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Thoughts about Economic Sanctions (e.g. UN/EU/UK/OFAC) Evasion

29/09/2021

Sanctions evasion techniques cover a vast area, and there is no 'textbook' that those targeted use to work around prohibitions.

Indeed, the limits of sanctions evasion techniques, as with other forms of criminality, are only provided by the ingenuity and creativity of the criminals themselves.

Nonetheless, there are common themes that recur across different situations of which businesses should be aware such as:-

  • Attempts to camouflage the identity of individuals, firms, and countries involved, or
  • Items being traded, usually through complexity,
  • But also through straightforward deceit.

And because of their distinctive political, economic, and geographic profiles and the various regimes they face, targeted countries, organizations, and individuals will use some techniques more than others. For example,

  1. A small and comprehensively targeted jurisdiction such as North Korea will have a greater need to secure hard currency to conduct illicit trade than a large and selectively designated economy such as Russia.

However, none of the techniques is unique, and there is evident cross-pollination of ideas and typologies between those subject to sanctions.

One area where there are signs of increasing 'take up' is, as we shall see, the use of cryptocurrencies.

Key Evasion Challenges

Depending on the type and scope of sanctions being applied, targets typically face one or more of the fundamental problems listed:

  1. Sourcing widely accepted international currencies – especially US dollars – through which prohibited items can potentially be purchased.
  2. Sourcing and purchasing prohibited goods or services in other jurisdictions.
  3. Transporting and delivering those goods or services to the targeted jurisdiction, organization, or individual.
  4. Making payments for those goods and services without detection.
  5. Protecting assets – financial and physical from detection, freezing, or seizure.

Paying for Evasion

  1. The need to source hard international currency to conduct illicit transactions will depend on the economic and financial heft of the given jurisdiction.
  2. As a general rule, the issue is more pressing for smaller, developing nations that face more comprehensive sanctions regimes.
  3. A good example here is North Korea, whose isolation from the global international financial and political systems has led to it being described as the "Hermit Kingdom.'
  4. However, the problem has affected other sanctioned jurisdictions too, despite having more developed economies, such as Iran.
  5. Two techniques have long been used to source legitimate currencies, especially where overseas travel has still been feasible.
    • One has been the despatch of individuals to neighbouring unsanctioned – but often poorly regulated – countries to use foreign exchange markets to buy major currencies, or use local proxies to do the same. This is a technique that has been used by Iran in neighbouring Arab countries in the Persian Gulf, and more recently in Iraq.
    • Similar techniques include the despatch of foreign nationals overseas to work, with the hope of sourcing hard currencies that can be clandestinely remitted back home, something which the North Koreans have attempted to do at scale in the past.
    • However, as controls and monitoring on travel have become tighter, these activities have been hard to execute, forcing sanctioned entities to find more innovative – and explicitly criminal – ways to source those funds.
  6. Much of this is increasingly being achieved through cybercrimes against financial institutions, businesses, and individuals.
  7. North Korea in particular has become adept at massive cyber thefts.
    • It is suspected by the US authorities of involvement in the 2016 'Bangladesh Bank Cyber Heist' when hackers illegally transferred nearly $1 billion from the Bangladeshi central bank's account with the Federal Reserve Bank of New York to accounts in Sri Lanka and the Philippines.
  8. However, North Korea's interest in cryptocurrencies as a potential funding source for sanctions evasion has become noticeable.
    • Although information about the scale of the problem remains challenging to identify, there are indications that the country has been behind a growing number of thefts targeting major crypto exchanges and ransomware attacks where the demanded payment is in cryptocurrency.
    • In one  US case from February 2021, authorities announced that three North Korean hackers had been indicted for stealing or extorting more than $1.3 billion in cash and cryptocurrency from financial institutions and companies.

Front Companies

  1. Complexity and opacity are vital when it comes to building structures that provide opportunities to source prohibited items overseas. At the heart of this is the use of the so-called 'shell company' – a legal business entity that is mainly opened for completing financial manoeuvres rather than trading in its own right.
  2. Such companies – which remain relatively easy to set up in many jurisdictions – can be used as 'fronts' for sanctioned countries, organizations, and individuals.
  3. To make matters more complex, sanctions evasion operations will often involve intricate ownership structures for shell companies, making chains of true control and beneficial interest difficult to identify.
  4. A further ingredient will also be creating a chain of international interconnections between these firms or using tax havens or secrecy jurisdictions to add a further layer of ambiguity.

