Iran Primer: Financial Sanctions
by MATTHEW LEVITT
21 Oct 2010 22:39
Iran sanctions extend as far back as 1979. But the United States launched more extensive efforts after the 2005 election of President Mahmoud Ahmadinejad. Shortly after he took office, the regime resumed uranium enrichment efforts, abruptly ending an agreement Tehran made with Britain, France and Germany to suspend its controversial program.
In response, Congress passed a bill in April 2006 extending and strengthening the August 1996 Iran Sanctions Act (ISA). (The Clinton administration had weakened ISA in 1999 and 2000 in an attempt to engage the previous reformist government.) A modified version of this bill was signed into law on September 30, 2006, three weeks after the U.S. Treasury Department cut off Iran's Bank Saderat from the U.S. financial system for transferring funds to terrorist organizations. A round of United Nation sanctions followed on December 23, 2006.
The financial measures levied against Iran have focused on specific illicit conduct and specific illicit actors -- what are known as "targeted sanctions" -- not the entire regime. The sanctions started small. They gradually became more severe as Iran continued to engage in three types of activities:
* Refused international inspections of its nuclear facilities
* Engaged in deceptive financial conduct harmful to the international financial system
* Rejected diplomatic overtures and negotiations.
Sanctions imposed since 2006 represent a marked improvement over the broad-based, country-wide sanctions levied against Iraq that President Saddam Hussein easily evaded and abused. Targeted sanctions against Iran have been enacted with three goals in mind: First, they aim to disrupt Iran's illicit activities. Second, they seek to deter third parties from acting as enablers for Iran's illicit activities. Third, they aim to force Iran to recalculate the cost-benefit ratio of -- and reconsider continuing -- its illicit activities. Targeted measures have been directed at specific Iranian companies, sectors and individuals engaged in illicit conduct.
Targeted sanctions against Iran are graduated -- they have been implemented in stages, each round building on the previous ones in order to gradually constrict the regime's air supply, leaving it gasping for breath and desperate to acquiesce. The graduated approach, which includes both multilateral and unilateral efforts, is intended not simply to punish, but to encourage the Iranian regime to alter its behavior.
Targeted financial restrictions include blocking "U-turn" transactions. Iranian banks are prohibited from engaging in financial transactions with American banks under sanctions passed after the 1979 seizure of the U.S. Embassy in Tehran. But U.S. banks had been allowed to process certain dollar transactions for Iranian entities simply for the purpose of clearing those transactions. This authorization was referred to as a U-turn exception. It applied as long as no U.S. bank directly debited or credited an account of an Iranian party. In 2006, however, the U.S. Treasury Department denied Bank Saderat access to this U-turn, effectively cutting off its ability to do business in dollars, the international currency for oil markets.
The Treasury Department cited the bank's ties to terrorism, specifically evidence that Bank Saderat had facilitated Iran's transfer of millions of dollars to Hezbollah and other extremist groups for several years. The so-called "U-turn license" remained available to all other Iranian banks for the next two years. But in late 2008, after Iran's illicit activities continued, the Treasury Department ended the U-turn license. This new restriction effectively denied all Iranian banks the ability to use dollars for any transactions related to the international oil economy.
As of September 2010, the Treasury Department had targeted 16 Iranian banks. They include:
Bank Mellat: A state-owned commercial bank meaning "bank of the nation," Mellat was formed in 1980. It was designated in October 2007 for moving funds for Iran's nuclear program and providing financial services for the Atomic Energy Organization of Iran and Novin Energy Company. Treasury targeted Mellat's Malaysian subsidiary, First East Export Bank, in November 2009, as well as the Mellat-linked Mellat Bank SB CJSC (Armenia) and Persian International Bank PLC (United Kingdom) in October 2007.
Bank Melli: Iran's first national bank, formed in 1927, Melli is now the country's largest commercial retail bank. Melli provides a wide range of financial services for entities involved in Iran's nuclear and ballistic missile programs, among its other illicit activities. It was designated in December 2008. Arian Bank (Afghanistan), Bank Kargoshee (Iran), Bank Melli Iran ZAO (Russia), Future Bank (Bahrain) and Melli Bank PLC (United Kingdom) have also been designated for being controlled or owned by Melli.
Bank Sepah: First opened in 1925, the Iranian Army pension fund provided its original capital. The bank was designated in January 2007 for servicing designated Iranian firms involved in proliferation activities. Sepah is Iran's fifth largest state-owned bank. Treasury targeted its wholly-owned subsidiary, Bank Sepah International PLC (United Kingdom), the same day it targeted Sepah.
Bank Saderat: One of Iran's largest banks, it was the first to be cut off entirely from the U.S. financial system in September 2006. Treasury targeted the state-owned Saderat for transferring funds to Hezbollah and other terrorist organizations. Saderat was founded in 1952.
Further, Treasury designated Banco Internacional de Desarollo, C.A. (Venezeula) and the Export Development Bank of Iran in October 2008, as well as Post Bank in June 2010.
Islamic Revolutionary Guard Corps (IRGC): The IRGC has also been a major focus of both U.S. and U.N. sanctions. The Revolutionary Guards are deeply involved in the country's ballistic missile and nuclear and weapons proliferation activities. They also maintain a special branch, called the Qods Force, which provides funds, weapons and training to terrorist groups.
In recent years, the Revolutionary Guards have become one of the largest economic actors in Iran, controlling vast financial assets and resources. Most of the IRGC's actual funds and assets lie beyond seizure in Iran, but its business and industrial activities -- particularly those connected to the oil and gas industries -- are heavily dependent on the international financial system. Targeted financial measures against the IRGC represent the kind of regime-hostile, people-friendly initiative that punishes those engaged in offensive behavior, without harming the average Iranian citizen.
