The effect of sanctions on trade finance instruments regulated by ICC rules - Trade Treasury Payments

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The effect of sanctions on trade finance instruments regulated by ICC rules

What are sanctions?

Sanctions are economic penalties imposed by the United Nations, the EU Council or individual countries on a targeted nation to influence its political or military behaviour without resorting to armed conflict. They restrict or ban certain types of trade, services, or financial transactions to compel changes such as curbing human rights abuses, stopping illegal military actions, or preventing nuclear proliferation. 

Common forms include embargoes, export restrictions targeting critical industries like energy and technology, and import bans designed to reduce the targeted country’s export revenue. Sanctions remain a key diplomatic tool, offering an alternative to military action by exerting economic pressure to influence international behaviour. Thus, sanctions significantly impact trade finance and all parties involved in trade transactions by introducing complex compliance challenges and operational risks.

What are the consequences of failing to comply with sanctions laws and regulations?

Financial institutions such as banks, insurers, and freight companies must navigate evolving and often divergent sanctions regimes imposed by different jurisdictions, complicating the processing of trade finance in international trade. The sanctions laws and regulations to which a bank is engaged when issuing a trade finance-related instrument may include those of its country of operation, its country of incorporation or registration, the country of the currency or the place of payment, and any other jurisdiction whose laws govern the transaction. Where they are determined to apply to the instrument, sanctions laws and regulations are generally considered mandatory and thus may override the ICC rules applicable to that instrument and, more generally, the contractual terms of the instrument.

Financial institutions that fail to comply with sanctions laws and regulations in international trade face severe consequences. These can include substantial financial penalties and legal repercussions, as regulators often impose fines reaching millions or even billions of dollars for violations. Additionally, institutions may suffer reputational damage, resulting in decreased trust from clients and partners, leading to reduced business opportunities. 

Non-compliance with sanctions regulations can also trigger increased scrutiny from regulators, necessitating more frequent audits and compliance checks, thus straining resources and operational efficiency. Furthermore, the risk of losing banking licenses or facing criminal charges for key individuals can disrupt business operations and limit access to critical markets. Ultimately, the failure to adhere to sanctions risks financial loss and can jeopardise the foundation of a financial institution’s integrity and operational viability in the global market.

How have sanctions laws and regulations affected trade finance instruments in recent years?

The enforceability of sanctions is a question to be decided by courts, national regulators, or administrative agencies; it is not an issue that rules of banking practice (such as ICC rules) can address. While comprehensive in many aspects of trade finance, the ICC rules do not provide guidance on how sanctions should be interpreted or their impact on the trade finance-related instrument in which they are incorporated.

The complexity of complying with the sanctions laws and regulations often leads banks to adopt a risk-averse stance. Some banks, however, take a proactive approach by implementing an internal sanctions-related policy that goes beyond what is required under the laws and regulations applicable to that bank. This proactive stance aims to better manage risks and protect their reputation, even if it means rejecting transactions that comply with trade finance rules. 

In some cases, banks add a clause in a trade finance-related instrument stating the bank’s commitment to respect such sanctions law or regulation applicable to it by law. There is no standard wording for these clauses, and they vary considerably in their scope. Banks usually include sanctions clauses in trade finance instruments to manage the legal risks arising from the complex and sometimes conflicting sanctions regimes applicable in the multiple jurisdictions where they operate. These clauses explicitly state the bank’s intention to comply with applicable sanctions laws and regulations, helping to clarify its obligations and provide a secure shield against potential liability when sanctions restrict its ability to perform under instruments like letters of credit or demand guarantees.

However, it has been noticed in several trade finance instruments, such as letters of credit, demand guarantees, or counter-guarantees, that the issuing bank sometimes includes sanctions clauses that go beyond the statutory or regulatory requirements applicable to that bank. When sanctions clauses that refer to the internal policy requirements of issuing banks are included in a letter of credit or counter-guarantee, the nominated bank (whether acting as a confirming bank or as a guarantor) may find itself in a challenging situation. 

This is because the nominated bank might not be aware of the internal sanctions policy that the issuing bank chooses to apply. The ICC Banking Commission advises that banks should avoid reference to bank policy and procedures related to complying with sanctions laws and regulations in trade finance instruments at all times. This is because using sanction clauses that refer to an issuing bank’s internal policy related to sanctions would raise concerns about the irrevocable and independent nature of the letter of credit, demand guarantee, or counter-guarantee. It also brings into question the certainty of payment and the intent of the issuing bank to fulfil its obligations. 

ICC guidance on the use of sanction clauses in trade finance instruments

With the increasing use of sanction clauses by various banks, the ICC issued a guidance paper on the use of sanctions clauses in trade finance-related instruments subject to ICC rules in 2014. The ICC recommends that banks avoid issuing or accepting trade finance instruments that include sanctions clauses that impose restrictions beyond, or conflict with, the applicable statutory or regulatory requirements. This is because broader sanctions clauses would undermine the principle of independence in letters of credit and demand guarantees, compromising the documentary nature of these instruments and creating uncertainty.

In 2020, the ICC issued an addendum to their paper on the use of sanctions clauses in trade finance-related instruments subject to ICC rules issued in 2014. The addendum indicated that ICC confirms its guidance that sanctions clauses should not be used generally. However, if a bank, after consultation with its customer and counterparty in the trade finance transaction, considers that a sanctions clause is to be used, ICC strongly recommends that the clause should be drafted in clear terms and used restrictively, to limit the reference only to mandatory law applicable to the bank, as according to the following sample clause:

 “[notwithstanding anything to the contrary in the applicable ICC Rules or in this undertaking,] We disclaim liability for delay, non-return of documents, non-payment, or other action or inaction compelled by restrictive measures, counter-measures or sanctions laws or regulations mandatorily applicable to us or to [our correspondent banks in] the relevant transaction.”

The ICC Banking Commission indicated that this approach helps banks’ balance compliance with sanctions requirements while maintaining the effectiveness and reliability of trade finance instruments.

Summary 

The imposition of sanctions significantly complicates the use and effectiveness of trade finance instruments regulated by ICC rules, such as documentary and standby letters of credit and demand guarantees. Banks face challenges in balancing adherence to ICC rules with mandatory sanctions compliance, leading to risk-averse behaviours such as transaction rejections and de-risking, which can restrict global trade, especially in emerging markets. 

The ICC has consistently advised caution in the use of sanctions clauses, recommending that they should not extend beyond applicable statutory requirements and urging banks to adopt clear, narrowly drafted clauses when necessary to reduce uncertainty. This guidance aims to preserve the functionality and reliability of trade finance instruments.