Significant attention has been drawn to the adaptability of Russia’s defence industry and how it has diversified its supply chains, circumvented sanctions, and bolstered its ability to conduct its war of aggression on Ukraine. While scrutiny has been directed towards adversaries, such as Iran and North Korea, and intermediaries (e.g., China), including Western allies and partners (e.g., Türkiye and the United Arab Emirates), scant attention has been paid to Western business entities that are either directly or inadvertently contributing to Russia’s defence industry. This article aims to shed light on some of these Western entities and the complexity of dual-use components in international trade and supply chains. The analysis will be followed by a discussion on policy recommendations for better sanctions enforcement, focusing on multilateral governance, institutional and structural change, diverging philosophies of sanctions enforcement across Western states, and how Western corporate entities also bear a level of responsibility for how their products and intellectual property are being sold, to whom, and for what purpose.
The primary objective of sanctions on Russia has been to disrupt its ability to wage war against Ukraine and to deny it access to battlefield goods and critical components needed for its defence industry. However, Russia’s adeptness in circumventing sanctions and shift towards lower-quality inputs has made enforcement increasingly labyrinthine. This complexity arises from dual-use components that have civilian and military applications and how interconnected global trade and supply chains operate. As multinational corporations operate within various jurisdictions globally – engaging in extraction, production, shipping and sales – an intricate web of supply chain logistics obscures where high-priority and critical components end up. This also means that customs agencies and sanctions enforcement require institutional and legal resources to navigate through numerous layers of legislative frameworks and business operations, making it difficult to effectively monitor and control the flow of goods and resources across the international market. This is further complicated by the reality that Russia is utilizing shell companies and loopholes to gain access to battlefield goods and critical components. Moreover, inadvertently involved multinational producers and their production subsidiaries, and small-to-medium size enterprises (SMEs), are also faced with a conundrum due to increased supply chain complexity, international sales, and sanctions enforcement. This is compounded by realities that SMEs do not possess – especially in developing markets – the resources to ensure that the goods and components in question are not sold to the Russian defence industry through shell companies along the supply chain.
According to a study by the KSE Institute, Russian imports of battlefield goods before the invasion (January 2021 – February 2022) averaged $1.04bn per month and $3.21bn in critical components used in Russia’s defence industry, whereas after sanctions were imposed (March-July 2022), battlefield goods and critical components imports drastically dropped ($565mn and $1.69bn per month). This represented a 45.5% and 47.4% decline, respectively. However, from August to December 2022, Russia adapted its supply chains, with battlefield goods and critical component monthly imports respectively averaging $1.01bn (84.1% higher than during March-July 2022) and $2.41bn (42.8%+) per month. In 2023, from January to October, imports of battlefield goods reached $8.77bn in that nine-month period, with critical components coming in at a whopping $22.23bn worth. Obviously, Russia is finding ways to circumvent sanctions.
The KSE Institute evaluated Russian trade flows on battlefield goods and critical components, and although Western nations have drastically reduced direct exports of battlefield goods and critical components to Russia, the study shows that almost half of all the goods in question stemmed from multinational corporations based in Western countries. This is due to the flow of dual-use components before Russia’s invasion, and critically, that Western-based parent companies have production in third-party intermediaries that are not a part of the sanctions coalition, including China, Hong Kong, Turkey, United Arab Emirates and among others. Moreover, while businesses inside China, Turkey, and the UAE were responsible for the majority of sales and shipments to Russia in 2023, this analysis lacks a comprehensive understanding of supply chains and the role Western-based companies play in Russia’s defence industry.
