Global Trends in Trade Control 2023
Global trade controls are in a state of flux in 2023.
Trade controls (economic sanctions, export controls and FDI screening) are deployed more frequently by the United States, its partners and other major powers to achieve national security policy objectives. However, the term “trade controls” may no longer be broad enough to reflect the impact of 2023’s geopolitical headwinds.
Nowadays it may be more instructive to describe this phenomenon as “foreign transaction controls.” Governments are looking to weaponize all aspects of global business: finance, investment and trade (including on food and other non-traditionally strategic items).
Companies must now think about the full spectrum of foreign transaction risks.
Russia Remains a Reluctant Focal Point
One year into Russia’s invasion of Ukraine, the conflict has become a new center of gravity for the United States and its partners. There are few signs the war will soon end. It continues to distract the United States from fully shifting focus to the perceived long-range challenge posed by China. As such, the thirty-seven states comprising the counter-Russia coalition are planning more sanctions and export controls in hopes of compelling a conclusion.
Nevertheless, the effectiveness of Russia controls requires follow-through in two key areas: enhanced enforcement and the enlargement of the counter-Russia coalition. Both are illustrative of larger global trends.
Lack of enforcement has long been the moderator on trade controls’ true impact. This is true for Russia, or for any other target.
While the counter-Russia coalition succeeded in quickly imposing more-or-less harmonized controls, the enforcement of those controls on a member-by-member basis was always going to be scattershot.
Certain coalition members, like the European Union, are in the early stages of harmonizing criminal offenses and penalties for sanctions violations generally in response to the conflict. A year into the conflict the G7 is likewise ramping up discussions to establish an “Enforcement Coordination Mechanism” (ECM) to better share information and coordinate actions.
The reality is that any such effort would have a mostly medium-term effect, as an ECM would take time to establish and mature into effectiveness. There is also the reality that similar measures have been long-proposed and little enacted before.
The European Union planned an unrelated ECM as part of the implementation of Regulation (EU) 2021/821. The creation of the EU’s ECM – ironically – was stymied by EU authorities’ shift in focus to Russia’s invasion. Nonetheless, 2023 may well be the year enhanced enforcement leaps off the pages of white papers as a factor in global compliance.
The second necessity for maximizing the effect of the counter-Russia coalition is enlarging it.
The forging of the 37-country coalition against Russia was perhaps the most significant trade compliance event in 2022; but so far in 2023, that coalition remains unchanged.
Enforcement coordination is all well and good, but it will remain a high priority for the U.S. and coalition leaders to draw in new and reluctant partners. Some countries cannot easily join the effort to target Russia as they lack a legal basis to impose measures beyond UN sanctions. Bringing new trade control legislation forward is a lengthy process that is often not a political priority.
Other candidates may have more intrinsic reasons to avoid the counter-Russia coalition.
Of potential coalition candidates, the most prized might be India. However, India and the other BRICS countries (Brazil, China and South Africa) have remained relatively aloof from the counter-Russia coalition.
As India makes inroads on bilateral and plurilateral defense and technology cooperation with the West, it continues to place a premium on its own “strategic autonomy.” As India recorded record imports of Russian oil, it maintains the incentive to play both sides – the West for defense and technology, Russia for resources and equipment. India’s continued reliance on Russian S-400 missile systems is indicative of the tightrope walk their government must sustain. India’s arms-length view of the counter-Russia sanctions can be best summed up in one official’s remark: “The existing sanctions on Russia have had a negative impact on the world.”
Another impediment to coalition enlargement is that certain countries continue to benefit from their economic ties with Russia, even if that means serving as unofficial hubs for sanctions evasion. Turkey, the UAE, Armenia, Azerbaijan, Georgia and Kazakhstan have all been identified as funnels for controlled items to flow into Russia. Coalition enlargement means these governments would have to take an unconformable and potentially domestically unpopular position, before even considering the impacts coalition membership would have on their standard cross-border or regional trade.
Enlargement, like enforcement, is an uphill battle; both are indicative of rising trade control challenges regardless of target. Such challenges explain why Russia continues to suck the oxygen out of the West’s short-term strategic thinking. Ideally, the West would like to pivot to China, but that does not mean all is quiet on the Eastern front.
China Controls Balloon
Will 2023 finally be the year of the vaunted Pivot to Asia? No, but not for a lack of desire.
