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Toward a Trans-Atlantic Strategy on Russia Sanctions

The status quo of the U.S.-E.U.-Russian relationship has been unsatisfying, to say the least. Despite the sanctions piling on, they do not seem to bring progress on any track — neither resolving the crisis in and around Ukraine, reducing human rights violations, or deterring new cyber attacks. The West’s failed attempts to reset a Russia policy have culminated in this suboptimal strategy: the balancing of containment and selective cooperation. As the United States and Europe discuss additional sanctions to deter Russia from further aggressive actions against Ukraine, it is worth revisiting U.S.-E.U. thinking about sanctions.

With Washington’s striving for multilateral coordination and Brussels’ quest for strategic autonomy, there is an opportunity to revamp a trans-Atlantic sanctions policy toward Russia. Instead of routine sanctions, the United States and the European Union should broaden the scope of their economic statecraft and focus on building resilience to external influences at home.  By reducing its own domestic vulnerabilities, the West can become more resilient to Russia’s attempts to exploit weak spots in Western systems, thus reducing the need for a sanctions offensive. Stricter anti-money laundering regulations, robust foreign investment screening, and tighter export controls could minimize the West’s domestic vulnerabilities and strengthen its room for maneuver to exert influence externally. This might not solve the United States and Europe’s problems deterring Russia in the short term, but taking the long-term perspective may enable clearer thinking about a more effective use of economic statecraft.

U.S. and E.U. Common Policy Objectives  

As Moscow is amassing as many as 100,000 troops on its border with Ukraine, the United States and Europe are discussing new deterrence measures in the case of a Russian invasion of Ukraine. The Kremlin’s new round of muscle-flexing has put Washington and Brussels’ resolve to the test: How far is the United States prepared to go to push back against Russia, and is Europe willing to act on par?

In the short term, deterring Russia with new measures of higher intensity is likely to work this time. The West has already threatened to impose “high-impact” sanctions if Russia invades Ukraine, which could include sanctions on Russian banks and energy companies as well as on the country’s sovereign debt. While sanctions are known for being mostly effective in deterrence, their track-record in coercion is less impressive. Sanctions alone are not sufficient enough to coerce Moscow to change its behavior. Moscow lacks an incentive to change its behavior, as it perceives sanctions as an end in themselves, driven by the desire to punish Russia for past actions.

Unlike deterrence, coercion is a long-term problem that requires a complex approach. Diversifying away from sanctions to other tools of economic statecraft and shifting focus to bolstering the West’s domestic resilience can help to change the perspective of how to deal with Russia in the long term. It’s possible to do this without agreeing that Russia sanctions failed. Over the past seven years, Western sanctions performed important constraining and signalling functions. They exacerbated Russia’s already adverse business climate and constrained the government’s budget flexibility. However, despite having made an impact, sanctions are yet to become truly effective. The lack of trans-Atlantic strategy on Russia often led to reactionary moves from the West, while the pressure from sanctions failed to penetrate to the decision-making level. This is a helpful reminder that sanctions are not a silver bullet and should be deployed in conjunction with other instruments as part of a larger strategy. As Richard Nephew, a former principal deputy coordinator for sanctions policy at the U.S. Department of State, nicely put it, “One can’t blame the saw if it fails to perform the work of a screwdriver.”

The United States and the European Union are currently aligned in their approaches toward Russia. Washington and Brussels have low expectations and both seek a stable, predictable relationship with Moscow. Their strategies focus on managing the fraught relationship, rather than attempting to fix it. Like Washington, Brussels aims to juggle containment and selective engagement. This is a starting point for a trans-Atlantic sanctions policy, but it does not preclude full alignment between the allies. In the past, the European Union struggled to speak with a united voice and to act coherently. A combination of historic, geographic, and economic factors led to pushing and pulling attitudes within the Union when it came to the decision-making on Russia. These internal divisions often handicapped the formulation of a swift response and frequently resulted in contradictory policies. Germany’s insistence on the continuation of Ostpolitik led to heated tensions with Central European countries. Warsaw supports a more adversarial approach, while Berlin persists in expanding energy relations and maintaining dialogue in the hope of avoiding a direct confrontation with Russia.

