In December, we had the chance to talk with Eric Lorber, an attorney based in Washington, DC at Gibson, Dunn & Crutcher LLP who assists multinational companies in compliance with US economic sanctions. He was formerly a member of the Iran Sanctions Team at the Office of Terrorist Financing and Financial Crime (OFAC) in the US Department of Treasury, and is the author of numerous articles for Foreign Affairs on the subject of sanctions, the Iran deal, Russia, and US foreign policy.

His articles in Foreign Affairs Magazine can be read here.

SD: Sanctions against Russia have thus far seen several rounds of escalation. The first round imposed simply restricted travel options for several hundred politicians, but the third round targeted the Russian government’s bread and butter against Rosneft, Novatek, Gazprombank, and Vneshekonombank. Notably all of these sanctions come from Western powers and their allies, and have limited the ability of public and private entities with Russia to obtain access to credit. How important will these restrictions on credit access be for the Russian economy moving forward – are there viable alternatives in say, Chinese banks? Are these sanctions meant to be mostly symbolic gestures of diplomacy or more as real punitive measures?

Eric Lorber: These sanctions are not simply symbolic gestures; they are actually quite painful. In fact, I would say they are probably more painful than US and European authorities intended when they initially imposed them. These sanctions are mostly financial in character – they basically restrict the issuance of debt or equity or certain transactions with major Russian banks. The result of this is that Russian banks and Russian energy companies like Rosneft and Gazprom cannot refinance their debt using Western capital markets. How this works specifically is that when a Russian company needs to refinance a loan, they are unable to do so at a good rate because all the best lenders are in the West, and thus, it’s costing them a lot more to borrow money and refinance. This is why there is a shift to Chinese banks for assistance. The problem with that approach is that because it is costing them so much more to refinance using these sub-par alternatives, the Russian government has been obligated to prop up and provide particular financial subsidies to most of these companies. The Russian government has billions of dollars in reserves, and thus can afford, for the time being, to prop up these companies that are about to become insolvent and mitigate any pain in the short term.

But in the medium term, let’s say a year or two, what we will see is that the Russian government will no longer be able to spend a lot of its reserves to provide that refinancing assistance. That is when we will start seeing some real pain in the Russian economy. The element of these sanctions that US and EU policymakers probably considered as well when they imposed them, but cause even more economic hardship, is the general chilling of foreign direct investment (FDI) into the country. The sanctions themselves don’t actually forbid US and EU companies from investment in Russia, but they do create uncertainties regarding the future of the country’s ability to refinance its private sector and for the government itself to remain solvent. What we have been witnessing is a very substantial decrease in FDI throughout the country. When that is coupled with decreasing oil prices and energy-specific sanctions as well, you see that it is a much faster slide into a recession than US and EU policymakers had considered when they first began to impose major sanctions in July.

In terms of turning to Chinese lenders as an alternative, or other foreign entities, there are two important points to note. The first is that Russian companies are turning to Chinese lenders out of necessity, and they have had to do this on extremely unfavorable terms. While Chinese companies will refinance Russian private sector debt, they know that the Russian companies have no alternatives to them, so they have increased the price of that service by as much as 50% of the total refinancing, which would be outrageous under more equitable circumstances. It’s a very expensive proposition. The second point has to do with legislation just passed by Congress in December called the Ukraine Freedom Support Act. The President signed it into law in December, and what this legislation does is give the president authority to sanction foreign companies that conduct certain transactions with Russian companies. This is exactly what the US strategy was with Iran in 2010. So what happens if the US sees a Chinese firm financing to a Russian energy company? It can now sanction the Chinese firm, and cut it off from the US financial sector. As a result a lot of these companies, be they Chinese or Indian or whatever, are faced with the choice of either doing business with Russian companies or US companies, but not both. Obviously, given the size of the US economy, most choose the West. This exacerbates the inability of Russian companies to seek out alternative forms of financing.

SD: What does that mean for a multinational corporation, for example a foreign oil major?

Lorber: Most oil majors are US-owned and operated. They have operations in the US, they are incorporated here and thus they are already prohibited from doing business with most Russian companies. These sanctions aren’t designed to affect the major corporations that already have a presence in the United States. The real effect will be on those other companies, for example smaller oil companies or banks, that don’t have an active presence in the United States, but do business and transact in dollars in US markets. The lion’s share of oil transactions occur in dollar currency, or where the currency is denominated as the dollar in oil transactions. If you can’t get access to US dollars because you cannot access the US financial market, that means you are essentially cut out of the oil transaction trade. It’s going to have a powerful effect on financial institutions and foreign companies that don’t necessarily have a presence in the US, but will still be unable to carry out some of their core business. When companies have to choose between doing their core business and transacting with these sanctioned Russian companies, most will choose the former. It will become harder for these Russian companies to obtain any financing from Chinese or Indian sources.

