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What every business needs to know about sanctions compliance

Sanctions compliance, as understood by Moody's, refers to the adherence to laws, regulations, and standards set by national and international authorities to prevent and penalize engagement with entities subject to sanctions. These entities may include countries, organizations, or individuals identified as posing threats to national security, human rights, or global economic stability.

A compliance process to manage and mitigate sanctions risk typically involves rigorous customer or supplier due diligence, transaction monitoring, and ongoing risk assessment to ensure clients or suppliers aren’t involved in any prohibited activities. These review and monitoring processes help businesses avoid sanctions violations and can include verifying third party identities, analyzing ownership structures, understanding business activities, assessing risk profiles using various factors, and continuously monitoring to detect potential links to sanctioned entities or those sanctioned by extension.

Compliance with sanctions regulation is a crucial component of broader Know Your Customer (KYC) and Anti-Money Laundering (AML) efforts, aimed at maintaining the integrity of the financial system and preventing illicit activities.

What are the different types of sanctions and compliance to consider?

Categorizing sanctions into specific areas helps promote understanding of the tools used by international entities to exert pressure or respond to key actions. The categories are not mutually exclusive and often a combination of sanctions from different categories is used to increase their effect. For example, in response to Iran's nuclear program, a combination of economic, financial, and military sanctions were used by the United Nations, the European Union, and the United States.

  • Diplomatic Sanctions: These involve the reduction or removal of diplomatic ties with a targeted country. This can take the form of limiting diplomatic presence, restricting diplomatic communication, or expelling diplomats altogether. For example, in 2014, several Western countries expelled Russian diplomats as a diplomatic sanction following Russia's annexation of Crimea.
  • Trade Sanctions: These are measures that disrupt the economy of a targeted country. They can involve dual-use goods and highly critical items, trade embargoes, import/export restrictions, or tariffs. For instance, the United States has imposed economic sanctions on North Korea, which include prohibitions on trade of specific goods and services.
  • Military Sanctions: These sanctions limit the military capability of a target country. They may include arms embargoes, restrictions on military aid, or prohibitions on the transfer of military technology. For example, the European Union imposed military sanctions on China after Tiananmen Square, prohibiting the export of technology and equipment that could have potential military use.
  • Financial Sanctions: Financial sanctions involve measures that affect the financial sector of a targeted country and may include freezing assets, limiting access to financial markets, or prohibiting financial transactions. An example of financial sanctions are those the US imposed on Iran, restricting its access to the global financial system.

In addition to these four types of sanctions listed above are “International sanctions”, such as those imposed by the United Nations, as well as “sectoral sanctions”, which are a type of economic sanction that targets specific sectors of a country's economy rather than the entire nation. These sectoral sanctions are sometimes used as a strategic tool by governments to apply pressure on another country without causing widespread humanitarian distress. The sectors targeted are typically those crucial to the country's economy however and might include the energy, defense, or financial sectors. 

What is sanctions compliance?

Sanctions compliance is an essential aspect of international business operations, not just for financial institutions, but for businesses of all types and sizes. When new sanctions are issued, businesses must comply and deal with high-risk situations to avoid falling foul of the law and incurring penalties for sanctions violations. Companies operating across borders may need to adhere to various sanctions regimes, which can be complex and multifaceted. Also, sanctions are dynamic, with sanctions lists and watchlists changing overnight, meaning ongoing vigilance is important to compliance and avoiding a breach.

However, sanctions compliance is not a one-size-fits-all practice, and every organization needs to tailor its own approach. It’s also important to note that sanctions compliance applies to transactions, such as mergers and acquisitions or joint ventures, as well as client onboarding and risk monitoring.

Additionally, sanctions screening and compliance extends beyond an organization’s own customers – i.e. know your customer (KYC) processes – to include knowing suppliers; a customer’s customer; and a supplier’s supplier. All touchpoints with an organization need to be considered and factored into sanctions compliance appropriately. Ensuring sanctions compliance can therefore cast a very wide net.

OFAC’s five pillars of sanctions compliance

The "five pillars” of sanctions compliance specified by the OFAC framework include management commitment, risk assessment, internal controls, testing and auditing, and training. These pillars constitute a framework that can guide organizations in designing and implementing an effective sanctions compliance program, providing a comprehensive approach.

