Analysis: Russia sanctions have potential unintended consequences for trust services
Frank Flanagan and Daragh O’Shea, partners at Mason Hayes & Curran LLP, warn of potential unintended consequences of EU sanctions on Russia.
Council Regulation (EU) 833/2014 (as amended), concerning restrictive measures in view of Russia’s actions destabilising the situation in Ukraine, set out an extensive set of prohibitions on trade in goods or services with or to any person, entity or body in Russia or for use in Russia.
The Regulation was recently amended by Council Regulation (EU) 2022/576, which amongst other things, introduced a new Article – Article 5m. With very limited derogations, this new article imposes restrictions on the provision of (what are generally called) fiduciary and corporate services, to trusts or similar arrangements, where the settlor or beneficiary of the trust is (broadly) a Russian legal or natural person, or a person controlled by or acting for, such Russian persons. This drafting is wide and so potentially has a significant impact on the business and operations of corporate services providers (CSPs).
What is restricted?
Article 5m appears to be designed to capture persons holding assets in trust for Russians. However, it is poorly drafted and appears to go further than is necessary or appropriate. To take some examples, it is at least arguable that the following would fall within the ambit of the Regulation:
- If an employee share ownership trust holds shares in trust for 1,000 employees of a company, one of whom happens to be Russian, and 999 of whom are not, it appears that the trustees would be obliged cease acting to the detriment of all of the beneficiaries.
- If a security trustee holds security for 10 syndicated lending banks, one of which happens to be Russian, the trustee would be obliged to cease acting.
- If a common depository holds the legal title to debt securities (such as bonds or loan notes) on behalf of a clearing (share settlement) system, but the ultimate beneficial bond/note-holders up the custody chain includes Russian persons, the common depository and intermediate custodians would be obliged to cease acting.
One example that we are of the preliminary view is not captured is in respect of orphan trust holding structures.
The orphan structure is commonly used by debt issuance SPVs that issue bonds or loans notes in debt capital markets and securitisation transactions. This structure is important as it allows the SPV to establish its independence, and insolvency remoteness, from other transaction parties. Under the structure, a professional trustee is appointed to hold the shares in the SPV as a nominee, on trust for a charitable purpose. The SPV then issues the bonds/notes and is able to use the funds to (e.g.) on-lend to an associated company to fund business activities (in a corporate debt transactions) or fund the purchase of a securitised portfolio of assets (in a securitisation).
The reason that this is not caught is because the beneficiary of the orphan trust is the charitable purpose.
This is sensible as the sanctions are not designed to prevent the outflow of money from Russia/Russian entities in order to repay their debts to bond/note-holders on existing transactions. Moreover, if the legal title to debt securities issued by the SPV are held by a common depository on behalf of a clearing (share settlement) system, assuming there are no Russian ultimate beneficial owners of the debt securities (which, admittedly, could be hard to establish in practice), the common depository could continue to act.
However, if the above scenario is altered slightly and the Irish SPV is a 100 per cent subsidiary of a Russian entity, rather than an orphan, the SPV would be a legal person controlled by a Russian legal person. Accordingly, if it placed anything, for instance debt securities, into a trust, the trustee(s) would be obliged to cease to act.
Separately, it is unclear what is meant by “any similar legal arrangement”. We are aware that the Ministry for Finance in Cyprus has issued guidance to the effect that this does not extend to companies and that Step Europe has taken a similar view. However, we are not aware of any EU or Irish guidance on this point. Prima facie it appears arguable that an executor under a will, one of the beneficiaries of which is Russian might be obliged to cease acting (section 10(3) of the Succession Act 1965).
While well intentioned, we are of the view that Article 5m requires clarification, if it is not to have significant unintended consequences. Article 5m requires trustees, including corporate service providers, who hold assets in trust for beneficiaries, some, but not all, of whom are Russian to simply cease acting, in breach of their fiduciary duties. We are of the view that it would be more appropriate, and effective, to simply prohibit the disbursement of money or assets to the Russian beneficiaries and perhaps require disclosure of those beneficiaries.