SD: Oil transactions seem exclusively dictated on benchmarks such as Brent Crude or West Texas Intermediate, which are measured in dollars. So this refinancing for energy companies additionally have to add another layer of costs because of how lopsided current exchange rates are?

Lorber: Exactly.

SD: There are a lot of countries party to the sanctions against Russia – the United States, the EU in general, Japan, Australia, and specific financial centers within the EU like Switzerland. For lack of a better word, how tight are sanctions against countries like Iran and Russia? Through what institutions or mechanisms do countries work together to ensure that Iran or Russia don’t take advantage of loopholes? Additionally, how prevalent is smuggling to circumvent official sanctions and how is this dealt with by governments that are trying to enforce them?

Lorber: It’s helpful to differentiate between the Iran sanctions regime and enforcement and Russia’s, obviously because Russia’s is far newer. The primary enforcement mechanism/overarching agency in the United States is called OFAC (Office of Foreign Assets Control) at the US Department of Treasury. They have an in-house intelligence shop; they are the people who levy the fines against sanctions evaders and individuals that violate the sanctions. In the EU these mechanisms are far more diffuse. It is usually performed by member state governments, for example the EU will pass a sanctions resolution, but then that will be implemented in a non-uniform way by each one of the member states. Each member state’s authority will have responsibility for implementing and enforcing the sanctions. This has the potential to cause some gaps to appear that Iran or Russia could take advantage of. But in the case of Iran, those sanctions are now quite tight, for a couple of reasons. First, they’ve been around longer – they really ramped up in 2006-2007 and as a result regulators have become more adept at determining who is cheating and conducting enforcement actions against them. The second reason is that larger financial institutions are far more reluctant to attempt to game the US and EU sanctions and regulations now. The reason is due the astronomically high fines that the US has forced those companies to pay. A French bank was obligated to pay to the order of $10 billion of compensation for sanctions violations. And more routinely, we’ve seen fines of hundreds of millions of dollars. Banks have largely decided that it’s not worth it. At the multinational corporation level, likewise, nobody is trying to get around these. The smaller company level, however, is where it gets interesting.

Some Middle Eastern companies and European companies may fly under the radar a bit more, and they may actually not understand the sanctions regime altogether. In the case of Russia it’s a bit of Wild West type situation. The reason I say that is because certain companies and individuals are trying to comply with sanctions, but nobody really knows what is going on. The sanctions are new, they are very complicated, and the regulators have not sufficiently spelled out what does or does not constitute illegal behavior. In the case of Iran, examples are more clear cut. You can’t sell to an Iranian company, period. But in the case of Russia, you are dealing with very advanced financial institutions – you can’t issue new debt or equity for instance, and with more complex financial products, it gets into a gray area of determining what is or is not prohibited. It’s created a situation where most transactions are going through, because nobody actually knows what is legal or illegal. It’s going to take regulators an equivalent amount of time for Russia to spell out prohibitions and close loopholes.

SD: Russian debt-to-GDP ratios hover at around 13%, due to the government default during the financial crisis of 1998, and now Russian government debt is seen as a subpar asset in a lot of emerging markets, holding companies, and financial institutions. Is this third round of sanctions as big of a deal for the Russian economy as we are making it seem? Will the restricted access to credit affect the Russian economy the way US policymakers want it to? And who has been lending, who is lending, and who will be lending to the Russian economy, given the fact that Russian debt has been viewed as a subpar asset for quite a long time?

Lorber: The best way to think about this is not simply in terms of financial sanctions, but a coordinated penalization of the entire Russian economy. For the most part these sanctions are targeted less for the immediate or short term, and more towards the medium term (1-2 years down the road). On the one hand, the sanctions will make it harder for Russian companies’ ability to refinance, and therefore this will deplete Russian reserves despite the fact that Russian debt is essentially junk anyway. The second point is rather unexpected, which is the diminishing FDI into the country as a direct result of the sanctions and the uncertainty that they have created. There is a diminished appetite among Western companies for Russian assets. The third point are these energy sections, which if you look at the way energy sanctions are structured, they attempt to make it more difficult for Russian to develop its offshore, Arctic and deep water resources, which are the major expansion points for these energy companies over the next four to five years. That is where the truly significant damage the Russian economy will come from, since by prohibiting trading with these Western companies, we have denied them the technology necessary to develop these offshore reserves. In many ways, these secondary and tertiary effects are almost more important than the sanctions themselves.

SD: With regards to Russia, sanctions appear to be having a redundant effect, much in the same way the commodities market has been doubly effected by the crash in oil prices. If Arctic extraction costs go up, surpassing Saudi production costs of $20/barrel, and comparing more closely to US shale production costs of $40-50/barrel, then Russian energy companies have probably already arrived at a point where new exploration is cost prohibitive based on falling oil prices alone. Now with energy sanctions, this problem is compounded even more, making oil extraction and exploration substantially more cost prohibitive – is that reasoning sound, and were those effects anticipated on the part of US policymakers?

