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• Table of contents
• Introduction
• Interventionist trends in financial regulation
• Object, subject, and goal of this paper
• Target audience: professionals in international banking compliance
• Problem discussed: how to deal with extra territorial regulation
• Study scope: regulatory conflicts involving USA, Switzerland, and Russia Federation
• Research result: a model of extra-territorial conflicts in regulation of banking activity
• Paper plan: Review - Model - Guidance
• Part 1. Review
• 1.1 Cases of extraterritorial sanctions resulting in fines
• 1.1.1 U.S. Department of Justice Tax division vs. UBS AG
• 1.1.2 U.S. Department of Treasury's Office of Foreign Assets Control vs. BNP Paribas
• 1.1.3 U.S. Department of Treasury's Office of Foreign Assets Control vs. Bank of Moscow
• 1.1.4 New York Department of Financial Services vs. Credit Suisse AG
• 1.1.5 Bank of Russia vs. Atlas Bank
• 1.1.6 Swiss Financial Market Supervisory Authority - no issues
• 1.1.7 Ukraine-/Russia-related Sanctions.
• 1.2 Extra-territorial regulatory frameworks
• 1.2.1 Coordination in AML
• 1.2.2 Coordination for financial stability
• 1.2.3 Conflicts over trade sanctions
• 1.2.3 Conflicts over tax collection
• 1.3 Publications on extra-territorial sanctions
• 1.3.1 Academic description of banking regulations
• 1.3.2 Legal perspective: cases studies by legal experts
• 1.3.3 Economic theory on regulatory conflicts
• 1.3.4 Sectorial surveys by audit firms
• Conclusion part 1
• Part 2. Model
• 2.1 Regulatory components: category, mode, and geographical scale
• 2.1.1 Financial stability category
• 2.1.2 Ethical category
• 2.1.3 Criminal category
• 2.1.4 Political category
• 2.1.5 Mode
• 2.1.6 Geographical scale
• 2.2 Components of regulatory conflicts
• 2.3 Conflict patterns
• 2.3.1 Scope of USA
• 2.3.2 Scope of Russia
• 2.3.3 Scope of Switzerland
• Conclusion part 2
• Part 3. Guidance
• 3.1 General recommendations
• 3.1.1 Be informed
• 3.1.2 Promote the culture of escalation
• 3.1.3 Collect evidence and document conflicts
• 3.1.4 Implement regulatory governance
• 3.1.5 Use risk-based approach
• 3.1.6 Price the risk
• 3.2 Recommendations in model application on example
• 3.2.1 Geographic organization
• 3.2.2 Regulatory bodies
• 3.2.3 Key banking regulations
• 3.2.4 Step by step
• Conclusion part 3
• General conclusions
• Extra-territorial regulatory conflicts: a reality of modern globalization
• For a typology of regulatory conflicts
• Conflicting regulations: the challenge for compliance
• Compliance as part of strategic risk management
• Bibliography
• Appendixes
• Appendix 1. Acronyms
• Appendix 2. History of economical sanctions
• Appendix 3. Cost of non-compliance for banks
• Appendix 4. Overall goals of banking regulations
• Appendix 5. US regulators: OCC, SEC, CFTC, CFBP, FSOC, OFAC
• Appendix 6. Russian regulator: Central Bank of Russia (CBR)
• Appendix 7. Anti money laundering international cooperation
• Appendix 8. Swiss regulator: FINMA
• Appendix 9. Interbank settlement systems
• Appendix 10. Key banking regulations in USA, Russia, Switzerland.



Introduction

Critical analysis of banking regulation is not especially popular among students in financial analysis. In fact, the study of regulation receives only limited attention in the curriculum of most bank institutes and master degrees in finance. Students may be invited to learn about financial regulations implications in terms of competition and in terms of managerialresponsibilities. Still, regulation is widely regarded as being out of the scope of financial analysis. As if finance professionals were not entitled to question the inspirations and the influences that shape regulations, and should leave this task to economists orto lawyers.

The followingresearch develops the simple idea that it is important to spend some time analysing banking regulation trends in the financial degree programs, because the ability to understand implicit consequences of regulatory frameworks is critical for business performance.

Interventionisttrends in financial regulation

Financial regulation is now a global trend, widely accepted and even promoted by the public as a way to ensure security, stability, and justice in market economies.

Security: threats such as international terrorism create the need for security agencies to use exceptional control measures to track criminal funds.

Stability: more regulation ofis necessary to prevent «too big to fail» financial institutions from causing new systemic crises.

Justice: budget austerity implies toactively fight tax evasion.

The result of this global trendis a significant increase in the amount of regulations of banking activities produced by local or regionalregulators. On the one hand, issues such fighting against money laundering gather a large consensus from national governments in all countries. On the other hand, other issues such as trade regulation and tax collection generate more difficulties,with a lack of international coordination and sometimes attempts by sovereign governments to impose their interests beyond their own borders.

For global financial operators, whose scope spans over multiple economic zones, this inflationary regulation is problematic: not only it requires from them permanent watch, staff training and task automation to cope with compliance and reporting obligations without affecting operational performance; it also often lets them faced withconflicting regulations issued by different sovereign authorities. Making arbitrage decisions within multiple regulatory frameworks has become part of bank governance daily routine.

