Sanctions: The Good, The Bad and The Ugly

Sanctions have popped up a lot in the news over recent years, primarily driven by Russian leader Vladimir Putin's decision to invade the sovereign nation of Ukraine. Most people will have heard of sanctions before this but the recent attention has given people outside the industry a much greater insight into their purpose. Everyone working in finance should have completed some form of mandatory training telling you that North Korea is bad etc but there is far more to sanctions than simply blocking payments. They can have huge consequences, cause significant collateral damage and, like anything that gives power to the beholder, they can also be abused. But sanctions in some form date back much further than Russia.

Long before banks were screening payments against lists of sanctioned entities, there were other ways of making sure someone wasn't welcome in town. This may not be an article about the beloved spaghetti western (sorry!) but in the American Wild West, being excluded from the local economy could make life pretty difficult. If businesses refused to trade with you, banks wouldn't deal with you and nobody wanted to do business with you, your options became fairly limited.

Going back even further, governments have been controlling access to valuable resources and trade for thousands of years. Ancient Egypt exercised state control over commodities and industries including gold, mining and other valuable resources. Later, the Ptolemaic state operated formal monopolies over industries including oil, textiles, salt, timber and mining. These weren't sanctions as we would understand them today, but they demonstrated how controlling of access to the economy has been a powerful tool of government for a very long time.

The ancient Greeks give us something much closer to the sanctions we recognise today. Around 432 BC, Athens introduced the Megarian Decree, excluding merchants from the neighbouring city of Megara from Athenian markets and ports throughout the Delian League. In simple terms, Athens was attempting to punish and pressure another state by restricting its ability to trade. It is often described as an early example of an economic embargo or sanctions measure.

The Athenians didn't have OFSI, sanctions screening systems or compliance analysts sitting in queues investigating potential matches. But the basic principle was already familiar.

Fast forward to 1919 and sanctions became part of something much closer to the international system we recognise today. The Covenant of the newly created League of Nations included sanctions directly. Article 16 stated that a country going to war in breach of the Covenant could face the severance of trade and financial relations with other member states. Sanctions were no longer simply an individual country's tool for putting pressure on another state. They had become part of an attempt to create an international mechanism for responding to aggression.

We then get one of the more famous early examples of sanctions failing to achieve their intended objective.

In 1935, Mussolini's Italy invaded Ethiopia. The League of Nations responded by imposing economic sanctions on Italy, restricting trade and financial relations in an attempt to pressure Mussolini to stop the invasion. The sanctions didn't work. They were incomplete, including the fact that oil wasn't initially included, and Italy ultimately conquered Ethiopia.

It's a useful early lesson in sanctions. Imposing economic pressure on someone and actually changing their behaviour are two very different things.

I won't go into the ins and outs of how sanctions screening works or your job from an analyst perspective, this is purely some background information and my opinions on the pros and cons of sanctions which will hopefully help you stand out in coffee conversations around the office

THE GOOD

So why do we have sanctions?

Sanctions are measures used by governments or international organisations to restrict or prohibit economic, financial or other activities with particular countries, organisations or individuals, usually to achieve political, foreign policy or security objectives.

Fairly straightforward definition for a change. Basically, sanctions can be used to try and change the behaviour of an individual, a government, a business or another group.

Using Russia as an example. Following the invasion of Ukraine, Western governments imposed extensive sanctions on Russian individuals, government officials, banks, businesses and other entities. The objective wasn't simply to annoy Russia. The idea was to impose significant economic costs, restrict access to finance and technology, limit the resources available to the Russian state and make continuing the war more difficult. There was also another target closer to home for the sanctions: the Russian oligarchs. Take away the yachts, freeze the money and restrict access to assets, and perhaps those with influence over the regime might think twice about supporting its actions and push for a change.

There are many other examples where sanctions seem much more obviously to be a force for good. Protecting people and attempting to prevent serious harm.

