Can t You Just Sanction Them? Financial Measures as an Instrument of Foreign Policy

Virginia Policy Review 61 Can t You Just Sanction Them? Financial Measures as an Instrument of Foreign Policy Jonathan Burke In the 2006 film Casino Royale, the villain is a financier of global terrorism. After losing money belonging to a Ugandan terrorist organization, the villain attempts to recoup his losses via a highstakes poker game. James Bond s mission is to disrupt the plan by winning the game, thereby depriving the terrorists of their money. At the center of this saga are money and a terrorist organization s banker. Like in any economy, money is a necessity for most activities, including those that are illegal and that threaten global security. But at some point, most money must flow through the formal financial sector. There, it becomes vulnerable to government oversight and regulation. Governments cannot ignore this vulnerability when combating threats to national security. Financial measures, including sanctions, sometimes offer useful policy solutions. Following September 11, 2001, President George W. Bush began the War on Terror by saying: We will direct every resource at our command to win the war against terrorists. He stated that the administration would utilize every financial influence and would starve the terrorists of funding. i Subsequently, in 2004, Congress created the Office of Terrorism and Financial Intelligence within the Treasury Department. Its mission is to integrate intelligence, policy, and enforcement functions to protect the U.S. financial system from abuse, promote the integrity of the international financial system, and combat national security threats. These range from terrorism to troublesome nations such as Iran. The Office does this by developing and implementing financial measures made up of sanctions, other financial regulatory authorities, and international diplomacy. Financial measures have since become some of the sharpest arrows in the quiver of national security. They are part of an arsenal of global sanctions and strategies designed to deprive bad actors of access to the global financial system. However, the concept of financial measures is often misunderstood. Some think that the government can apply sanctions indiscriminately. Others believe that sanctions will automatically stop certain behavior. None of these assumptions is true and very few people see the extensive

62 Virginia Policy Review diplomacy and myriad of regulatory authorities that are brought to bear. What are Financial Measures? Sanctions are nothing new. Historically, they have been viewed as trade restrictions based primarily on political posturing towards a particular country. However, the rise of transnational threats and an increasingly integrated international financial system create new risks for financial institutions, and new opportunities to combat illicit actors. Financial measures can therefore be used both as a tool of foreign policy and to protect the international financial system from abuse. The fall-out from September 11, 2011 and the growing threat posed by Iran provide excellent examples. In these cases, the United States developed targeted financial measures to sanction actors based on their conduct, freezing assets within the United States and prohibiting access to the U.S. financial system. The United States does this by publicly designating individuals and entities that provide support to terrorist organizations or aid in the proliferation of weapons of mass destruction (WMDs). ii Labeling these enablers exposes their illicit conduct, often resulting in a loss of access to other major financial centers and near complete isolation from the international financial system. Multilateralizing Actions Unilateral As a foreign policy tool, unilateral sanctions in today s global financial system are inherently limited. For example, the U.S. Treasury has designated over 200 individuals and entities for supporting Iran s WMD proliferation activities. However, most of them neither had assets in the United States to freeze nor access to the U.S. financial system to block. In order to augment the effectiveness of these sanctions, the United States engaged in an extensive diplomatic campaign aimed at exposing the illicit conduct behind the designations. The belief was that foreign governments and global financial institutions would not want to facilitate illicit activity and, if aware of the risk, would take actions similar to the United States. This belief turned out to be true. As a result, a truly international sanctions framework emerged, comprised of separate, but complementary, unilateral financial measures against Iran by almost every major financial sector in the world. These actions have severely impaired Iran s access to the international financial sector. In 2010, there was a paradigm shift in the application of targeted financial measures. Exposing the illicit activities of certain Iranian banks had been enough to get many foreign governments and many banks to sever all direct ties. However, Iran still retained a few access points to the financial

