The Treasury Department just went full Alderaan on North Korea (updated)

For decades, North Korean drug dealers, counterfeiters, proliferators, arms dealers, money launderers, and most recently, bank burglars have used our financial system to move their profits into the regime’s offshore bank accounts, or into casinos. For years, the U.S. Treasury Department had to fight Pyongyang’s abuse of the financial system with its hands cuffed behind its back by the State Department, which sought a deal with Pyongyang at almost any cost.

But yesterday, in a move that was at least ten years overdue, the Treasury Department imposed the single most powerful sanction in its arsenal against North Korea. Using the authority of section 311 of the Patriot Act, it found North Korea to be a jurisdiction of primary money laundering concern, and cut its banks off from the financial system.

WASHINGTON ”“ Today, the U.S. Department of the Treasury announced a Notice of Finding that the Democratic People’s Republic of Korea (North Korea) is a jurisdiction of “primary money laundering concern” under Section 311 of the USA PATRIOT Act.  [Treasury Dep’t Press Release]

A finding of primary money laundering concern allows for five sets of special measures. Of these, the toughest is to ban the target jurisdiction’s banks from using correspondent accounts in U.S. financial institutions. Invoking the Fifth Special Measure requires Treasury to issue a regulation. In its Notice of Proposed Rulemaking, Treasury elaborates:

The proposed rule would prohibit covered financial institutions from opening or maintaining in the United States a correspondent account for or on behalf of a North Korean banking institution. It would also prohibit the use of a foreign banking institution’s U.S. correspondent account to process a transaction involving a North Korean financial institution. As a corollary to this prohibition, covered financial

institutions would be required to screen their correspondents in a manner that is reasonably designed to guard against use by foreign banking institutions to process transactions on behalf of a North Korean financial institution, including access through the use of indirect correspondent accounts held by those foreign institutions. A violation of the special measure could result in the imposition of civil monetary or criminal penalties. [U.S. Treasury Dep’t, Notice of Proposed Rulemaking]

This is, without question, the single most powerful sanction the United States has ever imposed on North Korea. By cutting off North Korean banks’ access to correspondent accounts in the U.S. financial system, it cuts North Korea off from the system itself. The action will have an effect beyond its strict legal terms, by putting a black spot on North Korea’s entire banking sector. Third-country banks, which are fearful of the legal and reputational risks of running afoul of Section 311, will shun North Korean banks, and other North Korean entities that act like banks.

[I sense a great disturbance in the force, as if billions of dollars cried out in terror and were suddenly frozen.]

It would be correct to say that the announcement was very big news, and also, that it was a foregone conclusion. Congress had strongly urged Treasury to designate North Korea as a primary money laundering concern in H.R. 757, and in Paragraph 33 of U.N. Security Council Resolution 2270, passed on March 2nd, U.N. member states were given 90 days to close North Korea’s correspondent accounts. On March 15th, in Executive Order 13722, Treasury hit North Korea with sectoral sanctions on its financial services industry. So the designation and the special measure aren’t a surprise, but in this case, the details and the context suggest that while this action is based on the same authority as the Banco Delta Asia action, it is likely to have a less direct ” but ultimately, a far greater ” impact.

According to Treasury, North Korean banks do not access the U.S. financial system directly by keeping correspondent accounts in our banks. Instead, they use so-called “U-turn” transactions, using correspondent accounts with Chinese and other third-country banks that have their own correspondent accounts with U.S. banks. North Korean banks, non-bank institutions, and unlicensed money transmitters then use these indirect relationships, often disguised through deceptive financial practices, to access our financial system. By banning U-turn transactions and indirect correspondent accounts, Treasury makes clear that it expects banks worldwide to cut off North Korean banks’ access, at the risk of losing their own access to our financial system. 

“The United States, the UN Security Council, and our partners worldwide remain clear-eyed about the significant threat that North Korea poses to the global financial system.  The regime is notoriously deceitful in its financial transactions in order to continue its illicit weapons programs and other destabilizing activities,” said Adam J. Szubin, Acting Under Secretary for Terrorism and Financial Intelligence.  “Today’s action is a further step toward severing banking relationships with North Korea and we expect all governments and financial authorities to do likewise pursuant to the new UN Security Council Resolution.  It is essential that we all take action to prevent the regime from abusing financial institutions around the world ”“ through their own accounts or other means.” [Treasury Dep’t Press Release]

Here, the enhanced due diligence requirements play an essential role in making the cutoff work. You may reasonably ask how that works. It begins with American banks notifying their foreign correspondents that if they service transactions for North Korean banks, their own correspondent accounts may be closed:

As part of that special due diligence, covered financial institutions must notify those foreign correspondent account holders that the covered financial institutions know or have reason to believe provide services to a North Korean financial institution that such correspondents may not provide a North Korean financial institution with access to the correspondent account maintained at the covered financial institution.

