Did the Security Council Just Get Tough? The Role of Secondary Sanctions

August 7, 2017 1:45 PM

The last several days have seen an extraordinarily complicated set of diplomatic moves that culminated in a new UNSC sanctions resolution. The historians will have to sort out the reasons why China and Russia got on board, but three things probably mattered: the comments by Secretary Tillerson that nodded at Chinese concerns about diplomacy (recent posts on Tillerson’s comments here and here); passage of new legislation in the US that includes mandatory as well as discretionary secondary sanctions; and—looming large behind these—a Chinese effort to delay trade actions.

The main offerings from the UNSC resolution are essentially four: some carefully calibrated commercial import bans on iron and iron ore, lead, and seafood; some individual designations and asset freezes, including the Foreign Trade Bank, the Korean National Insurance Company and the Mansudae art-and-statue export group; a ban on vessels associated with the weapons programs and on reflagging North Korean vessels; and some prohibitions on additional investments with North Korean entities or export of labor.

Let me start with some cynical comments on each of these, but with the observation that it is at least something. As always, though, much will depend on what else goes on across the China-DPRK border. As we noted in our review of the latest KOTRA report, both imports to and exports from China increased 6 percent in 2016 despite two nuclear tests and in 2017, trade is roughly constant, albeit with a widening current account deficit.

The sectoral bans are potentially significant; The State Department reports the sectoral losses from 2371 banned sectors to be around $1 billion and is broken down as follows:

  • Coal – $401 million per year (the cap set by UNSCR 2321)
  • Iron and iron ore – $250 million per year
  • Seafood – $300 million per year
  • Lead and lead ore – $110 million per year

Coal is now completely banned, so looking forward to 2018 that alone would be about a $1.2 billion loss from 2016. If we include the coal cap, the additional restricted trade appears to be approximately $660 million (seafood, iron, and lead) plus $401 million more from coal, or about $1.06 billion additional. Viewed from yet another perspective, the total of coal plus the new products would put the loss closer to $1.85 billion. That is not trivial by any means given that North Korea’s exports in 2016—largely unaffected by the two resolutions of that year—was $2.8 billion.

Topping my list of the cynical: a prohibition on additional investments and labor exports is almost the definition of a non-sanction, since it stipulates precisely that what is in place will continue. However, existing efforts may well be affected as political risk mounts.

But we need to look at adaptive behavior both on the part of North Korea and of China and Russia. As we have said repeatedly, including in Hard Target, there has been a tendency for sanctions elsewhere to be met by diversion to China and sanctions from China to be replaced by other goods trade with China. Again, we see the whack-a-mole phenomenon at work: ban import of good X, but then expand export of good Y; see our analysis of the DPRK’s current account deficit in particular. For example, has Russia been picking up some of NK coal exports? And was China increasing iron ore imports, as some reports have suggested?

There is probably some additional loss of income from the other measures, but it is much harder to estimate given that we don’t know the base rate. An outright asset freeze on the Foreign Trade Bank was a little surprising, although it had already in principle been sanctioned earlier; it is not clear to me that it should be allowed to operate anywhere at all. The ban on vessels and reflagging has been the definition of “whack-a-mole,” and cooperation on finding the ships that are ultimately North Korean and shutting them out will be a slog.

Topping my list of the cynical: a prohibition on additional investments and labor exports is almost the definition of a non-sanction, since it stipulates precisely that what is in place will continue. However, existing efforts may well be affected as political risk mounts. In the “bad timing” category, check out the Paektu Cultural Exchange's efforts, some well-meaning engagement, others commercial activities that are likely to face significant headwinds. 

As noted above, I suspect that China was acting in part because its firms are likely to face looming secondary sanctions anyway. As a result, we have to also look at the new US sanctions legislation, which essentially rolls in the earlier so-called Royce bill into measures against Russia and Iran. (A good tabular summary can be found at the National Committee on North Korea here.)

The first part of the Korea portion of the new sanctions legislation is devoted to legal cleanup: essentially updating authorities to include UN Security Resolutions passed since the North Korea Sanctions and Policy Enhancement Act of 2016, most notably UNSC Resolutions 2270 and 2321, passed following the two nuclear tests of last year.

In the 2016 legislation, mandatory designations were largely aimed at the export and import of: goods related directly to the DPRK’s nuclear and missile programs; other classes of goods already covered by existing UNSC resolutions, such as conventional weapons systems and luxury goods; and activities that were in any case illegal such as money-laundering. A handful of exceptions to this rule were mandatory designations of individuals involved in illicit cyber activities, censorship, human rights abuses and any dealings with the internal security apparatus; those provisions were new to the 2016 bill.

