The Challenges Facing Enforcement of American financial Sanctions on North Korea

Introduction

On September 26, 2016, the United States Department of Justice announced that it was charging four Chinese nationals and a trading company with conspiring to evade American economic sanctions aimed at North Korea’s nuclear program. Dandong Hongxiang Industrial Development Co. Ltd. (DHID), based in Dandong, China, was accused of utilizing front companies to facilitate transactions for the North Korea-based Korea Kwangson Banking Corporation (KKBC) in U.S. dollars and laundering money through U.S. financial institutions on KKBC’s behalf. The Department of Justice’s indictment was followed by an investigation by Chinese police into DHID’s operations for “major economic crimes.”[i]

The case is an example of tightening U.S. sanctions on North Korea and any organizations suspected of conducting business with the country. It also exemplifies a new strategy of the United States and others in approaching sanctions on North Korea, by targeting financial transactions in order to exclude North Korea from the global financial system completely. Financial transactions theoretically increase pressure on North Korea, by cutting off its access to U.S. dollars and discouraging other states from doing business with them, in order to protect their own interests in the global financial market.[ii] Financial sanctions have been proposed as an effective and humanitarian alternative to economic sanctions, by maximizing the effect on the society’s elites while minimizing the suffering of the society’s population.[iii]

However, the enforcement mechanisms of US financial sanctions and multilateral U.N. sanctions are still imperfect and contain loopholes. Moreover, the case of North Korea sees specific challenges to the full implementation of a sanctions regime, such as the role of China in implementation and North Korea’s use of offshore accounts. This article will explore the legal framework surrounding the enforcement of financial sanctions, and the unique challenges faced by the United States and the United Nations in targeting North Korea’s nuclear program.

The legal framework surrounding financial sanctions & enforcement mechanisms

The main legal basis for American sanctions against North Korea lies in the Patriot Act, passed in 2001 in the wake of the September 11 terrorist attacks on New York City. The United States Treasury Department is empowered by S

ection 311 of the Patriot Act to designate financial institutions or jurisdictions as being of “primary money laundering concern”.[iv] The consequences of such a label are significant, and enable the Treasury Department to require domestic American financial institutions to keep records concerning the designated institution, provide the Treasury Department with information regarding accounts with the designated institution, and even to prohibit the institution from maintaining accounts with domestic financial institutions.

Institutions or jurisdictions designated as “primary money laundering concerns” are therefore effectively cut off from doing business with American financial institutions, as well as from conducting any transactions in American dollars.[v] The consequences of sanctions under Section 311 of the Patriot Act are considered so serious that even the threat of Section 311 designation by the Treasury Department can have significant consequences. For example, in 2005, Banco Delta Asia, a bank based in Macau accused of violating sanctions and “conducting business with North Korea”, experienced a 34% depletion of resources in days when rumors of Section 311 designation triggered a run on the bank.[vi]

On June 1, 2016, the Treasury Department officially designated the entirety of North Korea as a jurisdiction of “primary money laundering concern”. The designation was actually aimed mostly at financial institutions in China, particularly small banks in the Northeast region of China, which facilitate trade with North Korea. Additionally, financial institutions in Macau, Hong Kong, and Singapore would be targeted by the designation.[vii]

At the international level, the United Nations Security Council unanimously adopted new sanctions on North Korea in March 2016. U.N. Resolution 2270 was significant in that China, North Korea’s major geopolitical ally, did not veto the sanctions and instead offered their support for the full implementation of the resolution. These new sanctions called for all member states to terminate “joint ventures, ownership interests, and correspondent banking relationships” with North Korea within 90 days.[viii] However, as will be discussed moving forward, these sanctions contain giant loopholes through which North Korea can easily conduct trade and financial transactions. The enforcement of the sanctions ultimately relies on China’s willingness to take them seriously.

Challenges facing the enforcement of sanctions on North Korea

While the Treasury Department is empowered by the Patriot Act to impose financial sanctions on institutions labeled as “primary money laundering concerns” and the Department of Justice has brought charges in a few cases, such as the case of Dandong Hongxiang Industrial Development Co. Ltd., there remain other institutions in China conducting similar transactions that have not been targeted for sanctions. China was reluctant to cooperate with the case against DHID,[ix] and it remains to be seen whether China will be open to further cooperation in the future in targeting institutions engaging with North Korea in violation of sanctions.