Ownership Structures

  1. Of course, sanctions are not just about the prohibition of trade in certain goods but can include trade barring with certain companies and individuals, and this is where the subject of ultimate beneficial ownership becomes vital.
  2. If a firm is majority-owned by a sanctioned firm or individual, it is also sanctioned under most regimes.
    • Here, creating opacity around ownership is a tried and tested evasion technique, usually through manipulating ownership structures.
  3. Sanctioned Russians and Russian businesses have become particularly adept at such techniques,
    • Moving the ownership of organizations among friends and family who remain in their sphere of influence, or
    • Looking to other friendly but non-sanctioned firms to take the majority ownership of subsidiaries of sanctioned firms as a form of 'safekeeping.'

Nominee Management

  1. Although company structures are essential, so too are the international networks of individuals that are involved in overseeing and managing businesses.
  2. As is often the cause in other forms of financial crime, the management structures of front businesses involved in sanctions evasion will feature nominee directors who have agreed – for a fee – to be listed as officers of the firm, despite fulfilling no actual duties.
  3. And many of these individuals will appear over and over again as officers of multiple companies – far more in fact than they could ever practically manage if the roles were real.

Proxy Networks

  1. Nonetheless, the firms will be under the real direction, usually, under the control of networks of nationals of the sanctioned country located overseas – a tactic widely used by North Korea, Iran, and others.
  2. Some of these individuals will hold multiple nationalities to hide their potential links back to designated jurisdictions, such as the Iranian businessman Reza Zarrab, who was arrested in Miami by the FBI in March 2016.
    • In addition to his Iranian citizenship, Zarrab also held passports for Turkey – where he was based, as well as Azerbaijan and Macedonia.
    • The use of multiple citizenships has become an increasingly common technique for obfuscating past national links in the last decade, due to the growth in the number of smaller countries (for example, St Kitts and Nevis) who have been willing to sell what has been described as 'economic' citizenships to those willing to invest in their country.
  3. Alongside these clandestine networks, sanctions-busting is also organized through the pre-existing business connections of legitimate diaspora communities. For instance,
    • Lebanese Islamist terrorist organization Hezbollah is believed to rely on a wide group of overseas Lebanese businessmen operating in regions under limited international surveillance, such as the Tri-Border Area (TBA) of Argentina, Brazil, and Paraguay.
    • Such networks are often used to source sanctioned items or undertake other forms of criminality on the group's behalf – we and others have sanctioned Hezbollah itself – and its sponsors such as the Assad Regime in Syria or Iran.

Logistical Camouflage

  1. Such commercial infrastructures are only a foundation, as the key challenge in any sanctions evasion scheme is the clandestine transfer of goods and services – one which is particularly great where commodities such as oil and gas, and manufactured dual-use items, are concerned.  Such items, either because of size or specific shipping requirements, are far from easy to camouflage.
  2. One way the most heavily sanctioned jurisdictions have worked around this has been through direct collaboration to support each other. In 2020, for example, Iran dispatched several tankers to Venezuela with petroleum products to breach the US embargo.
  3. Countries have also found ways to collaborate with other more powerful and sympathetic jurisdictions to mount 'under the radar' smuggling of sanctioned goods.
  4. The UN Panel of Experts on North Korea made this point in their most recent report, noting that Chinese and Russian firms – coming from countries that have argued for some sanctions relief for North Korea – have been involved in systematic evasion.
  5. Nonetheless, sanctioned organizations and individuals cannot rely on the goodwill of sympathetic countries alone, as most trading occurs within the context of an international logistical system dominated by western countries. Considerable efforts at logistical obfuscation are also required.
  6. At its most rudimentary, this can come down to the falsification of trade documents such as Bills of Lading, and at its most complex, to the conscious manipulation of logistical operations to provide cover for where an item is coming from, or going to. This can include
    • Circuitous routes of air or more likely sea travel, transshipment through high-risk jurisdictions (often close to the intended sanctioned destination), and
    • Working with shipping companies from jurisdictions that are willing to rename and reflag ships to avoid detection.
  7. Another common approach is the use of ship-to-ship (STS) transfers in international waters when ships will become 'invisible' to satellite surveillance by disengaging their Automatic Identification System (AIS). In one example in January 2021,
    • Indonesia seized an Iranian-flagged tanker to transfer crude oil to a Panamanian-flagged Chinese-owned ship in the middle of an STS.
    • Neither vessel was flying its flag at the time of transfer, and both had turned off their AIS.