Leveling the Playing Field

Recently, both the United States and European Union have updated their respective sanctions policies. Concerned about the diminishing effectiveness of U.S. sanctions, the U.S. Treasury’s long-awaited sanctions review re-affirmed a more moderate use of sanctions. Sanctions are meant to be used as a forward-looking instrument to alter a target’s future behavior. Strategic and judicious use of sanctions seeks to avoid unintended consequences and capitalize on the tool’s most powerful effect — deterrence. For the European Union, the Treasury review’s mention of multilateral coordination was particularly welcome. Brussels has been apprehensive about Washington’s use of extraterritorial sanctions and launched the revamp of its Blocking Statute and a new anti-coercion instrument. Enacted in the 1990s in response to U.S. sanctions against Cuba, Iran, and Libya, the Blocking Statute aimed to prohibit E.U. firms from complying with U.S. measures. Recently, the European Commission outlined amendments to beef up the effectiveness of the statute, by adding deterrence measures and reducing compliance costs for E.U. businesses. In the same vein, the new anti-coercion instrument seeks to deter and counteract coercive practices by third countries.

While Washington strives for multilateral coordination, Brussels is also on a quest for strategic autonomy. Together these two trends provide an opportunity to revamp the trans-Atlantic relationship. America may be back, but the European Union can no longer assume that it can always rely on the United States. And that is a good thing. The European Union’s geopolitical aspirations mean that the Union will have to take greater responsibility, greater risks, and greater economic and political engagement in its neighborhood and beyond. In January 2021, in its report on how to boost the European Union’s global influence, the European Commission acknowledged as part of this the need to become more consistent in the enforcement and implementation of sanctions. To improve the efficacy of E.U. sanctions, Brussels envisaged more effective information-sharing and a more harmonized implementation of sanctions among member states. The commission laid out an ambitious plan to strengthen the resilience of the bloc’s economy and of financial market infrastructures, promote the role of the euro, and sharpen its strategic thinking. The new capabilities can help the Union to convert its geopolitical ambitions into action. Whether Brussels is comfortable using the language of power, including against Moscow, remains to be seen.

A Wider Use of Economic Statecraft

The overuse of sanctions leads to their routinization and could nullify their deterring effect. Customary visa bans and asset freezes on middle-ranking officials can no longer work as an effective deterrent. It is an expected reaction from the West and target states are prepared to respond with their own counter-sanctions — both Russia and China have responded that way in the past. This should urge the West to become more creative while exercising its economic statecraft — ultimately, the craft of strategically managing economic instruments. This logic applies to measures deployed externally as well as internally.

For the West, it means building domestic resilience at home and insulating itself from external influences. By minimizing domestic vulnerabilities, the West would strengthen its room for maneuver to influence the behavior of others. Stricter anti-money laundering regulations, robust foreign investment screening, and tighter export controls could bolster the West’s domestic resilience and thus complement sanctions. To be effective, all three instruments would require enhanced trans-Atlantic cooperation.

The United States and Europe should strengthen their defenses against money-laundering as a national security threat. The U.S. and U.K. financial systems — mainly via the state of Delaware, the British Virgin Islands and the Cayman Islands — are the main channels for the conduit of Russian illicit finance. According to some estimates, the Russian offshore holdings amounted to $950 billion at the end of 2019. A scandal recently erupted involving the Estonian branch of Danske Bank’s complicity in the laundering of $200 billion shows how Russian kleptocrats profit from the weaknesses of Western anti-money laundering regulation. The West’s system of enablers helps kleptocrats to move their illicit money into the financial system and conceal its origin.

Robust anti-money laundering regulation is not about changing Kremlin policy per se. It is about protecting the integrity of domestic institutions and altering the kleptocrats’ economic calculus. It is unsurprising that Russian kleptocrats fleeing high-level lawlessness in Russia itself prefer to stash their illicit funds in Western banks protected by the rule of law and an impartial judicial system. By strengthening due diligence at home, the United States and Europe can raise the costs for kleptocrats seeking to enjoy their ill-gotten gains abroad — leading a luxurious lifestyle and traveling to the West for the high-quality education and healthcare systems.