Data shows that Western-based multinationals were responsible for 43.9% of battlefield goods and 32.8% of critical components from January to October 2023, with U.S. companies alone accounting for 25.5% of battlefield goods and 15.1% of critical components, followed by the EU and Taiwan. Companies from the United States implicated in this include Intel, Analog Devices, AMD, Texas Instruments, and IBM, with South Korean giants, Samsung and Hyundai also being prominently represented. Within the production process, trade data shows that Western business entities from January to October 2023 accounted for 20.9% of battlefield goods and 27.2% of critical components making their way to Russia, including entities in the EU, Japan, Taiwan and the United States. Western business entities from January to October 2023 were involved in 9.7% of battlefield goods and 11.8% of critical component sales to Russia. This process shows that countries that have enacted sanctions against Russia and their businesses decrease their direct linkage to Russia and instead, are inadvertently selling battlefield goods and critical components via third-party jurisdictions. However, this also shows that Western-based multinationals are either unable or unwilling to provide compliance and enforcement on the sale of sanctioned goods and components downstream through the international market.
Ukraine’s National Agency for Corruption (UNAC) collected 2,800 individual components found in Russian weaponry, including missiles, drones, armoured vehicles, and other systems, of which 95% originate from producers in Western countries, with U.S. entities accounting for 72% alone. The KSE Institute examined 250 companies linked to these components, including U.S.-based Broadcom, Hewlett Packard, Honeywell International, Kingston Technology, and Microchip Technology, as well as Hitachi (Japan), Infineon Technologies (Germany), NXP Semiconductors (Netherlands) and STMicroelectronics (Switzerland). U.S.-based Analog Devices and Texas Instruments are well represented due to being semiconductor and integrated circuit corporate behemoths, making their components vital to Russia’s defence industry. Traces of Analog Devices and Texas Instruments components were discovered in almost all analyzed weapons, representing 14% and 13% respectively of all foreign components identified by UNAC.
Critical to Russia are Computer Numerical Control (CNC) machines and Western business products still inadvertently participating in its defence industry. CNC machines are automated industrial tools and are extensively used in aerospace, automotive, metalworking and electronics. Due to CNC’s unique features and accuracy, they are critical for the defence industry, especially in the production of weapons hulls, aircraft parts, missiles, and drone/UAV components. Consequently, the Russian defence industry is a key consumer, with the industry using 70-80% of CNC machines in Russia. From January to October, 2023, Russia’s imports of CNC machines were 88% higher than in the pre-full-scale invasion period. This indicates that Russia substantially developed its defence production in 2023. Western-based companies such as Germany’s DMG Mori and Japan’s FANCUS could also still be involved in the CNC machines that make their way into the Russian defence industry.
The KSE Institute’s dataset also shows that Taiwan-based I Machine Tools were intricately involved in the sale of CNC Machines in Russia, either directly, or through third-party intermediaries in China and Turkey. A Washington Post investigative team also revealed that I Machine Technology has a long history of collaborating with Russian businesses, with an executive being observed at a summer retreat in Sochi in June 2023. It is believed that the Russian-based company, Machine Technology, is a branch of I Machine Technology. According to the Post, Taiwan-made machines accounted for virtually all of the Russian company’s imports from January to July, of which the company sold overwhelmingly to Russian efforts to mass-produce attack drones and to Avangard, a key supplier of missiles used by Russia’s S-400 air defence system. While direct shipments have reportedly ceased, they have filtered through China and Turkey. Details from Russian trade data provided by the Center for Advance Defence Studies indicate exports were dispatched through 63 separate shipments. Enforcement on export CNC machines is complex, as “CNC machine tools are quintessential dual-use goods”, Allen Maggard, from C4ADS said, as they remove human error and increase productivity. This creates an increasingly difficult and complex issue for sanctions enforcement due to the nature of the international sales of dual-use products and for export and customs authorities in countries that have agreed to enforce the sanctions.
