01/03/22

GLOBAL REGULATION: Russia sanctions bring offshore assets into focus.

As published on caymancompass.com, Tuesday 1 March, 2022.

The international sanctions against Russia are bringing renewed attention to offshore transparency and anti-money laundering efforts. The UK’s Economic Crime Bill is likely to be only one of many legislative projects that could also affect offshore financial centres like the Cayman Islands.

As President Vladimir Putin has turned Russia effectively into a pariah state, through his invasion of Ukraine, the reputational fallout from ties to the country, especially to oligarchs and businesses friendly to the president and his regime may be severe.

Sanctions lists and asset freezes are the first step to target Russian elites.

The willingness to freeze, and potentially seize, their assets is growing in the UK, Europe and the US, putting financial service providers, including those in Cayman, into focus.

While the UK, and London in particular, are well-known havens for Russian wealth, how the money gets there is less-well established.

Transparency campaigners have long been arguing that the UK’s Crown Dependencies and Overseas Territories play an important role in holding cash, securities, properties and other assets for Russian oligarchs and channelling funds, as investments, into the Western economies.

Russia is arguably one of the countries with the highest share of offshore wealth, in relation to the size of its economy. Estimates put the country’s private offshore holdings at between $800 billion and $920 billion.

The UK, as a focal point for many of these funds, has acted quickly and accelerated its Economic Crime Bill, introducing it on 1 March.

The proposed law will pave the way for a Register of Overseas Entities, identifying foreign owners of U.K. property. It will apply retrospectively to property bought by overseas owners up to 20 years ago in England and Wales and since December 2014 in Scotland.

Entities who do not declare their beneficial owner will face restrictions over selling their property, and those who break the rules could face up to five years in prison.

The UK’s Home Office said the new legislation will help the National Crime Agency prevent foreign owners from laundering their money in UK property and ensure more corrupt oligarchs can be handed an unexplained wealth order (UWO).

UWOs are a type of court order designed to compel the target to reveal the sources of their unexplained wealth. If they remain unexplained, law enforcement can confiscate criminal assets without having to prove that the property was obtained from criminal activity.

Under the proposed UWO reforms, those who hold property in the UK in a trust will be brought within scope. The definition of an asset’s ‘holder’ will be expanded to ensure individuals cannot hide behind opaque shell companies and foundations, the Home Office said.

At the same time, the UK Treasury will intensify sanctions enforcement by introducing a more wide-ranging ‘strict civil liability test’ for monetary penalties, rather than the current one, which requires firms to have knowledge or a ‘reasonable cause to suspect’ sanctions are being breached.

This will make it easier for the Office for Financial Sanctions Implementation (OFSI) to impose significant fines.

If the bill is enacted, the OFSI will also be able to publicly name organisations that have breached financial sanctions, but have not received a fine.

In addition, a new ‘Kleptocracy’ cell based in the National Crime Agency, was announced last week and has been set-up immediately to investigate sanctions evasion.

Bill Browder, CEO of Hermitage Capital, who, at one point, was the largest foreign investor in Russia, has actively lobbied for a more stringent piece of legislation.

In an interview aired on PBS on 28 Feb., he said going after the oligarchs, who “are holding Putin’s money for him”, is what is going “to sting” the Russian president the most.

Browder said there is, for the first time, “more appetite” in the UK, Europe and the US to seize oligarchs’ assets. “This is a total game changer when it comes to affecting Vladimir Putin’s calculations.”

For that to happen, the list of Russian oligarchs on the sanctions lists need to be longer and the UK, EU and US sanctions lists need to be coordinated.

Browder demanded that there should be stricter penalties, including for financial services providers who do not provide information, under the sanctions legislation.

“I told the government and members of parliament that there needs to be a provision in the Economic Crime Bill that includes the western enablers of the oligarchs – all of the bankers, accountants, lawyers, trustees – so that they are required to come forward with information on where the oligarchs’ assets are.”

All of the information should be available to the government so that that those assets can be frozen and seized, he said.

