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U.S. DOLLAR PROVIDES THE MUSCLE FOR ECONOMIC SANCTIONS

U.S. DOLLAR PROVIDES THE MUSCLE FOR ECONOMIC SANCTIONS

Money Talks

From drug kingpins to terrorists and from human traffickers to money launderers, the United States has nearly 8,000 economic sanctions in place, and the list is growing. Particularly in the post-9/11 era, the U.S. government has leveraged the global preeminence of the U.S. dollar to turn off spigots of funding for sinister activities and unwanted behaviors by state actors.

Among additional sanctions against Iran, Russia and Venezuela, The Trump administration earlier this month tightened travel restrictions to Cuba stating, “Cuba continues to play a destabilizing role in the Western Hemisphere…these actions will help to keep U.S. dollars out of the hands of Cuban military, intelligence, and security services.”

The muscle behind an array of U.S. financial sanctions derives from the reach and power of the U.S. dollar as the “lead currency” in the global economy. This status makes it possible to not only prevent U.S. individuals and companies from doing business directly with a sanctioned entity, it makes it risky to do business with third-country companies that do business with sanctioned entities. Acutely aware of their vulnerability, non-U.S. companies also frequently take steps to minimize their exposure to possible violations of U.S. sanctions lest they jeopardize their access to the U.S. financial system.

The U.S. Dollar Reigns

How strong is the dollar’s foothold in the global economy? The U.S. dollar was used in 88 percent of global foreign exchange transactions in 2016. For comparison, the euro was the medium of exchange in 31 percent of transactions in 2016, the Japanese yen in 22 percent, the British pound in 13 percent, and China’s renminbi in four percent (as two currencies may be involved in exchange, these numbers will add up to more than 100 percent).

Companies selling their goods and services outside the United States often accept dollars as payment because they can easily turn around and use dollars to pay for imported products and inputs. Or, they can hold onto their dollar revenues with confidence they are storing value.

Why is the Dollar Preferred?

The dollar is the world’s lead currency because it meets three key conditions.

First, the dollar is fully tradable and exchanged at relatively low costs. The U.S. government does not restrict the purchase or sale of the dollar.

Second, the dollar holds its value against other currencies. The United States is still considered a stable and open market economy, current tariff vagaries notwithstanding. At the end of last year, just under 62 percent of all central bank reserves were held in U.S. dollars.

Third, the United States is still the largest economy in the world, equivalent to 24 percent of global GDP. Below is a snapshot from the International Monetary Fund comparing the world’s largest economies. We have a large money supply, providing liquidity for the global economy.

Into the Arms of Another

Some have argued bad actors like North Korea will find always find ways to evade U.S. sanctions. Buyers of Iranian oil will seek alternative currencies for their transactions, both diluting the effect of sanctions and hastening reduced dependence on the dollar.

Several European countries developed a clearinghouse to enable companies to avoid the U.S. financial system in transactions involving Iran as part of their effort to salvage the nuclear pact the Trump administration pulled out of last year before restoring a slew of sanctions against Iran.

Despite initial discussions about a wider scope, Europe’s Instrument in Support of Trade Exchanges (INSTEX) will, at least for now, only facilitate trade in humanitarian goods such as pharmaceuticals, medical devices and agri-food products, all of which are already permissible under U.S. sanctions. Despite European government grumbling about being beholden to the U.S. dollar, there appeared to be little appetite on the part of European companies and commercial banks to risk U.S. penalties by using such a clearinghouse for other types of transactions.

Will the Euro or Renminbi Overtake the Dollar?

Not anytime soon.

The euro covers a large economic zone featuring sophisticated financial market institutions, but the politics surrounding continued support by members of the euro zone and unresolved debt discussions with southern states (we were talking about Grexit long before Brexit) are holding the euro back in overtaking the U.S. dollar.

Although the renminbi’s share in global transactions is still low, it should be noted that usage and overseas holdings of China’s currency by individuals, businesses and central banks has expanded in the last decade, enabling China to break through in 2016 to join the top five most-used currencies. The Chinese government is making a big push to internationalize its currency through global infrastructure investment funds associated with its Belt and Road initiative and through renminbi-denominated commodities futures contracts, among other initiatives.

China’s currency, however, is not freely convertible, its performance has been volatile, and the degree of state and private debt in China’s financial system remains murky.

The Dollar’s Achilles Heel

For the time being, most experts believe there’s no real threat to the U.S. dollar’s dominance. Europe would need to address skepticism regarding the monetary union’s future, China would need to implement significant reforms to its financial sector, and much-hyped cryptocurrencies still have long way to go to challenge the conventional system of global payments.

These are all big “ifs”. Instead, the dollar’s Achilles’ heel is of our own making. One of the biggest risks to the dollar’s long-term value is continued fiscal imbalances in the United States and the sustainability of our debt burden.

Andrea Durkin is the Editor-in-Chief of TradeVistas and Founder of Sparkplug, LLC. She is a nonresident Senior Fellow at the Chicago Council on Global Affairs and an adjunct fellow with CSIS. Ms. Durkin previously served as a U.S. Government trade negotiator and has proudly taught International Trade for the last fourteen years as an Adjunct Associate Professor at Georgetown University’s Master of Science in Foreign Service program.

