Economic Sanctions and the Capital Market: How Financial Institutions Keep Themselves Unscathed

We’re living in turbulent times. Afghanistan, Iraq, Yemen, Libya, Mali, Ukraine, and Syria are just a few contemporary examples of theaters of conflict that have our world on tenterhooks. These conflicts are complex and enduring, and they have far-reaching repercussions – also for the world economy – because foreign-policy disputes often bring economic sanctions in their wake.

Economic sanctions are penalties applied by one country against other self-governing states, individuals, or companies. For example, when Russia annexed the Crimean peninsula from Ukraine in 2014, countries in the Western world imposed sanctions in an attempt to thwart the funding of Russia’s actions. One consequence of this was that Western banks were no longer allowed to extend credit to certain companies in Russia. But the capital market was also affected. There, for instance, was a ban on investing in new debt securities issued by certain Russian banks and enterprises.

The “know your customer” principle obligates banks to run rigorous identity verification checks on their clients to protect themselves from being misused as conduits for money laundering, terrorist financing, or other financial crimes. This also means that banks must refuse to accept inflows of money from sanctioned markets and sanctioned individuals. Conversely, financial institutions must make sure that no money flows from them to markets or companies under sanctions. Financial institutions that fail to comply with sanctions face hefty fines and reputation damage.

Economic sanctions have been in existence for decades, but the use of them has intensified in recent years. At the same time, sanctioned individuals and countries have been going to ever greater lengths to conceal shareholdings and financial interests to circumvent sanctions. It is thus becoming increasingly important but also ever more difficult for financial institutions to comply with sanctions, as evidenced also by the substantial surge in demand for the Sanctioned Securities Monitoring Service from SIX in recent years.

The Sanctioned Securities Monitoring Service (SSMS) enables financial institutions to keep track of the growing number of sanctions. With the SSMS, SIX monitors over 8.3 million financial instruments and more than 375 million corporate entities. Financial institutions that subscribe to the service receive a daily scrubbed list of all securities linked to sanctioned individuals, companies, and regions.

The algorithm also uncovers complex entanglements. For example, if a name appears on the list of sanctioned individuals, not only is that specific person flagged as sanctioned, but so are all companies in which that person holds an equity interest of more than 50%. If a flagged firm is a holding company that owns a stake of more than 50% in another enterprise, that subsidiary also is flagged as sanctioned. This web can extend ever farther to encompass even several hundred companies in some cases.

SIX recently began providing the SSMS also for exchange-traded funds (ETFs). After acquiring ETF and index data provider Ultumus, in July 2021 SIX expanded its data coverage to include passive mutual funds. Ultumus covers 97% of the global ETF market (almost 10,000 ETFs). For the SSMS, SIX identifies all ETFs that contain shares of sanctioned companies, consolidates the data, and passes it on to financial institutions. With the new service for ETFs, SIX now also covers a financial instrument that has gained enormous popularity in recent years and thus gives financial institutions even better assistance in navigating their way through the torrent of sanctions.

By the way, it can also be advantageous for retail investors to avoid investing in ETFs that contain securities affected by sanctions because exposure to sanctions often causes them to lose value and thus hurt the performance of ETFs.