The effectiveness of financial sanctions without Chinese cooperation has been called into question. Often, the case of Iran is referenced as a precedent when advocating for the effectiveness of financial sanctions in suppressing North Korea’s nuclear program. However, while Iran was “heavily dependent” on the international financial system in order to conduct transactions in the global oil market, North Korea is already a financially isolated state that depends on the global black market and offshore financial havens, making it difficult for sanctions to choke off their access. Furthermore, North Korea’s major trade partner is China, a global economic power and permanent U.N. Security Council member. Most business is conducted within the domestic Chinese economy.[x] Strong sanctions supported by China would have a massive effect on North Korea, since 70% of their trade is with China.[xi] However, China is protective of its own sovereignty and also has many reasons to continue to engage with North Korea, as will be discussed later. Thus, while the United States can act unilaterally and have some impact, the effectiveness of unilateral sanctions is questionable.

When it comes to international sanctions, one of the biggest problems facing the enforcement of the United Nations’ sanctions on North Korea is termed the “livelihood loophole”. While U.N. Resolution 2270 prohibits the export of “coal, iron, and iron ore” to U.N. member states, Section 29(b) grants an exception for “transactions that are determined to be exclusively for livelihood purposes and unrelated to generating revenue for the DPRK’s nuclear or ballistic missiles programs”.[xii] This broad exception is self-monitoring, meaning that so long as North Korean companies state that their coal exports are for humanitarian purposes, then those exports can continue virtually unhindered. It is almost impossible to fully determine what the bounds of humanitarian purposes are, let alone how revenue from coal exports will exactly be spent.[xiii] The loophole provides cover for any country (namely China) seeking to trade with North Korea.

China and North Korea have exploited this loophole to continue trade in coal. While China’s coal imports from North Korea dropped in April 2016, the first month in which U.N. sanctions when into effect, the livelihood loophole allowed Chinese imports of North Korean coal to balloon to 2.465 million tons of coal in August 2016, the highest recorded level at that point.[xiv] Coal exports to China account for about one-third of North Korean exports, and give the regime access to hard currency.[xv]

It is clear that an effective sanctions diet against North Korea is impossible without the support and cooperation of China, their major geopolitical ally. China has expressed opposition to “unilateral sanctions” based on domestic laws, such as Section 311 designation by the United States Treasury Department, and instead continues to state its support for multilateral sanctions by the United Nations. However China’s true level of support for such sanctions regimes is called into question when considering its exploitation of the livelihood loophole and its “desultory” implementation of other international sanctions.[xvi] Even after being praised by the United States and others for supporting the U.N. Security Council’s sanctions last year, Chinese president Xi Jinping met with a North Korean official in June to “mend strategic ties”, once again calling into question its commitment to sanctions.[xvii]

China’s continued support and advocacy for North Korea at the global level is an entirely self-interested strategy.[xviii] Maintaining stability on the Korean peninsula is a top geopolitical priority for China as it continues to focus on the rapid development of its economy. The breakdown of the current North Korean regime, or grave poverty or famine, could lead to an influx of refugees into China that the country desperately wants to avoid.[xix] North Korea also provides a geographical buffer between China and South Korea, a close United States ally.[xx] These interests make it appear unlikely that China will cooperate on stronger sanctions, even to combat North Korea’s rapidly progressing nuclear program.

In November 2016 the United Nations attempted to target the livelihood loophole in U.N. Resolution 2270 by implementing a hard cap on North Korean coal exports.[xxi] China’s support for the cap, however, calls into question the effectiveness of this strategy.

