Sanctions and the impact on corporate America

Sanctions have become the go-to foreign policy tool for the United States. Coercive economic measures such as trade tariffs, financial penalties, and export controls affect large numbers of companies and states across the globe. But while U.S. policymakers see sanctions as a low-cost tactic, these measures also have potent side effects that can harm American interests. Sanctions affect multinational companies, governments, and ultimately millions of people around the world.

Economic sanctions create a mixed set of risks and rewards that alter the business environment for firms to which they can respond either reactively or proactively. Risk-acceptant companies may seek to exploit legal loopholes that allow them to circumvent sanctions or engage in deliberate sanctions-busting activities that violate sanctions requirements. Some firms may respond cautiously to the risks created by sanctions and limit their business activities with a target state more than sanctions may require.

In the case of the Western sanctions against Russia following its 2022 invasion of Ukraine, both behaviors have been observed. Over 1,000 firms that voluntarily committed to cutting back on or ceasing their business relationships involving Russia. At the same time, Russia has formed active sanctions-busting relationships with firms operating in the United Arab Emirates, China, Turkey, Kazakhstan, and Georgia.

Companies exist to maximize their value in the long run via suitable strategies that make use of internal resources and external relations to ensure a long-term competitive advantage on the market. When sanctions are introduced, the external environment suddenly changes. For firms, sanctions are disruptive and costly; furthermore, difficult-to-implement regulatory policies adversely impact their bottom line. Firms in target states have strong incentives to find ways of cost-effectively adapting to the disruption sanctions inflict. Companies bear the costs of sanctions in two ways. The first is the present and future costs of complying with sanctions, while the second is the severity of the costs incurred because of the avoidance of sanctions.

The corporate exodus from Russia since 2022 has cost foreign companies more than $107 billion in write-downs and lost revenue, a Reuters analysis of company filings and statements showed. Moscow has taken temporary control of assets owned by several Western companies including Fortum, Carlsberg and OMV. Several American companies are also negatively impacted such as ExxonMobil. The American oil giant had more than 1,000 employees in Russia and had been in the country for over 25 years. McDonald’s is also losing a vital market. The burger chain had categorized Russia as a high-growth market and continued to open locations there throughout the last decade. These companies and many others are likely not coming back to Russia for quite a while.

Washington introduced yet another package of sanctions against Russia’s financial, energy, and technological infrastructure on June 12th. Two years after Russia’s central bank was banned from using dollars, the Moscow Exchange and its subsidiaries the National Clearing Center and the National Settlement Depository were added to the sanctions list. The latest measures effectively isolate the sanctioned companies from the global dollar system and forced the Moscow Exchange to stop trading U.S. dollars, euros, and Hong Kong dollars. Of the ten currencies that the exchange traded for rubles before the conflict in Ukraine, only four remain: the Turkish lira, the Belarusian ruble, the Kazakhstani tenge, and the main beneficiary of these changes, the Chinese yuan.

Now trading in dollars and euros in Russia will be done directly between buyers and sellers. Exporters will hand over currency directly to financial institutions, and importers, accordingly, will buy. The result of this direct trading will be an increase in the spread, the difference between the purchase price and sale price of a currency. It will likely now be more profitable for banks to work with both sellers and buyers of currency, and to bring them together. In other words, the interbank market will be skewed in favor of several large players doing very well out of the commission.

Another difficulty is that there are hardly any large interbank market operators left that have not been sanctioned. The currency market in Russia will most likely be divided into sanctioned and non-sanctioned segments, each with its own currency exchange rate. The ruble exchange rate will become more volatile, and the more complicated it gets to import goods, the less demand there will be for foreign currency. This will lead to increased inflation risk.

The new June 12th sanctions are turning the yuan into the main currency of exchange trading and settlements in Russia once and for all. In May, its share in exchange trading once again hit a new record, reaching 53.6%. Its share in the over-the-counter market was 39.2%.

Both Moscow and Beijing have shown that they are capable of adapting to evolving sanctions. The major U.S. banks with global platforms such as JP Morgan Chase, Citigroup and Bank of New York Mellon are not happy as they are losing global market shares, losing revenues and they are witnessing a fragmentation of the global banking industry that is not serving the global U.S. banks well.

When leading Chinese banks stopped dealing with Russian clients over the threat of secondary sanctions, regional banks stepped up to take their place. Schemes with numerous intermediaries from places such as Kazakhstan and the UAE also began to be used more actively, and companies began to use cryptocurrencies in payments. Bartering is also now flourishing, with Russian products exchanged for Chinese goods, eliminating the need for any bank transaction at all.

The new sanctions amount to a direct ban on U.S. tech companies consulting for or supplying IT solutions to anyone located in Russia. The U.S. Treasury’s net is closing in on supply chains, and the chances of getting caught are increasing. In the past two and a half years, an entire infrastructure of intermediaries in various jurisdictions has sprung up, schemes for swiftly restoring supply chains interrupted by sanctions have been developed, and payments in yuan and rubles have been settled using local infrastructure.

Jet manufacturing was among the sectors more severely affected by sanctions imposed on Russia, a big player in the global aerospace supply chain. Boeing cut ties with a major Russian titanium supplier with which it had launched a joint venture to develop key airplane parts. Now the American aeroplane giant is facing a new problem, an inability to meet its production target on its 787 Dreamliner due to a lack of critical parts from Russia. Boeing appears to have relied on Russian production for a part called a heat exchanger. After sanctions were put in place, Boeing turned toward British and American suppliers, but they could not produce enough of the component to meet Boeing’s demands. This latest act in the sanctions saga highlights once again just how interdependent the globalized world economy is, but also the risks of sanctions as they are creating fragmentation, supply chain disruptions and increase de-globalization.

The fact that the sanctions on Russia are causing such severe problems for a core strategic industry in the U.S. speaks to a contradiction in American geopolitical and economic strategy. Sanctions are designed to hobble foreign economies, but the Russian sanctions increasingly appear to be hobbling Western economies. American policymakers may have been able to tolerate the destruction of European industry under the high energy prices caused by the Russian sanctions, but now they are seeing their own critical industries under threat.

The whole world is closely watching the sanctions battle between Russia and the West, uneasy over the growing politicization of the global financial system and continued fragmentation. Apprehension is rising not only in Asian countries and the Persian Gulf, but also within the European Central Bank, which is concerned about the euro’s declining share in world reserves.

Cutting off Russian banks from the SWIFT payment system, along with secondary sanctions, has proved a powerful incentive to accelerate the development of China’s Cross-Border Interbank Payment System, India’s Unified Payments Interface (UPI), and other alternatives. There is still a long way to go before there is a real threat to the dominance of the dollar, but the trend toward the fragmentation of the global financial system cannot be reversed now.

It is clear that sanctions have several negative implications on major U.S. corporations such as the key banks, global multinationals, and other global firms like Boeing. Also, the U.S. consumers feel the heat as prices of food, goods and energy have increased significantly, and the inflation pressure is still strong. The geopolitical cost is also high as there is a global trend and development towards a U.S.-lead camp and an anti-U.S.-lead camp, leading to higher levels of geopolitical tension and risks of conflict.

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