Sanctions Reform
The current sanctions enforcement system poses significant challenges for the Russian economy and its defence industry, yet its effectiveness remains insufficient. The complexity of existing control regimes is increasing, mirroring the expanding scope and scale of sanctions that target various entities, products, and technologies. The sheer volume of transactions in the Russian supply chain, for instance, exceeding 800,000 between January and October 2023 in battlefield goods alone, indicates the scale of the institutional enforcement challenges. This complexity is overwhelming institutional entities’ capacities to ensure sanctions enforcement and monitor the diverse destinations of goods, particularly those with dual-use applications. Compounding this complexity are the disparate jurisdictions with varying institutional frameworks, legal parameters, and resources, each possessing differing expertise in sanction monitoring and enforcement. Furthermore, the intricate nature of global trade, foreign direct investment, and production supply chains further complicate efforts.
Additionally, states are also driven by comparative economic interests in specific sectors and obligations through international trade and investment treaties. This political-economic factor influences the regulatory framework and allocation of institutional resources. Moreover, trade promotion and domestic industries that operate through international trade to promote competitiveness operate to maximize profitability and market share, and complicated sanctions enforcement mechanisms without clear and relatively seamless guidance, create unnecessary regulatory obstacles for businesses. Moreover, politically, the variability of political will from political elites that seek to safeguard respective industries and business entities that lobby to protect or bolster their international market share and assets creates a political obstacle to sanctions enforcement and institutional resource allocation. These political-economic factors create a political complexity for foreign policy considerations and sanctions compliance, with negative notions of extraterritorial jurisdiction and/or domestic customs agencies being too heavy-handed with compliance and enforcement, and the effect this can have on domestic economies and critical sectors in a globalized market. Consequently, all these complications add directly and indirectly to loopholes and a lack of accountability for business entities to exploit either consciously or inadvertently.
Establishing a Multilateral Institution
To enhance sanctions enforcement against Russia, this report recommends the establishment of a multilateral sanctions body among allies and partners, improving institutional capacity and promoting and supporting corporate and SME accountability. A multilateral institution would serve to align, harmonize, and expand sanctions while pooling resources, sharing best practices, and streamlining compliance efforts across partners that adhere to the comprehensive sanctions regime. This proposal evokes the Cold War-era Coordinating Committee for Multilateral Export Controls (CoCom), which was disbanded in 1994 when efforts were made to integrate Russia into sanctions enforcement mechanisms. Presently, the Wassenaar Agreement exists as a multilateral forum, but its efficacy in sanctioning Russia is questionable. Russia’s veto of regulations concerning microeconomics and other dual-use components in 2022 underscores this point. Hence, there is a pressing need to establish a new strategic multilateral export control regime for the 21st century that also considers the durability of international supply chains and market-based best practices. Thus, the dynamics of this regime would be different than the Coordinating Committee on Multilateral Export Controls, not least because of the vastly different dynamics of international trade in the 21st century.
Global trade now takes up a significantly greater role in the supply chains and the economic vitality of Western nations. This is witnessed in multinational corporations’ investments in production facilities that manufacture battlefield goods and critical components transnationally. Moreover, Russia’s defence industries are increasingly reliant on less sophisticated dual-use products, creating another level of complexity for enforcement. As such, while the Coordinating Committee for Multilateral Export Control may serve as inspiration, it cannot be directly replicated as a template in the current context of international trade, supply chain logistics, and sanctions enforcement. Nonetheless, the necessity for a new institutional multilateral body comprising Allied nations with sanctions on Russia and its entities is becoming increasingly apparent. This forum would facilitate the harmonization of sanctions across the existing 50 countries in the international sanctions coalition, offering benefits to both larger and smaller members alike.
