Secondary Sanctions: Why Are They Feared and How Do They Work?

Let me clarify that in this article, we are only talking about unilateral sanctions. In addition to these, there are multilateral sanctions, which are historically more effective, but these are imposed by the UN Security Council, and Russia has veto power, so we are not particularly interested in them, as they have not been applied to Russia. Moreover, I am referring to sanctions from the United States, as European ones have their own peculiarities.

The word “sanction” originates from Latin, and is etymologically related to the word “sacred,” as it literally means “to make sacred,” and has been in use since ancient times to describe rulings or decrees that became mandatory for execution. Over time, the term evolved to include the nuance of “punishment by an authorized entity.” But what legal grounds exist for sanctions against Russia? The discretion of the state.

In other words, a sanction is a restriction imposed by one state on another state, or on specific individuals, legal entities, or assets, etc. Of course, there is an argument that sanctions are a form of punishment, but that would be true only if there were an international legal order above states (which does not exist).

So, if a state or a union of states decides to impose sanctions on an entity or sector in another country, but these sanctions are bypassed by creating new entities or operating in a third country, then penalties or sanctions can be applied to the new entities or companies in that third country. This is what secondary sanctions are.

How does this work in practice, using personal sanctions (against specific individuals) as an example? A person (a) is added to a special SDN (Specially Designated Nationals) list, which is public. If another individual (b) from another country wants to interact significantly (a vague evaluative category) with person (a), they risk being added to the SDN list as well. If someone else (c) wants to interact with person (b), they too risk being added to the sanctions list, and so on, and so forth.

How does the U.S. extend its influence over other countries and their internal economic actors by imposing sanctions, and why does everyone comply? The typical justification used is the so-called US-nexus (connection to the U.S.). If you’ve ever worked with any bank, that connection, from the U.S. perspective, already exists. This is a feature of the banking system: it is dollarized and U.S.-centric. Just as all roads lead to Rome, all financial transaction chains lead to the U.S. But there’s still a narrow path.

Since the connection to the U.S. exists, no one wants to upset them in order to avoid being cut off from key market tools. Therefore, all rational market participants are typically forced to comply with U.S. legislation. In this way, fines and secondary sanctions work similarly to punishment for a crime committed within a country’s territory, but the territory of the U.S. is the entire world connected to the US-nexus.

But is this a perfect weapon? Not entirely, and there are several reasons for that:

1. Secondary sanctions cannot become tertiary or quaternary. It’s important to prove a significant connection between the individual on the SDN list and the person being subject to secondary sanctions. However, if there are other intermediaries between you and the SDN-listed person, preferably several, there is technically no connection, and you can rest easy.
   
   

2. Every actor always has multiple counterparties who can dilute the criteria of significance or reduce the likelihood of detection of the interaction with the SDN-listed entity.
   
   

3. Eventually, the investigation will inevitably turn back on itself. It would be foolish to deny that some of the greatest violators of sanction regimes are often the states imposing them or other states/entities that no one wants to offend. As a result, the enforcement of sanction regimes often devolves into behind-the-scenes squabbles.
   
   

4. Most countries' constitutions prohibit restricting the rights of their own citizens, so they can only be fined. This is what, for example, the OFAC (Office of Foreign Assets Control) does, but even they sometimes have their hands tied.

Given the above, the risk of secondary sanctions can always be minimized by complicating transaction chains, supply chains, diluting ownership shares, using schemes of indirect control, reducing the share of dollar-denominated transactions, increasing the use of alternative currencies, CFAs, digital currencies, cryptocurrencies, decreasing cross-border banking interactions, including through counter-performance transactions, barter, and various clever exchange schemes (similar to mirror transactions), etc.

The U.S. also faces the risk that sanctions will reach their logical conclusion, and there will be so many individuals and actors on the SDN list that the process will lose its effectiveness. Secondary sanctions are a weapon of mass destruction, and they must be used cautiously. Russia is too large an economy to simply disconnect without causing significant harm globally.

Indeed, at first, even the U.S. was hesitant to use this weapon of mass destruction, but over time, things became more interesting:

As of now, according to a credible study I found, the number of individuals under secondary sanctions is approaching 500, with about 100 from China, 75 from the UAE, and 66 from Turkey (quite realistically), and their number is growing annually at an accelerating arithmetic pace.

500 might not seem like many on a global scale, but who knows, maybe you’ll be next? Or you’ll get fined? The U.S. sanctions policy is carefully thought out in the sense that it works on the principle of gradually increasing the stakes. Yes, the ultimate increase in stakes could collapse everything, but that moment is not likely to come soon.

U.S. competent authorities constantly pressure Russian trading partners, threatening and persuading them to stop interacting with Russian individuals. Don’t forget that complicating and diluting trade chains also worked against Russian trade agents: if it became harder to find a sanctioned individual, now everyone is effectively a sanctioned entity, and it’s much safer for banks to just cease any interaction with Russian counterparts. And don't forget about sectoral sanctions. As a result, banking compliance becomes many times more complex, and banks refuse to work with Russians.

This is related to the great betrayal by several Chinese, Dubai, Turkish, Kyrgyz, and other banks and the freezing of transactions with Russian counterparts.

Therefore, the U.S. strategy is to gradually raise the stakes every time trade adjusts to the current sanctions situation, destroying it with new sanction packages, secondary sanctions, direct interactions with banks, and threats of various unpleasant consequences.

Also, we cannot forget other mechanisms of influence, such as U.S. anti-money laundering laws, which all financial institutions must comply with, and with which there are always issues, but can be used in this never-ending game. Criminal penalties for violating sanctions are also possible, although they are extremely rare.