On 17 April 2014, representatives of the European Union (“EU”), the United States (“U.S.”), the Russian Federation (“Russia”) and Ukraine reached agreement (the “Geneva Accord”) on a series of steps to de-escalate tensions and restore security in Ukraine. The Geneva Accord ordered all sides to refrain from violence and “provocative actions”, called for the disarming of all “illegal armed groups” and demanded the return of all “illegally seized buildings” to their legitimate owners. The Geneva Accord was prompted by an escalation in tensions as pro-Russian activists’ occupied official buildings in parts of eastern Ukraine.
As a means of responding to the crisis, the EU and the U.S., among others, issued a series of sanctions targeting certain persons and their assets in Russia and Ukraine. The introduction of sanctions has a significant impact on businesses dealing with persons designated on the sanctions lists and on companies associated with those persons. Most recently, the EU expanded its list of sanctioned persons on 14 April 2014. On 18 April 2014, U.S. Secretary of State, John Kerry, indicated that the next few days would be “pivotal” and that further US sanctions may follow if Russia fails to act in accordance with the Geneva Accord. The EU has also indicated that it would meet to discuss further sanctions if Russia does not comply with the agreement.
Recent events in Crimea and in eastern Ukraine have also sparked broader concerns for investors about the security of their investments in Ukraine and Russia. Both Ukraine and Russia have entered into numerous bilateral investment treaties (“BITs”) which provide varying levels of investment protection and permit recourse to international arbitration in the event of a dispute. In light of the current crisis, foreign investors in both Ukraine and Russia should consider whether their investments are adequately protected from possible State interference.
In November 2013, former Ukrainian President Yanukovych’s cabinet abandoned an agreement on closer economic ties with the EU and instead sought closer ties with Russia. This decision sparked protests and increasing incidents of violence in early 2014, leading ultimately to the overthrow of President Yanukovych (who subsequently fled to Russia) and the appointment of an interim government in Ukraine.
Ukraine has a large Russian-speaking population and historical ties to Russia. On 1 March 2014, the Russian parliament approved President Putin’s request to use force in Crimea, purportedly to protect ethnic Russian persons. Crimea held a referendum orchestrated by Moscow on accession to Russia, which most supporters of Ukraine in Crimea boycotted. The result was that 97% of voters in the region voted in favour of accession. President Putin then signed a law completing annexation and creating new administrative districts of Crimea and Sevastopol. While Russia has invoked the principle of “self-determination” to justify its actions in Crimea, Western nations have criticised its intervention as a violation of international law and the principle of territorial integrity.
Tensions increased recently when pro-Russian activists occupied several official buildings on 6 April 2014, in the cities of Donetsk, Louhansk and Kharkiv (located in eastern Ukraine). In response, the Ukrainian interim government launched what it termed an “anti-terrorist” operation on 7 April 2014, aiming to protect Ukrainian citizens and prevent the further annexation of regions of eastern Ukraine. In the midst of rising tensions, the Geneva Accord was signed on 17 April 2014 to adopt a plan that seeks to restore security in Ukraine. It remains to be seen whether the Geneva Accord will be respected by all sides involved in the crisis. Indeed, on 21 April 2014, it was reported that Russian Foreign Minister Sergei Lavrov had accused Ukraine of breaking the agreement by failing to disarm illegal groups.
The international community has widely condemned Russia’s involvement in the Ukrainian crisis and has taken a number of acts in response. Sanctions of the EU and the U.S. against Russian officials and former Ukrainian government officials from President Yanukovych’s inner circle are but one part of that response. Other States have also issued sanctions, including Canada, Australia, Switzerland, Austria and Lichtenstein.
Sanctions imposed by the EU
The first step leading to the imposition of sanctions by the EU took place on 20 February 2014, when the Council of the European Union (“EU Council”) decided to introduce targeted sanctions (including an asset freeze and a visa ban) against those responsible for “human rights violations, violence and excessive use of force” in Ukraine. EU Member States agreed to suspend export licences on equipment which “might be used for internal repression and reassessed export licences” connected to military goods and technology. On 5 March 2014, the EU Council enacted a Council Regulation designating 18 individuals (primarily members of the former Ukrainian government, including former President Yanukovych and former Minister of Internal Affairs Zakharchenko) whose assets within the EU would be frozen and with whom further dealings were to be restricted.