The greatest breach in the Western financial system, however, is a mechanism known as beneficial ownership which conceals true owners behind the layers of shell companies, thus enabling cross-border flows of corrupt proceeds. Creating beneficial ownership registries would make the financial transactions more transparent, while also helping combat sanctions evasion. Beneficial ownership registers would record the information about persons holding more than 25 percent of the shares in the company or controlling the company by other means and reveal the complex corporate structure, which is otherwise hidden behind shell companies. In April 2021 the Biden administration pushed ahead to create a beneficial ownership registry. As part of the Corporate Transparency Act, the Treasury’s Financial Crimes Enforcement Network will publish new regulations regarding mandatory beneficial ownership requirements. Any corporation will be subjected to reporting requirements, thus discouraging the use of shell companies. Earlier, the U.K. government committed to create registers of beneficial ownership, including in all British Overseas Territories, by the end of 2023. As part of the European Union’s Fifth Anti-Money Laundering Directive, all member states are required to set up central registers of beneficial ownership and make information public.

Given the interconnectedness of global markets, trans-Atlantic coordination on this front is crucial. Observing the Russian patterns of money laundering, European countries with weak financial oversight like Latvia and Cyprus are often used as the first stop. The cleaned-up funds are moved to major European financial centers like Germany and the United Kingdom and are subsequently transferred to U.S. jurisdiction. Although the launch of beneficial ownership registers has become a widespread idea, the discrepancy in the regulations across jurisdictions poses a threat of circumventions. In March 2020, Global Witness’ analysis established patchy progress on the implementation of the Fifth Anti-Money Laundering Directive: 17 out of 27 European Union member states did not introduce a publicly available register.

Another area where the West can strengthen its resilience is the robust screening of foreign direct investments. By acquiring stakes in strategically important sectors for the West such as energy and defense, Russian state-owned companies could increase their geo-economic leverage. For example, Gazprom owns a series of underground gas storage facilities in Germany and the Baltics, while Russia’s Rosatom is the only supplier of nuclear fuel to the Finnish and Hungarian power plants. In the defense sector, Russian Transmashholding sought to acquire Norway’s Bergen Engines, a subsidiary of Rolls-Royce, which could significantly improve Russia’s military capabilities. Norway cancelled the deal on grounds of national security.

Certain progress has been made in the United States and the European Union on this front. In 2018, the Committee on Foreign Investment in the United States passed the Foreign Investment Risk Review Modernization Act, which issued final regulations on how to address national security threats arising from foreign investments. The updated provisions call for closer scrutiny of foreign investments in critical technologies, infrastructure, and real estate transactions. In the European Union, the Commission set in place a new framework for screening foreign investments. The E.U.-wide coordination mechanism aims to safeguard European assets and protect collective security. Currently, only 18 of the 27 member states have in place national policies on how to screen investments from third countries in E.U. strategic sectors such as energy, space, and transport while safeguarding essential security interests (for the rest, the system of information-sharing and notification does not apply). On the trans-Atlantic level, the U.S.-E.U. Trade and Technology Council seeks to improve coordination of foreign investment screening and enhance information-sharing on inbound foreign investments. Although the launch of the Trade and Technology Council was primarily driven by the China threat, the coordination and synchronization of regulatory frameworks between the allies would also have repercussions for Russia.

Finally, tighter export controls could complement sanctions. The United States has already been resorting to export controls against Russia. In 2020, Washington expanded the scope of non-proliferation export controls on Russia, de facto denying the transfer of nuclear and aerospace technologies. After the poisoning and imprisonment of Alexey Navalny, the administration strengthened export and re-export of defense articles to Russia. In contrast, Brussels’ restrictions on dual-use and military technologies largely remain on the level of 2014.

Today export controls face new challenges due to shifts in the global technology landscape — emerging and disruptive technologies, stronger military-civilian fusion, and the human rights implications thereof. Due to highly globalized supply chains for advanced technology, building coalitions and coordinating international export control regimes will be essential. Unlike the Cold War era, the United States no longer enjoys an overwhelming technological dominance. Technological know-how is more diffused, making other pathways of acquiring new technologies possible. The discussions via the Trade and Technology Council have only begun, but both allies indicated an interest in aligning export control and investment screening practices.

Avoiding Misuse of Sanctions

The West should abstain from slapping on sanctions on Russia in situations where they cause collateral damage, have negligible impact, and are applied without trans-Atlantic coordination.

