Secondary sanctions may imperil U.S. financial leadership
America’s unprecedented secondary sanctions are a high-stakes gamble that could reshape global trade and spell the end of U.S. financial dominance.
In a nutshell
- U.S. secondary sanctions on global banks are unprecedented
- Emerging markets are largely complying while seeking alternatives
- Many nations seek non-U.S. dollar trade and payment systems
The United States’ efforts to contain Russia through sanctions may have unintended consequences. The most recent round of measures targets third parties doing business with entities that support Russia, namely banks worldwide, and it is countries in emerging markets that may be most affected. Washington’s restrictions may inadvertently push nations into uncharted territory, potentially threatening the global dominance of the U.S. dollar and its financial system.
U.S. sanctions explained
While politicians in Washington decide on introducing new sanctions, it is the U.S. Treasury’s Office of Foreign Assets Control (OFAC) that is the principal authority issuing and regulating both primary and secondary sanctions. Primary sanctions are economic restrictions by which Washington can target individuals, businesses and foreign governments through asset freezes and confiscations, travel bans against foreign persons, and trade embargoes of countries for acts which threaten U.S. national security or breach international law.
All individuals and entities connected to the U.S. legal jurisdiction through citizenship, incorporation or residence must comply with these sanctions. Additionally, transactions processed anywhere in the world through American financial institutions or in U.S. dollars thereby forming a financial link to Washington’s jurisdiction, are also required to comply with primary sanctions.
Transactions processed anywhere in the world through American financial institutions or in U.S. dollars are required to comply with primary sanctions.
Currently, some of the foreign governments subject to OFAC’s primary sanctions include Russia, Belarus, North Korea, Iran, Cuba, Syria and Venezuela, as well as others mostly in Africa and Asia. OFAC is also increasingly targeting business entities and individuals in China, Hong Kong, Turkey, the United Arab Emirates and Pakistan in a lengthening list focused mainly on developing economies.
Secondary sanctions, in contrast, have been created to deter non-U.S. persons (those not having any economic or legal links with the U.S. jurisdiction) from conducting business with foreign governments, individuals and businesses subject to primary sanctions.
A secondary sanction imposes penalties on non-U.S. persons by disallowing them to engage with American commercial interests including access to U.S. financial institutions or use of the dollar. Unlike primary sanctions, which are enforced by seizures of U.S.-situated or dollar-denominated assets, secondary sanctions depend on the need by non-U.S. persons to access the global largesse of the American financial system and universality of the dollar.
Unprecedented secondary sanctions
Previously, U.S. secondary sanctions were comparatively selective in scope. However, on December 22, 2023, the Treasury imposed a new set of restrictions targeting all non-U.S. financial institutions accused of dealing with “Russia’s military-industrial base” – a definition which was also considerably broadened in view of these new sanctions.
Foreign financial institutions now risk being penalized for conducting or facilitating Russia-related transactions even when there is no economic or legal connection to the U.S. These activities may include facilitating significant transactions or providing any service to organizations or individuals connected with Russia’s military-industrial sector.
A secondary sanction imposes penalties on non-U.S. persons by disallowing them to engage with American commercial interests.
On June 12, 2024, OFAC further expanded the definition of “Russia’s military-industrial base” to reflect “the Kremlin’s increasing use of Russia’s entire economy to support” its battlefield operations. This definition now incorporates numerous individuals and entities linked broadly to Russia’s procurement networks and supply chains including all persons who are subject to U.S. primary sanctions.
Developing economies grow ties with Moscow
Contrary to expectations in Washington, several months after the imposition of secondary sanctions, the global majority’s trade with Russia has continued on an upward trajectory, especially for larger developing economies. In relation to Russia’s energy exports, which are key to funding its weapons industries, recent weekly trade data gathered by the Centre for Research on Energy and Clean Air shows a steady rise in fossil fuel exports from Russia to China, India, Turkey and Brazil. The diversity of Russia’s mix of energy exports to each country is also increasing.
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- The disillusionment and hope of Western sanctions against Russia
Although major financial institutions in these developing economies are known to have taken steps to rigorously comply with the new U.S. measures to preserve their access to global markets, a plethora of new non-financial channels and smaller-scale banking organizations is emerging. This mushrooming group of entities is facilitating transactions between Russia and major developing economies to avoid sanctions.
