Raheb Homavandi / Reuters Iranians look at a list of candidates' names during elections for the parliament and Assembly of Experts, February 26, 2016.

Unfreezing Iran

And Doing It the Right Way

It makes sense that moderates’ recent electoral triumph in Iran—early results suggest that they have won a majority of seats in the parliament and in the Assembly of Experts—will improve the chances of success for the Iran nuclear deal. Iranian moderates, who generally back President Hassan Rouhani, were an important factor in concluding the deal and are likely to support its continued implementation.

As U.S. policymakers welcome the news that the Obama administration’s signal foreign policy achievement may be on sturdier ground, however, the continued successful implementation of the deal is having important and unanticipated consequences for the United States’ ability to use biting financial sanctions to achieve its foreign policy objectives.

In particular, the nature of the sanctions relief provided as part of the Iran nuclear agreement—which seems less likely to unravel after the election—may actually undermine U.S. sanctions in the future, in part by encouraging foreign companies to re-enter Iranian markets and decrease their reliance on the U.S. financial system. It is worth taking that risk into consideration as some policymakers cheer the outcome of the election and what it may mean for Iranian politics and the future of the nuclear agreement.

TARGET PRACTICE

Observers have focused on the role that economic sanctions played in bringing Iran to the negotiating table and ultimately signing the nuclear agreement. But the use of powerful financial sanctions has a longer history.

The United States introduced targeted measures after 9/11 to stem the flow of funding to terrorist groups. These were soon adapted for use against weapons proliferators such as North Korea and Iran. The Treasury Department, building off the framework established in the early 2000s, continued sharpening these tools and—under significant pressure from Congress, which wanted to increase the coercive pressure on Iran—began to rely more heavily on so-called secondary sanctions, that is, prohibitions on non-U.S. businesses or individuals that continue doing business with a sanctioned entity. In other words, foreign firms were given a choice between dealing with rogue regimes such as Iran and having access to the U.S. financial system.

In recent years, sanctions far removed from the economy-wide prohibitions of the 1990s have targeted human rights abusers and leaders who violate the territorial integrity of their neighbors. Some of these sanctions include creative new restrictions, such as prohibitions on issuing new debt and equity for certain targeted financial institutions and limits on cooperation for developing energy resources.

Policymakers have recognized the potential for such new sanctions to combat unconventional challenges as well. For example, U.S. President Barack Obama recently granted the secretary of the treasury the authority to impose economic sanctions on foreign countries and companies that engage in malicious cyber activity, namely launching cyberattacks on critical infrastructure or stealing commercially valuable information. Likewise, the United States has developed sanctions that target corruption in countries such as Venezuela and Belarus. In short, coercive economic measures have become the tool du jour. Today, U.S. officials are bullish about using more sophisticated and targeted sanctions when diplomacy alone is insufficient but force is not a feasible option.

UNSANCTIONED

Yet, as policymakers have become enamored with these tools, they have paid much less attention to how they can be unwound effectively—and what the specifics of the unwinding will mean for the United States’ ability to successfully use sanctions in the future. The implications are easy to see in the case of the sanctions relief provided to Iran on implementation day.

Whereas the EU and other states have largely relaxed their Iran sanctions programs, the United States has only discarded some of its restrictions. The different paces at which the United States and EU are unwinding their sanctions programs pushes European and Asian companies to avoid conducting transactions in U.S. dollars and in U.S. markets and so could diminish the United States’ ability to impose biting financial sanctions in the future.

Following implementation day, most EU sanctions and U.S. secondary sanctions—which applied to non-U.S. entities—were removed. European companies interested in doing business in Iran’s financial and banking industry (and its energy sector) are no longer prohibited from engaging in a wide range of activities. At the same time, extensive prohibitions remain on U.S. companies and individuals thinking about doing business in Iran, and European companies cannot use the American financial system for Iran-related transactions without running afoul of those sanctions.

The inability to access the U.S. financial system is a major impediment to foreign firms wishing to do business in Iran: transactions in U.S. dollars have long been the norm in most international markets and sectors, accounting for approximately 85 percent of global trade transactions, even when the parties involved are based outside the United States. By prohibiting firms from relying on the dollar to do business in Iran, the United States is giving those companies incentive to conduct transactions in other currencies, with potentially significant consequences for the preeminence of the U.S. financial system and the United States’ ability to impose financial sanctions.

For example, the State Bank of Pakistan has been asked by the Government of Pakistan to draw up an “interim credible payment mechanism” so that Pakistani businesses can enter Iran without worrying about dollars. South Korea is looking to encourage dealings with Iran in its own currency or else euros. Further, the Bank of Tokyo-Mitsubishi recently announced that it would handle payments by Japanese oil refiners to Iran in both yen and euros. Likewise, two other Japanese banks are reportedly looking to restart non-dollar wiring services to Iran as well. And Brazil’s trade minister recently announced that his government will look to enable payments in euros and other currencies to and from Iran because “everyone is racing after Iran now…the trade potential is very big.”

In short, governments and private actors around the world are experimenting with avoiding the dollar because of an unbalanced unwinding of the Iran sanctions.

These moves only continue a recent, larger trend of companies and countries avoiding the U.S. financial system. In the past few years, countries worried about being targeted by U.S. sanctions have begun developing alternative currency and payment systems. For example, many analysts believe that the recent Chinese push to make the renminbi a reserve currency was partly the result of a Chinese desire to ensure that the United States would not be able to bring significant coercive economic leverage to bear on China in the future. Similarly, China’s establishment of the China International Payment System (CHIPS)—a system designed to mimic SWIFT, which is an entity that helps coordinate the transfer of trillions of dollars in financial messages every day, and facilitate the processing of renminbi transactions—could insulate the country from the sanctions that proved so powerful against Iran.

The trend may also threaten U.S. economic competitiveness over the longer term. To the extent that international companies actively avoid the U.S. financial system, U.S. markets will no longer benefit from their business. While the extent of such potential damage is unclear, senior Treasury Department officials have expressed concern about these consequences.

And now, by giving foreign companies even more reason to use alternative currencies and financial markets the United States threatens to accelerate this trend. And that, in turn, could undercut the country’s ability to impose powerful financial sanctions in the future, since the United States often relies on the use of the dollar in cross-border transactions to create the jurisdictional hook necessary to impose biting sanctions. Without that hook, the United States will be less able to penalize companies that conduct business with rogue nations or terror groups.

FUTURE SANCTIONS

This is not to say that the United States should remove all of its sanctions on Iran just to match Europe. The United States has maintained those restrictions for good reason: as Iran’s recent activities have shown, it is still a state supporter of terrorism, routinely abuses the human rights of its citizens, and is actively seeking to destabilize the Middle East. Aggressive enforcement of a robust sanctions regime will continue to allow the United States to pressure the country to abandon such activities.

Policymakers and regulators tasked with protecting the U.S. financial system from exposure to illicit activity know that financial crimes, including bribery, other corruption, and money laundering, remain pervasive in the Islamic Republic. Iran ranked 130 of 167 countries in Transparency International’s 2015 Corruption Perceptions Index. U.S. officials know that allowing Iranian business to be conducted through the U.S. banking system might enable more such crimes.

But at the very least, policymakers need to recognize that they face a difficult choice. In their attempts to unwind certain sanctions on Iran while maintaining some economic pressure on the country, they may be hurting their ability to employ financial sanctions against Iran or other targets in the future. Given that policymakers have increasingly turned to these economic tools in recent years, they should understand the tradeoff and develop ways to maintain the United States’ ability to impose biting financial measures. Only then will it be able to preserve these powerful tools into the foreseeable future.

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