Definition
Secondary sanctions in Anti-Money Laundering (AML) refer to economic and financial restrictions imposed by a sanctioning country on third-party individuals, companies, or entities that engage in transactions or business with a sanctioned person, entity, or country. Unlike primary sanctions which directly target individuals or entities within the sanctioning country’s jurisdiction, secondary sanctions extend the reach of AML enforcement by penalizing foreign or non-national actors who continue dealings with sanctioned parties. These sanctions restrict access to financial markets, particularly by limiting access to key financial systems like the U.S. dollar and U.S.-based financial institutions, to dissuade broader global economic interaction with sanctioned entities.
Purpose and Regulatory Basis
The purpose of secondary sanctions in AML is to reinforce the effectiveness of primary sanctions by preventing circumvention through third parties, thereby enhancing economic leverage and political influence for the sanctioning state. They serve as a deterrent against indirect support or transactions with sanctioned regimes, which may be involved in money laundering, terrorist financing, or illegal activities.
Key regulatory frameworks underpinning secondary sanctions include:
- The USA PATRIOT Act and mandates enforced by the Office of Foreign Assets Control (OFAC) in the United States.
- Financial Action Task Force (FATF) recommendations, which promote robust AML/CFT regimes globally.
- European Union’s Anti-Money Laundering Directives (AMLD) and sanctions regulations.
These regulations highlight the critical function of secondary sanctions in safeguarding the integrity of the international financial system by preventing channels that could facilitate illicit financial flows.
When and How It Applies
Secondary sanctions apply when non-national third parties engage in activities prohibited under primary sanctions regimes. Real-world examples include:
- Non-U.S. companies trading with Iran’s petroleum sector despite U.S. sanctions.
- Foreign entities engaging with North Korean financial networks supporting weapons programs.
- Non-U.S. firms dealing with Russian military or intelligence sectors targeted by U.S. sanctions under CAATSA.
Triggers for secondary sanctions typically include business dealings, financial transactions, or providing services to sanctioned parties. The sanctioning country enforces compliance by limiting the offending third parties’ access to its financial system, markets, or dollar clearing systems, creating a significant financial incentive to avoid sanctioned dealings.
Types or Variants
Secondary sanctions can be categorized based on their scope and enforcement mechanism:
- Sectoral Secondary Sanctions: Target specific industry sectors such as energy, finance, or defense to prevent indirect support of sanctioned regimes.
- Entity or Individual-Based Secondary Sanctions: Target third parties who provide material support or engage in dealings with designated sanctioned entities or individuals.
- Financial System Access Restrictions: Denial or suspension of correspondent banking and access to U.S. financial markets.
For example, the U.S. FinCEN action against China’s Bank of Dandong effectively cut its access to correspondent banking in the U.S. due to its illicit North Korean activities, illustrating an enforcement of secondary sanctions.
Procedures and Implementation
Financial institutions implement secondary sanctions compliance through:
- Continuous screening against primary and secondary sanctions lists, including ownership linkages (10% or greater control) with sanctioned entities.
- Enhanced due diligence on customers, counterparties, and ownership structures to uncover indirect exposures.
- Use of sanctions screening tools updated with real-time data from OFAC, UN, EU, and other sanction lists.
- Procedures to block or reject transactions connected to sanctioned parties and reporting suspicious activities to regulators.
Institutions must establish robust controls including training, transaction monitoring, and audit trails to demonstrate compliance and respond effectively to evolving sanctions landscapes.
Impact on Customers/Clients
Customers and clients subject to or linked with secondary sanctions may face restrictions including:
- Denial of banking services, account closures, or transaction rejections.
- Heightened scrutiny and enhanced due diligence requirements.
- Potential freezing of assets and legal consequences.
From the client perspective, secondary sanctions pose reputational and operational risks and limit access to international financial systems, especially when dealing with entities from sanctioned jurisdictions or with significant ownership links to sanctioned persons.
Duration, Review, and Resolution
Secondary sanctions are imposed as long as the underlying primary sanctions remain in effect. Review processes include:
- Periodic reassessment of sanctioned lists by authorities such as OFAC.
- Re-evaluations during institution compliance audits and regulatory inspections.
- Potential resolution occurs when sanctioned entities are removed from designation lists or general licenses that allow limited business activities are granted.
Institutions have ongoing obligations to monitor updates and adjust their compliance programs accordingly to avoid violations over time.
Reporting and Compliance Duties
Financial institutions have several responsibilities under AML frameworks related to secondary sanctions:
- Documenting all transactions screened and decisions made regarding sanctioned exposure.
- Filing Suspicious Activity Reports (SARs) if secondary sanctions risks are identified.
- Maintaining comprehensive records to demonstrate adherence to regulations.
- Facing legal penalties, fines, or exclusion from financial markets in case of violation.
Regular compliance audits and communication with regulatory bodies are critical to managing secondary sanctions risks efficiently.
Related AML Terms
Secondary sanctions closely relate to various AML concepts including:
- Primary sanctions: Direct sanctions applied within the sanctioning country’s jurisdiction.
- Enhanced Due Diligence (EDD): Higher scrutiny applied to higher-risk customers or transactions.
- Sanctions screening: Automated or manual process of checking parties against sanctions lists.
- Correspondent banking: Key channel monitored under sanctions regimes to prevent illicit cross-border flows involving third parties.
- Beneficial ownership: Identifying ultimate owners to detect indirect sanctions exposure.
Alignment among these AML components is essential to mitigate risks stemming from secondary sanctions.
Challenges and Best Practices
Common challenges in secondary sanctions compliance include:
- Complexity in tracking ownership and control in global corporate structures.
- Conflicts between sanctions imposed by different jurisdictions, e.g., US secondary sanctions versus EU blocking statutes.
- Rapidly evolving geopolitical sanctions landscapes causing compliance uncertainty.
Best practices to address these challenges involve: - Investing in advanced screening technologies that provide context and ownership details.
- Training staff to understand nuances in sanctions laws and risk-based approach application.
- Engaging in regular risk assessments and scenario analysis.
- Coordinating compliance efforts across multiple jurisdictions to manage conflicting regulations.
Recent Developments
Recent trends in secondary sanctions enforcement include:
- Increased use by the U.S. to enforce foreign policy and national security goals.
- Expansion of sanctions regimes by other countries like the UK broadening their own secondary sanctions authorities.
- Advances in technology enabling more accurate and real-time sanctions screening solutions with ownership linkage analysis.
- Growing focus on mitigating secondary sanctions risks among non-U.S. financial institutions due to extraterritorial reach of U.S. sanctions.
These developments underscore the continuing prominence of secondary sanctions in AML compliance around the world.
Secondary sanctions serve as a vital AML tool that extends the reach of sanctions enforcement beyond national borders by targeting third parties that conduct transactions with sanctioned entities. Their purpose is to strengthen the effectiveness of primary sanctions through economic leverage and geopolitical influence, chiefly by restricting global access to the sanctioning country’s financial systems. For financial institutions and compliance officers, understanding secondary sanctions means implementing rigorous due diligence, continuous screening, and maintaining up-to-date knowledge of evolving regulatory landscapes. Adhering to these sanctions protects the financial system’s integrity and helps combat illicit activities such as money laundering and terrorist financing.