When it comes to sanctions, PE companies should be extremely careful – gotechbusiness.com


The economic sanctions imposed after the war in Ukraine pose a complex set of challenges for private equity (PE). Sanctions are driven by foreign policy and national security officials rather than regulators, so the landscape can change quickly and in the most unpredictable of ways.

Given the many sanctions imposed in recent months, PE firms need to be extra vigilant to ensure that their investors do not fall victim to the newly imposed sanctions. If so, PE firms will have to overcome the complexities associated with removing sanctioned investors from their funds.

After 9/11, the US passed sweeping anti-money laundering (AML) legislation requiring all financial institutions to understand who their customers really are. Shortly thereafter, the Treasury Department granted exemptions to certain categories of financial institutions, including hedge funds and PE. These waivers were intended to be temporary, but remain in effect today.

While financial institutions are subject to strict KYC (Know Your Customer) requirements, PE funds are not required to identify the source of customer funds or alert regulators about suspicious activity – a loophole.

Effectively managing sanctions risks in portfolio companies should start in the pre-investment phase.

Exploiting the loophole

Over the past two decades, many oligarchs and kleptocrats have exploited this loophole and parked billions of dollars without questioning the source of that wealth. They used empty corporations to push money through the tax heaven and eventually put the money in PE companies. Oligarchs and kleptocrats routinely rely on complex corporate structures to protect their wealth and bank on proxies to manage it.

Disentangling a limited partner (LP) property to determine exposure to sanctions can sometimes be a challenging process and requires in-depth due diligence. In today’s environment there is little to no margin for error. In addition, the typical tools that a financial institution relies on in an AML context are not sufficient to determine exposure.

Having expert knowledge of the most commonly used jurisdictions and structures, as well as experience in unraveling beneficial ownership, are critical to determining whether an LP is subject to sanctions.


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