Busting the Sanctions Busters

Ingo Walter

It looks now like BNP Paribas will plead guilyy to a criminal violation of US payments sanctions and an accompanying $9 billion fine and temporary suspension from dollar clearing business - coming only a few months after the guilty plea by Credit Suisse to a criminal charge of aiding and abetting tax evasion - elevates the real-world exposure of financial institutions to US regulatory enforcement.

Like it or not, in the dollar world, US law is the law. Banks must comply or face severe consequences. Since 2005 they have been fined heavily to settle civil violations of US tax or money laundering laws. Some bankers and investors may consider this a cost of doing business, It becomes another matter entirely when the legal venue transitions from civil to criminal.

Trade and financial sanctions have long had a place in international affairs – from the high-profile sanctions applied to South Africa under Apartheid to their increasing use as a substitute for military intervention in countries like Iraq, Libya, Iran, Cuba, Sudan, and most recently Russia, where they are still pending. The objective is to encourage targeted countries not to build nuclear weapons or engage in human rights abuses or invade their neighbors. Sanctions are both serious and controversial. Serious because the alternative may be boots on the ground and people dying. Controversial because lack of international cohesion may undermine the effectiveness of sanctions and because it has not always been easy to tell whether they actually work.

One thing is certain: Evading sanctions can be a very profitable business. Money is made in imperfect markets, and sanctions can be an excellent source of market imperfections. The global arms trade, “conflict minerals,” smuggling, aiding and abetting tax evasion, and money laundering have long been growth businesses and there are well-developed, adaptable transaction conduits around the world to facilitate them. As long as there are sanctions there will be sanctions-busting.

So it is with “wire-stripping,” a practice in international financial transactions to falsify the origin or destination of international payments, often routed through multiple intermediaries – a form of money laundering without which evading trade and financial sanctions would be much more difficult and costly. The falsification has to be executed by one or more intermediary banks willing to engage in transactions that are illegal in one or more countries. Presumably the idea of banks collaborating in sanctions-busting must have been to turn the routine business of global transactions banking into a much more profitable activity by intentionally skirting the law. Was this the work of a few rogue employees or deliberate bank strategy?

In 2005, ABN Amro’s Dubai branch was tagged for fraudulently bypassing US controls of financial transactions with Iran and Libya. In agreement with the Dutch Central Bank, ABN Amro was subject to a cease and desist order, permitted the bank to enter a no-contest plea, and was fined €65 million plus €1 million clawed-back from the previous year’s bonuses earned by the bank’s Management Board. Acquisition of parts of ABN Amro by the Royal Bank of Scotland led to a further $500 million fine imposed on RBS in 2010, and continuing probes by the Federal Reserve and Department of Justice. The wheels of justice sometimes turn slowly, but they do turn.

In 2012, Standard Chartered was alleged to have engaged in $250 billion of wire-stripping through its New York branch, almost all of which management initially attributed to “clerical errors.” StanChart briefly fought the charges, but in the end settled for a no-contest plea, $667 million in fines and a humiliating in-person apology in Washington by senior management. Its shares dropped 15% on announcement of the money laundering charge.

As well, HSBC was fined $1.9 billion and ING $619 million in civil money laundering settlements, joined by Lloyds, Credit Suisse, Barclays and others. Did bankers decide not to take US law seriously, or were they oblivious to risk exposure that accompanies circumventing the rules? Not entirely. An e-mail from Standard Chartered’s US CEO to headquarters in London noted that the US wire-stripping inquiry had the “…potential to cause very serious or even catastrophic reputational damage to the Group and expose senior managers to criminal liability.”

BNP Paribas may be no better or worse than some of its competitors in its alleged wire-stripping activity, but the enormous cost of the settlement indicates that the goalposts have now shifted in several ways.

First, US authorities have greatly improved their ability, both unilaterally and in cooperation with other countries, to monitor international dollar transactions and detect violations.  They have the ability to subpoena bank records and email traffic in building cases against firms that break the law and possibly show “intent.”

Second, US authorities, both state and federal, have abundant political support for no-tolerance enforcement policies, and are willing to threaten withdrawal of operating licenses to do business. Lingering public resentment over the financial crisis and its consequences continues to provide plenty of political cover.

Third, the US Justice Department has elected to bring criminal charges against banks deemed to be less that fully cooperative in order to force them into compliance and acceptable behavior going forward. This is a powerful weapon, because any bank on the wrong end of a US criminal indictment will normally be forced to shut down. For the time being, this weapon remains in its holster, with key regulators agreeing not to pull the trigger and revoke US operating licenses of both Credit Suisse and BNP Paribas in their criminal guilty pleas.

Along the way BNP Paribas did itself no favors. It allegedly obstructed the US investigation. It put forward an “advice of counsel” defense that some of the wire-stripping was done outside the US and therefore was technically not illegal when the funds passed through US payment system. It argued that the fine was excessive compared with previous money laundering cases and would force the bank to raise capital, suspend dividends and defer expansion plans. And it engaged the big guns - including the President of France, the Foreign Minister and the Governor of the Banque de France - in its “Chicken Little” defense based on the systemic importance of BNP Paribas in Europe. Overhanging everything was the threat of damage to US-European and Franco-American relations, a theme taken up by the US Chamber of Commerce in support of lighter punishment. The Obama Administration stuck by its guns.

Credit Suisse may have been able to swallow its criminal tax evasion “guilty” plea and accompanying $2.6 billion fine with relative impunity -- at least according to CEO Brady Dougan, who suggested that CS’s criminal conviction would have “no material effect” on the bank’s business and that no management or board changes were contemplated. Investors seemed to agree, with CS stock up by 2% in an otherwise flat market. That is not the case with BNP Paribas, which lost heavily in market value and will sacrifice about 30 senior management positions in connection with the settlement. Nor will it be for future violators. 

Global banks today continue to rely on the dollar market, the world’s largest for trade and financial transactions. Sanctions that restrict access to this market can be very burdensome for targeted countries, particularly those with mineral resources that need to be sold abroad. Whereas sanctions imposed on countries like North Korea may have been relatively ineffective, those applied to Iran are thought to be quite significant. Russia is next, and because of its dependence on dollar-priced hydrocarbon exports is highly susceptible.

For its part, Russia has announced that it hopes to switch its dollar trade in oil to Chinese Yuan in order to reduce the impact of any US sanctions. That may be a naïve, since the Yuan is neither convertible nor widely used as a currency for international trade. Russia may assume it can find banks willing to help subvert sanctions via the Yuan and drive wedges between the US and more sympathetic European governments. How China will react when its own banking regulations are subverted is anybody’s guess.

The BNP Paribas case shows that the US can still impose and enforce sanctions unilaterally in the dollar market without the kind of broad international agreement required for trade treaties and banking regulations. And it has the ability and the willingness to detect and punish those who violate its laws, including denial of access to its financial market - something that no major international bank can endure. This may change in the future. But for now it is the reality.