Lorber: It is sound, apart from the fact that this state of affairs is very dynamic and fluid. Oil markets are cyclical. The drop of oil prices will change in the next few years, more than likely. You will see a rise, albeit not to $150/barrel, but there will be another significant rise and it will be under those circumstances, not these, that Russia will feel the real pain from these sanctions because they will not be able to exploit their own natural resources as much as they could. In some way, you are right the pain might be mitigated, but there will be more repercussions down the road when oil prices start rising again.

SD: With respect to Iran, not all goods are restricted. For example, foodstuffs and medical supplies. How do these institutions go through the process of determining what is legal and what is not? Do large corporations see sanctions as a “stay away” sign, at least until boundaries and definitions are more clearly delineated?

Lorber: In the case of Iran, they definitely stay away. It’s not because they are waiting for more clarifications, however. The core problem with Iran is that there are certain exceptions that allow you import, say, wood pulp and food. Nevertheless, the issue is not the food itself, but its related transactions. If you get the food to the border, you have to hire someone to transport it – how do you pay them? Through an Iranian bank. That’s prohibited. So many of these related transactions go through these prohibited channels, most companies avoid this because of the complexity, and also because the costs reduce profit margins, and thirdly because the risk of an enforcement action associated with inadvertently violating sanctions is far too risky.

SD: Repealing sanctions is often a difficult and drawn out process that frequently leads to unexpected political or economic consequences in the target country. Could the creation of sanctions in the West be made easier in some way to carry out and repeal? How flexible can policymakers in Washington or elsewhere be in order to swiftly impose, remove, or re-implement sanctions in a timely and reactive manner – should this process be strictly limited to legislative authority or should it be in the hands of the diplomats?

Lorber: This question is especially difficult because there are all sorts of underlying legal technicalities, and in addition, even if there weren’t those technicalities, it’s a balancing act. The ability of the President to lift sanctions in response to a concession, based on the Joint Plan of Action, is an important ability. The president should have the ability to lift those sanctions if he’s on the precipice of a deal, otherwise there are serious diplomatic considerations. If they put it on the table and say that they don’t actually have the power to lift sanctions because Congress will not allow it – that is the sort of thing that will scuttle the deal.

We have seen this exact discussion play out over the past four months. There is a general desire for the President to have this kind of authority – but there are significant advantages for Congress to deny that kind of authority to him. Essentially this is a sophisticated diplomatic game of “good cop, bad cop.” The President will say that we can indeed lift the sanctions but Congress can insist on being placated with favorable terms as well. For the Iranians, this bartering position is much stricter, so there is more to concede in order to strike a deal.

In terms of actual way to go about providing the executive branch with the ability to lift sanctions, there are actually a number of tools. Much of the legislation that’s been passed recently – since 2010 or so – allow the President to waiver legal stipulations for national security reasons. For instance, he can say there is a national security reason why sanctions should not be imposed. Most of this sanctions legislation is also written in the permissive. So it will give the President the authority to impose these sanctions, but the President can choose whether or not to enforce them. In fact, what we’ve actually seen recently when the latest round of sanctions passed the House and Senate, they are permissive, with one small exception. They basically say that the President can go ahead and impose sanctions if he wishes, but is not required to do so under the law. Essentially this grants a large degree of flexibility, especially diplomatically.

SD: The issues of time limits and domestic political pressure have featured prominently in discussions surrounding the Iran deal’s feasibility. President Obama is nearing the end of his second term, and President Rouhani, while still in his first term, has lost key members of his inner circle and is in danger of falling out of favor with the conservative religious elite. Will limits on time and pressure to secure a foreign policy “victory” lead to one side or the other acquiescing to unfavorable terms?

Lorber: First of all, I do not think a deal is inevitable. I think there is a very strong incentive, especially for the US, to strike a deal. This is what Peter Feaver and I were writing about in our last Foreign Affairs piece – essentially that if you push for a deal now and try to get it signed as quickly as possible, and it’s not particularly acceptable to conservatives in the US or in Iran, then the sustainability of that deal comes into question. If people view this as a matter of signing the deal as quickly as possible to secure a diplomatic victory and that’s it, and then you have dissenting opinions that view the deal as suboptimal, then the likelihood it will last is extremely low. There’s an enormous list of reasons why a deal could be signed and then completely unravel within six months.

But it should be noted, most policymakers in Washington are not asking themselves, “How can we raise the cost of business high enough for the target country to bring that country to the negotiating table?” So I don’t know if that was the original intent. So it’s more a question of raising their costs as a punitive measure, and if it works secondarily as a future negotiating technique, then that’s even better.

