The Impact of Recent US Financial Institution Sanctions on Chinese Financial Institutions and Suggestions for Response

The impact of US Presidential Executive Order No 14114 on Chinese financial institutions

On 22 December 2023, the President of the United States signed Executive Order No 14114 to amend Executive Order No 14024 and Executive Order No 14068. Executive Order No 14114 authorises sanctions against foreign financial institutions that engage in or facilitate any significant transactions or transactions on behalf of or for the benefit of operators in the technology, defence, and related material sectors of the Russian Federation’s economy, as designated under Section 1(a)(i) of Executive Order No 14024, or in any other sector of the Russian economy as determined by the Secretary of the Treasury in consultation with the Secretary of State. It also targets those that engage in or facilitate significant transactions involving the Russian military-industrial complex or provide any services, including the sale, supply, or transfer of certain items or classes of items determined by the Secretary of the Treasury in co-ordination with the Secretary of State and the Secretary of Commerce, directly or indirectly to the Russian Federation.

The term “foreign financial institution” as defined in Executive Order (EO) No 14114 refers to any foreign entity that is engaged in the business of:

• accepting deposits;
• making, granting, transferring, holding, or brokering loans or credits;
• purchasing or selling foreign exchange, securities, futures or options; or
• procuring purchasers and sellers thereof, as principal or agent.

It includes:

• depository institutions;
• banks;
• savings banks;
• money services businesses;
• operators of credit card systems;
• trust companies;
• insurance companies;
• securities brokers and dealers;
• futures and options brokers and dealers;
• forward contract and foreign exchange merchants;
• securities and commodities exchanges;
• clearing corporations;
• investment companies;
• employee benefit plans;
• dealers in precious metals, stones, or jewels; and
• holding companies, affiliates, or subsidiaries of any of the foregoing.

Regarding the so-called “significant transaction”, according to No 1151 of the Frequently Asked Questions of the Office of Foreign Assets Control (OFAC) of the US Treasury Department, OFAC may consider all facts and circumstances when determining whether one or more transactions are “significant”. Generally, the following factors can be partially or completely considered:

• the size, number, and frequency of the transactions;
• the nature of the transactions;
• the level of awareness of management and whether the transactions are part of a pattern of conduct;
• the nexus of the transactions to persons sanctioned pursuant to EO 14024, or to persons operating in Russia’s military-industrial base;
• whether the transactions involve deceptive practices;
• the impact of the transactions on US national security objectives; and
• such other relevant factors that OFAC deems relevant.

Therefore, if a Chinese financial institution’s client is an operator in the aforementioned specific industries or has engaged in any significant transactions involving the Russian military-industrial complex, the provision of services by the Chinese financial institution to that client, such as opening accounts for operators in specific economic sectors of the Russian Federation, both inside and outside of Russia, transferring funds, or providing other financial services, could very likely result in sanctions by the United States. Assisting companies or individuals in evading US sanctions against the Russian military-industrial complex could also result in sanctions, including helping to establish alternative or non-transparent payment mechanisms, altering or removing customer names or other relevant information from the payment field, obfuscating the true purpose of the payment or the payer, or taking measures to conceal the ultimate purpose of the transaction to evade sanctions. For foreign financial institutions that engage in the aforementioned actions, the United States can impose the following sanctions:

• prohibit the opening of, or prohibit or impose strict conditions on the maintenance of, correspondent accounts or payable-through accounts in the United States; or
• block all property and interests in property that are in the United States, that hereafter come within the United States, or that are or hereafter come within the possession or control of any United States person of such foreign financial institution, and provide that such property and interests in property may not be transferred, paid, exported, withdrawn, or otherwise dealt in.

The impact of the US “Iran–China Energy Sanctions Act of 2023” on Chinese financial institutions

On 23 April 2024, the “Iran–China Energy Sanctions Act of 2023” officially took effect. In fact, the “Iran–China Energy Sanctions Act of 2023” is an amendment to Section 1245(d) of the National Defense Authorization Act for Fiscal Year 2012, which “imposes sanctions on the Central Bank of Iran and other Iranian financial institutions”. Section 1245(d)(1)(A) of the National Defense Authorization Act for Fiscal Year 2012 authorises the President of the United States to impose sanctions on foreign financial institutions that knowingly engage in or facilitate any significant financial transactions with the Central Bank of Iran or other Iranian financial institutions designated by the Treasury Secretary, including prohibiting the opening of correspondent or payable-through accounts in the United States, prohibiting the maintenance of such accounts, or imposing strict conditions on the maintenance of such accounts.

According to Section 1245(h) of the National Defense Authorization Act for Fiscal Year 2012, the United States Code, and the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010, a “correspondent account” is an account established to accept deposits from a foreign financial institution, make payments on behalf of a foreign financial institution, or handle other financial transactions related to that institution. A “payable-through account” refers to an account opened by a foreign financial institution at a custodial institution, including transaction accounts, through which the foreign financial institution allows its customers to directly or through sub-accounts engage in banking activities related to US banking. The term “financial institution” includes:

• insured banks;
• commercial banks or trust companies;
• private bankers;
• foreign bank agencies or branches in the United States;
• any credit union;
• thrift institutions;
• brokers or dealers registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934;
• brokers or dealers in securities or commodities;
• investment bankers or investment companies;
• currency exchange, or businesses engaged in the exchange of currency, funds, or value that substitutes for currency or funds;
• insurance companies; or
• any business or agency that engages in any activity which the Secretary of the Treasury determines, by regulation, to be an activity which is similar to, related to, or a substitute for any activity in which any business described in this paragraph is authorised to engage.