Object, subject, and goal of this paper

The object of this paper is the problem of compliance of international commercial banks with financialregulations in their cross-border business activities.How to comply with regulatory discrepancies, inconsistencies, and conflicts appearing between or within international regulations?To answer this question, the goal of our research is toelaborate a practical model of extra-territorial conflictsthat can be used by compliance professional and bank executives to structure an analysis of situation, prior to furtherarbitrage decisions.

Target audience: professionals in international banking compliance

Our analysis is intended mainly for compliance and audit professionals, as well as for executives in charge of bank governance, and for financial analysts interested in the problems of regulatory risk assessment, pricing and provision.

For compliance and audit professionals, the concept of how regulatory frameworks interfere with each other is often critical to properly analyse business situations. Advisory functions need analytical toolsto expose a situation of conflicting regulations inside business practice.

For executives in charge of governance, purely legal approach to the regulatory conflicts is not sufficient. Decisions taken by international commercial banks are to take into account business interests as well, where practical view is required to perform bank operations.

For financial analysts, one has to point out that financial analysis today implies to understand regulatory risks. Financial analysis should pay attention to possibilities of future fines and investigate whether the compliance of a bank is actually efficient.

Problem discussed: how to deal with extra territorial regulation

Since the world is unified by economic players into a global market and divided into territories by local or regional regulatory powers, contradictions in international banking activity regulation are unlikely to disappear soon, and there will be a demand for experts able to make optimal ad-hoc and systematic organizational decisions in uneasy and contradictory regulatory environment.

The practical problem discussed in this research is how international commercial banks can anticipate and minimize regulatory risks while deploying their activities across multiple sovereign jurisdictions at the same time.

Study scope: regulatory conflicts involving USA, Switzerland, and Russia Federation

The present research does not aim at covering all possible patterns, not even in the field of AML (the author's speciality) and without mentioning other categories of the financial regulation. Pretending to be exhaustive wouldn't be realistic, since most of the implications of aregulatory inconsistence or of a contradiction between regulations are discovered post factum, at the expense of the business that has encountered them.

Our study concentrates on cases of extra-territorial regulatory conflicts faced by international banks. Emphasis is put on the multiplicity of law and regulations of international banking activity in 3 jurisdictions: the USA, Switzerland, and the Russian Federation, making is especially useful for experts working at commercial banks of those countries.

The United States of America have got a unique track record of setting standards in the field of international bank activities regulation since Bretton-Woods in 1944 and since their adoption of the “effects doctrine” in 1945 See below: part 1.2.3. Conflicts over trade sanctions. In recent years, their coercive policy based on massive fines and mass-media communication has been highly effective to force commercial banks around the globe to play by US rules beyond their territory. So that USA can be regarded as the country with the most advanced regulatory framework and the most successful practical results in the field.

Switzerland is also an interesting case because their traditional fiduciary and private banking activities were largely based on territorial sovereignty, a constitutional aspect that was recently challenged by regulators the USA and the EU. The pressure for international fiscal cooperation after 2008 has forced Swiss banks to reshaping their international asset management business model to accommodate potentially conflicting regulations and practices at home and abroad.

Russian Federation is a country where conflicting categories of local and international regulations is very acute. The structure of capital flows in and out of Russian Federation make it a country highly exposed to international money laundering cases. Meanwhile, the Russian regulatory framework applicable to international banking activities is relatively recent (mainly developed after the collapse of Soviet Union) and not fully developed yet. Last, but not least, recent diplomatic sanctions and increased security concerns of the Russian government set the ground for systematic extra-territorial conflicts with the USA and UE regulations.

Research result: a model of extra-territorial conflicts in regulation of banking activity

The contribution of this paper is a model to analyse potentially extra-territorial conflicting regulations, and to describe conflicts in terms of specific pattern, with a scoring scale.The result is a practical guidance on how to analyse to regulatory requirements,and to assess the risk of potential conflicts prior to making decisions.

Paper plan: Review - Model - Guidance

This paper is divided into three main parts: Review, Model,and Guidance.

Review: the first part of this paper consist in a review of existing studies dedicated to the problem of extraterritorial regulatory conflicts, and in a presentation of the AML regulatory framework in the USA, Switzerland and Russian Federation.

Model: the second part describes the systematic structural patterns existing within extra-territorial conflicts and sorts them out into a typology of conflicts with a scoring scale.

Guidance: this part provides recommendations on how to identify, expose, anticipate regulatory risks resulting from conflicting multiplecompliance obligations in a way that preserves business continuity and shareholders value.



Part 1. Review

The first part of our research combines(part 1.1) the review of actual recent sanctions imposed on international banks for infractions to financial regulations in the frame of extra-territorial regulatory conflicts with (part 1.2) the explanation of recent regulatory trends explaining the rise of such extra-territorial conflicts in the three countries within the scope of this study, before reviewing (part 1.3) recent publications about the problem.

