Screening Financial Instruments for Investment-related Sanctions Risk

Refinitiv identified over 190,000 financial instruments relevant to the US investment ban against Non-SDN Chinese Military-Industrial Complex Companies as of 28 July.

On 4 August, a ban on US persons investing in 59 Chinese companies that operate in the defence or surveillance technology sectors took effect.

The ban prohibits US persons from investing in companies on the so-called Non-SDN Chinese Military-Industrial Complex Companies List (NS-CMIC List) through their publicly traded debt and equity securities, funds that contain the securities in their portfolios, and any related publicly traded derivatives.

US persons – defined as any individual present in the US, every US citizen and US permanent resident located anywhere in the world, entities formed or incorporated in the US along with their foreign subsidiaries, and the US branches of any foreign entities – have been given until 3 June 2022 to divest their holdings in these financial instruments.

The ban was originally imposed through EO 13959, enacted by former US President Donald Trump in November 2020, initially targeting companies with alleged links to China’s military. In June, President Joe Biden amended EO 13959 through EO 14032 to modify, expand upon and clarify the investment ban.

The revised EO was credited with addressing a lack of clarity in the original EO – such as in relation to the extent of the ban’s reach to subsidiary firms, how companies with similar names to the designated companies would be affected, and what financial market and investment facilitation activities would fall into scope.

However, the impact of the investment ban is still significant, and has broad implications for firms that go beyond being able to address regulatory and sanctions risks.

Taking Risk Management a Step Further

From a risk management perspective, financial institutions may need to identify and manage financial instruments related not only to the companies named on the NS-CMIC List, but those issued by their subsidiaries, and those subject to majority ownership by the companies.

Despite the Biden administration clarifying that subsidiaries are not included in the investment ban, some financial institutions have expressed a desire to be able to identify these subsidiaries, both domestic and foreign. In addition, from a risk management point of view, they are seeking data on securities that could potentially be impacted implicitly in the future.

To be clear, OFAC’s 50 percent rule – which states that any entity in which one or more sanctioned entities own, either directly or indirectly, more than a 50 percent interest may also be implicitly sanctioned – does not apply to entities listed solely pursuant to EO 13959. For the investment ban to apply to entities majority owned by NS-CMICs, they would have to be added to the NS-CMIC List, following which they would be covered under the ban 60 days later.

Yet, many firms have been seeking the ability to verify whether NS-CMICs have majority ownership in other entities that issue securities to which they are exposed, according to Ms Anubhuti David, Proposition Director of Risk Intelligence & Financial Crime at Refinitiv, part of the London Stock Exchange Group. In fact, some firms are taking their risk management a step further, seeking to also identify securities based on ownership thresholds as low as 25 percent.

“There have been a few clients who said that they would have a bigger focus on majority owned entities, but that they do want to be made aware of and keep an eye on minority owned ones as well, to certain thresholds such as 25 percent ownership,” Ms David said.

An Expanding Universe

This significantly expands the universe of financial instruments that need to be identified and monitored. And the universe of financial Instruments that could be impacted is significant – ranging from equities and debt securities to options, futures, forwards, swaps, indices, ETFs and funds.

“Financial institutions also have to be mindful that they may continue to hold and serve some instruments issued prior to the sanctions taking effect, but they may not hold those issued after the effective date,” Ms David said. “The biggest challenge institutions face is in identifying which securities and financial instruments are affected, so that they can make sure to divest these products by the required deadline, and preferably not before they are either delisted from markets or removed from indices.”

Historically, sanctions announcements have only come with the names of the entities, and not with ticker symbols, CUSIPs, or ISINs of the financial instruments the designated entities have issued. As such, identifying even the securities impacted by explicit sanctions commonly requires significant research. (Note: OFAC has provided equity tickers and ISINs for the NS-CMICs)

But even more complex is identifying the entities owned and controlled by sanctioned parties (implicit) and uncovering their domestic or foreign subsidiaries. While there is inherent difficulty in identifying the instruments linked to these entities, firms may also have difficulty monitoring for status changes, as financial instruments that are currently not sanctioned may become so as a result of corporate actions such as capital increases or tap issues​.

Furthermore, the list of designated companies is not likely to be static. The November 2020 EO was initially meant to apply to just 31 Chinese companies that were designated by the US Defense Department as having links to China’s military. The list has since been supplemented several times, eventually resulting in the final list of 59 so-called NS-CMICs. Yet, the list may yet be expanded in the future, requiring firms to take a proactive approach to screening for sanctioned securities.

To address these challenges, firms will ultimately need to ensure they have access to reliable data on sanctioned entities and instruments and be able to screen for these exposures across their lending and investment portfolios.

Financial Instrument Risk Intelligence

In a webinar on Tuesday (24 August), Refinitiv announced plans to launch a new content set on its World-Check data file that intends to address these issues and help financial institutions, corporates, and other entities to meet their regulatory and risk management obligations to screen financial instruments for sanctions risk.

The World-Check risk intelligence database is already widely used in the financial industry. It covers all global sanctions lists, other official lists, millions of additional records not found on official lists, data on PEPs and their relatives and close associates, and negative media reports – among other data sets.

The new content set, called Financial Instrument Risk Intelligence (FIRI), specifically covers financial instruments issued by sanctioned entities (explicit and implicit), issued prior to the effective dates of sanctions orders but with maturities after these dates, as well as securities issued after the sanctions dates regardless of the maturity.

“This is significant because a lot of clients have been finding it difficult to determine which financial instruments actually matter, despite knowing which entities are subject to explicit and implicit sanctions,” Ms David said.

“Clients were ending up with a massive list of instruments, most of which weren’t relevant because they had either already matured, or were issued before the effective date of the sanctions. What has been needed is a consolidated list that takes into account the dates when the financial instruments were issued and when they mature.”

During the Refinitiv webinar, attendees were asked whether they have considered additional controls in response to EOs 13959 and 14032. Around 68.5 percent of participants said they have indeed either implemented or are considering implementing new controls. Specifically, 59.2 percent of the respondents indicated that these additional controls were to enable screening of financial instrument identifiers such as ISINs.

According to Ms David, FIRI leverages Refinitiv’s existing research capabilities to capture sanctioned entities as they are listed, the entities that could fall into scope through implicit sanctions (e.g. via the 50% rule or Russia-related sectoral sanctions), and the financial instruments they are associated with, including their ISINs, CUSIPs, SEDOLs, tickers and other identifiers.

“Given the demand for information on entities that are owned or controlled by sanctioned entities by less than 50 percent, and to account for situations where ownership cannot be known with certainty, FIRI will also cover entities that are 25 percent owned by certain sanctioned entities,” Ms David said. “These will be marked appropriately so that clients have the option to segment out this data to focus on what they might consider most relevant.”

The development of the new content set has so far been telling. For the 59 companies on the NS-CMIC List, based on the inclusion criteria Refinitiv has selected, FIRI already included about 192,000 financial instruments that were relevant to the US investment ban as of 28 July.

This number is expected to continue to grow as more financial instruments are identified as being connected to the NS-CMICs.

To find out more about FIRI ahead of its official launch at the end of September, watch this on-demand webinar.

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