While major players such as the U.S., EU, and the UK’s new Office of Trade Sanctions Implementation (OTSI) have bolstered, and are looking to increase capacity and technical expertise in, sanctions enforcement, smaller members often lack the resources and skilled personnel necessary for effective implementation and compliance enforcement. Therefore, major nations with effective sanctions enforcement agencies and institutions must show leadership by sharing institutional knowledge and providing technical assistance to enhance enforcement capabilities amongst allies and partners. This support extends beyond mere financial resources and includes structural deficiencies also amongst large organizations and economic powers. For instance, the EU’s current approach, governed by its treaties (TFEU/TEU), is primarily delegated to member states, which have their own jurisdictional apparatuses, institutional and structural complexities, and in many instances lack the know-how and resources to enforce and implement the sanctions regime. Another example includes the EU Council’s seemingly weak response to legal action, including the EU’s personal sanctioning system (i.e., sanctioned individuals) which is in ‘crisis’ due to Russian oligarchs suing in EU Courts and winning. This has resulted from the cavalier documentation of sanctions by the EU Council and a lack of comprehensive clarity across jurisdictions. Another disjointed example is from the major economic power Japan and its sanctions regime, which is governed by the Foreign Exchange and Foreign Trade Act, which regulates international trade. However, institutionally, Japan does not have a comprehensive coordinated legal and enforcement structure, nor does it operate through civil law; instead, enforcement and coordination rely on the Ministry of Economy, Trade and Industry, Ministry of Finance and where needed, the Public Safety Commissions and Criminal Financing Punishment Law in the Ministry of Justice. These institutional bodies are relatively competent in many sanctions enforcement and monitoring tasks. However, due to the vast complexity and fluidity of international trade and supply chains (especially in dual-use components), the coordination of international sanctions enforcement in a globalized marketplace is disjointed, at best.
These realities create an increasingly difficult enforcement and monitoring landscape for the sanctions coalition, as the sanctions expand and the Russian defence industry uses dual-use components and circumvention tactics in the international supply chain system. Additionally, this disjointed approach limits customs agencies’ effectiveness in the supply chain, as financial transactions are fragmented through transnational boundaries and financial capital is relatively fluid. Couple this with the reality that the production of goods and critical components in question are increasingly located in intermediary jurisdictions that are not enforcing sanctions. This means financial transaction agencies need to be better incorporated into the institutional structure of customs agencies across the democratic world. Without financial agencies, investment transactions in production facilities that are part of the Russian defence industry’s supply chain will continue.
In June 2023, Fives Eyes, which includes Australia, Canada, New Zealand, the UK and the United States, formalized coordination and information-sharing on export control enforcement. Moreover, the United States has been establishing an Allied partnership framework, including 38 jurisdictions, such as the EU, the UK, Taiwan, and Canada. Therefore, there is an appetite amongst the Allied partners to coordinate for better sanctions enforcement and pool resources, as well as less impact on domestic sectors and seamless business processes and activity operating through international trade norms and provisions. This appetite for coordination can also be witnessed in the Ukraine Defense Contact Group, which is led by the United States Department of Defense. The group is comprised of NATO members and roughly eighteen other nations and organizations, including Japan, South Korea, Australia, New Zealand, the EU, and Taiwan. This group of about 50 nations meets monthly to discuss Ukraine’s security needs. While the U.S. generously coordinates the UDCG, it can not be assumed that the responsibility for coordinating a new CoCom falls solely to the U.S. Commerce Department, but rather, that the U.S. Commerce Department can use its institutional memory and best practices in conjunction with the sanctions coalition to create a new advisory group on how best to reestablish a new multilateral Allied sanctions regime. This could include a partnership framework through the U.S. Commerce Department, the UK’s Department of Business and Trade, the EU Council, and a recommended new body for joining the Japanese METI, MOF and Ministry of Justice, amongst other coalition partner’s applicable institutions and agencies. Moreover, a new multilateral CoCom should include a supplementary grouping for individual developing nations that look to collaborate and seek greater diplomatic and economic access to Western nations’ foreign direct investment and other economic preferences. In this instance, it must be abundantly clear through diplomatic dialogue that the West is open to business with friendly partners that wish to develop their economies in conjunction with complying with provisions that Western-based FDI must not foster industries that supply battlefield goods and critical components to Russia.