1.1 Cases of extraterritorialsanctionsresulting in fines

Here are the latest examples of fines applied in extra-territorial sanctions.

1.1.1 U.S. Department of Justice Tax division vs. UBS AG

World-known conflict is conflict of Swiss data secrecy and U.S. during 2014 involving the Swiss Federal Department of Finance DFF (“Département Fédéral des Finances”).

The biggest Swiss bank UBS was blamed for using their banking secrecy laws to help US citizens to avoid taxes. In 2009 Swiss bank UBS entered into a Deferred Prosecution Agreement with the U.S. Department of Justice Deferred prosecution agreement between The U.S. Department of Justice Tax division and UBS AG, 2009:URL: http://www.justice.gov/sites/default/files/tax/legacy/2009/02/19/UBS_Signed_Deferred_Prosecution_Agreement.pdf. The bank paid 780 million USD. In fact in article analysing the case of UBS the open conflict of regulations were raised. This is the conflict of international level. USA obtained the data about American citizens' accounts opened in Swiss Jurisdiction, although it was contradicting the Swiss bank secrecy laws. With the involvement of Swiss Financial Markets Supervisor authority “cases involving fraud” can be disclosed to US based on tax information exchange agreement (TIEA) between the United States and Switzerland initially signed in 1997 and modified after UBS case in 2011. Under international pressure and the pressure of US Switzerland however cooperated in the proceeding, nevertheless in article devoted to detailed discussion of this case remarked that US showed lack of respect to the sovereignty of Switzerland and its Domestics laws following own national interestsBeckett G. Cantley, The UBS case: The U.S. attack on Swiss banking sovereignty, 2011: URL: http://www.law2.byu.edu/ilmr/articles/spring_2011/BYU_ILMR_spring_2011_1_UBS.pdf.. Nevertheless under pressure of Organization for Economic Co-operation and Development (OECD) later Switzerland accepted OECD standards about Tax Information Exchange in 2010STEP Israel Annual Conference 2011, Tax Information Exchange between Switzerland and the USA: Introduction to the New Regime, June 2011:

URL: http://www.cms-vep.com/Hubbard.FileSystem/files/Publication/28d31fb2-a74e-46c8-89df-06ac58780f90/Presentation/PublicationAttachment/25afde2f-f68c-460d-8cfc-0ce9ffb9b1a7/TIE%20CH-USA%20-%20Introduction%20to%20the%20New%20Regime%20(Version%2022.6.11).pdf.and provided information according to ratified agreement about 4450 clients of UBSRadio Télévision Suisse, UBS consent order, URL: http://www.rts.ch/info/suisse/2123331-l-accord-ubs-est-accepte-definitivement.html.. As it was said by one of Swiss politicians, it was decision for the interest of Swiss economy.

1.1.2 U.S. Department of Treasury's Office of Foreign Assets Control vs. BNP Paribas

Real penalties for infringements to financial regulation have been growing in many countries since 2008, often exceeding consensus expectations. In case with BNP Paribas the audit identified and priced the risk in 2006-2007 before the fine was imposed, but the initial provision of USD 1,5 bln was underestimated; the fine of USD 8,97 bln finally imposed by US regulator was much higher than the provision made.Settlement agreement between the U.S. Department of Treasury's office of Foreign Assets Control and BNP Paribas SA, 2014: URL: http://www.treasury.gov/resource-center/sanctions/CivPen/Documents/20140630_bnp_settlement.pdf



1.1.3 U.S. Department of Treasury's Office of Foreign Assets Control vs. Bank of Moscow

In January 2014, U.S. Department of Treasury's Office of Foreign Assets Control announces that Bank of Moscow violated Iranian sanctions regimes by transferring more than 40 mln USD on behalf of Bank Melli Iran ZAO, which Russian subsidiary of Iranian bank. Since payment details of SWIFT messages did not contain any reference to “Melli” or “Iran”, U.S. Financial institutions processed the payments. The OFAC states that activity of Bank of Moscow “resulted in significant harm to U.S. sanctions program objectives”ENFORCEMENT INFORMATION FOR JANUARY 27, 2014, URL: http://www.treasury.gov/resource-center/sanctions/CivPen/Documents/20140127_moscow.pdf.Bank Melli Iran is called “Mir Bank” today, official web-site announces services for transfers in USD, Mir Bank official website: URL: http://www.mbbru.com/pic/tf.pdf which means that bank is working with some intermediaries who consciously violate U.S. sanctions regime against Iran.

1.1.4 New York Department of Financial Services vs. Credit Suisse AG

There is a famous case when Credit Suisse AG signed a consent order Consent order pursuant to banking law between the New York State Department of Financial Service and Credit Suisse AG, 2014:URL: http://www.dfs.ny.gov/about/ea/ea140519.pdf with Department of financial services of New York. The bank declared net income for 3.38 BLN USD in 2013 and about 21% i.e. 715 MLN USD was to pay according to that order. According to official text of the order available in open sources, employees of Credit Suisse used their New York office to help US citizen to construct schemes of tax avoidance using the bank secrecy in Swiss jurisdiction. The representative of the bank signed the order, confirming that the facts are correct, never the less it's possible that US citizens used the services of Credit Suisse might be looking for such type of services. Is not proper income declaration and tax payments are responsibility of the citizens themselves? There might be of course indeed illegal actions from the side of the bank which let its client to benefit Swiss data secrecy regime.