Virginia Policy Review 63 system. The political appetite within the United States government to increase pressure on the Iranian government and deny Iranian banks from using their remaining access to facilitate illicit activities spawned the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (CISADA). Under this law, foreign banks that continue to conduct certain business with Iran can lose their access to the U.S. financial system. The rationale was that if a non-iranian foreign bank is doing business with designated Iranian banks, then U.S. financial institutions could still be indirectly exposed to Iranian risks by virtue of their relationship to those non-iranian foreign banks. For this reason, those non-iranian foreign banks should not be able to access the U.S. financial system. The CISADA was an extraordinary move that leveraged the role of the U.S. financial system in international commerce. What global bank would want to forego its access to the United States in favor of continuing its business with bad Iranian banks? Currently, only two have been sanctioned under CISADA. Most Banks Care The U.S.-designated Iranian banks, now numbering twentythree, have struggled to maintain their international access. In the face of U.S. sanctions, only two banks, Kunlun Bank in China and Elaf Bank in Iraq, continued their business with designated Iranian banks. Using CISADA, the U.S. Treasury Department took action to prohibit Kunlun and Elaf from accessing the United States iii, even though they did not actually have any access. Why would Kunlun, Elaf and their respective governments be concerned about losing access when they do not have any access anyways? As the Chinese government pointed out when condemning the sanction, it hurt China s interest. iv This is likely very true as Kunlun has probably faced a loss of access to other financial sectors where it once did have access. As China rightly acknowledged, financial measures against Kunlun, however symbolic, hurt both the interests of Kunlun Bank and the greater Chinese financial sector because it caused damage to both of their reputations. The world was put on notice that Kunlun and Elaf were doing significant business with institutions linked to terrorism and Iran s nuclear program and that the Chinese and Iraqi governments did not have measures in place to stop them. Most global banks are extremely sensitive to the risks of being connected to illicit activity. As a result of the U.S. Treasury s action, international financial institutions would likely apply enhanced scrutiny on any business with Kunlun or Elaf, if they even agree to continue any business with them at all.

64 Virginia Policy Review For the most part, banks want to do the right thing. Banks know if they incur damage to their reputation, the ability to conduct international business becomes increasingly difficult and expensive. Financial institutions are also more swift, decisive, and nimble than governments. Banks can and do act quickly to respond to risks while governments often get mired in political debates over the cost and effectiveness of sanctions. Sanctions and Financial Measures: Are They Effective? Many advocates of sanctions expect them to have an immediate and crippling effect, while many opponents feel sanctions only harm the innocent. Some believe that sanctions on Iran have not worked because the Iranian government is believed to be continuing its nuclear program. Others believe those sanctions have only hurt the Iranian people. Some think that using sanctioning authorities to designate a pirate or terrorist is as good as a bullet. Through this lens, financial measures will never look effective. When evaluating effectiveness, it is important to consider the foreign and national security policy objectives. In the case of Iran, financial measures are intended to pressure the Iranian government to pursue a diplomatic solution. In that context, financial measures have isolated the Iranian government from the global economy and strained its ability to manage its domestic economy. A result that some believe likely contributed to Iran s decision to come to the negotiating table and request relief from sanctions. v While the Iranian regime has so far entertained no offers to achieve that relief, the sanctions will likely continue to increase until the effects are unsustainable for the Iranian government and its economy. Financial measures used to combat terrorism are both similar and different to those targeting Iran. In both cases the intent is to protect the international financial system from abuse by illicit actors. However, unlike in the Iran context, sanctions targeting terrorism are not designed to create pressure through isolation. Instead, financial measures are used to deny terrorists the ability to collect, use, and move funds. Effective sanctions against terrorism do not only identify and cut off the flow of money to the terrorists themselves. Most terrorists live outside of the formal financial sector where sanctions are implemented. Financiers of terrorist organizations, however, traditionally depend on access to the formal financial sector for legitimate business as well. Therefore, the ability to target terrorist financiers with sanctions offers a deterrent for those who have legitimate business interests that they do not want to jeopardize by supporting terrorism. As a result, funding sources for terrorist organizations such as Al Qaeda have become significantly