This burgeoning industry of new intermediaries is a reflection of increased discontent among governments in key developing countries at their being subjected to the vastly expanded extraterritoriality of U.S. sanctions. Countries have responded to Washington’s secondary measures in various ways.
China
In the immediate aftermath of the introduction of secondary sanctions, China’s trade with Russia declined sharply. Yet in the second half of this year bilateral trade has begun to recover. Moscow’s trade with Beijing is likely to further improve as new avenues facilitating cross-border business transactions are speedily brought onstream.
After China’s larger banks halted acceptance of yuan payments from Russian enterprises in April 2024, a growing number of Russian businesses in May began setting up direct payment acceptance agreements with smaller Chinese financial institutions. In the same month, Russian President Vladimir Putin and Chinese President Xi Jinping met to resolve payment issues arising from secondary sanctions. They reportedly agreed for specially authorized banks to be set up at Sino-Russian border regions, allowing Russian importers to open non-resident accounts with those institutions.
Facts & figures
U.S. dollar vs Chinese yuan
Chinese non-financial entities are also opening offices in Russia to accept payments in rubles. Many long-term development plans for Russia and Central Asian nations overlap in areas where the ruble is widely accepted as a means of exchange. Chinese companies have also been utilizing cryptocurrencies in their transactions with Russian partners. Such transactions are typically routed through Hong Kong.
The central banks of China and Russia plan to establish longer-term diversity in foreign-currency trade between themselves and partner economies in the developing world. This includes the prospective introduction of a multiple-currency trading mechanism, referred to as the “BRICS bridge.” The novel concept would enable intra-BRICS trade to be settled in a variety of the ten BRICS-plus member currencies.
India
As one of the world’s fastest-growing economies and its largest democracy, alongside being a largely English-speaking Asian nation governed by the rule of law, India, perhaps more than China, sets an example for much of the developing world in terms of aligning against U.S. secondary sanctions. In a recent move, the Reserve Bank of India has permitted commercial banks from 22 mainly developing countries, including Russia, to open special accounts for settling payments in Indian rupees − a process which strengthens India’s bilateral economic ties with the participating countries and reduces dependence on the dollar.
New Delhi has a longstanding track record of seeking innovative ways of getting around U.S. secondary sanctions. This included Washington’s restrictive measures on Iran, to which India responded by instituting a rupee-rial arrangement allowing it to continue making payments for Iran’s crude oil supplies in local currencies. The scheme laid the groundwork for a similar national currency accord launched between New Delhi and Moscow after the U.S. first imposed sanctions on Russia in 2022.
Indian officials are also looking at ways of avoiding the long arm of American sanctions by setting up distinct businesses dealing exclusively with the Russian market, as is reportedly the case in China. This would involve Indian businesses establishing separate production facilities to service the Russian market.
Balancing India’s trade books with Russia while getting around U.S. secondary sanctions was a principal reason for Indian Prime Minister Narendra Modi’s intensive talks with Mr. Putin in Moscow in July of this year. The leaders agreed on a plan for their mutual strategic cooperation through 2030 and forecasted bilateral trade reaching $100 billion by that year.
Turkey
Turkish President Recep Tayyip Erdogan is unlikely to be dissuaded from his non-aligned status following recent U.S. secondary sanctions. Not only has he refused to participate in the Western sanctions regime, but Ankara’s trade relations with Moscow skyrocketed after Russia’s invasion of Ukraine, expanding by over 55 percent since before the conflict.
However, the new U.S. secondary sanctions have hit Turkish-Russian bilateral trade hard. Further sanctions introduced in June 2024 were imposed on a record 13 Turkish companies trading in machine tools, industrial polymers and chemicals, internal combustion engines, pumps and electronic products. More recently, the U.S. has even warned NATO ally Turkey of serious consequences if it does not halt the export of military-linked goods to Russia. This toughening U.S. position may be an outcome of talks on July 3-4 at the Shanghai Cooperation Organisation meeting, where Presidents Putin and Erdogan agreed to expand their annual bilateral trade over the coming five years to $100 billion annually from the current $43 billion.
BRICS
The 10-nation BRICS group has been generally critical of U.S. secondary sanctions due in part to the members’ growing economic ties with Russia. Brazil’s President Luiz Inacio Lula da Silva has been especially vocal in denouncing the secondary sanctions in addition to his longstanding opposition to U.S. sanctions against Venezuela and Cuba. He has also called on developing countries to work toward replacing the dollar with their own currencies in international trade.
