By Troy Stangarone
The United States has utilized financial measures to go after hard to reach targets engaged in illicit activities at least since tax evasion was used to bring down Al Capone. Now modern day financial methods are being utilized to inhibit North Korea’s efforts to advance its nuclear weapons and ballistic missile programs.
As part of the new sanctions measures passed by Congress after North Korea’s nuclear test earlier this year the Department of Treasury was directed to determine whether there was reasonable evidence to classify North Korea as a “primary money laundering concern.” Having made an initial finding that there was, the United States has begun the process of formalizing a new rule that would further limit North Korea’s access to U.S. financial markets. While Treasury’s action is significant in that it prohibits both direct and indirect contact by North Korean financial institutions with the U.S. financial system, what are the practical implications of the change?
Limiting North Korea’s access to U.S. financial markets is significant step as a substantial amount of global financial transactions take place in U.S. dollars due to the dollar’s status as a global reserve currency. This means that dollar denominated transactions flow through U.S. correspondent accounts in the United States even if the transaction is between two parties not in the United States. By limiting North Korea’s ability to undertake financial transactions the United States can make Pyongyang’s efforts to develop its nuclear program and develop its economy increasingly difficult.
The new measures, which will require additional due diligence on the part of financial institutions, including third country institutions, are designed to inhibit North Korea’s direct and indirect access to the U.S. financial system. Treasury has determined that North Korea has used that system to move millions of dollars through a series of front companies, joint ventures, and other opaque methods. Should financial institutions fail to deny North Korea access to the U.S. financial system, they themselves would run the risk of being cut off from the U.S. financial system.
The new measures by Treasury are also in line with the new sanctions by the United Nations which call for countries to discontinue bank accounts with North Korea that they have credible reasons to believe contribute to North Korea’s nuclear weapons and missile programs. While Treasury’s actions go farther, other countries such as Russia and Switzerland have also taken measures to limit North Korea’s access to their financial systems.
However, limiting North Korea’s access to the U.S. financial system may not be enough to hinder its ability to conduct financial transactions and there may be little immediate impact from Treasury’s new designation. North Korea has no correspondent accounts with U.S. financial institutions and “current U.S. law already generally prohibits U.S. financial institutions from engaging in both direct and indirect transactions with North Korean financial institutions.” In addition, in light of the Financial Crimes Enforcement Network’s prior guidance on the risks of illicit activities by North Korea and prior U.S. sanctions, North Korea will already be on the list of countries with which financial institutions would want to eliminate their exposure. Even in the case of China, major banks have already cut ties with North Korea. It is likely the smaller banks that may still have exposure.
While designating North Korea as a primary money laundering concern pushes Pyongyang further to the edges of the global financial system, it does not push it out of the global financial system. To achieve that goal will require additional steps.
The Role of the U.S. Dollar in the Global Financial System
While the U.S. dollar remains the primary global reserve currency and a significant percentage of global transactions take place in U.S. dollars, it is not the only reserve currency and not all transactions are settled in U.S. dollars. As of April 2016, the U.S. dollar accounted for 41.92 percent of international payments. It was followed by the Euro at 30.69 percent, the British Pound at 8.4 percent, the Japanese Yen at 3.24 percent, and the Canadian dollar at 1.83 percent. Other currencies used for international settlements include the Chinese RMB, the Thai baht, and the Chilean peso, among others.
In most cases, any international settlements in one of these currencies would be conducted by financial institutions that also maintain U.S. dollar accounts and would be at risk of losing access to the U.S. financial system if it came to light that they facilitated North Korean transactions in an alternative currency. However, not all financial institutions maintain dollar denominated account and are, therefore, outside of the U.S. financial system. In the case of European financial institutions, it may be relatively easy to have European counterparts put in place similar restrictions, but it may be challenging in the case of small Chinese banks, especially those that conduct trade with North Korea under the “livelihood” exception in UN sanctions.
Additionally, some of the challenge will be relative to the types of currency North Korea’s partners might be willing to accept.
Iran Sanctions and the Case of Kunlun Bank
North Korea is not the first country to be designated as a primary money laundering concern. As part of the efforts to bring Iran to the negotiating table over its nuclear program, Treasury designated Iran as a primary money laundering concern and prohibited the maintenance of U.S. correspondent accounts.
In the case of Iran, which has one of the world’s largest oil reserves and a growing middle class, there was a strong incentive for countries to find ways to maintain trade ties. However, the combination of financial and oil sanctions had a substantial impact on Iran. GDP fell from $592 billion in 2011 to $425 billion in 2014. Trade was impacted as well with Iran unable to pay for food.
In the past, Iran would avoid sanctions by booking orders though the United Arab Emirates, but that option was closed off. Though Iran was still selling oil in yen, won, and rupees, it was unable to repatriate profits. As a result, Iran entered into a series of barter arrangements. These barter arrangements included the trade of Iranian oil for either local currency or food supplies in China and India.
Beyond the use of barter, Iran and China were able to evade sanctions by utilizing a toxic bank. In 2012, Treasury designated Kunlun Bank as a primary money laundering concern after it facilitated transactions for designated Iranian banks. After Kunlun was cut off from the U.S. financial system, China utilized it to processes billions in oil payments with Iran and to protect other banks in China.
The Black Hole of International Finance
The revelations of the Panama Papers may reveal and counter the practices used by North Korea to conduct financial transactions. The firm behind the Panama Papers, Mossack Fonseca, engaged in many of the practices that Treasury has identified as allowing North Korea to move money through the U.S. financial system.
Mossack Fonseca created what was essentially a financial black hole for its clients to hide their finances from the U.S. and other governments. In addition to creating shell companies, Mossack Fonseca would identify individuals with the appropriate amount of assets to properly serve as a front for an individual who did not want to be identified.
What About NGO’s?
One area for clarification is how the new designation will impact the work of NGOs. When Congress passed the new sanctions earlier this year language was specifically included in the text to clarify that nothing in the legislation was designed inhibit the legitimate work of NGOs in North Korea. After the implementation of the new sanctions, Treasury issued a general license for NGO work in North Korea. Western NGOs doing work in North Korea are likely using Western financial institutions for their work. The status of their accounts may need to be clarified going forward.
The Road Ahead
While the significance of Treasury’s move should not be downplayed, it should also be kept in perspective. The designation of North Korea as primary money laundering concern is only one step in a long-term process of pressuring North Korea to return to negotiations over its weapons programs. While it will increase the due diligence conducted by banks on accounts and transactions potentially related to North Korea, pressuring North Korea will require a long-term, multi-faceted effort.
To ensure that banks conduct proper due diligence, Treasury will need to designate institutions with ties to the U.S. financial system that continue to facilitate North Korea’s transactions. However, simply pushing North Korea out of the U.S. financial system would be insufficient to completely push it out of the global financial system. That will require additional efforts to move parts of finance out of the dark and address the types of tactics exposed by the Panama Papers to hide and transfer money. It will also mean working with governments to ensure that institutions without connections to the U.S. financial system take similar steps within their own financial systems.
Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America. The views expressed here are his own.
Photo from Matt Paish’s photostream on flickr Creative Commons.