Regulating Trade and Investment in the Aerospace, Security and Defence (ASD) Industries: Key Concerns & Common Misconceptions
6 Min Read
2024-11-18

topic

Trade & Investment

jurisdiction

Global
More questions on this topic? Email the Editorial Team.
Sabine Naugès
Partner, McDermott

executive summary

  • Supply chain security is paramount: Aerospace, Security and Defence (ASD) manufacturers are increasingly motivated to reduce reliance on foreign supply, particularly for sensitive or essential inputs, due to recent geopolitical events and supply chain disruptions.  
  • Geopolitical factors impact regulations: Areas like sanctions, export controls, and foreign direct investment screening have become more complex and are being more rigorously enforced.  
  • Check for any misconceptions: Address common misunderstandings regarding export controls and sanctions, such as assuming civilian projects are exempt or compliance with U.S. sanctions is sufficient.

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article

Sample

What is currently top of mind for executives in the ASD sector when it comes to trade and investment policy?

Supply chain security is the number one concern. The past few years have been marked by poly-crises, including supply chain disruptions due to the pandemic, the formation of new blocs driven by geopolitical tensions, and governments responding to violent conflicts.  

This is motivating—if not forcing—manufacturers to reduce reliance on foreign supply. The more sensitive or essential the products are from a national security perspective, the more critical the question of continued supply becomes.

Yet, restructuring supply chains is not easy and takes time. Meanwhile, the geopolitical environment has profoundly impacted several areas of regulation. Areas previously considered afterthoughts or mere check-the-box concerns have now become key compliance issues, further complicating supply structures. For example:

Sanctions

The EU, UK, US, and their allies—such as Australia, Canada, Japan, and South Korea, often referred to as "partner countries" in sanctions terminology —continue to tighten their sanctions regimes.

  • Extra-territorial reach: The territorial reach of these sanctions has expanded. Business activities can now fall under sanctions even if they occur entirely outside the imposing or the sanctioned country.  
  • Rigorous enforcement: Authorities have intensified efforts to investigate and punish sanctions violations. The EU Criminalisation Directive now mandates that all member states treat sanctions violations as criminal offenses.

Export & import control

Supply chains are further impacted by export and import controls, which are changing in two material ways:

  • Increase in controlled technologies: There are additional import and export control restrictions targeting technologies particularly relevant for the ASD sectors, such as dual-use technology, artificial intelligence, semi-conductors or quantum computing.  
  • Patchwork of rules: We also see the growing fragmentation of the regulation within the EU. Individual EU Member States imposing different restrictions relating to national security goods, such as semiconductors (for instance, France, Spain, Italy or the Netherlands).

Foreign direct investments

Foreign investors are subject to significantly more scrutiny, in particular if they come from “strategic competitors” , such as China, with heightened national security concerns. 

How can ASD businesses reduce vulnerability to geopolitical volatility and what are the potential costs?

Sanctions & Export Control Policy: Key Elements of a Compliance Program

To reduce vulnerability to geopolitical volatility, ASD businesses should develop comprehensive due diligence for export controls and sanctions, as well as resilience plans.

This includes understanding not only their own risk exposure but also the risk exposure of their customers and their customers’ customers (the principle of 'Know-Your-Customer’s-Customer').  

Additionally, it is crucial to have contingency plans in place for unexpected supply chain disruptions or regulatory changes. Conducting regular legal risk assessments is also vital, particularly to stay ahead of evolving export control rules and sanctions regimes.

What are some common misconceptions you encounter when speaking with businesses in the ASD sector?

Most companies in the ASD sector are now highly sensitive when it comes to export control and sanctions compliance. However, because these rules are ever-expanding, even for highly sophisticated customers, staying ahead of the latest developments is not easy.

To name a few misconceptions:

Misconception 1: “My company is not headquartered in, and does not export anything, from the U.S. or Europe.”

The company may still be caught, because of what lawyers call “extra-territoriality.” Extra-territoriality means a country’s laws can apply to activities outside its borders, even when the companies involved or their staff are not from that country.  

Example: If a South African company uses American-made technology or software in its products, it still has to follow U.S. laws. This means that the South African company may need approval from U.S. authorities before exporting its own products to countries like China.

For U.S. export control and sanctions rules, “extra-territoriality” is an established concept and company compliance programs typically take this into account.

For the EU, the concept is rather new and it is still unclear how it applies. The European Commission maintains its EU sanctions are not “extra-territorial.” But in response to the Russia-Ukraine war, the EU clearly expanded its definition of “territoriality.”  

Example: If a Turkish construction company works on an EU construction project and uses EU resources, such as paying or being paid using an EU bank or currency, it may have to follow EU sanctions in all their dealings, even if most of their business is outside the EU and is not using euros or EU-based banks.  

This creates significant legal uncertainties and drives up compliance costs for businesses operating internationally, as they are forced to navigate complex and often conflicting laws from multiple countries.

Misconception 2: “I am working on civilian projects and am not subject to any trade controls.”  

This is often inaccurate, as there are numerous factors that can trigger the application of trade controls.

