This article examines some key considerations for market participants.
April 2018 has seen highly volatile commodity prices as a result of US sanctions aimed at Russia. The biggest effect was on the price of aluminium, which rose almost 30% in two weeks. The price has since fallen back towards levels seen before the sanctions were announced, due to an extension of time for compliance that was granted by the US authorities. Nonetheless, the sanctions give rise to significant legal risks for banks and commodities trading houses, which will need to be managed. Contractual arrangements will require scrutiny, and counterparty due diligence will need to be undertaken with utmost care. The consequences of breaching sanctions are severe, so the stakes in relation to compliance are high.
Under legislation passed in 2017 - the “Countering America’s Adversaries Through Sanctions Act” - the United States government has recently introduced sanctions against Russia that have very broad scope and potential impacts. Those sanctions were announced on 06 April 2018 with immediate effect. US citizens are banned from conducting business with 24 Russian individuals and 14 Russian companies.
Moreover, and importantly, the sanctions extend to non-US citizens who “knowingly facilitate significant transactions for or on behalf of [the sanctioned individuals or entities]”. This provision applies to secondary trading, clearing and settlement of securities on global markets, as well as a wide variety of financing arrangements. It means that banks and commodities houses conducting transactions in US dollars with those connected to the sanctioned entities may potentially be in breach. Considering the role played by Russia in global commodities markets, the implications for market participants are likely to be complex.
One of the sanctioned individuals is Oleg Deripaska, the owner of Rusal, the second largest producer of aluminium in the world, which itself is one of the sanctioned entities. Following the 6 April announcement the price of aluminium traded on the London Metals Exchange (LME) rose by over 30% due to concerns about the impact of the sanctions on trade and supply.
Possibly as the result of diplomatic efforts, on 23 April 2018 the US Treasury Department announced that it was allowing a period of six months for the wind down of operations, contracts and other dealings with Rusal. The aluminium price has since fallen back most of the way towards its pre-sanctions level (as at 30 April 2018). There have also been suggestions that sanctions against Rusal could be lifted if Mr Deripaska were to divest his stake, which may allow for orderly market conditions to resume.
These developments do not, however, mark the end of the road for the legal issues presented by the sanctions. We discuss below some key considerations for market participants in connection with this issue.
Context: the implications for breaching sanctions
Lessons can be learned, and warnings taken, from the actions of US law enforcement against a number of major banks in respect of US sanctions against Iran. The fines levied were substantial, and were accompanied in some cases by deferred prosecution agreements which provide for repercussions if failings are repeated. Sanctions compliance plainly needs to be taken seriously, as the result of non-compliance can be draconian.
Aluminium: the legal minefield ahead
LME participants are likely to remain concerned at the prospect of receiving Rusal metal when trading on the LME. That is because the LME operates as a physical exchange, meaning that traders can settle transactions by delivering physical metal, and are not generally restricted as regards the source of the metal that can be delivered to the buyer.
The LME responded to the 6 April 2018 announcement of sanctions by temporarily banning placement of Rusal’s metal in the exchange (with effect from 17 April 2018) unless its owner can prove that it does not breach the sanctions. This measure was designed to avoid the LME becoming overloaded with Rusal aluminium that buyers did not want. However, the measure does not mean that buyers on the LME can assume they will not receive delivery of Rusal aluminium, since a significant proportion of aluminium already in the LME as at 6 April was thought to be Rusal’s. The LME has put out guidance concerning the situation of Rusal aluminium placed on warrant pre- and post- announcement of the sanctions.
We anticipate scope for disputes under existing contracts if one of the parties wishes to terminate the contract, or allege breach, due to supply of Rusal aluminium. Parties will need to proceed with caution in respect of their position.
Review of existing contracts
Due to the fact that continued dealings with any of Mr Deripaska’s companies may be in breach of the sanctions, it is clear that a review of commercial arrangements is needed by companies operating in this space.
Those trading aluminium contracts may wish to consider protective clauses in their contracts to avoid receiving affected Rusal aluminium for as long as it is subject to US sanctions.
Firms involved in the financing of aluminium may also wish to seek express representations and warranties by the counterparty that the metal being financed is not connected with Rusal. Disputes may arise if this is called into question and the financing party considers rescission for misrepresentation.
Rio Tinto is understood to be in the process of invoking the force majeure clauses in a number of its deals with Rusal, including one in the contract for the supply of bauxite to Rusal’s alumina refinery in Ireland. Glencore, which is Rusal’s biggest customer as well as a significant shareholder, is also evaluating its contracts with Rusal.
However, the required extent of unwinding trading relationships may not always be entirely clear. This is illustrated by Renova Group, which is subject to sanctions along with its owner Viktor Vekselberg. Renova acts as a holding company with a great many business interests and subsidiaries, not just in Russia but also abroad. This illustrates the thorny questions that are likely to arise for parties which deal with (or provide financing to) parties that are subsidiaries of or connected with sanctioned entities or individuals.
Impact of aluminium price volatility
There are likely to be winners and losers when any asset rises 30% in price in under two weeks, then returns just as suddenly to near its prior level, without any forewarning of either price movement. The contractual frameworks in place between counterparties are therefore likely to be tested.
Another potential impact is on aluminium financing arrangements. Since the sudden unexpected movement in aluminium price was upwards, one would not expect it to have resulted in margin calls made by parties that have financed physical aluminium. However, those firms engaged in commodity and trade financing are no doubt keeping a close eye on developments, so as to manage their own risk exposures within their contractual arrangements.
Enhanced due diligence
The sanctions regime is likely to place increased emphasis on conducting counterparty due diligence. This in turn means ensuring that dedicated compliance KYC functions have received detailed training on the sanctions and the affected individuals and entities. The recent experience of banks that have fallen foul of past sanctions (including against Iran, Libya and Cuba) serves as a powerful reminder and incentive to put in place effective systems in this area.
While political risks, including the risk of sanctions, have always been present in the commodities markets (especially for those doing business with Russian oligarchs), the new US sanctions have raised them to a new level.
Whatever the future holds, political risk should be at the forefront of commodity traders’ minds. Lawyers advising banks and commodity traders will need a sharp eye for potentially problematic contractual arrangements, so as to ensure sanctions compliance but also protect commercial interests.
This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.