Facts & figures
U.S. dollar vs. Brazilian real
Since the outset of the Ukraine war, Brazil has substantially expanded its imports of oil products and other commodities from Russia. This includes being a significant buyer of Russian fertilizers – Russia accounts for a quarter of the country’s total fertilizer imports. Brazil has criticized sanctions against Russia which, through U.S. secondary sanctions, could make shipping companies refuse to transport some goods to Brazil.
South Africa’s President Cyril Ramaphosa has also opposed U.S. sanctions on Russia, asserting that “bystander countries” were suffering on account of the measures. In light of his stance, various analysts have warned that South Africa could face American secondary sanctions including the risk of exclusion from the SWIFT system. After raising concerns over Pretoria’s ties to Moscow, U.S. Treasury Secretary Janet Yellen warned South African officials about the consequences of violating Washington’s sanctions.
While Saudi Arabia, a country currently joining BRICS, has steered clear of criticizing U.S. secondary sanctions, its willingness to diversify currencies used in selling its oil aligns it with other major developing countries seeking alternatives to the dollar and to minimize risks from expanding U.S. secondary sanctions. The extent to which Saudi Arabia continues to employ the “petrodollar” moving forward could be a pivotal indicator of future financial ties between major developing economies and the U.S.
Scenarios
Less likely: Developing economies conform to secondary sanctions
Since U.S. secondary sanctions were first announced in December 2023 and further bolstered in June 2024, governments in developing economies and their financial institutions have been quick to comply with the restrictions. In many instances, the larger developing economy banks and financial institutions acted fast to cut their links − both directly and indirectly − with the Russian military-industrial sector.
On balance, the global largesse of the U.S. finance industry and the flexibility of the dollar as the primary reserve currency, combined with the open and significant size of the U.S. market for absorbing international trade, means that developing economies have very few equivalent alternatives for enabling their economic prosperity. Moreover, while some political leaders of developing countries may hit the news headlines with their denunciations and criticisms of the dollar, in practice, there is very little concrete action among them in agreeing on suitable substitutes to the American currency.
The question of alternatives to the U.S.-dominated financial system is equally as challenging. A large proportion, if not a majority, of banks and large financial concerns in developing economies remain in state ownership, subject to government agendas as much as market forces. They are simply not as open or flexible as U.S.-based financial institutions in the financing of trade, investment and various cross-border banking activities involving foreign business.
Despite the various new developing economy initiatives which have been crafted in response to recent controversial U.S. secondary sanctions, most may only be temporary forms of relief rather than permanent features. Some initiatives are essentially so peripheral as to have no more than a marginal difference in global trade and finance. Lastly, some of the major proposed alternatives to the dollar and SWIFT system that have been much-touted as a threat to U.S. dominance, such as the BRICS-bridge, seem to be more of an unfulfilled promise than an awakening reality.
More likely: Developing economies move to alternate financial and trade arrangements
The aggressive expansion of U.S. secondary sanctions over the last year targeting non-U.S. financial institutions across the world has been unprecedented in scope and scale. As the great power rivalry intensifies between the U.S. and Russia, China and Iran, among other competing states, the likelihood of Washington resorting to additional secondary sanctions by leveraging its leadership in sectors such as technology, aerospace, high-end manufacturing and beyond will intensify.
In response to what appears to be evolving into a normalized set of unilateral extraterritorial policy tools to wage against its rivals, the developing world is being galvanized into seeking alternative financial, trade and economic measures to protect their independence and sovereignty. It is also becoming increasingly clear that the developing world, which has borne the brunt of U.S. secondary sanctions for some years, is undertaking tentative steps toward building parallel trade and investment platforms to act as viable future substitutes to the current U.S.-dominated international economic and financial architecture.
While Russia is clearly the most combative in seeking to dislodge the U.S. from its prime position, it is the role of much larger economies, including China and India, involving both their individual and collective efforts, that will be key in defining whatever new institutional financial and trading order materializes. While the expansion of U.S. secondary sanctions was meant to break the back of the Russian economy through dissuading financial organizations in third countries from dealing with Russia, it may ironically have the contrary effect – prospectively engendering the demise of America’s global trade and financial dominance.
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