SD: Won’t a deal more or less trigger a gold rush of private sector interest in the opening Iranian economy, and couldn’t that be a deterrent against any such deal unraveling after signatures?

Lorber: If you were to ask me if the deal was more likely than not to happen, I think it is more likely. Some contacts close to the dealmaking process last November told me that they were within 24 hours maximum of a deal right before Thanksgiving, and that they were 80% sure there would be a deal before the next deadline. It does seem fairly likely that something will come out of this, but some of these Iranian, European, and American companies are probably in for a rude shock if they try to go into the country full throttle. The main reason is that the lifting of sanctions will be piecemeal, and the ones that will be prioritized are nuclear-related, and haven’t been decided yet. If you look at most US sanctions against Iran, many of them have nothing whatsoever to do with the nuclear program, despite the fact that they are the target. The second major issue is that the partial opening of Iran is going to expose foreign companies in the EU and US to a much greater probability of violating the sanctions. If these companies go into Iran, but only some of the sanctions are lifted, they are going to try to perform these transactions, whatever they may be, and they will inevitably run into problems dealing with sanctions that are still preventing them from doing very basic things. My guess is, what we will see is that US and EU regulators will slam down on any company that goes into the Iranian economy full-tilt. They will still be at a risk for violating these other sanctions, which will still be imposed.

SD: Are there any organizations in particular that OFAC is pursuing for sanctions violations?

Lorber: Without listing any particular company names, there was a company in 2010-2011 – a Chinese bank – that was doing business with companies under designated Iranian sanctions. The US then sanctioned this bank, which caused a diplomatic uproar with the Chinese. While the US can go after these entities, it oftentimes will not because the political costs are so high. It instead relies on the idea that these companies know what they are doing, and could end up being significantly penalized by OFAC, and as a result will be deterred from doing it in the first place.

SD: Sanctions have thus far been praised as being instrumental in bringing Iran to the negotiating table, but they may also be difficult to repeal due to a newly Republican controlled House and Senate. Should a deal be reached next July – do you foresee a large debate within Congress to honor the terms of the deal or to torpedo it?

Lorber: That’s definitely the big question on everyone’s mind. At the end of the day, I think they would be unlikely to torpedo a deal that was already signed. But that will also depend heavily on the terms of the deal. Obviously, we will not see a deal that allows Iran to enrich uranium, so that’s clearly off the table at this point. The goal now is to extend Iran’s breakout time as much as possible – that is, extend the time frame in which Iran could theoretically kick out any IAEA inspectors and produce enough fissile material to create nuclear weapons. That goal is 12 months. If the deal included that, Congress would probably say that’s good enough. But if final terms are not ideal for the Obama administration or whoever is in power when the final agreement is signed, there’s a much lower likelihood that Congress will agree. Keep in mind that the US is also making significant concessions and in effect, giving up the power they had over the regime they wanted to get rid of. After the deal, it will be a lot harder to force Iran not behave in a way that the US wants. Thus, if the quid-pro-quo is not to Congressional standards, then there is no deal. But generally, I do not think they will scuttle the deal, and if they do, it will be contingent on what exactly the terms of the deal are.

SD: Lastly, even after sanctions are lifted – how willing are members of the private sector to invest or open up an economy like Iran’s or re-engage in Russia? Will the lifting of sanctions or restrictions really create a gold-rush type situation, or will most companies still be wary of loaning out money or creating oil and gas projects due to the risk of sanctions being re-engaged at any moment?

Lorber: In Iran’s case, we will not see a lot of large multinationals attempting to rush in because of the points we touched on earlier, because the sanctions will still be in force. There’s also a huge difference between Iran and Russia. US companies haven’t been in Iran in three decades – they don’t know how they operate, what business practices are like, how to navigate the bureaucracy. Corruption is touted frequently as an issue in the Iranian economy and there’s a huge area of legal practice that focuses on Foreign Corrupt Practices Acts (FCPA). The FCPA is US legislation which says that US individuals cannot bribe foreign officials in order to obtain business. That’s an oversimplification, but that’s the basic idea of the law. Thus, there would be a lot of trepidation because there would be expectations on the parts of Iranians for bribes, and US businessmen wouldn’t be able to do that. Additionally, for sectors like energy – capital investments for those sectors are usually very drawn out and large, and companies won’t make those sorts of investments in such an uncertain environment.

The situation in Russia is substantially different. On the flipside of Iran, US companies operating in Russia have partners in Russia and have been working there since 1990, roughly 25 years. They know how the economy works, even if it is corrupt and the size of Russia’s economy is also substantially larger than Iran so the incentive to go back in is much, much higher. There’s also a probability that once there is a reconciliation between the US, EU, and Russia that almost all of these sanctions will be lifted. Most of them are much more narrow than Iran’s, which are far more extensive. There would be much less risk in re-entering the country and accidently running afoul of residual sanctions than there would be in the case of Iran.