On 17 March 2014, the EU Council adopted a Council Decision providing for travel restrictions and the freezing of assets of 21 prominent Russian and Ukrainian individuals “responsible for actions which undermine or threaten the territorial integrity, sovereignty and independence of Ukraine”. On 21 March 2014, the EU Council adopted an implementing Decision adding 12 other individuals to the list. Russian Prime Minister Dmitry Olegovich and adviser to the President of the Russian Federation, Sergey Glazyev, were among those added to this list; both had publicly called for the annexation of Crimea.
On 14 April 2014, the EU Council passed an implementing Regulation adding a further four persons to the list. Three former Ukrainian ministers (former Prime Minister Serhiy Arbuzov, former Minister of Revenues and Charges, Oleksandr Klymenko and former Minister of Fuel and Energy, Edward Stavytskyi) and Member of Parliament Yuriy Ivanyushchenko were targeted due to their involvement in crimes relating to the embezzlement of Ukrainian State funds and the illegal transfer of those funds outside of Ukraine. The EU has indicated that it may consider further sanctions, depending on Russia’s compliance with the Geneva Accord.
Sanctions imposed by the U.S.
The U.S. has also imposed sanctions. President Obama signed three Executive Orders relating to the crisis in Ukraine. The first Executive Order (“Executive Order 1”), signed on 6 March 2014, authorised the US Treasury Department to “block” assets of natural or legal persons who had: (1) taken actions that undermine democratic processes or institutions in Ukraine; (2) taken actions that threaten the peace and territorial integrity of Ukraine; (3) misappropriated State assets; (4) asserted governmental authority over any part of Ukraine (including Crimea) without the authorisation of the Government of Ukraine; (5) been owned or controlled by, “directly or indirectly”, any person whose property and interests are blocked under Executive Order 1. Executive Order 1 did not designate any specific persons, but on 17 March 2014 the Treasury Department imposed sanctions on four individuals pursuant to this Executive Order, namely Crimea-based separatist leaders Sergey Aksyonov and Vladimir Konstantinov, former Ukrainian presidential chief of staff Viktor Medvedchuk and former President Yanukovych.
A second Executive Order (“Executive Order 2”) was enacted on 16 March 2014. It set out a list of seven persons whose property in the U.S. would be blocked, and provided that sanctions may also be imposed against a broad class of persons, including: (1) officials of the Government of the Russian Federation; (2) persons in the arms sector; (3) persons owned or controlled, “directly or indirectly”, by “senior” officials of the Russian Government or persons blocked pursuant to the Executive Order; and (4) any person who materially assisted or supported senior Russian officials or persons whose property is blocked pursuant to Executive Order 2. Accordingly, by 17 March, 11 persons had been subject to U.S. sanctions pursuant to Executive Orders 1 and 2.
A third Executive Order (“Executive Order 3”), signed by President Obama on 20 March 2014, extended the scope of persons subject to sanctions. It gives the Secretary of the Treasury the capacity to block the assets of any person operating in “such sectors of the Russian Federation economy as may be determined by the Secretary of the Treasury,” including: (1) financial services; (2) energy, metals and mining; (3) engineering; and (4) defence and related materiel. Executive Order 3 froze the assets of persons designated within the U.S., and prohibited transactions by US persons or within the U.S. involving the designated individuals and entities.
Also on 20 March 2014, the Office of Foreign Assets Control designated an additional 20 persons pursuant to Executive Order 2. Of these, 16 Russian government officials were listed, including Viktor Ozerov, Chairman of the Security and Defence Committee of Russia, and Senator Nikolai Ryzhkov, both of whom had publicly supported the annexation of Crimea. Four members of the Russian leadership’s inner circle and Bank Rossiya were also designated.
The US Treasury announced on 14 April that future sanctions may also expand the list of targeted individuals and companies due to the escalation of events in eastern Ukraine. This threat of additional sanctions was reiterated on 18 April, pending Russia’s compliance with the Geneva Accord. It is possible that further acts taken by Russia against Ukraine could trigger wider sector-specific sanctions, including against Russia’s energy, banking and finance and weapons procurement industries. Both the EU and U.S. are considering and preparing such sector-specific sanctions.