1.1.5 Bank of Russia vs. Atlas Bank

In 2014 Bank of Russia revoked licence for banking operations from Russian subsidiary of Atlas Banka (Montenegro) - Altas Bank Ltd. The official reasons named were incompliance with local anti money laundering requirements i.e. conducting suspicious activity and improper identification of beneficial owners of the clients. Bank ranked number 744 in Russia by assets size. Bank of Russia, Information Notice, URL: http://www.cbr.ru/eng/press/pr.aspx?file=05052014_135540bank2.htmTechnically, every bank can be involved into suspicious operations unwillingly. Also, Russian legislation in terms of beneficial owners identification is still a subject of discussions. The term “beneficial owner” was introduced in June 2013 by federal law ¹ 134 FZ about changes Russian legislation in part of money laundering only. At the same time this is an uneasy mission for banks since beneficial owner does not always exist (case of funds or publicly traded companies). When banks are not able to identify beneficial owner of their clients they should recognize the CEO of the company as beneficial owner and perform a full identification procedure, which includes collecting identity documents. Since many banks are cooperating within loro and nostro accounts schemes, it is possible that foreign bank, Swiss, for example, has an opened account in rubles with another bank, with presence in Russia. And Russian banks, started such relationship before 2013 will be have a portfolio of clients without beneficial owner identification just because Swiss bank is very much unlikely to send personal data of its CEO to Russia. Coming back to Atlas Bank Ltd, it is impossible to identify real reasons of license revocation with certitude.

1.1.6 Swiss Financial Market Supervisory Authority - no issues

According to Enforcement report 2014Finma Enforcement report, 2014, URL: http://www.finma.ch/e/aktuell/Documents/enforcementbericht-2014-20150224-e.pdf of Swiss Financial Market Supervisory Authority revoked 5 licences in 2014 and imposed 12 Special conditions and restrictions but without providing much details. Also, report says that quite often enforcements proceedings are not required because supervised entities are cooperative and willing to fix their issues. Switzerland is neutral in most of the cases on international arena; it looks like it does not make much noise in banking neither. On the other hand, FINMA announces its international cooperation. Its report mentions requests for assistance processed by country (assistance provided by FINMA) in 2014 was equal to 479. The only world-know case of recent penalty was the case of FOREX market rate manipulation. Since Swiss authority was not the only one involved possibly fines were just an act of international cooperation.

1.1.7 Ukraine-/Russia-related Sanctions

During March - December 2014 the president if United States signed executive orders and directives which resulted in cutting an access to the biggest Russian companies and state-owned banks to US capital markets The Sectoral Sanctions Identifications List: URL: http://www.treasury.gov/ofac/downloads/ssi/ssi.txt,(later European Union applied similar sanctions) and requirement to freezing the assets for number of individuals contributing to the situation in Ukraine Ukraine-related Designations: URL: http://www.treasury.gov/resource-center/sanctions/OFAC-Enforcement/Pages/20140428.aspx. As most of U.S. sanctions it should be applied by “United States person'' which means “any United States citizen, permanent resident alien, entity organized under the laws of the United States or any jurisdiction within the United States (including foreign branches), or any person in the United States”.Ukraine/RussiaUkraine-/Russia-related Sanction: URL:http://www.treasury.gov/resource-center/sanctions/Programs/Pages/ukraine.aspx sanctions were introduced byorders of President, whose authority is regulated by public laws passed the Congress such as International Emergency Economic Powers Act (IEEPA), 50 U.S.C. §§ 1701-1706International Emergency Economic Powers Act (IEEPA): URL: http://www.treasury.gov/resource-center/sanctions/Documents/ieepa.pdfand National Emergencies Act (NEA), 50 U.S.C. §§ 1601-1651 National Emergencies Act (NEA): URL: http://www.treasury.gov/resource-center/sanctions/Documents/nea.pdf.This example is just to demonstrate with which speed and due to which reasons new legislation sometimes politically driven and with extra territorial application can be developed.

1.2 Extra-territorial regulatory frameworks

Around the globe there is an understanding that international cooperation is required in many aspects of banking activity.International attempts to coordinate regulation of banking activities focus on anti-money laundering (AML), and on prudential rules such as liquidity ratio and minimum reserves to preserve the financial system stability. At the same time, conflicts involving banks and sovereign government keep appearing in relation to two major issues: trade sanctions, and tax collection.

1.2.1 Coordination in AML

In 1989 the Financial Action Task Force (FATF) was created based on agreement of ministers of the country-members. Today there are 34 countries-membersFATF: URL: http://www.fatf-gafi.org/pages/aboutus. FATF develops policies and recommendations to facilitate combatting money laundering at the level of governments. Countries are to develop their legislation, regulation and controls in order to follow the recommendations issued.

