There have been many articles and papers published on sanctions that have covered why sanctions exist, the aim of sanctions, the various sanctions regimes of different bodies and countries, how to implement sanctions controls, how to perform efficient screening, the results of failing to perform efficient screenings and various other topics.
This article does not aim to discuss the seriousness of the issue from the perspective of the originator of sanctions, from the perspective of the target of sanctions nor from the perspective of the parties involved in busting or circumventing sanctions. However, it will provide information on the effects of sanctions to those on the receiving end of sanctions restrictions and the reaction from the sanctioned parties.
Sanctions Against Individuals
In June 2020, the U.S. government imposed sanctions against Fatou Bensouda from Gambia and Phakiso Mochochoko from Lesotho, employees of the International Criminal Court (ICC), through Executive Order 13928.1 Former President Donald J. Trump stated the following reasons for issuing this order:
“…the situation with respect to the International Criminal Court (ICC) and its illegitimate assertions of jurisdiction over personnel of the United States and certain of its allies, including the ICC Prosecutor’s investigation into actions allegedly committed by United States military, intelligence, and other personnel in or relating to Afghanistan, threatens to subject current and former United States Government and allied officials to harassment, abuse, and possible arrest.”
Former President Trump claimed that the actions by these ICC officials infringed the sovereignty and national security of the U.S. and that the country has never accepted the jurisdiction of the ICC. How did it affect the parties being sanctioned and how did it affect their banking relationships? The initial reaction from both persons was to continue their work as usual, unperturbed by the sanctions against them.
The impact on their personal lives must have been more profound. Banks would have taken a risk-based approach on whether to terminate the relationship or not. Additional factors the banks would have considered to terminate the relationship would have included the following: the bank’s exposure to the U.S. markets through its correspondent banking relationships; the exposure through other business arrangements and funding agreements; or even a physical presence in the U.S. Most banks would be very careful not to expose themselves to the wrath of U.S. regulators by ignoring the imposed sanctions and the likely decision would be to exit the relationship with the sanctioned individuals. The fact that banks are closing the bank accounts of the sanctioned individuals places them in an impossible position. These individuals have households, medical expenses, school fees and insurance premiums to pay but without a bank account, the situation can lead to frustration and financial impacts.
Sanctions Against Iran and North Korea
Taking the impact wider to a country level—specifically Iran and North Korea—imposing sanctions is devastating to the local population. It is primarily the population that suffers rather than the elite and the politicians. With the restricted trade and choking of imports to or exports from the country, the economic activity within these countries is very limited. The result is food shortages, lack of medical supplies and more.
The natural response to the imposed sanctions is to find alternative ways to keep the economy alive and source the goods required to satisfy the most basic needs of the population. On the other end of the continuum, country leaders try to import goods in support of their overall agenda. In the case of North Korea and Iran, it is to develop their nuclear capabilities purportedly for peaceful purposes. In these attempts, these governments apply various methods to circumvent the restrictions imposed―they try to bust sanctions.
What Is Sanctions Busting?
Sanctions busting is described by Bryan R. Early in his book Busted Sanctions: Explaining Why Economic Sanctions Fail 2 as “third-party states that respond to the imposition of sanctions by increasing their economic engagement with target states in ways that ameliorate the sanctions’ adverse consequences.” Furthermore, Early describes the parties involved in sanctions busting as follows: (1.) the sender state, which is the country imposing sanctions (2.) the target state on the receiving side of the sanctions and (iii) the third-party state assisting or attempting to bust the sanctions against the target state.
In the book Economic Sanctions Reconsidered,3 the term “black knight” describes “powerful or wealthy allies of the target country to assume the role of black knights…their support can largely offset whatever deprivation results from sanctions themselves…ready and willing to provide offsetting assistance.”
At the time of writing the books, both authors indicated that sanctions-busting initiatives normally take the form of foreign aid, foreign trade, foreign direct investment and foreign remittances of which foreign aid and foreign trade were the most prevalent.
Trade-based sanctions busting saw an increase in trade between the third-party “black knight” state and the target state, especially by companies and individuals located in the third-party state that were primarily driven by making a profit. Trade transactions negotiated and executed by the government were less in number and quantum between the two states.
Initiatives by the target state to increase trade with third-party states willing to assist in busting sanctions was a costly exercise because potential new partners became weary of doing business with the target state, resulting in higher trade tariffs and fees. The target state and its businesses—having suffered cashflow constraints due to imposed sanctions—were hardly able to either negotiate or absorb the increased tariffs.
