Sanctions and SWIFT have recently made headlines worldwide. We’ll discuss what these terms really mean and why they’re important.
Russia’s invasion of Ukraine has triggered the West to announce widespread economic and other sanctions against Russia. On March 12, a number of important Russian banks are also set to be cut off from accessing the SWIFT network.
But what are sanctions and SWIFT, really? And what do these measures mean? Perhaps you’ve never given much thought to what actually happens behind the scenes when money is transfered anywhere around the globe.
The actions being taken by world governments and major economies are unprecedented and significant. Even Switzerland is breaking with its long tradition of neutrality and has announced it will join the EU in imposing sanctions against Russia.
We thought it might be helpful to explain sanctions and SWIFT in more detail. We’ll cover the basics here, so we all understand a bit more about what exactly is going on.
What are sanctions?
Economic sanctions are a way to financially isolate a target. Countries frequently use them as a measure to combat money laundering and other illegal activity. This is because sanctions can prevent known criminals and terrorists from conducting financial transactions or being able to wire money offshore.
Increasingly, countries are also using sanctions in place of military force as an instrument for foreign policy. Especially to apply pressure to countries that threaten peace or don’t cooperate with international law.
Sanctions range from very selective to comprehensive:
- Targeted – sanctions imposed on specific persons or entities, such as key political leaders in a country. These sanctions often include freezing of assets and travel bans.
- Industry – sanctions aimed at key sectors or industries. Prohibit specific subsets of financial dealings within those named sectors. For example, energy or weapons.
- Comprehensive – generally include broad-based trade restriction, and prevent commercial activity with an entire a country.
Once in place, sanctions essentially make it illegal to allow money to flow to/or from sanctioned people, entities, industries or countries.
In the case of Russia, its actions in Ukraine have resulted in the worst-ever sanctions against the country. These range from sanctions against named individuals, to Russian-owned entities and financial institutions. There are also restrictions on trade in certain goods in services, including goods for the technology, military, energy and aviation sectors. As well as restrictions on access to financial and capital markets.
Who decides who will be sanctioned?
Most jurisdictions impose sanctions regimes, particularly to comply with sanctions imposed by powerful intergovernmental parties such as the United Nations Security Council and the European Union. Countries that are member states of these bodies will be bound by their decisions. Some countries also have standalone legislation to impose their own sanctions, independently of the decisions of any international governing body.
Regimes are controlled and implemented at the country-level by governmental departments, such as the Department of Foreign Affairs and Trade (DFAT) in Australia and the U.S. Treasury’s Office of Foreign Assets Control (OFAC).
Who must comply with sanction orders?
Sanctions must be complied with within the territory of the country that imposed the sanctions. They typically apply to banks, financial institutions and in fact, any legal entities or individual citizens and residents. They can also attach to branches located overseas or when an individual is visiting another country.
Anyone contemplating doing business with a sanctions target must carefully review sanctions requirements. A violation of sanction regulations is a serious offence, and there are large monetary fines for non-compliance. There are also potentially significant PR downsides as well as the possibility of individual liability and inprisonment.
For these reasons, banks, financial institutions and businesses are typically very hesitant to engage with, or process transactions for, the subjects of sanctions targets.
What is SWIFT?
The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is a vast messaging network that links the world’s banks. It doesn’t move any money itself. Think of it as secure direct messaging (DM’s) for banks and financial institutions, allowing them to transmit transfer requests to each other and securely send/receieve information.
It’s important to know that when money is transferred internationally, it doesn’t always go from Bank A directly to Bank B. Often it passes through multiple banks in a chain like manner, especially if it involves a foreign currency.
SWIFT routes messages with instructions instantly and securely from one bank to another. It allows banks to know details about the originator and the recipient/beneficiary of the funds and in which country and account the money should ultimately end up.
SWIFT is to payment systems, what Facebook is to social media. SWIFT handles an average of 42 million messages every single day across more than 200 territories and 11,000 financial institutions. Until now, the only countries that had been cut off from it were Iran and North Korea.
What does blocking someone from SWIFT do?
Essentially, what this means is that major Russian banks are now largely being cut off from efficiently accessing international markets, harming their ability to operate globally. There are workarounds – a bank could use other messaging systems, such as email. But the transactions will be slower, less secure and there are no gaurantees that banks in other countries will be receptive to using alternate systems.
Part of the considerations when removing a country from SWIFT is the unintended consequences of cutting off these financial channels. For example, the EU currently relies on Russian imports for 40% of its gas consumption. Another issue is Western banks’ exposure to Russia – money owed that would become difficult to collect without the SWIFT network.
Are there alternatives to SWIFT?
An inevitability and potential risk of all this, is that a country cut off from SWIFT and the global financial network will look to other systems it can use to complete transactions and fulfil its financial and economic requirements.
One potential alternative that is being discussed among commentators is the possibility of the DeFi network and the use of Bitcoin and other cryptocurrencies. Russia is also known to be developing its own payments system, called SPFS. Cutting Russia off from SWIFT will no doubt accelerate this. Similarly, China has its own version of a payment system called CIPS.
One of the main arguments for not turning the SWIFT tap ‘off’ on a country is that fostering the development of these alternatives could ultimately end up being damaging in the long run. By undermining Western power and the diplomatic leverage that sanctions and the SWIFT network offer.
KYC: a critical step in the process
Sanctions are an effective method to frustrate the efforts of their intended targets. Despite this, there will always be complexities in their implementation and some transactions that slip through the cracks.
It’s inevitable that bad actors will continue trying to use complex techniques to attempt to circumvent or evade sanctions detection. Examples of such methods include the use of trusts, shell companies and nominee shareholders and/or addresses.
Know Your Customer (KYC) and client onboarding process at financial institutions play a key role in running sanction checks and detecting matches. These processes have important functions in helping to detect and prevent sanctions avoidance. In light of recent world events, AML/KYC processes and sanctions compliance are set to become increasingly important issues in future.
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