Financial Camouflage

  1. Finally, illicit goods and services have to be paid for.
  2. As with other aspects of sanctions evasion, the most tried and tested methods rely on the complexity and careful obfuscation.
  3. This will mean the use of long and often curiously routed payment chains between multiple countries and institutions to avoid the attention of any financial institution involved.
  4. Another common device is to conduct mainly legitimate business and transactions around the suspect as a way of hiding illicit behaviors 'in plain sight.' For example,
    • Many of the Hezbollah-linked traders involved in Iranian sanctions evasion have also had extensive legitimate business concerns that form the majority of their activity.
  5. Another common countermeasure is seeking to work with smaller banks in emerging markets with extensive correspondent banking relationships with larger international institutions that can fulfil financial activities on a global scale – primarily in US dollars –  that the smaller bank cannot.
  6. In the past, western governments have expressed concern about the vulnerability this brings to the international financial system, and following waves of fines and censures in the 2010s, many of the largest financial institutions have undertaken wide-ranging de-risking exercises which have ended those correspondent relationships.
  7. Nonetheless, many such linkages remain, and even where banks have undertaken extensive Enhanced Due Diligence (EDD) on their smaller partners,
    • Risks of weak screening and other financial controls
    • As well as the potential corruption of individuals working within the smaller institutions remain.

The Rise of Virtual Assets and Central Bank Digital Currencies

  1. Much of what is discussed above deals with using the international economic and financial systems, based on fiat currencies, that we have known for a long time.
  2. However, fiat currencies are not the only value transfer system available, and therefore not the only means through which varieties of sanction evasion can be executed.
  3. The use of Virtual Assets has become a popular choice for isolated international actors who need to find ways to pay for illicit items.
    • The first option has been to steal already existing currencies,
    • But states such as Iran and Venezuela have also been encouraging the growth of native crypto mining;
    • According to a recent BBC report, 4.5% of all Bitcoin mining is estimated to take place in Iran.
  4. Some heavily sanctioned states are also looking at the development of sovereign cryptocurrencies to underpin trade and work around the dollar-dominated system.
  5. In March 2018, the Venezuelan government launched Petro, its own national cryptocurrency, which President Maduro described as a form of 'Kryptonite' against the American 'Superman's' control of international finances. Reports suggest that the Russian government has been encouraging these efforts, seeing them as a way to shift the world's economic balance away from the US.
  6. At this stage,  the evidence suggests that the role of cryptocurrencies in sanctions evasion, whilst growing, is still relatively small in comparison to that of fiat currencies. It is also potentially difficult to sustain, given the large amounts of energy required to undertake crypto mining.
  7. In May 2021,  the Iranian government suspended mining for four months because of the massive strain it placed on the country's power supplies. Thus – although crypto offers an evolving and additional option for those facing sanctions, it is unlikely to become the sole means of evading restrictions.
  8. A further linked development – and one with perhaps more serious longer-term consequences for the US dollar's position – are the rise of Central Bank Digital Currencies (CDBC).
  9. Although not 'virtual' in the same way as cryptocurrencies – they would be notionally backed by fiat rather than 'mined' cryptocurrencies – CDBCs would be electronic currencies, well adapted for a world of mobile payments.
  10. China is already running pilot projects with its digital Yuan, and according to a 2020 survey by the Bank for International Settlements (BIS), more than 80% of the 66 central banks questioned are considering creating a CDBC.
  11. The development of CDBCs is motivated by a wide range of economic and financial needs, including leveraging the potential of a cashless society. Nonetheless, the growth of successful CDBCs is likely to have implications for sanctions evasion too.
  12. China has expressed a desire to see the internationalization of its sovereign digital currency, and it would be feasible to see it becoming the basis of an alternative international financial system running parallel to the one dominated by the US, especially in the medium to long term.
  13. Although this prospect remains some way off, it raises the possibility of a more permissive financial environment in which sanctioned states, entities and individuals might be able to transact freely and without western interference.

What does this mean for business?

  1. Sanctions screening against published lists is the prerequisite under national laws; however, given the level of effort that sanctions evaders invest in subverting sanctions regimes, it is far from adequate to manage risks effectively.
  2. To begin, firms need to be aware of their potential vulnerability to complex sanctions evasion schemes. They, therefore, need to undertake an honest and thorough enterprise risk assessment to identify
    • Potential exposure to high-risk individuals,
    • High-risk jurisdictions and their neighbors, and
    • Vulnerable industries such as shipping and logistics.
  3. In such higher-risk situations, firms need higher levels of comfort about the people they are doing business with, and what that business involves. This means
    • Businesses will need to take appropriate and commensurate measures to manage the risks identified proactively, using Enhanced Due Diligence (EDD).

Source - https://complyadvantage.com/resource-hub/type/guide/global-sanctions-2021/

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