Switzerland is a FATF member wince 1990sFATF report on Switzerland, URL:

http://www.fatf gafi.org/media/fatf/documents/reports/mer/mer%20switzerland%20resume%20english.pdf. Although the country established relevant regulatory bodies, has a anti-money laundering legislation base and developed self-regulation practices, the FATF report of 2005 highlighted that Swiss data secrecy laws may be a problem for information exchange between “competent authorities on the international level” as well as the problem for supervision by foreign regulator. It is a problem for USA, for example, because Switzerland does not share so easily the information with tax authorities. USA is Member of the FATF since 1990, Russia joined in 2003 after establishing appropriate infrastructure. The membership in this organization gives following results: countries have more or less similar organization for combatting money laundering.

Every regulator claims that its primary goal is to protect the consumers of financial services and make sure that financial system is stable and safe. Bank regulators are to make sure that the supervised institutions comply with the law while the law follows the national interests. As the result banks are to control tax evasions, combatting money laundering, terrorism financing.

Swiss authority listed combatting money laundering among its responsibilities, although in fact FINMA, OCC and Bank of Russia just make sure that institutions under their supervision has relevant controls to reveal and prevent money laundering and terrorism financing, timely reporting to anti-money laundering authorities which are presented in the table below.

Table 1

Country	Russian Federation	USA	Switzerland
Anti-money laundering authority	Federal service of financial monitoring (“FSFM” or (“Rosfinmonitoring”)	Financial Crimes Enforcement Network (“FinCEN”)	Money Laundering Reporting Office Switzerland (MROS)
Web-site	www.fedsfm.ru	www.fincen.gov	https://www.fedpol.admin.ch/fedpol/en/home/kriminalitaet/geldwaescherei.html

Except FATF, there others organisation for anti money laundering cooperation which provided in Appendix 7. The significant number of organisations argues for the importance of the topic.



1.2.2 Coordination for financial stability

There are other attempts to coordinate regulation worldwide. And good example is the oldest international organisation, Bank for International Settlements (BIS), established 1930 The Bank for International Settlements (BIS): URL:https://www.bis.org/about/index.htm,which includes Basel Committee on Banking Supervision, The Committee on the Global Financial System (CGFS), The Committee on Payments and Market Infrastructures (CPMI), Financial Stability Institute (FSI).

1.2.3Conflicts over tradesanctions

International economic sanctions belong to the arsenal of diplomatic tool. US has been using such sanctions on regular basis based on “effect doctrine” under which activity oversees may have an effect on US directly or indirectly, as stated by judge Learned Hand of the US Court of Appeal in his ruling of the US vs. ALCOA 1945 case: “any state may impose liabilities, even upon persons not within its allegiance, for conducts outside its borders that has consequences inside its borders which the state reprehends” United States vs. Aluminum Co. of America, 148 F 2D, 443 (2d Cir., 1945).

International economic sanctions are the typical situation when regulations conflict with each other. It is impossible to avoid for international bank operators. For instance, if Russian subsidiary of US national bank receives an order from its client in Russia to make a wire transfer to Cuba in USD. On the one hand according to Civil Code Part II, Chapter 45, Article 849 client orders are to be executed not later than next business day unless the shorter term is stated in banking agreement. On the other hand, Cuba is sanctioned country, so what Russian banks can do?

In the USA,a separate branch of regulation enforces sanctions with huge fines in case of sanctions regime breach. It is not based on common missions of other US regulators related to financial stability of fair and efficient markets (see Appendix 5: the US Regulatory framework).

US treasury has a special “office”, created in 1950, the Office of Foreign Assets Control (OFAC) which “administers and enforces economic and trade sanctions”.Economic sanctions should be respected by “persons subject to the jurisdiction of the United States”. In other words, US sanctions are applicable to: 1. Any entity located or conducting its activity in USA; 2. Any US citizen or US resident regardless his/her location; 3. Any activity worldwide by a company incorporated under US legislationU.S. economic sanctions compliance for non-U.S. firms/ Freshfields Bruckhaus Deringer LLP, 2009; URL: http://m.freshfields.com/uploadedFiles/SiteWide/Knowledge/U.S.%20economic%20sanctions%20compliance%20for%20non-U.S.%20firms.pdf. The consequence of this regulation for international banking activity is that banks incorporated under US law and their transactions all over the world should respect the economic sanctions of USA. But this is not all. There are particular sanctions, i.e. sanctions against Cuba and Iran which are to be respected by entities all over the world which are owned or controlled by entity established under US law, by US citizen or resident or by person or entity located or operating in USA. This means that subsidiaries of international banks might be between 2 obligations: 1) to respect the law of the country where it is created; 2) to comply with extraterritorial US sanctions. They will face the conflicting obligation when local law prohibit discrimination (like in Canada) or when actions required, to fulfil the obligations (like transactions blocking) are not allowed by the local law (this is the case of Russian Federation).

Since US financial market is huge, US dollar is extremely widespread the sanctions penetrated the financial system as well. At the modern world wars became wars of sanctions, economical power and they are for markets, resources and economic growth. So US can use US nationality of access US markets as tool to influence other countries and follow the national interests. Going further US partners are to respect its sanctions as well: for example, listing at Euronext exchange which is consolidated exchange of several European exchanges, is forbidden if issuer of its beneficial owner is in OFAC list (list of US sanctions)International and foreign financial regulation: institutions, deals, infrastructure: book in 2 parts/ redacted by Shamraev A. Moscow, KNORUS, 20014. Part 2. 640 pages..

