June 15, 2018
By: Keith Preble and Dr. Bryan R. Early*

The main goal of imposing sanctions on a target country or entity has always been to disrupt the target’s commercial relationships and make it costlier for them to do business. Governments try to achieve this goal by imposing administrative and criminal penalties for individuals and entities that violate their sanctions.

Though these restrictions generally apply only to firms and citizens operating in the country imposing the sanctions, the United States has recently employed far more aggressive and wide-reaching methods in penalizing foreign firms.

This has included imposing “secondary” sanctions, which target U.S. persons anywhere in the world, or “sectoral sanctions”, which black-list individuals and entities for certain types of transactions Governments that adopt sanctions have significant incentives to prevent firms in both their own and foreign countries from undercutting their sanctions, as such activities dramatically reduce the likelihood of the sanctioning efforts succeeding.

As sanctions disrupt commercial relationships, affected firms must either heed the law and find new business partners or find other ways of circumventing sanctions restrictions to continue trading with their old partners.

What is ‘Sanctions Busting’?

Commercial-based ‘sanctions busting’ occurs when sanctioned entities circumvent sanctions restrictions by finding replacement business partners or devising methods of maintaining existing relationships despite the sanctions. These strategies allow sanctioned entities to minimize the disruption and hardships that sanctions would otherwise impose, which undercuts the impact of the sanctions.

Sanctioned entities rely on businesses in states imposing sanctions or third-party states not participating in the sanctions that are willing to still do business with them despite the risks of penalties or potential reputational costs.

Direct Violation and Legal Loopholes

Though penalties remain high, especially in the United States, doing business with sanctioned entities can still be lucrative, depending upon how badly the sanctions have affected their targets’ terms of trade.  It can be very profitable for businesses in third-party states or in the sanctioner state(s) willing to tolerate the risks of detection and punishment, and to‘sanctions-bust’ on behalf of targeted entities.

Some sanctions-busting commerce will directly violate the sender governments’ laws while other forms can exploit legal loopholes or are not explicitly forbidden.  Variation in the jurisdictional scope of sanctions will influence the degree to which firms face potential legal punishments as opposed to ad hoc retaliation for undercutting sanctions.

Some sanctions policies can leave loopholes that allow foreign-owned subsidiaries to continue doing business with sanctioned parties.  For example, it wasn’t until the passage of the Iran Threat Reduction and Syria Human Rights Act of 2012 that U.S. firms became liable for their foreign-owned subsidiaries’ violations of U.S. sanctions policies vis-à-vis Iran.

Business Relocation

Firms and even governments can go to elaborate lengths to engage in sanctions busting. One of the most straightforward methods is for firms to relocate their business to third-party states that are not participating in the sanctions.  This can be done by employing brokers or “middle-men” to facilitate transactions as intermediaries in third-party states.

Alternatively, firms from sanctions-imposing states can set up their own operations in third-party venues.  In the case of the U.S.-led sanctions against Iran, for example, Dubai in the United Arab Emirates emerged as a critical intermediary for trading to and from Iran for many years.

Obscuring Transactions

Not surprisingly, the fear of possible detection and punishment by sender governments will give firms a strong incentive to hide their sanctions-busting transactions.  To that end, they may develop strategies for obscuring the point of origin or end-destination of products by employing complex transactions, front companies, illicit diversions, or smuggling tactics. They may also employ elaborately structured shell companies, fraud, money laundering, or informal financial networks to finance illicit or gray market transactions that violate sanctions. For example, numerous European banks, such as HSBCCredit Suisse, and BNP Paribas, were penalized hundreds of millions of dollars by the U.S. government for facilitating transactions that violated U.S. sanctions policies.

Importance of International Cooperation

While sanctions busting often involves violating the law, a significant amount occurs openly between third-party and target states through legitimate channels when third-party governments refuse to cooperate in imposing sanctions.

The decision to cooperate with a sanctioning effort is highly political for third-party governments and takes into account the foreign policy interests and the commercial interests of their constituents. Governments cannot only refuse to join multilateral sanctioning efforts but may also push back against the use of secondary sanctions against their firms by sender governments.

The European Union (EU), for example, is seeking to protect its firms from U.S. secondary sanctions over their trade with Iran by employing blocking legislation that would bar EU firms from complying with renewed U.S. sanctions. The EU successfully used this statute during the 1990s to protect its firms from having to comply with expansive U.S. sanctions imposed against Cuba. The benefit of such a statute is that it politicizes any secondary sanctions that would be imposed by the U.S. Government on EU firms, turning the action from a law enforcement issue into a diplomatic one.  Even so, being caught in the middle of diplomatic disputes creates uncertainty and will tend to hurt their bottom lines.

Third-party governments can also use other forms of push back to protect their firms from secondary sanctions.  The Chinese Government lobbied the Trump Administration hard on ZTE’s behalf, for example, after the U.S. government imposed harsh penalties that would have blocked its access to critical U.S. technologies and components. Formal channels also exist, in some cases, for foreign firms to request exemptions from U.S. extraterritorial sanctions obligations, and third-party governments can offer political support for those requests.

Risk vs. Reward

Firms that engage in sanctions-busting transactions are making trade offs between profiting from the premiums created by sanctions versus the risks of potential detection and punishment.

Sanctions-busting is driven by profits but inherently affected by politics as well. Most firms will prefer to find venues where sanctions-busting can be conducted without having to break any laws. Increasingly expansive sanctions policies adopted by the U.S., in particular, mean that many sanctions-busting transactions necessarily entail breaking at least some country’s laws.  This can be an effective deterrent to keep large multinational firms from sanctions-busting, especially given the U.S. Government’s demonstrated willingness to impose large fines on foreign companies.  At the same time, it could also encourage small and medium-sized enterprises in foreign countries to adopt strategies that increasingly rely on grey market or illicit tactics in order to hide their transactions.

For larger-sized, risk-averse businesses, and especially those that rely on doing business in the U.S. or with U.S. entities, the best option in the current business environment is to comply with their own governments’ sanctions policies and to also comply with U.S. sanctions policies.

*Bryan R. Early is an associate professor of political science and the Director of the Center for Policy Research at the University at Albany, SUNY, where he conducts research on economic sanctions, strategic trade controls, and weapons of mass destruction security issues.He is also the founding Director of the Project on International Security, Commerce, and Economic Statecraft (PISCES), which provides international outreach to promote the adoption of effective strategic trade control policies. Early’s book Busted Sanctions: Explaining Why Economic Sanctions Fail (Stanford University Press, 2015)offers the first comprehensive explanation of the causes and consequences of sanctions busting.

*Keith Preble is pursuing his PhD in political science at the University at Albany with a focus on economic statecraft, foreign policy, and political methodology. He has a Master of Public Policy and Administration from Northwestern University and a Master of Arts in government and politics from St. John’s University. 

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