctions hit the bull’s-eye, others go to the reality of how sanctions work. For tar- astray. Sanctions also sometimes overshoot gets are less like static archery butts than live their mark or veer off in crosswinds to hit in- game, ducking and weaving to avoid projec- dividuals and companies which are innocent of tiles. In Russia, these feints have taken a variety any wrongdoing. These companies may find it of forms, including exploiting loopholes, alter- more difficult to access capital markets, struggle ing share structures and using tax havens with to recapitalise their debts and cut back on in- the aim of concealing beneficial ownership. If vestment, hampering economic growth. These sanctions do not change direction in the course three themes, evasion, compensation and over- of their flight, they will miss their target or sim- compliance, are all visible in the case of Russia. ply deliver glancing blows. Evasive measures But the archer is no sadist. Inflicting pain on the target is a means to an end, the end being Bank Rossiya offers a case study in how compa- a change of behaviour on the part of a third nies close to the Kremlin succeeded in evading player, the state. If close allies of an autocratic sanctions, at least for some time. Bought in 1991 leader see their fortunes endangered by erratic by close allies of Vladimir Putin, including Yuri behaviour, they might apply pressure to change Kovalchuk, it expanded rapidly in the 2000s by his foreign policy. The problem, of course, is buying state assets at knock-down prices to be- that he too is a dynamic actor. As fast as the come the 17th largest bank in Russia at the start sender can inflict pain, the leader can deliver of 2014. Described by the US Treasury as ‘the analgesics in the form of new contracts, thereby personal bank for senior officials of the Russian buying his allies’ continued loyalty. If his econ- Federation’, it was the first Russian entity to be omy is not growing, however, the autocrat can- blacklisted when the US introduced sanctions not make the pain disappear altogether: he can on 20 March 2014. European Union Institute for Security Studies May 2015 1 As an investigation by The Economist showed, The answer is that it concealed beneficial own- the bank protected its subsidiaries by exploit- ership. Since RNCB was sold in March 2014 ing loopholes in the sanctions legislation. and changed hands again in early 2015, it ap- Until March 2015, it held a controlling stake peared to be independent of Bank of Moscow. (51%) in the insurance company, Sogaz. But In reality, the two banks were as connected as with sanctions looming, it transferred 2.5% they ever were, since Bank of Moscow’s direc- of its shares to a newly created subsidiary. As tors continued to negotiate on behalf of their a result, Sogaz was not listed, because, under erstwhile subsidiary. the rules as they then stood, a firm owned by multiple targets could not itself be listed unless Keeping it in the family one of those targets individually held a 50% stake. The US Office for Foreign Assets Control As well as altering share structures and conceal- (OFAC) closed this loophole in August 2014, ing beneficial ownership, targets may protect so that the combined shares of targeted entities their assets by passing them on to family mem- became the deciding factor, but before it could bers, with the hope, perhaps, of resuming con- do so, Bank Rossiya acted again. trol when sanctions are lifted. Hartwall Arena, a music venue in Finland, was one such asset. On 11 August 2014, just before the new rules Until 2014, it was half owned by Timchenko took effect, Bank Rossiya transferred a por- and half by the Rotenberg brothers, childhood tion of its shares in Sogaz to a subsidiary of friends of President Putin. Since all three of Gazprom, a company which is not subject to them were soon to be blacklisted, the venue’s full sanctions. The stakes of fully sanctioned future appeared to be in doubt. In the event, entities therefore added up to less than 50% Arkady and Boris Rotenberg saved it by trans- and Sogaz avoided sanctions. ferring all of their shares to Boris’s son, Roman, and arranging for Timchenko to sell Roman a Second, Russian targets have sought to shield 0.5% stake. Sanctioned individuals now owned their subsidiaries by relinquishing (or at least only 49.5% of the arena, allowing it to continue appearing to relinquish) ownership. Half of the operating unimpeded. shares in Gunvor, one of the world’s largest oil trading firms, were until March 2014 owned by Arkady Rotenberg repeated the trick later on another Putin loyalist, Gennady Timchenko. On in 2014. Bloomberg reported in October that the very day that he was blacklisted by the US, he had transferred TPS Real Estate Holding, a however, Timchenko company that builds sold all his shares to shopping malls, to his his Swedish business ‘...although Putin’s inner circle became son Igor. He also an- partner. He is also re- nounced that he had ported to have sold his poorer in absolute terms, they grew disposed of his stake stake in the Finnish stronger in relative terms as the in OAO Mostotrest, airliner Airfix and in Russia’s largest builder airport business termi- president rewarded loyal acolytes with of roads and railways, nals in St Petersburg a larger slice of a shrinking pie.’ only for the very same and Moscow. The sus- Igor to appear on com- picion, of course, is pany documents as a that although ownership changes on paper, the 26% shareholder. Because the family members previous owners continue to control the com- of sanctioned individuals are legally obliged to pany in practice. The case of Russian National declare that they are related to ‘politically-ex- Commercial Bank (RNCB) shows how this posed persons’, however, and banks often give might be achieved. them a wide berth, it is not clear whether this tactic always works. At the start of 2014, RNCB was a small sub- sidiary of the Bank of Moscow and the 587th Despite all this ducking and diving, however, largest bank in Russia. But it took advantage of Russia’s wealthiest men incurred stinging loss- Russia’s annexation of Crimea to expand rap- es in 2014 due to the combined effect of fall- idly, to the extent that by January 2015, it had ing oil prices, structural economic problems 200 branches on the peninsula and was pro- and Western sanctions, with the twenty rich- viding financial services to the regional author- est losing a combined total of $62 billion. But ities. How did it evade sanctions, then, after its although Putin’s inner circle became poorer in parent company was blacklisted in July 2014? absolute terms, they grew stronger in relative European Union Institute for Security Studies May 2015 2 terms as the president rewarded loyal acolytes It would appear, then, that sanctions have sped with a larger slice of a shrinking pie. up the concentration of resources in the hands of a coterie of Putin loyalists. Bloomberg reports Let the good times roll… that between March and December 2014, firms connected to Gennady Timchenko and Arkady Bank Rossiya once again exemplified the trend. Rotenberg won 309 billion roubles (around On 10 April 2014, an obscure body called $8.1 billion) in government contracts, 12% the Market Council voted to transfer financial more than in the whole of 2013. In a country business related to Russia’s wholesale electric- in which the state can make or break a person ity market from Alpha Bank to Bank Rossiya at will, a businessman’s absolute wealth matters in a deal that promised rich rewards for the less than his position in the pecking order. By sanctioned bank. The business is worth 4 bil- cementing his allies’ position at the top of the lion roubles a year, only slightly less than Bank food chain, Putin calculated correctly that they Rossiya’s total net profit in 2013. All the evi- would swallow sanctions without demanding dence suggests, meanwhile, that the decision a change of course. Whereas a few public fig- was taken at highest state levels. Igor Sechin, ures have openly criticised government policy, head of Rosneft and long-time friend of Putin, most notably former Prime Minister Yevgeny is chairman of the board, while the loser in this Primakov and former Finance Minister Alexei deal, Alpha Bank, is headed by an oligarch who Kudrin, no one at the top has voiced any op- has made no bones about his desire to diversify position. his portfolio away from Russia. But although Putin’s strategy has been effective Putin has bought the loyalty of sanctioned oli- in the short term, it might prove dangerous in garchs by channelling existing business in their the long run. In times of growing scarcity, Putin direction but his ‘foreign adventures’ have also will try to feed his followers by starving their opened up new opportunities for faithful aco- rivals. Last October, the state expropriated lytes, not least in Crimea.