The fact that OFAC requirements might contradict with other legislations is not an excuse for the breach. At the same time the subsidiaries of US companies incorporated in other countries have first of all to comply with the law of the country under which jurisdiction it was incorporated. At the same time, violation of Cuba and Iran Sanctions regimes for US subsidiaries has the same level of consequences as for parent company. For these reasons multi-national US companies, including banks, might be in the situation of the law conflicts when they try to comply with extraterritorial regulation related to sanctions. At the same time this compliance might not be related the key goals of financial system regulation like financial stability, solvency of the banks or fair markets.

1.2.4 Conflicts over tax collection

A second typicalextra-territorial conflict isthe contradiction between data privacy and bank secrecy with contradiction to extraterritorial requirement to cooperate for tax purposes.

In Russian Federation, according to article 857 “Bank secrecy” in Civil Code bank secrecy is to be guaranteed by banks. In case of violation, the client of the bank can claim the compensation. The explanation of bank secrecy is introduced in Federal Law “On Banks and Banking Activities”. Information subject to bank secrecy regime includes transactional data, information about accounts and deposits of clients and correspondents.

Russian legislation allows disclosure to a number of state authorities like courts, tax authorities, pension fund and other authorities. Also, there is another law, which takes care of data privacy - 152-FZ about “Personal data” dated 27.07.2006. This law is to protect data privacy, the information can be disclosed by banks with the client's agreement, while the information of legal entities falls under bank secrecy law. So far there is now famous cases, nevertheless for the multi-national companies this legislation cause some additional limitation in terms on information exchange between legal entities within the group, for example.

1.3 Publications on extra-territorialsanctions

In recent publications about actual financial regulation, we can observe three different perspectives: legal, economic, audit & compliance. Our approach is closer to compliance, but it is interesting to review the other point of views.

1.3.1 Academic description of banking regulations

A first group of publications about banking regulations consists in academic description national regulation organization in a descriptive and encyclopaedic manner.

For example, the article of MurphyEdward V. Murphy. “Who Regulates Whom and How? An Overview of U.S. Financial Regulatory Policy for Banking and Securities Markets”. 2015: URL:https://www.fas.org/sgp/crs/misc/R43087.pdf the author describes the regulatory system of the USA with a lot of details, but does not question its impacts outside the US. It doesn't mention the extra-territorial implications of US regulation; neither does it explain how the USA regulates its potential conflicts with other jurisdictions.

Another example is “International and foreign financial regulation: institutions, deals, infrastructure”, a book in 2 parts of Shamraev, where the regulation of banking activities is described in details for a number of countries. The author reviews parallel regulations next to each other, without comparing them and without questioning the possibility that some these regulations might interfere with each other in real life.

This type of descriptive approach is adopted in the major part of the literature on financial regulation and compliance. The critical analysis that our research is looking for cannot be found there.



1.3.2 Legal perspective: cases studies by legal experts

The second group of publications is where experts elaborate on extra-territorial conflicts in the international banking sector through the prism of specific case studies.

An example of this literature is the article of John Ellicott, “Between a rock and a hard place: how multinational companies address conflicts between US sanctions and foreign blocking measures” where the author mentions the subject of trade with Cuba and analyses the implications of conflicting regulations on trading activities and international trade negotiations. In that article of John Ellicott, partner in American law firm, practitioner in the fields of U.S. export trade and foreign transaction control regulations, there is no a simple solution for subsidiaries of US companies and its parentsJohn Ellicott, Between a rock and a hard place: how multinational companies address-conflicts between US sanctions and foreign blocking measures: URL: http://www.stetson.edu/law/lawreview/media/between-a-rock-and-a-hard-place-how-multinational-companies-address-conflicts-between-u-s-sanctions-and-foreign-blocking-measures.pdf.. The author suggests to be prepared and to do the best to avoid the conflict. In more details it will be discussed in the end of this paper.

Another example is the article of Beckett G. Cantley, “The UBS case: The U.S. Attack on Swiss Banking Sovereignty”, 2011. This case study focuses on a concrete example of extraterritorial conflict to develop ironical comments on the United States unilateral one-sided interpretation of their own doctrine: “the United States appears to be trying to have it both ways with the rest of the world--other countries must follow U.S. laws but they should not attempt to make the United States follow their laws.”

Overall, the legal case studies concentrate on the legal fact thatInternational law does not recognize unilateral sanctions and does not allow states to unilaterally impose sanctions beyond the boundaries their local jurisdictions.

This legal argument is perhaps applicable in the settlement of extra-territorial disputes is logic between sovereign governments. For instance the US trade embargo on Cuba, decided by the Congress in 1996, and known as the "Helms-Burton Act”: following this decision of the USA, Cuba has protested to the WTO, Canada and Mexico requested consultations with the US under Chapter 20 of the NAFTA Agreement. The EU requested consultations under the WTO dispute settlement procedures, and the UN General Assembly has passed resolutions condemning the embargo.