Section 1245 of the National Defense Authorization Act for Fiscal Year 2012 does not further clarify the meaning of “significant financial transaction”. Through this amendment, the “Iran–China Energy Sanctions Act of 2023” further clarifies the meaning of “significant financial transaction”, with Article 2(2) stipulating that the “significant financial transaction” under Section 1245(d)(1)(A) of the National Defense Authorization Act for Fiscal Year 2012 includes the following two types of transactions:

• any transaction in which a Chinese financial institution is involved in the purchase of Iranian oil or petroleum products; and
• any transaction in which a foreign financial institution is involved in the purchase of Iranian unmanned aerial vehicles (UAVs), UAV parts, or related systems.

It is noteworthy that the determination of the above two types of “significant financial transactions” does not take into account the size, quantity, frequency, or nature of the transaction.

It can be seen that the United States has expanded the scope of sanctions that may be imposed on Chinese financial institutions through the “Iran–China Energy Sanctions Act of 2023”. Once the United States determines that Chinese financial institutions have knowingly engaged in or facilitated any transactions involving the purchase of Iranian oil or petroleum products and Iranian unmanned aerial vehicles (UAVs), UAV parts, or related systems, regardless of the size, quantity, frequency, or nature of the financial transaction, Chinese financial institutions may be subject to US sanctions, thereby being unable to open or maintain correspondent or payable-through accounts through US financial institutions in the United States. The risk of Chinese financial institutions being subject to US economic sanctions has further increased.

Suggestions for Chinese financial institutions on responding to recent US sanctions against financial institutions

Convey compliance expectations to clients

• Convey the relevant sanctions compliance requirements and risks to clients, inform them not to use their accounts to conduct business with designated individuals in specified industries or engage in any transactions involving the Russian military-industrial complex or Iranian oil and UAVs.
• Share the list of certain items or classes of items subject to sanctions legal control with clients engaged in import and export, manufacturing, or any other related businesses.

Conduct due diligence and compliance review of clients and related business and transactions

• Conduct due diligence and compliance review of clients and related business and transactions to determine whether there are clients operating in specific sectors of the Russian economy, any clients conducting business with designated individuals in specific industries, clients that may be involved in selling, supplying, or transferring certain items to Russia, and clients involved in transactions related to Iranian oil or petroleum products or Iranian unmanned aerial vehicles (UAVs), UAV parts, or related systems.

It should be noted that compliance review should also be conducted for non-US dollar currency transactions. According to OFAC’s Frequently Asked Questions No 1151, the sanctions stipulated in Executive Order No 14114 and No 14024 also apply to non-US dollar currency transactions conducted by foreign financial institutions.

Incorporate sanctions risks into client risk grading and take corresponding sanctions response measures

• Include the risks of US sanctions against foreign financial institutions in the client risk grading criteria and take different measures for clients with different risk ratings.
• For clients not engaged in activities subject to sanctions control, obtain written statements from the clients stating that they are not operating in the specified industries, have not sold or transferred specific items to Russia, have not engaged in any transactions involving the Russian military-industrial complex, and have not been involved in transactions related to Iranian oil, UAVs, or related systems.
• For clients engaged in high-risk activities or those who have not responded to relevant investigations, appropriate restrictive measures should be taken. These measures include restricting accounts, limiting the types of business allowed to be conducted, strengthening control over trade financing for specific client projects, and placing clients or counterparties on an internal “do not engage” watchlist, among others.

Effectively implement sanctions compliance frameworks in daily operations

Financial institutions should effectively implement sanctions compliance frameworks in their daily operations. Firstly, financial institutions should develop and improve effective sanctions compliance frameworks. The top management should provide clear support for the development and implementation of compliance frameworks and ensure the provision of necessary resources to integrate compliance requirements into the daily operations of the organisation. On this basis, a comprehensive risk assessment should be conducted to systematically analyse customers, products, services, supply chains, intermediaries, and counterparties, in order to identify and quantify potential sanctions compliance risks.

Based on the results of the risk assessment, design and implement internal control measures, including developing clear policies and procedures aimed at preventing, identifying, reporting, and documenting activities that may violate sanctions. In addition, establish a comprehensive, independent, and objective testing and auditing mechanism to ensure timely identification and remediation of weaknesses and deficiencies in the sanctions compliance framework. In order to enhance the compliance awareness and ability of employees, regular training programmes should be carried out to ensure that all relevant personnel understand the importance of sanctions compliance and are able to master specific knowledge and skills related to their responsibilities.

Ensure clear communication of policies and procedures related to sanctions compliance framework to relevant personnel, and effectively integrate these policies and procedures into the daily operations of the company. In addition, it is advisable to establish clear records of the implementation and execution of the above matters, in order to face potential investigations and provide a basis for proving the compliance of institutional operations.

Finally, given the constantly changing sanctions regulations and market environment, the sanctions compliance framework should be regularly reviewed and updated to ensure that it can adapt to the latest developments in the external environment, including updates in regulatory requirements, changes in business models, and new market trends. The risk of violating sanctions regulations can be effectively reduced through continuous self-assessment and improvement, and appropriate remedial measures taken when necessary.