Sanctions should not be deployed when there are risks of unintended consequences. Certain Russian entities like Gazprom and Rosneft are simply “too big to sanction” and it would unleash collateral damage, hurting Western interests in the first place. The designation of Rusal is an example. In April 2018, the Office of Foreign Assets Control targeted Rusal, the world’s second-largest aluminium producer, owned by Russian billionaire Oleg Deripaska. The designation quickly triggered disruptions in the global supply chains and sent the price of aluminium up by 30 percent. By December, a hasty agreement was reached to lift sanctions after Deripaska conceded to reduce his ownership and relinquish control in the sanctioned entity. The designation unleashed collateral damage, while the lifting cast a shadow over the efficacy of the divestiture agreement with Deripaska. Instead, a more delicate and surgical approach is required. Targeting certain activities of systemic companies or sanctioning their subsidiaries with little international exposure is one way of mitigating collateral damage. For example, to avoid a ripple effect across the energy markets, Rosneft was subjected to sectoral sanctions banning certain financial activities, as opposed to full blocking sanctions. With the same goal of avoiding collateral damage, Rosneft’s Swiss subsidiary was targeted, leaving the core of the company untouched.

Extraterritorial sanctions, which target non-U.S. individuals and entities mainly through the dominance of the U.S. dollar, prompt particular concerns across the Atlantic. In the European Union, they are viewed as an unlawful application of U.S. authority abroad that contradicts domestic European law. U.S. extraterritorial sanctions have driven the European Union to reduce its reliance on dollar-based financial infrastructures and motivated the bloc to insulate itself from America’s “exorbitant privilege.” Brussels’ drive to bolster its financial sovereignty coincides with Russia’s drive to de-dollarize. Moscow was quick to offer collaboration on the Instrument in Support of Trade Exchanges, a European special-purpose vehicle established to facilitate non-dollar payments with Iran to allow European companies to continue trading with Iran while avoiding the far-reaching U.S. sanctions regime. Moscow has also been supporting E.U. efforts to switch to euro-denominated payments in the energy sector. Russia has already developed an alternative to the Society for Worldwide Interbank Financial Telecommunication (the largest international messaging system, through which many financial wires move) and Visa and Mastercard.

Alternatives to U.S. financial centrality like these are still in their infancy and unlikely to pose a risk in the short and medium term. In the long term, if left unchecked, digital currencies and alternative payment platforms could undermine the effectiveness of U.S. sanctions. It is unfeasible for Washington to prevent others from developing alternatives. However, avoiding uncoordinated unilateral sanctions, particularly on European allies, would help assuage the concerns that are accelerating their development.

Finally, the West should be prepared to lift sanctions if the target complies. The failure to provide sanctions relief could backfire on the West’s credibility and the ability to negotiate future concessions. If the West is not prepared to follow through on its promises, targets will have even fewer incentives to do so. The historical track record of sanctions lifting does not provide much hope for Moscow. The 1974 Jackson-Vanik amendment imposed against the Soviet Union for restrictions on Jewish emigration applied to Russia, years after the Soviet collapse. Upholding the commitment to sanctions relaxation would send a powerful signal to the target and contribute to regaining mutual trust. Ultimately, sender states need cooperation with the target to claim that sanctions are effective in changing behavior and not as a tool for punishment.

With the Biden administration’s renewed commitment to trans-Atlantic coordination, the United States and the European Union are making huge strides to align their economic, financial, and regulatory instruments of statecraft. The U.S.-initiated Summit for Democracy scheduled for December 2021 represents a pivotal opportunity to galvanize collective commitments for fighting against corruption and advancing more coordinated solutions.  The next meeting of the U.S.-E.U. Trade and Technology Council is scheduled for spring 2022, which will continue to deepen coordination on key trade, economic, and technology issues. It remains to be seen whether trans-Atlantic coordination will bear fruit, but it will bolster the West’s economic security and expand leeway to exert influence externally.

Dr. Maria Shagina is a visiting fellow at the Finnish Institute of International Affairs and a postdoctoral fellow at the Center for Eastern European Studies, University of Zurich.

Photo courtesy European Parliament, CC-BY-4.0: © European Union 2021 – Source: EP

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