A covered financial institution may satisfy this notification requirement using the following notice:

Notice: Pursuant to U.S. regulations issued under Section 311 of the USA PATRIOT Act, see 31 CFR 1010.659, we are prohibited from establishing, maintaining, administering, or managing a correspondent account for, or on behalf of, a North Korean financial institution. The regulations also require us to notify you that you may not provide a North Korean financial institution, including any of its branches, offices, or subsidiaries, with access to the correspondent account you hold at our financial institution. If we become aware that the correspondent account you hold at our financial institution has processed any transactions involving a North Korean financial institution, including any of its branches, offices, or subsidiaries, we will be required to take appropriate steps to prevent such access, including terminating your account. [U.S. Treasury Dep’t, Notice of Proposed Rulemaking]

Treasury expects banks to apply a “risk-based” approach to identifying transactions involving North Korean banks, including by using commercially available screening software. It expects them to look for suspicious patterns, the use of front companies, efforts to conceal a requesting bank’s identity, and (oddly enough) reading wire transfer orders to see if they say, for example, “Central Bank of the DPRK.” Another important part of enforcement will be know-your-customer protocols, which have long been a key part of banks’ anti-money laundering compliance requirements.

In effect, Treasury uses KYC rules to outsource much of the hard work of investigating North Korean links to the rest of the banking industry. If you’re the compliance officer for one of two or three banks involved in a suspicious transaction, you have to consider the risk of being the only bank that doesn’t report it to Treasury.

As I’ve long argued, the U.S. has a special role as steward of the global financial system, but as the Cuba example also shows, we can’t make sanctions work alone. That’s why U.N. Security Council Resolution 2270 will be so important to making the new sanctions work. Last month, for example, the European Union approved a tough new sanctions regulation that banned its banks from maintaining correspondent accounts for North Korean financial institutions. Last week, the EU followed up with a round of asset freezes, a ban on funds transfers to or from North Korea, a ban on North Korean ships in EU ports, and a ban on Air Koryo departures, arrivals, and overflights. Switzerland and Russia have also imposed restrictions on North Korean banks and assets. Chinese banks, the obvious target of H.R. 757’s secondary sanctions, began blocking North Korean accounts almost as soon as H.R. 757 passed, even before the U.N. Security Council approved Resolution 2270.

Here is an important lesson in why good diplomacy matters. What is too seldom said about the designation of Banco Delta Asia was that it was only the beginning of a broader campaign of financial diplomacy that saw Treasury Department officials travel throughout the world to warn bankers that dealing with North Korea also risked their own access to the dollar-based financial system. Although Treasury’s section 311 action was limited ” it never designated North Korea as a jurisdiction ” the combination of a credible threat and broad-based diplomacy was devastating to Pyongyang while it lasted.

The key test will be the reaction of the Chinese. American officials will have a chance to find out next week: Secretary of State John Kerry and Treasury Secretary Jacob J. Lew are traveling to Beijing for the Strategic and Economic Dialogue, where the isolation of North Korea will be a major subject of discussion.  [N.Y. Times]

Given time, political will, and good diplomacy, this squeeze will put unprecedented financial pressure on Kim Jong-un.

[Which will, admittedly, have at least one beneficial effect for Kim Jong-un]

Today’s long-overdue measure is the death knell for Kim Jong-un’s byungjin policy. By cutting off his access to his sources of regime-sustaining hard currency, it denies him a viable, long-term strategy for financial survival unless he commits, irreversibly, to disarmament and reform. It bears emphasis that none of this would have happened if not for the leadership of Representative Ed Royce, who quietly built a bipartisan coalition for the most important change in our North Korea policy since 1994. Our task now is to enforce the new sanctions rigorously, let Kim know we’re always ready for serious, good-faith negotiations, and watch for a clear sign that Pyongyang is prepared to accept the broad transparency without which productive diplomacy will never be possible.