Multilateral sanctions against Iran's financial institutions are an extremely effective tool in the fight against Iran's illicit activities. For instance, U.N. resolution 1929, passed on June 9, 2010, designated 40 Iranian entities linked to Tehran's nuclear and ballistic missile programs, including Bank Mellat's Malaysian subsidiary, First East Export Bank.
Multilateral bodies such as the Financial Action Task Force (FATF) have also been used to target Iran. Based in Paris, FATF is an international organization created in 1989 to establish standards to combat money laundering and terrorism financing. Its membership includes 34 countries and regional groupings. In a series of warnings between 2007 and 2009, FATF instructed its members to urge their financial institutions to use "enhanced due diligence" when dealing with Iran. In 2009, it went further and urged countries to begin developing "countermeasures" to deal with Iran's illicit financial activities. FATF also dismissed Iran's purportedly updated financial legislation, calling the changes "skimpy," noting their "big deficiencies."
The risk factor
Sanctions are most effective when they are multilateral. But achieving consensus is difficult and the resulting action often represents the lowest common denominator. As such, complementary measures -- including regional efforts by bodies such as the European Union and individual actions such as U.S. designations -- are critical in raising the risks of doing business with Iran. Unilateral sanctions are felt internationally because of integrated and globalized market forces.
The reputations of international banks, multinational corporations and insurance companies depend on their due diligence. The risks of engaging with an entity that has been publicly exposed for illicit activity often outweigh the potential profit margins. Executives of foreign corporations have opted to stop dealing with unilaterally sanctioned entities, even if they have no explicit legal obligation to do so.
After President Barack Obama signed a unilateral sanctions bill in mid-2010, Lloyd's of London denied insurance or re-insurance to petroleum shipments destined for Iran. Lloyd's' general counsel acknowledged, "The U.S. is an important market for Lloyd's.... Lloyd's will always comply with applicable sanctions." Iran's ability to develop its vast -- and extremely lucrative -- energy reserves has also been hard hit by investment cutbacks following unilateral U.S. and European actions.
U.S. measures have also led to several high-profile cases against major international financial institutions. In early 2009, Lloyds Banking Group was fined $350 million for processing payments that originated in Iran. In December 2009, Credit Suisse Group paid a $536 million settlement over similar charges. In August 2010, Barclays agreed to pay $298 million to settle charges that it altered financial records to hide payments from sanctioned countries, including Iran.
The actual cost of U.S. fines may not hurt large financial institutions, but firms are wary of the costs to their reputations for being associated with rogue regimes. Foreign financial institutions and private industries increasingly incorporate the Treasury Department's designation lists into their databases, not because they are required to do so, but out of their own fiduciary interests. Tehran's ability to do business as usual has taken a severe hit as banks, multinational corporations and insurers end their business relationships with Iran.
The Treasury Department has also embarked on an ambitious information campaign. Senior Treasury officials have met with private sector leaders around the world to outline Iran's deceptive financial conduct and the risks they pose for banks and businesses. Treasury provided evidence, for example, that Bank Sepah asked other financial institutions to remove its name from transactions when processing them through the international financial system. Informed of the risks, market forces have led many banks and corporations to forgo business with Iranian institutions.
In light of growing evidence, the Paris-based Organization for Economic Cooperation and Development, comprised of the world's 32 strongest economies, raised Iran's risk rating in early 2006. In addition, a growing number of banks and corporations wanting to conduct business in the United States have concluded that putting their U.S. business at risk is not worth the investment in Iran.
Offense and defense
Financial sanctions targeting Iran have also included offensive and defensive measures. Offensive tactics such as designations target actors engaged in illicit activity, from terrorism to weapons proliferation. The U.S. Treasury Department or its counterparts abroad proactively deny these companies or individuals access to the international financial system.
Defensive tools, on the other hand, protect markets by denying entry to banks, companies or individuals who continue to engage in business with risky entities such as Iran, despite knowing the risks. Section 311 of the U.S.A. Patriot Act, for example, gives the Treasury Department the authority to deny risk-prone entities -- defined as entities either exposed or involved in money laundering or terror financing -- access to the U.S. financial system. Defensive tools do not aggressively target offending companies or individuals but, rather, serve as stop-gap measures to protect the U.S. financial system from abuse. The consequences of being denied access to one of the most important world markets can be severe.
* To succeed, targeted financial measures must be credible. This may require follow-up efforts -- ranging from additional sanctions to the possibility of military action -- in the event that Iran fails to comply with its international obligations on its controversial nuclear program.
* Finding the right combination of financial sanctions is critical. The tool kit includes unilateral, multilateral and regional sanctions; formal and informal sanctions; offensive and defensive measures; and targeted and country-wide sanctions.
* Due to insufficient refining capacity, Iran still imports 30 percent of its oil from foreign refineries for domestic consumption. Limiting Iran's ability to import refined petroleum could be a powerful tool in exploiting one of the regime's primary vulnerabilities.
Matthew Levitt is director of the Washington Institute for Near East Policy's Stein Program on Counterterrorism and Intelligence and a lecturer in international relations and strategic studies at Johns Hopkins University's Paul H. Nitze School of Advanced International Studies. This article is presented by Tehran Bureau, the U.S. Institute of Peace, and the Woodrow Wilson International Center for Scholars as part of the Iran project at iranprimer.usip.org.