Sanctions placed on terrorist organisations aim to make it much harder for those organisations and their members to access the financial system and fund their activities. Terrorist organisations need food, weapons, accommodation, transportation, communications and bribes. All of that requires money. If a terrorist organisation or its members are listed, sanctions can make moving and accessing those funds significantly more difficult. Financial institutions can block or restrict transactions involving sanctioned parties and escalate potential matches for further investigation. Likewise, sanctions can target individuals and organisations involved in supplying weapons, materials or other resources to groups or regimes considered to pose a serious threat.

The same applies to organised crime.

The drug cartels of Central and South America, the Mafia in Europe, the Yakuza in Japan... these aren't merely the baddies of Hollywood. They are sophisticated organisations involved in fraud, extortion, kidnapping, corruption, drug trafficking, assassinations and many more delightful activities. But they have one thing in common. They're in it for the money. So what's one of the best ways to disrupt them? Stop the money.

Not that I've tried, but I can't just send the Mafia a bank transfer to buy a stolen car and have it delivered in 2–3 days. If a sanctioned organisation or individual was involved, the payment would hopefully be stopped by the financial institutions involved. I'd have to go to the murky underworld and pay cash or use some other method of moving the money. Not impossible, obviously. Criminals have been finding ways around financial controls for centuries. But restrictions make it harder, more expensive and potentially more risky to operate. And if you can make criminal activity harder to carry out or less profitable, that's surely a good thing.

All of this seems fairly obvious. Sanctions can serve a purpose. They can discourage unwanted behaviour, protect people and make it more difficult for individuals and organisations involved in illicit activity to access the financial system. They can be bypassed through cash, commodities, crypto, intermediaries and other methods, but surely any reduction in the ability of criminals to move and use money is a win?

Of course, it's not that simple. For someone to win, someone has to lose.

THE BAD

So sanctions sound pretty good so far.

Stop the bad guys getting their money, make it harder for terrorist organisations to operate, punish governments for doing things we don't like. What's not to like?

The first problem is that sanctions only work if you can actually stop people getting around them.

Take Russia again. When sanctions were introduced following the invasion of Ukraine, it would be fair to assume that some of the people being targeted had already spent quite a bit of time thinking about what might happen if the West came after their money. Yachts disappeared from European ports. Valuable artwork and other assets were moved. Money could be transferred through different entities or jurisdictions. Ownership structures could be made more complicated.

And Russia wasn't suddenly left with nowhere to sell its biggest exports either. Russian oil continued to find its way onto global markets through alternative routes, buyers and shipping arrangements outside the main Western sanctions regime. An entire ecosystem developed around moving goods while avoiding or navigating the restrictions. This doesn't mean sanctions had no impact. They clearly did but the people you're trying to sanction are not necessarily going to sit there and politely accept it. And unless there is widespread international collaboration to enforce the restrictions, there will always be opportunities to find ways around them.

There is another problem. The economic pain doesn't necessarily stop with the country you're trying to punish. Russia and Ukraine were major suppliers of commodities to global markets, including energy, metals and other raw materials. When those supplies were disrupted, the consequences were felt well beyond Russia's borders.

The UK is a good example. The UK wasn't particularly dependent on Russia for its overall trade, but it was exposed to the global price shock. Russia was the UK's largest supplier of refined oil in 2021, accounting for around 24% of UK imports of refined oil, and it also supplied crude oil and gas. The UK moved quickly to find alternative sources and phase out Russian energy imports but this wasn't as simple as replacing Russian supplies with another supplier. Energy prices surged. Wholesale gas and electricity prices more than doubled compared with their levels before the invasion, peaking at around three times those levels in August 2022. As a net energy importer, the UK was particularly exposed to the resulting increase in import costs.