The US-born financier, who is now a UK citizen, was instrumental in the Magnitsky Act passed by the US Congress in 2012.

Sergei Magnitsky was a Russian lawyer, who, while working for Hermitage Capital, discovered that millions of dollars of the fund’s tax payments had been syphoned off by Russian officials. He was arrested and died in 2009 having been mistreated, Browder says “tortured”, in jail.

The scandal sparked the US act, which imposed sanctions on the Russian officials involved. It was expanded in 2016 into a more general sanctions law for human rights and corruption violations, allowing for the imposition of asset freezes and travel bans on those listed.

The list of names whose assets are frozen is growing longer every day. EU sanctions, for instance, currently name 680 Russian individuals and 53 entities.

Although it is not a member of the bloc and traditionally neutral, Switzerland has adopted EU sanctions and said it will freeze listed Russian assets.

According to Swiss national bank data, Russian companies and individuals held assets worth more than $11 billion in Swiss banks in 2020. Holdings increased up to 2014 but have steadily decreased since then.

As a commodities trading hub, Switzerland also hosts many companies that trade Russian oil, metals and minerals.

Stocks controlled by Russian investors in Switzerland increased from US$8.7 billion in 2014 to $31.5 billion in 2018, making Russians the most significant direct investors in Switzerland, Neue Zürcher Zeitung reported.

Cayman’s exposure to Russian fund flows has historically been limited. Various data leaks, like the Panama Papers, have made little mention of the Cayman Islands.

Instead, the leaks suggested ties of the Russian president through confidants, like Sergei Roldugin, who is now on various sanctions lists, to banks in Cyprus, Swiss lawyers, BVI companies and Panama’s law firm Mossack Fonseca.

A 2016 analysis of capital flows to-and-from the Cayman Islands also shows no direct transfers from Russia. But the origin of funds is very difficult to track, if the money is transferred through more than one country.

A report by the Atlantic Council, a US think tank, on ‘Defending the United States against Russian Dark Money’ in Nov. 2020 noted that traditionally illicit Russian money left the country through Cyprus, because of a favourable double-taxation agreement dating back to Soviet times.

More recently, it found that Russian funds “typically proceeded to the British Virgin Islands and then to the Cayman Islands, but there are many alternative tracks”.

“Few jurisdictions with strong rule of law accept large amounts of dirty money, but the United States offers a ripe environment for offshore funds and is a hub for global money laundering,” the report said. “In the end, the money often moves from the Cayman Islands to the United States—mainly through the state of Delaware—and the United Kingdom.”

Most Russian oligarchs live in half a dozen countries and have layers of anonymous shell companies in a score of offshore jurisdictions, it added.

Investments made in Russia through Cayman-registered investment vehicles, as well as Russians investing in Cayman funds, will inevitably come under more scrutiny.

In 2019, there were six Cayman mutual funds that had Russian investors with more than a 10%-stake, according to the Investments Statistical Digest of the Cayman Islands Monetary Authority.

However, this does not cover the more than 14,600 private funds, registered in Cayman.

Any association to businesses that benefit from the war in Ukraine could suffer a reputational blow.

Australian wealth management firm Koda Capital had to apologise after it urged clients to take advantage of the crisis in Ukraine by describing Russian stocks as “cheap”.

“Our overarching view is that Russian stocks have become disproportionately oversold, and that Russia is well-placed to cope with current and likely future sanctions,” Koda’s investment team wrote in an email after the start of Russia’s invasion of Ukraine.

The email encouraged clients to invest into Cayman-based Prosperity Capital, an investment fund specialised in Russian equities.

After a public backlash, Koda backpedalled, stating the email was sent in error.

Sovereign funds in Norway and Australia already announced they are divesting Russian investments.

British energy giant BP, the biggest investor in Russia, divested its stake in Russia’s Rosneft.

Austria’s Raiffeisen Bank International (RBI), the foreign bank with the largest exposure to Russia, is considering pulling out of the country, Reuters reported.

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