A proliferation of Cold War-era framing belies the fact that economic co-dependency between the United States and China is at an all-time high. Trade between the chilly adversaries soared to $690B, $42B more than 2018’s previous record of $658B. If anything, the decoupling is happening in reverse: in 2022, Chinese imports of U.S. manufactured products, energy products and services all declined. Sino-American relations are deteriorating in parallel.
This is most absurdly exemplified by the recent balloon shootdown which led to the cancellation of a senior diplomatic meeting. Combined with enduring concerns over China’s technological ambitions, export controls remain an attractive option for U.S. policymakers. In 2023, the U.S. has already again turned to the Entity List to target Chinese companies engaged in “malign” activities, this time related to the balloon incident.
For several years, the Entity List has been the U.S.’s first resort for countering China, and currently, over 600 Chinese entities are subject to the Entity List’s increased licensing scrutiny. The use of the Entity List is significant as it is deemed less provocative than an outright SDN sanctions designation, while still seriously impacting Chinese companies’ ability to acquire dual-use goods. Yet for some U.S. politicians, the current export controls are not enough.
The 118th Congress is considering almost 100 China-related bills at present. Seven bills directly relate to the use of sanctions on China and 11 target the Communist Party of China.
The now Republican-controlled House Foreign Affairs Committee (HFAC) and the newly inaugurated Select Committee on Strategic Competition between the United States and the Chinese Communist Party augur a new era of scrutiny on China controls. The HFAC Chairman announced that “[export controls] will be one of my number one priorities” for the committee and stressed that the U.S. should “[confront] the China challenge with substantive actions.”
One target of those substantive actions would likely be in Washington D.C. rather than Beijing: the Bureau of Industry and Security (BIS).
During the 2022 midterm elections, the GOP called for a review of BIS’s licensing practices as it relates to China and advanced technology. While little has been done aside from requesting large troves of documents from BIS, such efforts have a chance to reorient U.S. trade controls to China in an even more hawkish direction, with potential complications for companies around the world.
If, in the most drastic scenario, BIS is sidelined for being soft on China, such slack could be taken up by other offices, potentially even the sanctions-issuing Office of Foreign Assets Control (OFAC). A shift towards OFAC as the arbiter of advanced technology trade with China would risk a serious escalation of Sino-American tensions. So far, the U.S. has been resistant to placing any preeminent Chinese companies on the Specially Designated Nationals (SDN) list.
However, with China being just about the only bipartisan issue in Washington, it does beg the question: Will the United States make life even tougher for Chinese actors by resorting to use of OFAC’s SDN list?
China will not take this lying down. President Xi has consolidated his power to an extent not seen since Mao. The Chinese government has taken measures to enhance its own ability to countersanction. In February 2023, China sanctioned two U.S. defense firms for arms sales to Taiwan. China will undoubtedly resort to additional countermeasures as the U.S. ramps up the pressure.
One thing is for certain though, there is a reluctance of other countries to join the United States in targeting Chinese companies. At a time when multilateralism is a buzzword par excellence in trade controls, the U.S. has often been largely forced to go it alone on China. There are various reasons why other countries, particularly in Europe, have been hesitant to join the China crusade, but there is no denying the balancing act the U.S. must play with China. Especially, when such unilateralism would undercut other interrelated matters.
Overlapping and Overcoming Sanctions Regimes
With such importance placed on Russia and China, it is almost inevitable that other countries are caught in the web of controls. Perhaps most notably Iran.
Sanctions on Iran have long been a fact of life, but Iran’s newfound role as drone supplier to the Russian military means that there is little sympathy in the West for a course correction, much less after nuclear deal talks went into hibernation last autumn.
What is notable is not that Iran is being sanctioned, but that Iran sanctions are increasing in the context of sanctions on Russia. The European Union on its own homepage for Russia sanctions lumps new Iranian sanctions with those on Russia (see Figure 1). The US has issued a half dozen tranches of sanctions against Iranian persons for their support of Russia’s military. However, the U.S.-led strategy to further isolate Iran took a blow with the recently announced, China-brokered rapprochement between Iran and Saudi Arabia.
Figure 1. EU homepage for Sanctions against Russia
The rest of 2023 could be defined by de facto bloc-forming that Western sanctions have engendered by targeting Russia and China. Russia and Iran have already taken additional steps, such as the linking of their banking systems, and accumulating trade controls will mainly serve to push Western adversaries closer together. Aside from sanctions compliance, Russia, China, Iran and others now have greater incentives to band together for sanctions evasion. Particularly as China weighs entering the fray with material support for Russia’s war.