And anyone living in Britain at the time doesn't need me to explain what happened next. Energy bills went up. Petrol became more expensive. Businesses faced higher energy costs. And those higher costs fed into the price of pretty much everything else. Construction was another example. Materials and energy became significantly more expensive, with rising costs for products including concrete, bricks, plaster, sand and gravel. Construction product prices were rising at record rates, while new orders fell sharply. So while the intention was to impose economic pain on Russia, some of that pain inevitably travelled elsewhere. And this impact wasn’t exclusive to the UK, it was felt across Europe. So did we hurt ourselves more than we hurt Russia?

The UK economy did not collapse, and sanctions were only one part of a much wider economic shock caused by the invasion, disrupted global supply chains and soaring energy prices. But that's exactly the point. When you use economic pressure as a weapon in an interconnected global economy, you don't get to choose exactly where all of the consequences land. Whilst I'm sure the sanctions have cost Putin and his oligarchs billions, many of them are still billionaires enjoying a lavish lifestyle. However, the collateral damage on average, innocent Russians as well as working Brits has been significant.

Venezuela gives us another, much more uncomfortable example of the potential collateral damage.

The country has faced extensive sanctions for years, aimed at putting pressure on the Venezuelan government and individuals associated with it. But Venezuela is not simply a government. It is a country full of ordinary people, businesses and families who still need to buy food, pay bills, import goods and access financial services. And when you make it harder for a country's government and businesses to access international finance and trade, the effects don't necessarily stay neatly contained at the top.

Venezuela's economic problems are the result of a huge number of factors, including years of economic mismanagement, falling oil production, political instability and other internal problems. It would be far too simplistic to blame sanctions for everything that happened. But sanctions can add another layer of difficulty. If you're a Venezuelan business trying to import goods, a charity trying to move money or an ordinary person trying to access financial services, you don't necessarily care which government is responsible for the problem. You just know that something that used to be possible has suddenly become much harder.

The challenge is working out how much collateral damage is acceptable when the objective is to change the behaviour of a government or organisation. Because if sanctions are supposed to protect people, but the people you're trying to protect end up suffering too, you've got a rather awkward problem on your hands.

North Korea is a good example of this.

Sanctions have been imposed on North Korea for decades in an attempt to restrict its access to international finance and pressure the regime over issues including its nuclear and weapons programmes. Yet the regime is still there. This doesn't mean the sanctions have achieved nothing. They may have restricted access to finance, increased costs and made certain activities significantly more difficult. But you have to ask, if sanctions don't change the behaviour they're designed to change, how long can we continue using them before we have to admit that the tool isn't achieving its objective? Is it worth the collateral damage, in this case the horrendous conditions that many North Koreans live in, when there is no significant change being made as a result?

And this is perhaps the biggest problem with sanctions. They can be powerful, but they aren't a magic wand. Countries can find new trading partners. Criminals can use intermediaries. Money can move through alternative financial systems. Goods can be sold elsewhere. Assets can be hidden. And businesses can adapt. The more valuable the activity, the greater the incentive to find a way around the restrictions.

Sanctions can be a well-intended and powerful tool, but they can come with considerable collateral damage.

So sanctions are good, but they are also bad.And guess what, there is an ugly side too.

THE UGLY

Sanctions aren't just a financial crime control.

A government can decide that an individual, company, organisation or even an entire country should have its access to the financial system restricted. Banks are often required to enforce those decisions, sometimes across borders and sometimes against customers who have never done anything wrong themselves. And whenever someone has that much power, it's probably worth asking a few awkward questions.

Let's go back to Russia. The objective of sanctions was to put pressure on Russia and make the invasion of Ukraine more difficult to fund. But at the same time, the world still needed energy so Russian oil didn't simply disappear. It continued to find buyers, often through countries and companies that weren't part of the Western sanctions coalition. Oil could be transported through different routes, sold to different buyers and sometimes refined and re-sold before reaching its final destination.

This creates an obvious contradiction. We want to punish Russia, but we also still want some of the stuff Russia sells. We are restricting the financial activity of Russia to try and make the war effort harder to maintain but at the same time sending them money to pay for oil which ultimately provides Russia with revenue.

