Washington Perspectives offers our clients and friends an overview of notable developments impacting the global economy, international trade, and U.S. foreign policy. In this newsletter, our lawyers provide not only the salient facts about current events and trends, but also the benefit of our perspective, drawn from the combined decades of experience of our senior global trade and policy team, on how those events and trends might influence the actions of lawmakers, policymakers, enforcement authorities, and private actors on the world stage. We hope you find this to be a useful tool in evaluating the global landscape and how international developments affect your business.
The consequences of the conflicts in Eastern Ukraine and Israel continue to dominate the foreign policy agenda in Washington, D.C. The military conflict between Israel and Hamas in Gaza recently occupied much of the attention of U.S. Secretary of State John Kerry, who has made a personal effort (to date unsuccessful) to broker a ceasefire. But it is the events in Eastern Ukraine, culminating in the downing of Malaysian Airlines Flight 17, that likely will have the more lasting impact on U.S. foreign policy.
The complicated web of interdependent economic ties between Russia and the Western European nations (particularly Germany, Italy and France) had largely prevented the EU from leading the global response to the events in Ukraine, notwithstanding the proximity of the region to Europe, the desire of leaders in Kiev to ally economically with the EU, and now, tragically, the loss of so many European citizens on a commercial flight that originated in Europe. It has thus fallen to the United States to supply the strongest response, a situation that will have difficult consequences for the U.S.’s future dealings with Russia and Vladmir Putin.
Sectoral Sanctions Against Russia. In the hours before rebels in Eastern Ukraine shot down the passenger airliner, using weapons systems and specialized training that the U.S. believes were supplied by the Russian military, the United States had already reacted to the increased Russian technical and military support by imposing what were, at the time, the strongest sanctions to date against sectors of the Russian economy, including such prominent players as Rosneft and the financial arm of Gazprom. (To read Paul Hastings’ summary of that initial set of “sectoral sanctions,” click here.) President Putin was on the telephone with President Obama, complaining loudly about the new sanctions, when the first reports on Flight 17 started coming in.
The EU has now finally shed some of its reticence and joined the U.S. in imposing sanctions on broader sectors of Russia’s economy, including major Russian banks, as its “go slow” approach became less politically tenable following the Flight 17 incident. The latest sanctions, described here, represent a signal development and a substantial new step in what is now likely to be an expanding effort by the West to ratchet up the financial pain on Russia and President Putin, to be eased only if the latter takes concrete action to withdraw support for and de-escalate the spiral of violence in Eastern Ukraine. Rosneft, Gazprombank, VTB, the Russian Agricultural Bank and the Kalashnikov conglomerate, all of which are among the entities newly targeted by the U.S. and the EU, are neither small nor insignificant concerns, demonstrating that the West is not afraid to impose measures with real bite.
The ripple effects of the expanding sanctions are only just beginning to be felt, as parties across the globe begin to re-evaluate the risks of conducting, financing and insuring business with Russian companies.
Yukos arbitration ruling. In addition, in an unexpected development, an arbitration panel of the the Permanent Court of Arbitration in The Hague issued a lengthy ruling in late July on the long-pending claim of the former shareholders of Yukos Oil – at one time the largest oil producer in Russia – against the Russian government. The panel concluded, in a 600-page ruling, that Russia had carried out a “devious and calculated expropriation” of Yukos’ primary business, and it awarded the complaining shareholders $50.08 billion in compensation – the largest arbitration award on record.
This ruling will spawn a legal sub-industry as the claimants seek to identify assets against which they can enforce the award, and as Russian interests forcefully defend against any payout. Rosneft, which acquired much of its current business by successfully bidding for the assets of Yukos auctioned by a Russian bankruptcy tribunal after the prior owners were displaced, quickly claimed that it had nothing to do with the expropriation and thus cannot be tarred with any misconduct of the Russian authorities – a position it will certainly argue in courts in which Rosneft assets are pursued to satisfy the award.
This arbitral award has no direct connection to the escalating sanctions on Rosneft and other Russian targets over the Ukraine dispute, but from the Washington perspective it will have much the same effect as another round of financial sanctions: more squeeze on the key Russian economic players, more uncertainty for the ability of Russian companies and the Putin government to access capital markets, more discomfort in credit committees of European banks who look to financing Russian transactions as a growth zone while their home markets remain torpid. Our Trade Controls group, along with our International Arbitration practice, will be watching these developments closely. Stay tuned for more Client Alerts on this topic.
The other big foreign policy story as of this writing is the sharp escalation of violence in Gaza. Israel will at some point curtail its operations and withdraw, although how far away that point may be remains unclear. As we write, one particular question mark revolves around the Israeli insistence that any easing of the Egyptian-Israeli blockade of Gaza accompany a demilitarization of the territory, in order to prevent the resumption of hostilities in the future. Whether Israel adheres to that position in the face of increasing global pressure to bring its operations to a halt may dictate how long the conflict continues. Absent a clear demilitarization or similarly tangible Israeli achievement in Gaza, Hamas may emerge politically strengthened, as the Palestinian Authority and its leader Abbas have proven entirely incapable of controlling either the dialogue or events on the ground. As difficult as the circumstances in Gaza are and will be in the near term, we believe the situation will remain a regional conflict with little ability to affect broader global affairs.
