We take a particular interest in the technology of sanctions (our posts on the topic can be found here) and have noted the whack-a-mole problem: that efforts to restrict transactions with North Korea—or any target–can be circumvented by the creation of front companies. A new report from the Permanent Committee on Investigations of the Senate Committee on Homeland Security and Government Affairs underlines that the problems are also at our end. The report is an exhaustive case study with the ominous sounding title “U.S. Vulnerabilities to Money Laundering, Drugs, and Terrorist Financing: HSBC Case History.” It shows that compliance is not straightforward, particularly on the part of multinational banks, and there are incentives to laxity.
HSBC—originally the Hong Kong and Shanghai Banking Corporation–is one of the largest financial institutions in the world: according to the report, it has over $2.5 trillion in assets, 89 million customers, 300,000 employees, and operations in over 80 countries. Its parent corporation, the HSBC Group, is headquartered in London, with its CFO in Hong Kong. The key U.S. affiliate is HSBC Bank USA N.A. (HBUS), which has 470 branches.
To control access to the U.S. financial system on the part of terrorists, drug traffickers, transactions related to weapons of mass destruction, and entities in sanctioned jurisdictions such as Iran, North Korea, and Sudan, the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) has developed a list of prohibited persons and countries. Banks use this list to create an “OFAC filter.” Transactions stopped by this filter typically undergo an individualized review to see if the transaction can proceed or the funds must be blocked.
Because the OFAC filter can end up delaying or blocking transactions that are ultimately permitted, some non-U.S. financial institutions have used tactics to circumvent it. These include stripping information from wire transfer documentation that can conceal the participation of a prohibited person or country; characterizing a transaction as a transfer between banks in approved jurisdictions, while omitting underlying payment details that might identify an illicit source; and so-called “U-turn transactions” in which funds are deposited to the US and immediately re-deposited in offshore banks not subject to similar restrictions.
Documents secured by the Subcommittee show that some HSBC affiliates took action to circumvent the OFAC filter when sending transactions through their U.S. dollar correspondent accounts at HBUS which might appear suspicious or were illegal outright.
Iran is the main focus of the report, but there are interesting details on North Korea as well. In August 2005, HSBC sought to tighten compliance with OFAC prohibitions. In that context, it circulated a managerial letter saying that the group had three accounts with North Korean entities it was trying to close but couldn’t due to lack of response from the banks concerned. Nearly two years later, however, a second internal HSBC document noted that HSBC affiliates in Mexico and Latin America were providing U.S. dollar accounts to North Korean clients. The offshore accounts in dollars only were small, but seven customers holding both dollar and Mexican peso accounts had assets totaling $2.3 million. We know; this looks like extremely small potatoes. But in financial terms, North Korea is small potatoes; the BDA episode—a major sticking point in US-North Korean relations—centered on less than $50 million.
According to Yonhap’s coverage, the HSBC officials appearing before the hearing were contrite; the hearings are posted on the website above. The spotlight on HSBC activities has put pressure on its anti-money laundering regulator, the Office of the Comptroller of the Currency, to step up enforcement; the Financial Regulatory Forum has a useful overview of the compliance issues. But as the report makes clear, the justification of a case study is that we have no reason to think that HSBC is particularly lax; the problems almost certainly exist elsewhere too.
For a contending view on these issues, we strongly recommend a post by Colin McAskill at Nautilus, who has actually done banking business with North Korea. McAskill does not condone illicit activities, but argues that engagement with North Korea will ultimately rest on opening up the country’s access to the international financial system. The problem is that in a regime and political economy like North Korea, it is virtually impossible to know what is legitimate commercial activity and what is not. Serious reform would clear that issue up.