  • Many technologies are considered “dual-use”, meaning they have both civilian and military applications. These items are often subject to export controls to prevent misuse.  
  • Sharing technical data or know-how across borders might still be regulated, regardless of the project’s overall civilian nature.
  • Some controls (e.g., sanction/embargoes) apply irrespective of the project’s civilian nature and only depend on the destination country.  
  • End-User and End-Use: Even civilian products can be restricted if the end-user is a prohibited party or if the item could be used for prohibited purposes.

Misconception 3: “It is enough to comply with U.S. sanctions.”

This is not true. The EU and UK sanctions are often stricter than U.S. sanctions—especially when it comes to bans on services and technical assistance. Therefore, businesses need to make sure they comply with all the different sanctions that apply.  

German Authorities Raid Russian Firms in Berlin Over Alleged EU Sanctions Violations: In August 2024, a large-scale raid by German customs officers unfolded in Berlin’s Tempelhof-Schöneberg district. The target? Two Russian logistics firms suspected of violating EU sanctions against Russia. Over 100 officers from the Central Office for Sanctions Enforcement (ZfS) were deployed to search the business premises, securing assets and seizing evidence in connection with the alleged breaches of economic sanctions. The sanctions, in place since Russia’s 2014 annexation of Crimea and further expanded after the 2022 invasion of Ukraine, aim to curb economic ties with Russian entities involved in strategic sectors. The businesses, both Russian-owned, faced the possibility of asset freezes under the EU's sanctions regulations.

Misconception 4: “We are not selling to Russia so we do not need to be concerned about sanctions against Russia.”

This is no longer true, unfortunately.

With a broad range of sanctions which apply extra-territorially, businesses should ensure that their customers, and the customers of their customers (distributors, end-customers), do not later sell to sanctioned jurisdictions or sanctioned persons. This requires adding contractual warranties to supply agreements and pretty extensive due diligence on customers and their customers.  

Example: My team recently advised on a case involving goods originating from Russia that were sold to India. Although the goods never entered the EU or Russia, the EU-headquartered distributor still had to respect EU sanctions because of the Russian origin of the goods.

In a recent ruling, the Court of Justice of the European Union (CJEU) upheld the confiscation of proceeds from brokering services related to the sale of military equipment manufactured in Russia, which were sold from Ukraine to India, without the goods entering the EU. This case highlights the broad reach of EU sanctions. 

Misconception 5: “We are not selling goods, but only services, so we are not concerned.”  

This is not true. The sanctions, in particular those adopted by the EU and the UK, extend not only to goods but now even to technical assistance and other services. Even the mere disclosure of documents can trigger sanctions and export control.  

Example: In a case involving Huawei, U.S. lawyers had to apply for a license from OFAC to share case documents with their own client. Given that the documents related to dual-use technology, the lawyers needed government approval due to U.S. export controls.

Misconception 6: “This is not prohibited under sanctions, so we should be fine.”  

This would only be true if the company's sole concern were penalties. Companies often overlook that non-banned activities can still pose financial, audit, reputational, or investment risks. This can cause delays, transaction uncertainty and an administrative burden, which can be addressed with proper preparation.

Examples: My team has been helping a German manufacturer whose auditors requested detailed confirmations of exposure to sanctions and Russian clients, even though the business was not directly affected by EU sanctions. We have also been representing a German company that needed to explain to a potential US buyer that the exports of their products to Iran were allowed under EU sanctions and the US sanctions were not applicable to it.

EU Court of Justice Upholds Confiscation of Proceeds from Russian Brokering Services: In September 2024, the Court of Justice of the European Union (CJEU) upheld the confiscation of proceeds from brokering services related to Russian military equipment sold from Ukraine to India, even though the goods did not enter the EU. The case involved a Romanian aeronautics company that brokered the sale of military radio sets, some manufactured in Russia. The Romanian export control authority (ANCEX) warned the company that the service violated EU sanctions, but the company proceeded with the transaction. As a result, the Romanian authority imposed a fine and confiscated nearly EUR 3 million in proceeds. The company’s appeal was rejected, with the CJEU ruling that EU sanctions apply broadly to brokering services linked to Russian military goods, even when not directly sold to Russia.

What are the most-overlooked aspects when it comes to managing export controls and sanction compliance in the ASD sector?

  • Third party risks: Companies often forget that suppliers, contractors, and distributors must also follow export control and sanctions rules. If they do not, the company can still be liable. Red flags include offshore companies, complex structures, and circumvention hubs—for example, using countries like Turkey or Kazakhstan to reroute goods to sanctioned countries like Russia. In these cases, even if the goods do not go directly to the sanctioned country, the company could still face penalties.  
  • Shareholders and director screening: Companies also need to check sanctions on not just the customers in high-risk areas but also their shareholders and directors.
  • Regular updates: Many companies forget to regularly update their compliance programs. Export control laws change often, and not staying up-to-date can lead to risks of non-compliance. This becomes crucial when trying to avoid criminal sanctions or negotiating plea deals.

What do you expect the biggest legal and regulatory challenges to be for global ASD companies in the next 10 years?

In the next decade, global ASD companies will likely face growing regulatory fragmentation. As the U.S., EU, and China follow different export control and trade policies, companies will struggle to meet the varying regulations across these regions.

Compliance efforts will become more complex, riskier, and costlier.

Sabine Naugès is a partner at McDermott Will & Emery in Paris.

Sources