Most worrying for global companies is the fact that the lines between sanctions regimes targeting different countries are increasingly blurred. Thus, the challenge of trade compliance is doubled: adversary countries have an incentive to evade sanctions together, while the complexity of existing controls is only increasing for industry.
Priorities of Control
With so much change taking place in 2023, where do prior trends hold? The answer is the continued focus on emerging technology and human rights.
Emerging technologies (…excuse us: 1758 technologies) remain the holy grail for Western authorities to control. The problem is deciding how best to control cutting-edge or theoretical technologies is easier said than done. Industry and academic stakeholders often chafe against regulators’ control proposals for fear of foreclosing lucrative future business ventures or stifling in-progress innovation. While controls on emerging technologies have yet to be tackled in one grand regulatory swoop, controls on the grounds of human rights remain the more functional option.
In fact, the linkage between human rights controls and emerging technologies is doubly convenient. As summarized by China Focus, “[the U.S.] crafts human rights issues in a way that serves its national interest in standing up for its partners in peril and to slow Chinese technology acquisition and development.” Emerging technologies capable of infringing human rights are no longer monopolized by the West and this wider technological distribution is reflected in how nascent multipolarity is defining this period.
Bridging the Transition: Ad Hoc and Private
This year will see a deepening of the transition from a unipolar world. The challenge for the West is that it cannot rely on the international institutions forged during the unipolar moment to ride out the new era. Existing multilateral export control regimes, like the Wassenaar Arrangement, are hobbled by Russia’s membership.
This means the United States and its allies are seeking ad hoc arrangements to circumvent Russia on the one hand and to address tech issues vis-à-vis China on the other. Industry is taking its own initiatives to preemptively adjust and diversify supply chains to reflect unstable geopolitical realities and mitigate risks.
Figure 2. New Plurilateral Groups May Augment Existing Multilateral Regimes
Ad Hoc Arrangements
The existing multilateral export control regimes operate on the basis of consensus. The harsh reality is that Russia can block new efforts to tighten controls on emerging technologies via the Wassenaar Arrangement. As such, the U.S. and its allies have embarked on a process of creating new plurilateral arrangements, that while lacking the totalizing force of old regimes could compensate in the cumulative. All such arrangements are a hedge against the loss of China or Russia as reliable economic partners.
Such a rationale extends beyond export control to FDI screening. The U.S.’s CFIUS whitelist known as the “Excepted Foreign States” is now in force and enables Five Eyes countries to “benefit from exception from CFIUS jurisdiction over certain non-controlling transactions, real estate transactions, and mandatory filing requirements as established under law.” It is conceivable that efforts will be made to incorporate other allied states into similar arrangements.
Figure 3. Current CFIUS Excepted Foreign States
The cumulative effect of the efforts described above is to create an in-group of like-minded countries linked by common trade and control policies. However, this process is neither smooth nor linear.
A country like India may be happy to deepen cooperation with the West on defense manufacturing but not on Russia controls. A European state might jump at membership in the counter-Russia coalition but remain wary of a similar effort targeting China. As different governments negotiate a new normal of multilateralism, industry has been forced to react before such arrangements are finalized.
In conjunction with the pressure of tightening controls, industry is resorting to offshoring to less precarious destinations, nearshoring (or “friend shoring,” as Janet Yellen would call it), and scaling supply chain redundancies. Attempts at reviving a China + 1 strategy with countries such as Vietnam or India will likely become more common.
Such efforts are not without challenges of their own, either owing to political instability, poor infrastructure, or less available expertise. But such hedging is expected in a foreign transaction environment defined by risk.
2023 will be a significant year for trade compliance.
All foreign transactions are now potential pressure points for national security measures. Existing multilateral regimes are being reevaluated for geopolitical reasons. Acceptable business practices are evolving in line with the securitization of trade policy. Regardless of outcome, the global trends converge on complexity.
So what should compliance professionals keep in mind for 2023?
Circle the lawyers: review contracts and reps and certs to ensure relevant indemnifications; insert compliance expectation riders into supply chain agreements.
Expect the broadening of scope: trade control regimes can change quickly in response to international crises and foreign transaction controls can expand quickly (e.g., U.S. outbound investment in designated sectors in China.)
Pay attention to secondary markets: as supply chains become less secure, look to other countries as sources of resilience or diversification.
Stress-test your compliance: ensure audits are exacting and regularly done.
Recognize the new normal: geopolitical tensions will continue to grow; new regulations covering foreign transactions control policies will result.
Track trade control regulations and policies globally: although the United States will continue to enforce more aggressively, there are countries looking to add teeth to their export controls and sanctions as well.