By Sean Parker Abdelaziz Abouelhoda Trevor Jones
Economic sanctions are by no means a recent phenomenon and can be traced back through world history but[TJ1] have steadily increased in use as a foreign policy tool since the end of the Cold War. Despite economic sanctions, targeted countries, businesses and individuals are able to navigate around them due to inconsistent application globally stemming from disagreement between countries and competing foreign policy objectives as well as competing legal frameworks. Case in point, China has been one of the biggest buyers of Venezuelan oil, purchasing approximately 500,000 barrels per day of crude oil and fuel[1] The US government has stated in the past month, that any country who purchases Venezuelan oil will face a tariff of 25%. Venezuela is currently sanctioned by the US government. As threats of tariff’s and trade wars looms, dealings with certain countries, like Venezuela, who the US government deem undesirable and who are sanctioned, may come at a cost.
Economic Sanctions are laws passed by countries which place financial restrictions on persons, entities and targeted financial activities. They are used to apply pressure on foreign states to change behaviour. Sometimes they are used as retaliatory measures. Generally, sanctions fall into three categories; comprehensive, sectorial and targeted. Comprehensive sanctions prohibit all financial activity with an entire country and often include travel bans, while sectorial sanctions apply to specific sectors of the economy. Targeted sanctions aim to block financial transactions with specific lists of businesses, groups or individuals.
Despite how long they’ve been around, the main problem and criticism of economic sanctions has always been the same – lack of enforcement and the continuous development of sanctions evasion techniques. In February 2024, one study referenced by John Hopkins University stated that, when looking at the Islamic Republic of Iran, the US only achieved 13 percent of its foreign policy objectives since the introduction of sanctions in the 1970s.[2] More recently, a US congressional research report[3] stated that, far from meeting their policy objectives, economic sanctions placed on Venezuela and North Korea did more harm by plunging millions of civilians into a humanitarian crisis.
This article seeks to highlight some of the methods that individuals, businesses and countries take to evade or circumvent sanctions, and the new approach of leveraging tariffs and sanctions to force political will.
Sanction Evasion Methods
Sanction evasion methods can vary but generally fall into the following categories:
· Involvement of third parties, which relies on the use of front/shell companies often with opaque or unverifiable or unknown ownership. Third party payments from countries or parties which do not appear to be directly involved with the transaction may also be used
· Concealed or obscured information is the use of false, inaccurate, inconsistent or incomplete documentation to facilitate the illicit flow of funds. This leads to a lack of transparency with the parties involved and the ultimate end user of the goods or services.
· Customer behavior and information is what is known about the customer and may include suspicious or inconsistent customer behavior and or transactions. Additionally, the customer may have known or suspected ties to a sanctioned target.
The Democratic Republic of North Korea (“North Korea”) has become skilled at sanctions evasions. There are generally four approaches North Korea leverages to evade sanctions, they include:
1. The use of their embassies abroad
2. Leveraging overseas workers
3. The use of front companies and
4. Shell companies (via trusted foreign nationals).
A perfect example of North Korea deploying some of these approaches would be the case involving the Korea General Corporation for External Construction (KOGEN). The company was identified during a UN investigation into banks providing financial support to North Korea. The investigation identified that the company was registered as a North Korean subsidiary of a Malaysian company, MKP.[4] The latter facilitated North Korea’s ability to export coal to Malaysia, while sending the proceeds of these sales into a Hong Kong-based front company. Further investigation by the UN identified additional front companies located around the globe which received such proceeds from Malaysia.[5]
From a compliance perspective the KOGEN case presents some significant questions:
· Which financial institutions banked or provided services to MKP?
· Were these financial institutions aware of risk exposure of MKP involvement with North Korea?
· What information was requested and provided to the financial institutions banking MKP and facilitating the transactions between them and the front company illegally importing North Korean coal.
· For the financial institutions who banked these front companies, how far and deep did their due diligence process go?
These are important questions to ask, because proper due diligence is the primary tool to identify and understand economic sanction risk as well as other financial crime risks which often overlap. If we use the same example of MKP, the same investigation identified that the Ugandan government entered into a joint venture worth USD 5.2mn with MKP. Subsequently the project was abandoned and MKP never returned the funds to the Ugandan government.[6]
What should we be looking out for?
