Sanctions Secondary Risk for European Capital

The mechanism is correspondent banking and the dollar system. International trade, including European-to-European trade, frequently settles in U.S. dollars. Dollar transfers route through correspondent banks in the U.S., which are subject to U.S. primary sanctions. A European bank designated under U.S. secondary sanctions loses dollar clearing access — its ability to participate in the world's settlement currency.

~58% of cross-border transactionsSource · BIS Triennial Survey 2022Share of global cross-border bank lending denominated in U.S. dollars. The dollar's structural dominance gives U.S. secondary sanctions extraterritorial reach without explicit jurisdiction over non-U.S. persons.

The historical consequence: when the U.S. designates a non-U.S. counterparty, the European banking system, even where European law would permit the trade, withdraws because the cost of being secondary-designated dwarfs the value of the trade.

Recent enforcement that confirmed the pattern: the late-2023 Treasury action against several non-U.S. banks for clearing payments associated with Russia's military supply chain; the 2024 enforcement against UAE-based logistics intermediaries; the 2024 Hong Kong electronics broker designations. None of these counterparties had a U.S. nexus in the obvious sense. All lost dollar clearing within days.

What this means for European fund managers and acquirers: the LP base, the fund administrator, the custodian, the audit firm, the placement agent, and the underlying portfolio companies all run on dollar rails. Sanctions exposure is portfolio-wide, not deal-specific.

Regulation (EU) 2019/452 establishes a cooperation framework for screening foreign direct investment into the EU on grounds of security and public order. Member States operate national screening regimes on top: Germany's amended Außenwirtschaftsverordnung (AWV) covers acquisitions of stakes in critical-technology and critical-infrastructure companies; France's IEF screening covers similar categories; the Netherlands, Italy, Spain, Sweden, and Belgium have all expanded their regimes since 2022.

1,649 FDI screening cases in 2023Source · European Commission FDI screening report 2024Total notifications to the EU FDI cooperation mechanism in 2023, up from 1,200 in 2022. Critical infrastructure, dual-use technology, and biotech are the most-screened sectors.

Screening grounds, broadly: critical infrastructure (energy, transport, water, health, communications, data, finance); critical technologies (AI, robotics, semiconductors, cybersecurity, aerospace, defense, dual-use); critical inputs (energy supply, food security, raw materials); access to sensitive information; freedom and pluralism of media.

Practical implication: cross-border M&A into EU targets in any of these sectors should expect FDI review. The review can extend transactions by 60–180 days; conditions and divestment requirements are real. For a fund, the FDI review timeline must be modelled into transaction documentation: long-stop dates, MAC clauses, and bid structuring (especially for non-EU bidders) need to anticipate review.

The regime is hardening. The Commission's 2024 proposal to revise the FDI Regulation would require all Member States to operate a screening mechanism, expand mandatory cooperation, and broaden the sectoral scope. The trajectory through 2025–2027 is more screening, slower transactions, and more conditional approvals — not fewer.

Council Regulation 2024/1745 of 24 June 2024 introduced four mechanically significant changes that any operator with Russia-adjacent exposure has internalised:

(a) The "No-Russia clause." Article 12g requires EU exporters of certain goods (high-technology, dual-use, battlefield items) to contractually prohibit re-export to Russia. The clause must be in writing in the export contract and must include adequate remedies. This shifts EU regulatory risk into commercial documentation: a contract without the clause exposes the exporter to enforcement.

(b) Best-efforts obligation on EU parent companies. EU parent entities must use "best efforts" to ensure that non-EU subsidiaries (in any jurisdiction) do not engage in conduct that undermines EU sanctions. This is novel: the EU is reaching into corporate group governance to enforce its sanctions extraterritorially. National competent authorities are still working out what "best efforts" requires in practice.

(c) LNG and refined petroleum measures. Prohibitions on transshipment of Russian LNG in EU ports (with phase-in), tighter price-cap implementation on Russian-origin refined petroleum, and increased reporting on tanker activity.

(d) Designations expansion. Roughly 100 additional individuals and entities added to the asset-freeze list. The cumulative Russia asset-freeze list now exceeds 2,200 entries.

What this means for capital allocators: any portfolio company with Russia exposure (direct or indirect via subsidiaries, suppliers, or customers) needs an internal review against the new package. The best-efforts obligation in particular requires a documented compliance program at parent level, not just at the EU subsidiary level.

Five-step framework that has held across mandates:

Step 1: Counterparty screening. Every counterparty (LP, portfolio company, vendor, advisor, customer of portfolio company) is screened against U.S. SDN, EU consolidated, UK consolidated, and UN consolidated lists. Screening runs at onboarding and on a re-screening cycle (quarterly for higher-risk, annually for lower-risk). Tooling: enterprise-grade screening providers (Refinitiv World-Check, Dow Jones Risk Center, Sayari, ComplyAdvantage) with audit trail.

Step 2: Beneficial ownership transparency. The 25% UBO threshold in EU AML rules is no longer sufficient for sanctions purposes. The 50% rule from OFAC means a designated person owning 50% or more (alone or in aggregate with other designated persons) of an entity makes that entity itself blocked. Beneficial ownership has to be mapped below the AML threshold to satisfy the 50% rule.

Step 3: Trade flow audit. Every portfolio company with cross-border supply chain runs an annual sanctions audit of its trade flows: who do we sell to, who do we buy from, where do the goods physically move, what is the dual-use classification of what we ship. Trade flow audits surface the indirect exposures (a sub-supplier sells to Russia, a customer routes shipments through a sanctions-relevant jurisdiction) that primary counterparty screening misses.

Step 4: Contract instrumentation. New contracts include sanctions clauses with specific reference to EU 2024/1745's No-Russia clause where applicable, U.S. secondary sanctions awareness, audit rights, and termination triggers. Existing contracts undergo selective remediation, prioritised by transaction volume and counterparty risk.

Step 5: Incident response. When a sanctions issue surfaces (counterparty newly designated, customs seizure, regulatory inquiry), the response runs on a documented playbook: legal review within 24 hours, voluntary disclosure decision within 72 hours, transaction freeze pending review, root-cause analysis. Voluntary self-disclosure reduces enforcement penalties materially under both OFAC and OFSI policy.

The board-level discipline: sanctions exposure is reviewed quarterly, not annually. The pace of designations and new measures (>40 sanctions-related EU and U.S. measures in 2024 alone) requires continuous attention.

Three trajectories the operator tracks:

First: U.S.-EU divergence on enforcement aggressiveness. The U.S. has signalled willingness to use secondary sanctions more broadly, including against allies; the EU has signalled willingness to develop its own anti-coercion instrument and a more aggressive 15th sanctions package. The cross-Atlantic tension is now structural; transactional decisions need to model both paths.

Second: critical-input controls. The dual-use control regime is expanding into critical raw materials (rare earths, lithium, certain refined products) and into AI compute (export controls on advanced chips and chip-making equipment, US BIS rules and EU regulatory follow-on). For portfolio companies dependent on these inputs, the supply-chain risk is now sanctions risk.

Third: financial-sanctions enforcement on AI/crypto/digital assets. OFAC, OFSI, and EU competent authorities are building enforcement capacity for sanctions evasion via digital-asset rails. Tornado Cash designations and follow-on guidance signalled the direction; enforcement is broadening.

The implication for portfolio compliance: the cost of getting sanctions wrong is rising; the cost of staying current is also rising; and the only operationally credible posture is continuous compliance with documented controls, not periodic catch-up. The deals that perform best from here are the ones structured with sanctions-clean counterparties from inception, not retrofit later.