Virginia Policy Review 65 limited and strained. Terrorist organizations are now seeking new methods to finance their operations. Choose Wisely In a New York Times Op-Ed, Former Deputy Secretary of the Treasury, Robert Kimmitt, advocated for the Treasury Secretary to be added as a statutory member of the National Security Council, rather than an invited attendee. vi His argument that financial and economic issues have become an integral part of national security is absolutely true. But it also goes beyond just having the Department of Treasury represented to evaluate the economic considerations of particular issues. The Department of Treasury is often turned to for specific actions and policy solutions. In the early days of the Arab Spring, when prompted for policy recommendations during an interagency meeting at the White House, one attendee asked, What can Treasury do? However, financial measures are not always the right answer. Even when they do offer appealing options, it is important to understand what authorities are available and what the potential ramifications of any action may be. When Libya erupted in February 2011, the Arab Spring turned into a Qaddafi thunderstorm. Yet, despite the urge to impose some sort of financial sanction, the appropriate authorities did not exist. A new Executive Order was necessary to provide the authority for financial sanctions on Qaddafi and his government. Given the circumstances and a concern over Qaddafi s misappropriation of state assets, President Obama declared a national emergency and issued a new Executive Order under the International Emergency Economic Powers Act (the same law used for WMD and terrorism sanctions). vii That Executive Order froze over $30 billion of Qaddafi s assets including those of his family and members of his government. This was an extraordinary circumstance that called for the creation of a new authority. Qaddafi was no friend of the United States and he had embarked on a destructive path against the Libyan people. Financial restrictions such as asset freezes, however, are not a panacea. Qaddafi was not ultimately defeated by financial sanctions, and sanctions cannot be applied on a whim or solely on political desire. Effective Financial Measures Are Not Easy Despite the appeal of financial measures as a middle ground, offering more tangible impact than diplomacy alone while avoiding the use of military force, financial measures are significantly more difficult to implement in a

66 Virginia Policy Review multilateral environment. Not every government wants to calibrate them the same way, which can limit effectiveness and create loopholes for circumvention. In the Iranian example, the United Nations Security Council agreed four separate times to impose sanctions on Iran for its failure to adhere to international obligations regarding its nuclear program. UN sanctions are potentially the most powerful because they are truly multilateral and each UN member state is obligated to implement them. However, UN sanctions can also be the most limited because each nation on the Security Council must agree to the extent of the sanctions. Among those four resolutions on Iran, only two Iranian banks were sanctioned. One of those two banks was First East Export Bank (FEEB), a Malaysian-based subsidiary of Iran s Bank Mellat. The Security Council stated in Resolution 1929 that FEEB is owned or controlled by, or acts on behalf of, Bank Mellat, and that Bank Mellat has facilitated hundreds of millions of dollars in transactions for Iranian nuclear, missile, and defense entities. viii However, the Security Council did not, and still has not, sanctioned Bank Mellat. Conversely, the United States, European Union, Japan, and South Korea, among others, have independently imposed sanctions on Bank Mellat and over twenty other additional Iranian banks. Governments that resist imposing far-reaching financial measures often cite an interest in preserving legitimate trade and avoiding consequences on the innocent population. Indeed, tailoring financial measures to specific targets allows for a balanced ability to disrupt illicit financial flows, pressure authoritarian regimes, and maintain legal commerce. However, when the threat of a military conflict becomes a real possibility, a resistance to sanctions will become more difficult to justify. After all, it is difficult to imagine that war would strengthen legitimate trade or benefit the global population either. Conclusion In Casino Royale, James Bond was the option chosen to shut down the flow of illicit funds to a threatening organization. The real world of illicit finance is far more multi-faceted and complex. However, illicit actors still rely on financial services, a vulnerability for which governments can take countermeasures. Some policymakers may not necessarily possess the glamour or physical skills of James Bond, but they can still be just as, if not more, effective in combatting illegal activity and threats to national security through targeted financial measures. Such measures are powerful tools that have become, and will continue to be, part of today s comprehensive approach to achieving global security.

Virginia Policy Review 67 Jonathan Burke is currently a manager at Ernst & Young LLP. He assists financial services clients with issues related to economic sanctions and anti-money laundering compliance. Prior to joining Ernst & Young, Jonathan was a senior policy advisor for the Treasury Department s Office of Terrorism and Financial Intelligence. He has also worked in security policy for the State Department and as a legislative fellow in the U.S. Senate. The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP, the United States Government, or any other organization. York Times, July 23, 2012. vii Executive Order 13566 Libya, February 25, 2011. viii United Nations Security Council Resolution 1929, Adopted June 9, 2010. i George W. Bush, Address to a joint session of Congress and the nation, September 20, 2001. ii Authorities relating to terrorism and WMD proliferation are examples. There are additional authorities that relate to certain human rights abuses, narcotrafficking, organized crime, and others. iii Press Release, Treasury Sanctions Kunlun Bank in China and Elaf Bank in Iraq for Business with Designated Iranian Banks, July 31, 2012. iv China Scolds U.S. over Iran- Related Bank Sanctions, WSJ, August 1, 2012. v Iran seeks sanctions relief at nuclear talk, Associated Press, June 18, 2012. vi Robert M. Kimmitt, Give Treasury Its Proper Role on the National Security Council, New