~   ~   ~

Update: Here are links to reports on Treasury’s action from Yonhap, the AP, Reuters, and The Wall Street Journal, which quotes a ChiCom spokesman calling the action “unilateral.” That is nonsense. Treasury’s action is fully consistent with UNSCR 2270, paragraph 33, which China voted for at the Security Council. That paragraph requires all U.N. member states to terminate “joint ventures, ownership interests and correspondent banking relationships with DPRK banks within ninety days from the adoption of this resolution.” To the extent anyone can argue that Treasury went beyond the resolution’s strict requirements, it was to ban the deceptive use of indirect correspondent accounts and U-turns through the U.S. financial system, something that wouldn’t be a problem at all if China was really prepared to enforce the sanctions it voted for. 

The Chinese government seems to be operating under the misunderstanding that North Korean money launderers have a sovereign right to use the U.S. financial system, as if it were a free global public utility for our friends and foes alike.

Frankly, the very objection calls China’s sincerity into question, especially right after Xi Jinping took time out of his busy schedule to meet with career money launderer Ri Su-yong. Ri reportedly stuck to the byungjin line and asked Xi to go back to helping Pyongyang break sanctions anyway, as China did for so many years. I wish Secretary Kerry good luck in persuading the Chinese that this is most certainly not in their interests. If not, Jack Lew and Adam Szubin might have better luck carrying that message directly to the bankers.

Obviously, Ri went to supplicate before Xi and beg him to help North Korea break sanctions, because sanctions never work and North Korea isn’t afraid of them.

Yonhap also carries this analysis piece with extensive quotes from your humble correspondent, and covers the South Korean government’s reaction, welcoming Treasury’s action. Really, until January 6th of this year, my sense of the South Korean government was that it was certainly interested in a Plan B strategy, but ambivalent about actually adopting it. Since then, Seoul really seems to have gone all-in, and despite my tendency to default to cynicism, I can’t deny that I’ve been both surprised and impressed by the determination and competence (no, really!) with which they’ve pursued it. Their facilitation of the restaurant defections in China also shows shrewdness about undermining Pyongyang politically, although Seoul still lags in fighting the information war ” on both sides of the DMZ, I’d add.

Treasury’s Notice of Finding explains the reasons for its determination, as if those reasons aren’t already obvious.

North Korea is proposed for action under Section 311 because (1) North Korea uses state-controlled financial institutions and front companies to conduct international financial transactions that support the proliferation and development of WMD and ballistic missiles; (2) North Korea is subject to little or no bank supervision anti-money laundering or combating the financing of terrorism (“AML/CFT”) controls; (3) North Korea has no diplomatic relationship, and thus no mutual legal assistance treaty, with the United States and does not cooperate with U.S. law enforcement and regulatory officials in obtaining information about transactions originating in or routed through or to North Korea; and (4) North Korea relies on the illicit and corrupt activity of high-level officials to support its government. [Treasury Dep’t, Notice of Finding]

It does have some interesting facts, however, relating to Korea Kwangsong Banking Corporation and Daedong Credit Bank, which recently came up as part of the Panama Papers story:

In spite of its designation, KKBC has continued to evade sanctions and process financial transactions that support the proliferation of WMD and ballistic missiles by using front companies to clear U.S. dollar transactions through U.S. correspondent accounts. In 2013, senior North Korean leadership utilized a KKBC front company to open accounts at a major Chinese bank under the names of Chinese citizens, and deposited millions of U.S. dollars into the accounts. The same KKBC front company processed transactions through U.S. correspondent accounts as recently as 2013.

[”¦.]

DCB also directed a front company, DCB Finance Limited, to carry out international financial transactions as a means to avoid scrutiny by financial institutions. DCB Finance Limited has conducted transactions through correspondent accounts at U.S. banks.

Although I could easily have written a much longer justification, it isn’t always wise to put all of your information out there if it could involve sensitive financial intelligence.

I should have clarified in my post that Treasury’s invocation of the Fifth Special Measure isn’t final until after it has considered and public comments on the proposed rule. I’ll check back and read the comments, which will be public, and if I have time, I’ll link or post the more interesting ones. After Treasury considers the comments, it will publish a Final Rule, which will include responses to the comments.

Finally, here’s a link to the European Union’s new North Korea sanctions regulation, its press release summarizing it, and a Wall Street Journal report about it. The EU’s move deserves a long post by itself, but frankly, there has been so much North Korea news recently that I just haven’t had time to write about all of it. If I’m certain about anything, it’s that the next year is going to be a very eventful one for North Korea watchers.