Sanctions Explained: Purpose & Power

Sanctions are powerful tools used by governments, international organizations, and regulatory bodies to influence behaviour, deter unlawful activities, and ensure companies and individuals comply with legal and political frameworks. Whether targeting illicit financial transactions or enforcing global policy stances, sanctions play a vital role in maintaining economic and national security.

In a financial context, sanctions compliance is critical for institutions to avoid hefty fines and regulatory penalties while assisting in combating crimes like terrorism financing and money laundering. This article will break down the meaning, purpose, types, and processes surrounding sanctions and their implications for businesses globally.

Sanctions are legally binding restrictions or penalties imposed on individuals, entities, governments, or regions. These restrictions are used to enforce international laws, deter illegal activities, or respond to geopolitical threats. Sanctions may take various forms, such as freezing assets, restricting trade, or limiting access to financial markets.  

For instance, the United Nations Security Council may implement international sanctions against a regime accused of human rights violations, freezing access to global financial systems to pressure behavioural change. Similarly, governments like the U.S. impose OFAC sanctions to penalize organizations directly responsible for specific unlawful actions or to deter broader illicit financial activities.

Sanctions are categorized based on their focus and objective. Below are the types of sanctions typically seen in global enforcement:

Imposed to financially weaken the target, economic sanctions restrict trade or monetary activity. Examples include bans on imports or exports of goods, freezing financial assets, or prohibiting certain investments. One of the most well-known economic sanctions is the embargo placed on Iran’s oil exports, designed to curb the country’s nuclear program.

Trade sanctions impose restrictions on imports or exports of specific goods, services, or technologies. For example, trade sanctions on arms and weaponry prevent their sale to conflict zones.

Administrative sanctions involve penalties for regulatory or statutory violations. For example, a financial institution may face administrative sanction fines for failing to report suspicious activities under anti-money laundering laws.

In certain jurisdictions, especially in the legal context, Rule 11 sanctions penalize parties involved in frivolous or malicious lawsuits, encouraging adherence to lawful practices.

Secondary sanctions penalize not just direct targets but also third parties engaged with them. For instance, the U.S. may impose restrictions on foreign companies doing business with sanctioned countries like North Korea.

These are individuals or organizations flagged by governments (e.g., by OFAC) as being involved in illicit financial or political activities. SDNs have their financial resources frozen and are barred from global transactions.

Sanctions aim to achieve various goals beyond punitive measures. The objectives include:

• Political Pressure: Sanctions can force countries or leaders to comply with international treaties or demands.
• Counteracting Financial Crime: Tools like sanctions screening help detect individuals involved in terrorism financing, corruption, or money laundering.

Discover how sanctions screening works  

• Securing Strategic Resources: Restricting access to strategic commodities such as rare earth minerals or oil strengthens national security.  
• Maintaining Economic Integrity: Sanctions deter businesses from engaging with harmful actors, protecting legitimate markets and trade.

Sanctions are overseen by several powerful organizations. The most prominent include:

• OFAC (Office of Foreign Assets Control): A U.S. body responsible for administrative oversight of financial sanctions related to terrorism, narcotics trafficking, and other global threats.
• United Nations Security Council: Enforces international sanctions on nations or entities violating human rights or international norms.
• EU and FATF: Both entities provide frameworks like anti-money laundering directives, ensuring sanctions compliance is consistent across jurisdictions.

Governments often rely on tailored tools like those offered by LSEG Risk Intelligence to comply quickly and effectively with these regulations.

In the financial industry, sanctions compliance is integral to avoiding business disruptions and reputational damage. Financial institutions must implement processes like:

• Customer Screening: Identifying entities under lists such as OFAC’s SDN list before onboarding customers.
• Transaction Monitoring: Advanced systems analyse patterns to detect activities potentially violating financial sanctions.
• Automated Sanctions Tools: Tools like LSEG World-Check help streamline compliance processes by cross-referencing global sanctions databases in real time.

Failure to meet these expectations leads to severe consequences, such as penalties and exclusion from critical financial networks.

Sanctions introduce several challenges for businesses, including:

• Evolving Regulations: Frequent updates to sanction lists require constant monitoring to ensure compliance.
• Cross-Border Transactions: Navigating sanctions in international trading, especially with secondary sanctions, is complex.
• Cost of Compliance: Implementing extensive compliance programs can strain resources, especially for smaller financial institutions.

Non-compliance exposes firms to hefty fines, reputational damage, and, in severe cases, criminal prosecution.