By Bob Blower, CEO Designate, Clarency
By the time you read this the disgraceful story of the Russian invasion of Ukraine will have moved on to a different chapter, the outcome of which can only be guessed at this moment.
In times past, the withdrawal of the ambassador was sufficient to demonstrate that one country was pissed off with another country. This would have escalated to military action if the issue was unresolved. But two world wars have taught us how costly this can be in life and materials.
Nowadays, economic pressure is the preferred route of influence, taking advantage of the need for most countries to pay for imports. The projected new sanctions against Russia show the extent to which the modern security infrastructures have become reliant on financial persuasion as an alternative to force. But how equipped are we to impose effective sanctions?
Is our financial arsenal sufficiently developed to laser-paint the right targets?
Today, sanctions start by targeting the opponent’s cronies, move on to freezing the assets of state enterprises and finally see the implementation of full sanctions against the target country and its citizens. Now we also have to option of freezing currency reserves (that by definition are overseas) and cutting off banks from SWIFT. The effect on the delinquent country’s economy – especially one in as parlous a state as Russia’s – should be devastating.
As it turns out, our current methods demonstrate the surgical precision of a blunderbuss.
In 1982, just when the UK was dismantling exchange and capital controls, Argentina invaded the Falkland Islands, a British territory in the South Atlantic. A conflict followed in which a UK task force expelled the invading force at the loss of several hundred lives. Relations between Argentina and the UK had been good until that point, despite the Malvinas issue. Exchange controls were relaxed and commerce prospered. The UK had provided warships and other military equipment to the Argentine Junta (a military dictatorship) and UK banks had been active in financing trade from Argentina with the world. A number of naval helicopters were in production in Weston Super Mare, UK, and were nearly ready for delivery. If only the Junta could have waited...
At the time I worked in the UK Treasury Home Finance team, and we were immediately asked to decide what penalties we could apply. Within hours we had laid an Order before the House of Commons under the Emergency Laws (Re-enactments and Repeals) Act 1964, making it illegal for any person to perform any financial transaction with any Argentinian.
The relaxation of exchange controls had seen the Bank of England’s exchange control officials redeployed to new jobs. Suddenly they needed to be re-redeployed. Am I the only one who can hear the voice of Jim Hacker?
“So, Humphrey, we must immediately redeploy the redeployed exchange control officials to enforce the exchange controls we didn’t need until we redeployed them?”
“Yes, Prime Minister.”
Almost immediately hardship cases began to emerge with, for example, Argentinian Students being frozen out of their bank accounts. We quickly published a General Permission enabling banks to disburse up to £30 per week to any Argentinian student to live on.
No thought was given to how the banks could apply this General Permission, leaving it to them to apply it manually.
I wonder how today’s bank systems would comply with these rules?
When Iraq invaded Kuwait in 1991, sanctions were put in place to punish the aggressor while protecting the assets of Kuwait. The weekly cash needs of the average Kuwaiti were assessed at £10,000 per week (Argentine students could get by on £30, but the National Bank of Kuwait had higher ambitions) and a General Permission published to that effect. The imposition of sanctions was such a surprise that I had to raid my old briefcase for a keepsake set of the Argentina regulations. Meanwhile, the NatWest branch in Cromwell Road nearly caused an international incident that would have provoked a Twitter storm today by freezing the Saudi Ambassador’s bank account. It was unfrozen after a call from the Prime Minister’s Office.
In the absence of electronic media, all sanctions and General Permissions were published in the Official Gazette. It was slow, laborious and much was left to discretion. Nowadays sanctions are quickly up and available on services such as ComplyAdvantage and Orbis. Verification of transactions occurs in near real-time and little discretion is allowed. At the same time economic sanctions vary in their effectiveness. Some countries that are faced with sanctions develop convoluted means of moving funds, using shell companies and intermediaries. Crypto currencies are used increasingly to obscure funds and their origin, or to bypass the financial system altogether.
When I first arrived in South Africa, I was asked what was the easiest way to move money from South Africa to Zambia.
The answer was to buy a Land Rover in South Africa, drive it to Zambia and sell it.
This was confirmed to me a few years later when a luxury car franchise opened in Lusaka and sold out of seventy Jaguars and Land Rovers on the first day - for cash. How could it be that, in a land as poor as Zambia, so much cash is available? I’m sure it has nothing to do with any sort of illegal mineral trade...
But today we have artificial intelligence, infinite connectivity and vast computer power. Such scams couldn’t hope to succeed... could they?
I find it difficult to reconcile the number of millionaires in a country with their purchasing power in, for example, rare wines or property. China has 10 per cent of the world’s millionaires – something like 5 million in total. With so few millionaires (and not all millionaires are “wealthy’ - often their cash is tied up in other enterprises), questions must be asked about how they acquired that wealth and why so few can have such a large aggregate impact on the property market. With many high-end properties held through trusts or corporate structures, the suspicion must be that wealth is being hidden.
The UK has a long tradition of accepting refugees. Many of these have already kept their wealth overseas to avoid sequestration by a malevolent government, or they may arrive with portable wealth such as diamonds, gold or art works.
Differentiating between wealth that has accrued legally (or morally) and wealth that has been improperly acquired is difficult, not least because this is often a question of political leaning rather than one of strict legal definition.
In the case of Russia, sanctions can’t be deployed fast enough to stem the bloodshed and, in the aftermath, those who suffer most will be people who didn’t choose this violent course of action. Many oppose and deplore the actions of its leaders. Our financial weaponry simply doesn’t have the precision to sort the good from the bad.
Sanctions against a geographical region are little different from the derisking applied to many countries; in the absence of sufficiently detailed (or, in the case of derisking, economically viable) information results in a blanket ban on transactions involving that region.
So what’s the answer – indeed, is there an answer?
Right now, I don’t believe there is. My own company has made significant progress by shifting focus from regions to transactions, and the results demonstrate that this has significantly improved the accuracy of our diligence. It’s a better approach, but it’s still not good enough. The world-threatening events in Ukraine, and the necessity of a rapid and effective economic response, demonstrate the need to strive for levels of diligence that are not only more effective in tackling today’s challenges, but have the flexibility and evolutionary capacity to adapt to circumstances that no one can predict.
Bob Blower is CEO Designate of Clarency, a payments and liquidity provider to banks and other financial institutions wishing to trade compliantly with derisked regions.
A pioneer of transactional diligence - derisking the transaction rather than the geography of its participants - he’s a highly vocal advocate of intercompany cooperation in order to eliminate financial crime.