This article originally appeared on TradeVistas.org. Republished with permission.

In Hot Extraterritorial Water

People often think that sanctions regulations are really for the financial sector. After all, they are referred to as “financial sanctions” as often, if not more so, than “economic sanctions.” And, in many countries, the primary sanctions regulator is the same as the one which oversees banks and other financial firms.

The greater public has, unfortunately, been lulled into a false sense of security by how enforcement of sanctions compliance failures is conducted across the globe – except in the United States and United Kingdom. Outside of those two countries, firms are only penalized if their system of controls to identify sanctions violations is found wanting during periodic reviews of their compliance programs.

In October 2018, the head of the U.K.’s sanctions regulator stated that they expect to mete out fines in the coming year based on the 122 reports of regulatory violations they have received. However, to date, there is currently no track record of enforcement based on investigation of actual breaches of the regulatory burdens.

That leaves the United States – the country with the longest, and most punitive, history of regulatory enforcement actions, the most aggressive and varied application of sanctions regulations, as well as the most expansive definition of legal jurisdiction. Fortunately, the Office of Foreign Assets Control (OFAC), the U.S. sanctions regulator, is also the most transparent about its requirements, expectations and the investigation and prosecution of sanctions violations.

The Long Arm of the U.S.

The U.S. claims legal jurisdiction broadly. In addition to “U.S. persons,” which are U.S. citizens and U.S.-incorporated firms, and foreign persons and operations of foreign firms located in the United States, the U.S. stakes a claim to take some manner of enforcement action when:

– Based on a 2017 enforcement action against 2 Singaporean firms, the U.S. currency is used to facilitate a prohibited transaction.

– Based on explicit wording in the regulatory framework for the U.S.’ Iranian sanctions, U.S.-origin goods are shipped to Iran.

– For elements of the Hizballah, Iran and Ukraine/Russia-related sanctions, a foreign person or organization is involved in (including advice, insurance and other facilitation) of transactions prohibited to U.S. persons.

In addition, U.S. sanctions programs generally provide the power to sanction those parties who, through their conduct of business with those already sanctioned, help lessen or delay the impact of sanctions restrictions and prohibitions. This was evidenced in late 2018 by the sanctioning of a Singaporean citizen and his companies who had facilitated trade involving North Korea, in contravention of OFAC and United Nations sanctions.

While the U.S. is not the only country to apply sanctions on foreign persons and organizations beyond what is agreed to on a multilateral basis by the United Nations or the European Union, its extraterritorial application of sanctions is, by far, the most far-ranging.

U.S. Regulatory Framework

Unlike the overwhelming majority of countries, to properly comply with the United States sanctions regime, one must master an array of legislation, regulation and guidance. While downloading a list of names of sanctioned parties and withholding any assets in which they have an ownership interest checks the box for most countries’ requirements, much of the U.S. regime’s nuances must be derived from descriptions of affected parties and types of commercial or financial  transactions. For example:

– In addition to any specifically-named parties, some securities issued or held by elements of the Venezuelan government are subject to restrictions or prohibitions.

– One is expected, due to the import and export restrictions placed on certain governments and countries, to identify references to geographic locations (including port facilities) in the affected countries in order to identify transactions that are potentially subject to compliance oversight.

Perhaps the most impactful of these regulatory expectations that are not explicitly provided by OFAC is the OFAC 50 Percent Rule. This regulatory guidance, which has been quoted in 3 enforcement actions since 2016, states that any organization which is at least 50 percent owned by 1 or more sanctioned parties is, itself, considered sanctioned. The European Union has also published a similar “ownership and control” guidance. Based on extensive, non-exhaustive research of publicly-available ownership and management control records, the number of additionally-sanctioned parties is between 3 and 4 times the size of the combined applicable U.S. and E.U. sanctions lists.

Same Sanctions, Different Day

The scope of foreign sanctions requirements, especially those of the United States, may appear daunting. However, one must contend with a pair of painful realities. While the cost of complying with another country’s regulatory requirements may feel like an unnecessary expense, it likely pales with the commercial impact of an enforcement action resulting from willful neglect of OFAC’s extraterritorial reach. Similarly, while one’s home regulator may currently seem inattentive with regards to oversight and enforcement, that can shift significantly in a blink of an eye, exposing one immediately to significant reputational and regulatory risk. Consider the regulatory responses in Hong Kong and Singapore in the wake of the 1MDB scandal as a prominent example.

When one reviews the outsized fines against European banks for their compliance failures, and the short-lived ban on exports to the Chinese telecommunications firm ZTE, perhaps, to paraphrase an old saw, an ounce of compliance prevention is worth a pound of enforcement action cure, even if the odds of catching the contagion seem remote.

Eric A. Sohn, CAMS, global market strategist and product director, Dow Jones Risk & Compliance, New York, NY, USA, eric.sohn@dowjones.com