In theory, banks may use this approach. The idea that international court settlement is an option to protect a bank from extra-territorial sanctions is presented by French professor of law Mathias Audit, in his analysishttp://www.lesechos.fr/idees-debats/cercle/cercle-101744-sanctions-contre-bnp-paribas-lextraterritorialite-du-droit-americain-est-elle-conforme-au-droit-international-1017445.php of the sanctions imposed by the New York Department of Federal Services on BNP-Paribas for operating transactions in US Dollar to Sudan and Iran. Pr. Audit complains that the French Government does not use the law to dispute US sanctions applied the leading French bank, and points out that a convention signed in 1959 between France and the United Sates of America would allow France to the seize the international court of justice to contest the fairness of the US sanction. financial regulation extraterritorial conflict

However, in his development, Pr. Audit neglects to take into consideration that, for banks, international court settlement of such disputes is problematic, precisely because the opponent is a sovereign state. To dispute the decision of a sovereign state is potentially dangerous for the image of commercial bank and might put its license to operate in the given country at risk. This is why legal counsels of banks usually recommend opting for arbitration, instead of court settlement.

1.3.3 Economic theory on regulatory conflicts

Economists usually analyze regulatory conflicts in terms of cost-benefits for their parties. Such approach is relevant for players who take decisions from their individual perspective. It is applicable to any type of actor, ranging from states governments to corporate entities. In this approach, sanctions are considered to be part of business, and materialize in the form of provisions in an individual P&L account. 

The cost-benefit analysis is most often used to determine how nations are impacted by restrictive economic sanctions. Every time USA take economic sanction against another state, the Congress Research Services uses such an approach to evaluate the impact on the US Economy, recent sanctions with Russia being no exceptionCongressional Research Service, U.S. Sanctions on Russia: Economic Implications, February 4, 2015, http://fas.org/sgp/crs/row/R43895.pdf. An economic model of this cost-benefit approach applied to a country is developed by Hufbauer, Elliott, Cyrus and Winston in their 1997 study for the Peterson Institute for Economics Studieshttp://www.iie.com/publications/wp/print.cfm?ResearchId=149&doc=pub titled "US Economic Sanctions: Their Impact on Trade, Jobs, and Wages”. This study is presents a model to calculate the economic impact of US unilateral sanctions on the US trade balance, economic activity and employment.

Banks facing extra-territorial regulatory sanctions use a similar cost-benefit analysis. As individual actors, banks analyze the regulatory environment and adapt their strategies to enter or exit markets accordingly. JuditTemesvary recently studied this rationale of international banks' behavior in her paper dedicated to “The Role of Regulatory Arbitrage in US Banks' International Lending Flows: Bank-Level Evidence”JuditTemesvary, “The Role of Regulatory Arbitrage in US Banks' International Lending Flows: Bank-Level Evidence”, FIW working paper 151, March 2015,http://www.fiw.ac.at/fileadmin/Documents/Publikationen/Working_Paper/N_151_Temesvary.pdf published by the Research Center International Economics (FIW) of Vienna in March 2015. By crossing bank balance sheets with regulatory frameworks, the author shows how US banks actually organize international loans on case-by-case basis depending on each local regulatory framework, switching alternatively from lending though local subsidiaries to lending cross-border directly from the USA, in order to optimize their margins and minimize capital requirements.

In other words, international banks tend to develop pragmatic attitudes towards international regulation to organize their activities and to settle conflicts. International regulatory risks are analyzed terms of costs and benefits, and potential fines will materialize in their P&L in the form of provisions for regulatory risks. From this perspective, efficient organization to detect, identify and analyze risks in regulatory frameworks will reinforce the bank international competitiveness. Following this economic logic, it is easy to understand how, in commercial banks, the compliance function indirectly contributes to the operational margin.

1.3.4 Sectorial surveys by audit firms

The last group of publications consists in sectorial surveys published by big audit firms in order to present themselves as experts in the field. The inflationary trend in banking regulation is of course a hot topic for them.

For example, the audit firm “Ernst & Young” in its “Regulatory challenges for bank” is talking about 4 big streams in which regulators will continue earlier started trends. Those 4 streams are:

Table 2

Capital	Liquidity	Resolution	Controls
Tougher stress tests Stricter capital requirements New requirement - to maintain minimum reserve	Implementation of liquidity coverage ratio Scrutiny on liquidity risk Relying on own sources of liquidity instead of financing by central bank Timely reporting on liquidity positions	Removal barriers to resolution Total Loss- Absorbing Capacity (TLAC) project Assurance that bank can perform critical economic functions without interruption Simplification of banking structure	Fair attitude to clients Proper market conduct Continuity of operations Strengthening anti-money laundering, counter terrorism financing measures. Enhancement of KYC (know you client principle) into KYCC (know your client's client). Sanctions implementation

Capital “stream” in Ernst & Young challenges corresponds to Capital adequacy policy mentioned in the article of Murphy. Regulators control the level of capital required to improve banks resistance to systemic shocks such liquidity squeeze or credit default in order to “minimize losses to investors, customers, and taxpayers when failures occur”. Based on Basel rules, capital requirements depend on the risk profile of the bank activities.