In the simplest terms, there are three main points banks and non-bank financial institutions (“NBFIs”) like money services businesses and cryptocurrency, need to focus on when safeguarding against sanctions evasions, they include:
1. Robust internal policies and procedures, including defined risk appetite, client due diligence/know your client process (“CDD/KYC”), escalation processes and employee role specific training
2. Appropriate and robust screening and escalation process and procedures
3. Holistic governance related to the sanction exposure of customers, products and services.
The bedrock of mitigating sanction evasion risk as well as other financial crime risk lies in effective documentation of policies and procedures. These should outline what risk the FI is willing to take (risk appetite) and specific steps to follow during day-to-day operations and when financial risk is suspected or identified. If a process is not well documented, there is always a chance for error or mistake. The framework around the CDD/KYC process is paramount to frame out an approach in the ongoing understanding of clients and their transactions. The more complete the CDD the easier it is to identify and manage the risk. Screening and monitoring capabilities can take many forms but should be sufficient to identify potential sanction and other financial crime risks and indicators. Jurisdictionally, the appropriate lists should be screened against, and any potential alerts should have a clear escalation route. As sectorial sanctions increasingly include import and export prohibitions, in the case of Venezuela and countries purchasing oil from them, financial institutions should look at the clients they onboard and their risk exposure to that sector, along with their transactional activity.
Finally, governance will oversee that the policy and procedures are adhered to and risk appetite is kept within tolerance. Governance forums help to frame out discussions around potential sanctions exposures of perspective clients, as well as newly discovered exposure.
A closer look at shell companies and payment transparency
What can we learn from previously exposed front companies? This is a worth while exercise every bank and non-bank financial institution should carry out to identify typologies and themes. Often shell companies appear to operate as general traders and interact with several companies across different geographies. A closer look at the transactions will find that a lot of these transactions often reference payment for invoices for goods or services. Some of these companies may indeed be exporting or importing goods and assisting other front companies in disguising the origin of goods and facilitating the movement of these goods and associated funds into different countries. Some front companies may even do this amid legitimate import/export business they have with other companies. The purpose here is to demonstrate to banks that they have legitimate business and rely on the fact that banks won’t scrutinise each and every relationship.
Once onboarded, front companies can utilise different services and products offered by the financial entity and look to use these to obfuscate and move illicit funds. Depending on the service and/or product being offered, it may make the transparency related to the payment more opaque and less clear to an outside observer. The thought process should be identifying if the activity being carried out is done in a way to avoid traditional established controls and if a product or service offering has risks that can be exploited or potentially used to circumvent sanctions evasion requirements and controls. Payment channel risk and payment risk is examples of where sanctions evasions can be leveraged. Payment channel risk is where an assessment should be done as to whether the payment channel is appropriate for the customer. This includes things like where the channel allows for bulk payments, which raises concerns on the ability to screen and monitor singular underlying parties. This is mostly prevalent with higher risk business types such as Money Service Businesses, Third Party payment Processors or Virtual Asset Service Provider.
The US has demonstrated that they will leverage tariffs in conjunction with sanctions, it becomes even more important for countries that have financial institutions and non-banking financial institutions with risk exposure to Venezuela and other sanctioned countries (depending on the level of sanction), to identify these clients and their related transactions. Asking in depth CDD questions, along with full transactional transparency is the best defence against sanction evaders, and in this case additional risk exposure related to tariffs. Just remember the risk may not just sit with your institution but pass along down the chain of your banking partners who are involved in the transaction.
[1] China’s Purchases Stall After Trump’s Tariff Threat on Buyers of Venezuelan Oil | OilPrice.com
[3] Venezuela: Overview of U.S. Sanctions Policy | Congress.gov | Library of Congress
[4]https://www.rand.org/content/dam/rand/pubs/research_reports/RRA1500/RRA1537-1/RAND_RRA1537-1.pdf
[5]https://www.rand.org/content/dam/rand/pubs/research_reports/RRA1500/RRA1537-1/RAND_RRA1537-1.pdf
[6]https://www.rand.org/content/dam/rand/pubs/research_reports/RRA1500/RRA1537-1/RAND_RRA1537-1.pdf