Aid-based sanctions busting takes the form of various types of aid to target states, such as financial grants, food and medicine, trade subsidies, direct investment in infrastructure, and military and technical aid. Aid-based assistance was normally driven by the government of the third-party state with political undertones. For example, North Korea received aid from the Soviet Union and China in 1950 to counter the impact of the sanctions against it. The Chinese aid consisted of food, fuel, fertilizer and about 70% of North Korea’s oil imports. China has also funded several of its factories and infrastructure projects.4
Aid-based busting is very costly to the third-party, the “black knight” state. It is a bottomless pit because the needs and requirements of the target state are ever increasing. As the effects of sanctions become more visible, the population of the target state suffers at greater levels, creating a humanitarian crisis in the region. In turn, that can result in mass movement of people to neighboring states to seek relief and medical services.
Iran has also been the beneficiary of sanctions busting and one of their “black knight” third-party countries was the United Arab Emirates (UAE), among others. Since 1979, the UAE was involved with Iran primarily through trade-based busting with profits being the main driver behind the assistance. Furthermore, the UAE, especially Dubai, became a hub for sanctions-busting businesses. The U.S. implemented a few executive orders to stymie the sanctions-busting activities over a few years by creating more stringent restrictions, creating very complex sanctions regimes.
Current Sanctions Approach
Since the 9/11 attacks, there has been an increased focus on sanctions as well as sanctions-busting attempts. New methods are being used and there has been an increase in prosecutions and fines by the regulatory authorities. Some governments, especially the U.S., promulgated a host of new legislation to stifle the increased attempts of sanctions busting. The most profound effect of such legislation is the increased focus on secondary sanctions and their extraterritorial application.
Better known as “circumvention,” sanctions busting took on a life of its own in recent years. The methods being used now take the form of shell companies and complex organizational structures to disguise the sanctioned entity behind an opaque corporate veil. In addition, sanctions busting attempts include disguising the true ownership or control of a sanctioned entity by using false names and false client information. Sanctioned entities will also change their ownership structure by reducing the shareholding of sanctioned individuals to a number below the reporting threshold applied by regulators (e.g., the 50% rule as a countermeasure by the U.S., the European Union and the United Kingdom). When it comes to vessels, it is a confirmed fact that both Iran and North Korea have fleets of ships being used across the globe to move goods. It is also known that the names of ships are changed to prevent detection.
From a payment processing perspective, sanctions circumventors use stripping of sanctioned parties’ information from payment messages to hide the true importer/exporter. Alternatively, non-alpha Latin characters such as $ & @ Ж ֏ can be used to prevent the information from being screened. Whether this circumvention attempt will be successful or not depends on the robustness of the entity’s screening application. Stripping or altering information in order to avoid detection in the sanctions screening applications usually takes a coordinated effort by the client and banking officials. The names could also simply be falsified, especially in cases where the counterparty to the payment is not the bank’s client. Financial Action Task Force Recommendation 16 prevents this kind of circumvention by requiring additional due diligence on the counterparty to a payment.
Trade-based money laundering methods, such as falsifying shipping documents to hide the true port of loading or port of discharge, are also used in sanctions busting. “Phantom shipping” is another way to move money to avoid sanctions. This is when the paperwork reflects a legitimate export of goods that are not subject to embargo on vessels and are from/via/to countries that are not subject to sanctions, but the container is empty and the actual flow of the related payment takes place. In addition, moving cargo from one ship to another in the open seas, or transshipment, is another way to avoid sanctions detection.
Other methods applied by North Korea are sending its citizens to be employed in third-party countries and sending a portion of the citizens’ salary back home in the form of a tax to fund the state. The United Nations Security Council reacted to this phenomenon by adopting Resolution 2397 to curtail the movement of North Korean citizens. Whether this was, or still is, successful is a question of which the answer still evades all.
As one reflects on how sanctioned targets design more daring and ingenious ways to avoid sanctions, it is obvious that this is a very complex and ever-changing environment. Consequently, regulators are becoming more aggressive in applying sanctions. Compliance officers are tasked with the execution of sanctions regimes from the various authorities, which is a very challenging task. A system can never solve the problem of identifying circumvention attempts alone. Human intervention is critical, especially with the more document-related attempts. Therefore, compliance officers and sanctions specialists must be aware and mindful of the circumvention risks in their organizations and react to this increasing threat.
Jan Hendrik Bester, CAMS, sanctions SME
- “Blocking Property of Certain Persons Associated With the International Criminal Court,” Federal Register, June 16, 2020, https://www.federalregister.gov/documents/2020/06/15/2020-12953/blocking-property-of-certain-persons-associated-with-the-international-criminal-court
- Bryan R. Early, Busted Sanctions: Explaining Why Economic Sanctions Fail, (Stanford University Press, 2015) 21.
- Gary Clyde Hufbauer et al, Economic Sanctions Reconsidered, (Peter G. Peterson Institute for International Economics, third edition, 2009).
- Bryan R. Early, Busted Sanctions, Explaining Why Economic Sanctions Fail, (Stanford University Press, 2015) 26-28.