Liquidity “stream” is about compliance with liquidity requirements; the bank should have liquid assets to be able to respond timely on its obligations.

Resolution “stream” looks reasonable as well because taxpayers should not pay for failures of the bank management and save “sinking” banks.

The last “stream” about controls. Fair attitude to client and proper market behaviour are completely in line with missions declared by regulators. Similar is with combatting money laundering.



Conclusion part 1

The role of compliance function has become more important as the level of fines has been increasing. Compliance departments used to be commonly considered as additional operational cost; nowadays their new role is to “protect” the profit made by the bank from regulatory fines.

Meanwhile, extraterritorial sanctions are difficult to avoid for banks. Multi-national financial groups face an uneasy situation when its business is conducted in the jurisdictions with contradictory goals.There are regulations and norms, which are to protect and support financial stability, and there are others to protect interests of clients or shareholders, ethical aspects of banking activity or constitutional human rights. There are also banking regulations that in fact protect national interests or prevent criminalization of banking sector. Banks, especially ones working in several jurisdictions are operation in the situations of vulnerability and dependency on the political situation and sometimes goodwill of the local regulator.

The approach developed in this paper is close to that of to audit firm surveys, in the effort to identify systematic patterns of regulatory conflicts in international banking. Our research work is based on the assumption that there is a need for a concept of extra-territorial conflict to help compliance professionals understand dynamics at work, and to guide in their daily practice dealing with a multiplicity of cases. In other words, understanding extra-territorial implications of national regulations requires conceptual tools, which this research will try to elaborate in the second part.



Part 2. Model

The first part of this research has shown how important is the quality of compliance function for the financial results of the bank, as illustrated by the spectacular fines recently imposed on foreign international banks by the USA for violating their sanctions regime using the US Dollar, or for encouraging tax evasion under coverage of bank secrecy. The second part will now concentrate on defining a conceptof regulatoryconflict patterns, to clarify potentially conflicting regulations.

The regulatory conflict can be defined as a situation when, to comply with the requirement of another regulator, a sovereign regulation is violated. Each regulator is the bank under its regulation and supervision is compliant with all applicable norms. Based on that it can be concluded that in fact the conflict is caused by the norms themselves. In order to understand the structure of the conflict, the norms will be looked at from the following model perspective:

In this model each norm (it can be any type of act, law, requirement, instruction issued by any type of relevant bodies) has 3 components:

· Category

· Mode

· Territory of application

Picture 1

2.1Regulatory components: category, mode, and geographical scale

The first component - Category -is the main idea behind of the norm or requirement. It answers the question of whatthe regulation has been introduced for. Categories described here correspond to the policies mentioned in the article of Murphy (see above, part 1.3.1)Edward V. Murphy. Op. Cit.. Every regulation is deployed in one major category:

2.1.1Financialstability category

The financial stability category is represented by such requirements as:

· Capital adequacy requirements

· Reserve requirements

· Liquidity requirements

The regulations within this category conflicts rarely with other regulations.The financial stability has become the world's common goal after financial crisis, which has been started in USA in 2007-2008 but the impact so significant that even other countries were harmed. In countries with quite developed or developing banking systems like in USA, Russia, Switzerland there is a regulatory body which declares and then controls how the requirement are followed. If one international bank is a subject to several different sovereign regulations, the bank should either comply with the stricter requirement globally, or adopt a fragmented legal organization to comply locally.The only possible conflict such regulation causes is a competition within localentities of the banks,to use capital reserves or cash available globally; the bank must decide what is the best way to allocate reserves to business whilemaintaining ratios requested by local regulations. An example of such arbitrage is described byJuditTemesvary in her paper on “The Role of Regulatory Arbitrage in US Banks' International Lending Flows: Bank-Level Evidence”JuditTemesvary, Op. Cit. (see above, Part 1.3.3. Economic theory on regulatory conflicts).

2.1.2 Ethical category

Ethical category addresses issues related to ethical aspects in international banking activity, unfair practices or protection of constitutional rights. To this category belongregulations applying to:

· Market manipulation

· Conflict of interests

· Customer interest protection

· Banking secrecy

· Data privacy

· Anti-trust regulation

Not every regulation from the ethical category has got aproblematic potential for international banks. Most countries agree that market manipulation should be restricted and controlled, as well as conflict of interests. Most regulators and conscious market participants also agree that customer interest should be protected from abuse.

Nevertheless, banking secrecy, data privacy and anti-trust regulationspresent potential difficulties for international banking. The concept of secrecy and privacy are still being used historically from a human rights protection perspective; but today some countries, most so called offshore placesare blamed for bank secrecy misuse them to facilitatemoney laundering and tax evasion.A first problem can data exchange within the firm itself, in case banks are forbidden to pass information to third parties, as in Switzerland (see above, Part. 1.3.2.) and in Russia (see above, Part. 1.2.2.), while another regulation requires requirement to provide the information as in the USA.