  1. Management commitment: The first pillar of sanctions compliance is management commitment. This involves the active participation of senior management in “setting the tone” for the organization's approach to sanctions compliance. Management commitment is crucial as it establishes leadership direction, which is then able to cascade through all levels of an organization. It includes the allocation of resources for a sanctions compliance program, appointment of competent personnel to oversee the sanctions program, such as a sanctions compliance officer (SCO), and creation of a culture of sanctions compliance.
  2. Risk assessment: The second pillar of sanctions compliance is risk assessment. This involves identifying, assessing, and understanding the specific sanctions risk an organization faces based on its business, size, complexity, and geographic reach. A robust sanctions risk assessment process enables an organization to tailor its compliance program to address its unique risk profile and allocate resources appropriately.
  3. Internal controls: The third pillar is internal controls. These are procedures and policies designed to detect and prevent violations of sanctions laws. Internal controls should be comprehensive and include clear lines of accountability, procedures for reporting potential violations, and mechanisms for promptly addressing any identified issues.
  4. Testing and auditing: Testing and auditing are the fourth pillar of sanctions compliance. Regular testing and auditing of a compliance program are essential to ensure its continued effectiveness over time, especially when considering how quickly sanctions and frequently sanctions, business ownership, and watchlists can change. The process of auditing and testing should be independent and objective, aiming to identify weaknesses or gaps in the program in order to recommend improvements.
  5. Training: The fifth and final pillar is training. Regular, tailored, and comprehensive training for all relevant staff is crucial to ensure they understand the sanctions risk their organization faces and the procedures in place to manage those risks. Training should be updated regularly to reflect ever evolving sanctions laws and the organization's corresponding risk profile.

Executed well, the pillars of sanctions compliance provide a robust framework for organizations to design and implement an effective sanctions compliance program. Each pillar is interconnected and important, offering a holistic and integrated approach to manage sanctions risk effectively.

The role of a sanctions compliance officer

As we know, sanctions are powerful tools used by governments and international organizations to enforce international law, promote human rights, prevent terrorism, and achieve foreign policy objectives. They range from economic and trade sanctions to more targeted measures such as arms embargoes, travel bans, and financial or diplomatic restrictions. Adherence to sanctions regulations is of huge importance to organizations the world over. And non-compliance can lead to severe penalties, including substantial fines from regulators such as OFAC, as well as reputational damage, and even criminal charges.

Sanctions laws and risks are not static, they can change day to day, evolving in response to international relations, which makes it crucial for organizations to constantly monitor and adapt their compliance program and to stay up to date.

A key figure in ensuring an organization's ongoing adherence to sanctions laws is often the Sanctions Compliance Officer (SCO). The SCO plays a critical role in managing and mitigating risks associated with sanctions. Their responsibilities and duties can be categorized into three main areas: policy development, risk assessment, and training.

  1. Policy Development: The SCO is responsible for developing and updating the organization's sanctions compliance policy. This includes understanding applicable sanctions laws and regulations, as well as designing policies and procedures to ensure compliance.
  2. Risk Assessment: The SCO is tasked with identifying and assessing risks associated with their organization's business activities. This involves conducting regular audits, monitoring transactions, and implementing controls to mitigate identified risks.
  3. Training: The SCO is also responsible for educating the organization's staff about the importance of sanctions compliance and the potential consequences of non-compliance. This includes providing regular training and updates on changes in sanctions laws and regulations.

Summary

Sanctions enforcement is a critical aspect of international law and policy. Organizations must be diligent in their adherence to these laws, creating a sanctions compliance program that is comprehensive, appropriate to the business, and responsive to changes. Effective compliance programs consider OFAC’s five pillars of sanctions compliance, which delivers a robust and holistic approach, and they are tailored to each organization, sponsored by senior leaders, and adopted throughout an organization.

Finally, the Sanctions Compliance Officer plays a pivotal role in coordinating ongoing risk management and compliance. The SCO develops adherence through policies and procedures, assessing risk, developing mitigation strategies, and helping to provide comprehensive training. While the SCO helps protect the organization from the most severe consequences of non-compliance, achieving compliance is a company-wide effort and a responsibility for everyone to bear.

Get in touch

Moody’s compliance and third-party risk management solutions can help support your organization achieve sanctions compliance. We have deep and global sanctions expertise, can help digitally transform compliance policies, automate data checks, and offer access to leading sources of data for effective sanctions screening.

For more information or to discuss your sanctions compliance program with us, please get in touch any time – we’d love to hear from you.