The big change in the new sanctions bill is to make mandatory designation of individuals involved in a much-expanded set of commercial transactions: import of a range of metals; sale of jet fuel; provision of bunkering services; registration of commercial vessels; and maintaining a correspondent banking relationship. Moreover, a separate part of the bill prohibits any US financial institution from maintaining indirect correspondent accounts for firms involved in these activities. Yet another section, devoted to human rights, opens the door on wide-ranging sanctions for those employing North Korean labor abroad.

Two features of these mandatory sanctions are important. First, they are not self-enforcing: designating such individuals and finding indirect correspondent accounts requires that we know who and what they are. We will soon learn a fair amount about what Treasury knows on this score, since OFAC will presumably be issuing these mandatory designations. Banks will also now be conducting due diligence on their accounts as well, using a variety of techniques to identify possible risks in their financial networks.

The second question is whether such designations have material effect, and that is a bigger puzzle. Designations have two effects: the assets of the designated entity in the US are blocked or frozen; and U.S. “persons”—including financial institutions—are prohibited from dealing with them. But for some of the entities involved in these activities, such designations may not be a constraint because they do not have property in the US nor transact with it. The important designations are clearly the larger, diversified firms—mostly Chinese, but including some larger entities in other trading partners—that need access to the US market and may even have assets here.

In addition to the mandatory sanctions, the bill provides the president with authority to go after individuals and firms that have engaged in a raft of other activities with the North, from purchasing textiles and food to online gambling. Despite some quite precise sectoral designations, one paragraph provides authority with respect to those engaging in “a significant transaction or transactions in North Korea’s transportation, mining, energy, or financial services industries.”

Probably the most interesting discretionary measure centers on petroleum products, and it is defined pretty expansively (“directly or indirectly, sold, transferred, or otherwise provided significant amounts of crude oil, condensates, refined petroleum, other types of petroleum or petroleum byproducts, liquified natural gas, or other natural gas resources to the Government of North Korea (except for heavy fuel oil, gasoline, or diesel fuel for humanitarian use or as excepted under subsection (a)(11).”) In theory, the president could go after none other than state-owned China National Petroleum Corp (CNPC). CNPC not only runs the pipeline between the two countries that feeds North Korea’s main refinery in Sinuiju but also has historically provided diesel, gasoline and jet fuel from refineries in Dalian by tanker to Nampo (see Reuters coverage here).

The legislation adds some new designations, and two are non-Korean: Chinpo Shipping Company Limited, a Singapore firm, and Sam Pa, believed to be the head of the notorious 88 Queensway Group and its various subsidiaries that are involved in dealings with authoritarian regimes from North Korea to Africa, including in mining. Also designated: North Korea’s Central Bank, at least with respect to gold sales that crop up periodically.

One of the more interesting secondary sanctions efforts of the new legislation is not with respect to designated individuals or firms but with respect to weak jurisdictions that are non-compliant with UNSC resolutions. These countries and ports do not engage in inspections and essentially permit transshipment and trade to take place; I increasingly believe that such services income earned on North Korean vessels plying trade between third country ports is a significant income-earner. The legislation is interesting in highlighting a number of ports that are leaky sieves with respect to North Korean trade (listed below). But good luck getting at any of them. It is more likely that the legislation will have effect with other developing countries more concerned about their reputation with the West. But as Secretary Tillerson and acting Assistant Secretary Thornton both recognized, this is not a magic bullet; it's a retail sanctions slog with an adversary that has become quite remarkable at squirming away.

From HR 3364, para. 205.

The new legislation demands a report from the executive with respect to the following ports and airports:

  • Dandong, Dalian, and any other port in the People’s Republic of China that the President deems appropriate.
  • The ports of Abadan, Bandar-e-Abbas, Chabahar, Bandar-e-Khomeini, Bushehr Port, Asaluyeh Port, Kish, Kharg Island, Bandar-e-Lenge, and Khorramshahr, and Tehran Imam Khomeini International Airport, in the Islamic Republic of Iran.
  • The ports of Nakhodka, Vanino, and Vladivostok, in the Russian Federation.
  • The ports of Latakia, Banias, and Tartous, and Damascus International Airport, in the Syrian Arab Republic.

Comments

Keith Richburg

Steph, excellent, and very detailed, analysis. I am eager to get your take on the latest ratcheting up of the rhetoric, from both Pyongyang and the White House (or Bedminster, New Jersey). I'm actually worried now we could end up blindly stumbling into a confrontation. 

Cheers, Keith

Add new comment