The slow-motion tragedy playing out in Syria, on the other hand, will likely linger as yet another agitation point between U.S. and Russian interests, as well as a breeding ground for the sort of foreign adventures being undertaken at the crossroads of Syria, Iraq and Jordan by the Islamic State. The U.S. and the EU continue to rely largely on sanctions and small attempts to support the relatively moderate elements in the Syrian conflict, without satisfactory results.
In a stark demonstration of the concept of realpolitik at work, in mid-July, even as the situation in Eastern Ukraine tanked U.S./EU - Russia relations, and even though the parties continue to support opposing sides in Syria, the “P5+1” group of countries (the U.S., Russia, China, the United Kingdom, France and Germany) found sufficient common interest to reach an agreement with Iran to extend talks on Iran’s nuclear program for another four months, to November 24, 2014. In the interim, the terms of the “Joint Plan of Action” negotiated last November, and implemented in January, will continue in place, with the U.S. temporarily suspending some sanctions and the West granting Iran access to additional frozen proceeds from crude oil sale, in return for Iran’s agreement to freeze certain nuclear development activities. Our Client Alerts describing the JPOA and sanctions suspension program can be found here and here.
The stakes for reaching a comprehensive agreement in the next four months are nothing short of enormous. Success contains Iran as a nuclear threat for the foreseeable future, and marks the start of a process to migrate Iran from (in the eyes of the West) a rogue state to a member of the community of nations. A sustainable nuclear deal could open a veritable “gold rush,” as companies seek to stake a claim in what could become the next great growth market for both energy development and consumer products. Some signs of this are being seen now, as demonstrated by Boeing’s agreement, for the first time in decades, to sell aircraft parts to Iranian carriers. By contrast, failure could set the stage for a military confrontation, certain to further destabilize the volatile Persian Gulf region.
The clamor of events and emergencies emanating from Europe and the Middle East has largely frustrated progress on President Obama’s “Asia Pivot” – a shift in foreign policy and strategic resources to the Asia-Pacific, viewed by many as a move intended to serve as a counterweight to the rising economic and military power of China.
China’s recent moves, including declaring an “air defense zone” over the East China Sea and sparring with Vietnamese and Japanese ships and planes in contested waters, have escalated tensions with its neighbors. Japanese Prime Minister Shinzo Abe has cited these actions in pushing the Diet to adopt a resolution reinterpreting Japan’s constitution to allow the government more leeway to use military force for “self-defense,” including, some say, in the case of attacks on the territory of an allied neighbor. The United States has so far supported Abe’s initiative, viewing it as an important element in its efforts to strengthen the strategic hand of its key allies (Japan, South Korea, Taiwan and the Philippines) and calm other governments in the region who have been noting China’s new territorial assertiveness with some alarm.
An important question is whether all of this military and diplomatic skirmishing will lead to something more, including an outbreak of hostilities under circumstances that will require the United States to come to the aid of its allies in opposition to China. The economic impact of this type of development could be severe, disrupting valuable trade flows, cross-border investments and capital markets, and possibly triggering a global recession.
Domestic Issues and Developments
U.S. domestic politics is entering its traditional late-summer hibernation period, as Congress prepares to leave town for a long recess. Given that 2014 is a mid-term (non-Presidential) election year, and the major parties continue to channel the heightened polarization between the right and the left in this country, it is certainly just a calm before the storm.
For the past several years, Republican control of the House of Representatives has succeeded in blocking President Obama from achieving major policy goals, including a much-needed reform of U.S. immigration laws. The Administration has also been hobbled on the domestic front by high-profile embarrassments such as mismanagement at Veterans Administration (VA) hospitals, a crisis caused by a surge of Central American families and unaccompanied children at the southern border, revelations that Internal Revenue Service emails sought by Republican House investigators may have been lost or deleted, and an appellate court ruling invalidating a key portion of the President’s signature health care law. The President’s domestic approval ratings continue to be low – although those of Congress and his Republican opposition are even worse.
However, firm Democratic control of the Senate has prevented the Congress from rolling back key elements of the President’s agenda, blocking dozens of efforts by the House to repeal the health care law, brokering a deal to provide emergency funding to fix the VA, and moving forward on key judicial and cabinet level appointments.
The balance of power may be about to shift dramatically. With fewer than 100 days until the midterm congressional elections, Republicans have a credible shot at gaining control of the Senate. No fewer than 10 Senate seats currently held by Democrats are being strongly challenged by Republicans, who need to win only six seats to gain the majority. Seven of the 10 seats are in states that voted for Republican candidate Mitt Romney over President Obama in the 2012 election, and several are in swing states that were won by Democrats who were helped in 2008 by the Obama coattails that year. Both sides are arming for furious battles this fall. Should the Republicans take control of the Senate, President Obama will spend the final two years of his second term as a “lame duck” President with a hostile Congress, and may have to focus most of his energy fighting a rearguard action to save the Affordable Care Act and other signature accomplishments of his Presidency.