Russia’s response to the EU and U.S. sanctions
Russia has responded to existing sanctions by barring certain individuals from travelling to Russia. However, in the event that sector-specific sanctions are introduced, Russian Foreign Ministry spokesperson Aleksandr Lukashevich noted that Russia has reserved its right to “give an adequate response to the undertaken action”. A key concern, particularly to European States and businesses, is that Russia will cut off or reduce gas supplies to Europe.
Impact of sanctions on trade and business
The current regime of sanctions freezes the assets of targeted persons and entities and prohibits EU and US nationals from doing business with designated persons and entities. This prohibition, for example, affects the ability of banks and other financial institutions to lend or make funds available to the individuals targeted by the sanctions. It also has affected customers of those entities associated with the listed individuals, which may not have had any involvement in the political violence in Ukraine or the annexation of Crimea. For example, Visa and MasterCard have blocked credit card services to some customers of Russian banks that had links to persons targeted by U.S. sanctions and have also stopped providing services to SMP Bank, which is controlled by individuals subject to US sanctions.
Sanctions have also had an impact on the Russian economy, as investors with actual and potential business interests in Russia have decided to invest elsewhere. Indeed, investors are expected to take $65-70 billion of capital out of the Russian economy in the first quarter of 2014 (compared with $63 billion for the whole of 2013). Russian companies in other sectors, including energy, have also been affected. For example, the stocks of gas major Gazprom, Russian steel company NLMK and gas producer Novatek have been affected by the sanctions.
Additional sector-specific sanctions by the EU and the U.S., and the expected Russian retaliation to such measures, will likely impose a significant financial cost and risk to all parties involved. For example, in the energy sector, Russia is the largest oil, gas, uranium and coal exporter to the EU; a prohibition on the purchase of Russian energy would thus harm a number of EU countries. Similarly, in relation to trade and investment, Russia is the third largest trade partner of the EU; any sector-based sanctions against Russia would thus affect companies in EU Member States.
It will be necessary for US and EU companies to determine whether they have dealings with sanctioned persons or with companies associated with such persons and adjust their conduct accordingly, or else face the legal consequences under the sanction regimes.
Security of investments in Ukraine and Russia
Beyond the impact of sanctions on the business interests of non-targeted, third parties, the situation in Ukraine raises a number of legal and business concerns for investors in Ukraine and Russia. It is of fundamental importance for investors to ensure that their business interests are protected from illegal State interference. Such business interests may be protected by BITs, which are international agreements between two States to protect the investments made by nationals of one Contracting State in the territory of the other Contracting State.
BITs provide investors with certain standards of protection, generally including protection against uncompensated expropriation, assurances of fair and equitable treatment, guarantees of full protection and security. Usually they also provide recourse to international arbitration in the event of non-compliance by the host State with those standards of protection. Whether any future measures by Russia or Ukraine would violate provisions of the applicable BITs will depend on the nature of such measures and the specific terms of the relevant BIT.
According to the United Nations Conference on Trade and Development (“UNCTAD”), as of June 2013 Ukraine and Russia were each party to 55 and 51 BITs currently in force, respectively. Both States have entered into BITs with the U.S. and a large number of European States. The level of investment protection available will depend on the BIT, but will typically include the substantive protections mentioned above and recourse to international arbitration.
Foreign investors who are subject to adverse measures may seek recourse to international arbitration in accordance with the terms of the relevant BIT. As Ukraine is a party to the International Convention on the Settlement of Investment Dispute between States and Nationals of Other States (the “ICSID Convention”), investors from other State Parties to the ICSID Convention may bring disputes before the International Centre for Settlement of Investment Disputes (“ICSID”) where provided for under the applicable BIT. Arbitration before ICSID has strong and generally effective enforcement provisions. The BITs generally also provide for access to arbitration under other arbitral rules.
The ICSID Convention has not entered into force for Russia. Nevertheless, investors in Russia may have recourse to international arbitration under other arbitration rules, as provided for under the relevant BIT.
Volterra Fietta remains available to provide advice on the specific investment treaty protections available to foreign investors and on the impact of the sanctions on particular business interests.