Following a North Korean ballistic missile test in February 2017, China announced a suspension of all coal imports from North Korea for the rest of the year.[xxii] While coal imports to China rose in February to $97.6 million of coal (up from $70.1 million in February 2016),[xxiii] it remains to be seen whether or not this suspension will entirely choke off North Korean exports in the coming months. China’s patience with North Korea’s nuclear program has been wearing thin,[xxiv] and the country’s support for the United Nations’ new sanctions show its annoyance with continued missile tests and threats from the Kim regime. The move could also be a signal to the new Trump administration that China is willing to “engage in talks” when it comes to North Korea.[xxv]

Chinese cooperation has always been central to an effective strategy of isolating and containing the North Korean nuclear program through sanctions. However, there is good reason for skepticism when China signals compliance with sanctions, due to its history of strong language but lax enforcement.[xxvi]

Conclusions

It is clear that Chinese cooperation is the key to effective sanctions on North Korea’s ascendant nuclear program. Recent indications show that China’s patience with its disruptive neighbor is shortening, and that Chinese leadership may be ready to be stricter as tensions in Northeast Asia rapidly escalate. However, it would not be wise to underestimate the power of self-interest when it comes to the Chinese-North Korean relationship. Even in the wake China’s announced suspension of coal imports, it will be months before we understand China’s true intentions and commitment to enforcement of such a radical measure.

Sanctions may also gain less prominence in the discourse surrounding North Korea’s nuclear program with the transition to the new Trump administration in the United States. Secretary of State Rex Tillerson indicated in a March 2017 trip to South Korea that the United States is not interested in diplomatic negotiations with regards to North Korea’s nuclear capabilities, a statement that could alienate China and push them closer to North Korea once again.[xxvii] And with Tillerson and Trump refusing to rule out a first strike on North Korea,[xxviii] it remains to be seen what role, if any, a strong sanctions regime will have in American policy regarding North Korea moving forward.

***The views expressed herein do not necessarily represent the opinions of NKR or Yonsei Institute for North Korean Studies.

[i] http://www.nytimes.com/2016/09/21/world/asia/north-korea-china-inquiry-hongxiang.html?_r=0

[ii] http://thediplomat.com/2016/07/why-economic-sanctions-have-failed-against-north-korea/

[iii] http://www.danieldrezner.com/research/smartsanctions.pdf

[iv] Patriot Act

[v] Carter & Farha, 910

[vi] Carter & Farha, 910

[vii] https://www.nytimes.com/2016/06/02/world/asia/treasury-imposes-sanctions-on-north-korea.html?_r=0

[viii][viii] UNSCR2270

[ix] https://www.nytimes.com/2017/03/17/world/asia/all-eyes-on-china-as-us-signals-new-tack-on-north-korea.html

[x] http://foreignpolicy.com/2016/10/06/u-s-weighs-iran-style-sanctions-on-north-korea-risking-a-rift-with-china/

[xi] Ibid.

[xii] UNSCR2270 Section 29(b)

[xiii] http://thediplomat.com/2017/02/is-china-serious-about-banning-north-korean-coal/

[xiv] http://www.reuters.com/article/us-column-russell-coal-china-idUSKCN11W0CO

[xv] http://foreignpolicy.com/2016/10/06/u-s-weighs-iran-style-sanctions-on-north-korea-risking-a-rift-with-china/

[xvi] Perlez, NYT

[xvii] Perlez, NYT

[xviii] http://thediplomat.com/2017/02/is-china-serious-about-banning-north-korean-coal/

[xix] Ibid.

[xx] Ibid.

[xxi] https://www.nytimes.com/2016/11/30/world/asia/north-korea-un-sanctions.html

[xxii] https://www.nytimes.com/2017/02/18/world/asia/north-korea-china-coal-imports-suspended.html

[xxiii] https://sg.news.yahoo.com/china-coal-imports-north-korea-surge-february-005001320--finance.html

[xxiv] https://www.nytimes.com/2016/11/30/world/asia/north-korea-un-sanctions.html

[xxv] http://thediplomat.com/2017/02/is-china-serious-about-banning-north-korean-coal/

[xxvi] Ibid.

[xxvii] https://www.nytimes.com/2017/03/17/world/asia/all-eyes-on-china-as-us-signals-new-tack-on-north-korea.html

[xxviii] http://www.latimes.com/nation/la-fg-tillerson-asia-20170317-story.html