Additionally, Information sharing is critical through a multilateral regime, as pooling compliance efforts, sharing knowledge, and targeting strategies need information and data to make evidence-based decision-making actionable and traceable. Enhancing multilateral cooperation should prioritize improving the exchange of information on trade and financial transactions, particularly concerning critical military or dual-use components. Publicly available data can serve as a valuable resource when coordinated and processed through the framework, facilitating better understanding and enforcement of sanctions. Collaboration with academics and think tanks (i.e., KSE Institute, CSIS, Stanford, to name a few) can further enrich this process by providing additional data and insights. By harnessing the collective intelligence of various stakeholders, the multilateral regime can significantly enhance its effectiveness in enforcing sanctions against Russia and its entities.
Sanction Philosophies
A critical difference among Western nations’ sanctions regimes lies in the jurisdictional philosophies on enforcement and the utilization of extraterritorial mechanisms. Given that a significant portion of export-controlled goods are manufactured on behalf of companies headquartered in coalition countries but produced and shipped from other locations, it is imperative to ensure that export control provisions extend beyond jurisdictional boundaries. The United States, for instance, adopts an extraterritorial approach through its Foreign Direct Product Rule (FDPR), which ensures export controls apply to goods with significant U.S. contributions, regardless of where they are produced or traded. However, challenges persist, as U.S.-based companies remain intricately involved in the supply chain through intermediaries. Authorities face difficulties in obtaining clear data for cross-checking voluntary corporate reporting to monitor FDPR compliance and conduct on-site checks. To address these issues, the U.S. Department of Commerce’s Bureau of Industry and Security has amended the Export Administration Regulations (EAR) to strengthen export control rules targeting Russia and Belarus, extending the reach of FDPR.
In contrast, the EU is deliberating the implementation of regulations akin to FDPR, such as features in its 11th sanctions package. However, these regulations do not ensure the same extraterritorial application on export controls as FDPR. The EU maintains reservations about secondary sanctions, considering them contrary to international law, and prohibits companies from complying with such measures via its blocking statute (i.e., Council of EU Regulation No. 2271/96). This blocking statute places EU businesses in a dilemma, as it de facto delegates the resolution of conflicts between governments to private companies. For instance, when the United States renewed sanctions on Iran in 2018, EU companies juggled the prospect of losing access to the U.S. dollar and markets with risking being fined by the EU for violating the blocking statute. Nonetheless, the 11th sanctions package from June 2023 introduces a new anti-circumvention mechanism. This tool allows the EU to impose restrictions on companies found violating EU sanctions, and if deemed necessary, restrict the sale, supply, transfer, or export of sanctions goods and technology to certain third countries posing a continued and particularly high risk of circumvention.
Corporate and Professional Accountability
Lastly, corporate and professional responsibility play a pivotal role in ensuring effective sanctions enforcement, particularly within Western-based corporate entities. While specific initiatives akin to anti-money laundering and anti-terrorist financing regulations can be used as guidance and inspiration for compliance reform, rectification of distribution networks entails substantial resources from corporations and SMEs. Therefore, governments must augment accountability and enforcement mechanisms, compelling multinational entities that engage directly or indirectly through third-party intermediaries to comply with sanctions imposed by their home countries or lose contracts and investment opportunities.
Drawing lessons from the financial industry’s ‘know your client’ practices which have been instrumental in anti-money laundering and anti-terrorist funding schemes, non-financial corporates can adopt similar best practices, emphasising the exchange of information. Utilizing the Harmonized System (HS) of codes, which is administered by the World Customs Organizations (see specific policy examples from the U.S., EU, and Canada), with clearly defined procedures, exceptions, and reporting obligations, can facilitate both enforcement agencies and private sector entities in streamlining due diligence processes. Moreover, collaborating with the financial industry to track transactions is crucial in this endeavour. A dual approach, comprising incentives and penalties, is necessary. Incentives entail providing better guidance and digital coordination tools to streamline compliance efforts for large multinational corporations. Meanwhile, a separate government or private-authorized entity could be established to offer resources and clear guidance to small and medium-sized enterprises (SMEs) globally regarding export controls, exceptions, and legal requirements.