Also, sanctions aren't handed down by some global financial crime referee. Different governments and international organisations decide who they want to target, why they want to target them and what restrictions should apply. One country's sanctioned individual isn't necessarily another country's sanctioned individual, and one country's terrorist organisation can be another country's freedom fighter.

That doesn't necessarily mean the sanctions are wrong but it does mean we should recognise what they actually are. Sanctions are political decisions implemented through economic and financial controls. And political decisions are, by definition, influenced by politics.

This becomes particularly uncomfortable when sanctions are used as a tool of political leverage. A government with significant economic influence can use access to its financial system, markets or currency to put pressure on another country, company or individual.

Which raises a fairly simple question. At what point does legitimate economic pressure become political power being used for purposes beyond the original objective?

I'm not suggesting that every sanction is politically motivated or abused. Many clearly have legitimate and important objectives. But when you've created a tool capable of freezing billions of pounds worth of assets and effectively cutting people and businesses off from parts of the global financial system, it's probably worth asking who is watching the people responsible.

And then there is the United States.

The US dollar is the world's dominant reserve and trading currency, and the US financial system sits at the centre of an enormous amount of global commerce. That gives the US an extraordinary amount of influence over international finance. US sanctions can therefore have consequences far beyond the borders of the United States. A transaction might involve two companies that aren't American, in countries that aren't the US, dealing with goods that never enter America. But if that transaction touches the US financial system or creates exposure to US sanctions, suddenly American rules can become very important.

The power of the dollar and the importance of access to the US financial system creates this bottleneck. Whilst most countries have their own sanctions lists that banks must follow, the reach of US sanctions means that many international banks and businesses also have to consider US sanctions when conducting global business.

And that is an extraordinary amount of economic power for one country to possess. And with great power comes great responsibility (just to bring it back to Hollywood)

If a government can designate an individual or organisation, freeze their assets and restrict their ability to access the global financial system, what safeguards should exist around that power? Who will guard the guards? How do we stop any country with this level of economic power from using sanctions for purposes beyond their original objective?

There needs to be a legitimate reason, evidence, a process for challenging decisions. And, where appropriate, there needs to be a way of getting off the list.Being sanctioned isn't exactly a minor inconvenience. For an individual, it can mean frozen assets, restricted travel or losing access to financial services. For a business, it can mean losing customers, suppliers, banking relationships and entire markets.

This is where financial institutions have an interesting role. We don't create sanctions and we don't decide who gets put on a sanctions list but we are often the ones who have to enforce the decision. That puts financial crime professionals in a slightly unusual position as we are effectively sitting between government policy and the customer. And sometimes doing our job properly means telling a completely innocent customer that we can't do something because someone, somewhere, has decided that a particular person, country or organisation is no longer welcome in the financial system.

And perhaps the most controversial part of all; One man's terrorist is another man's freedom fighter

History is full of groups that have been described as terrorists by one government and freedom fighters by another. The label depends on who is doing the describing and for sanctions it depends on who owns and controls the list. Sanctions aren't an objective measurement of good and evil, they are a decision made by a government or international organisation about who it considers unacceptable and what it is prepared to do about it. That doesn't mean sanctions are bad just that we shouldn't pretend they are completely neutral either. And perhaps that's the biggest lesson from sanctions.

The Good: they can protect people, disrupt criminal activity and put pressure on governments and organisations behaving in ways the international community considers unacceptable.

The Bad: they can cause false positives, disrupt legitimate business, create economic damage and hurt people who had nothing to do with the behaviour being punished.

The Ugly: they give governments enormous economic power.

And like any form of power, the question isn't just whether it can be used for good. It's who gets to use it, why they use it and who gets caught in the middle, and who could potentially abuse it.

For anyone working in financial crime, that's worth remembering. The next time you're sitting in a queue investigating a sanctions alert, you're not simply checking a name against a list. You're sitting at the end of a chain that starts with international politics and ends with a decision that could determine whether someone's money moves or doesn't.

That's quite a lot of responsibility for a Tuesday afternoon.