On the enforcement front, a proactive approach is imperative. Multi-jurisdictional procedures, with coalition authorities collaborating on investigations, charges, and fines, are essential. Currently, legal proceedings are infamously slow at investigating and adjudicating cases about sanctions violations. Moreover, this is also impeded by Western lawyers utilizing the complexity of corporate structures to help sanctioned individuals evade legal proceedings and sanctions in Western markets and jurisdictions. U.S. domestic legal structures are particularly receptive to sanctions violations by individuals operating in Western corporate entities. This is due to the relatively extremely high level of confidentiality, lack of reporting, and client due diligence obligations provided by major U.S. firms. According to Stanford’s Working Group on Sanctions, this could be remedied by the re-introduction and passing of the ENABLERS Act, “which would require lawyers, accountants and other professionals to conduct due diligence on their clients’ identities and report suspicious activity to U.S. authorities, as banks are already required to do.” In summary, current legal parameters and factors in turn create cross-jurisdictional legal impracticalities and over-complexity in a hot conflict such as Russia’s invasion of Ukraine. Instead, institutional resources must be allocated to expedite legal proceedings and reform legal loopholes, as current processes are often sluggish. Provisional application of penalties for severe cases, including the potential suspension of export licenses, quotas, or bans, could further bolster enforcement efforts. Publicizing fines can also enhance accountability and underscore the seriousness of enforcement regimes. By combining both incentives and penalties, Western nations can effectively encourage corporate responsibility and enhance sanctions enforcement mechanisms.
Conclusion
This report has illustrated that it is not only Russia, Western adversaries and third-party intermediaries that are supplying Russia’s defence industry with the means to create weapons to attack Ukraine and its civilian and energy infrastructure, but also Western-based corporate entities as well, at least inadvertently. The intricate web of global trade and supply chains presents a significant challenge for sanctions enforcement aimed at curtailing Russia’s ability to procure battlefield goods and critical components for its defence industry. Moreover, despite efforts to disrupt these flows, Russia has demonstrated adaptability in circumventing sanctions, utilizing shell companies, third-party intermediaries, and loopholes in international trade regulations and business practices.
Ultimately, Western business entities, whether knowingly or inadvertently, continue to play a role in supplying Russia’s defence industry, underscoring the complexity of dual-use components in productive industries. Efforts to curb these flows must address not only direct exports but also the broader ecosystem of investment, production, shipping and sales throughout the supply chain. This, however, requires enhancing cooperation and vigilance among global stakeholders. As long as vulnerabilities in the supply chain persist, Russia’s ability to sustain its defence industry will remain and foster its capacity to wage a war of aggression on Ukraine. Policy, akin to a battle plan, necessitates adaptation to emerging realities and unforeseen setbacks, all of which must be met with resilience.
This report has highlighted the need for comprehensive reforms in sanctions enforcement, focusing on multilevel governance, institutional capacity-building, and critically, corporate and business accountability. By establishing a multilateral sanctions body, allies can enhance coordination, harmonization, and information-sharing. Such a forum could address the evolving challenges posed by interconnected global trade and supply chains and limit the duplication of efforts in coordinating responses by identifying and tracking, where possible, dual-use components and investments in production facilities in intermediary jurisdictions. Moreover, the analysis of this report emphasizes the importance of aligning sanction philosophies and enhancing corporate responsibility. Jurisdictional differences in enforcement approaches, such as extraterritorial mechanisms, need to be reconciled to ensure a unified and effective response. Additionally, incentivizing compliance and imposing penalties on non-compliant entities would also strengthen accountability and deterrence.
Photo: “Cargo ship, logistics industry”, rawpixel. Licensed under Public Domain.
Disclaimer: Any views or opinions expressed in articles are solely those of the author and do not necessarily represent the views of the NATO Association of Canada.
