Priorities for the Japanese Economy in 2022 (January 2022)

Economic Sanctions as a Tool of Economic Statecraft: Importance of Collaboration across the Boundaries of Competent Authorities and Industries

Consulting Fellow, RIETI

1. Introduction

While economic statecraft is an urgent challenge, various measures related to economic security have already been implemented. Imposing economic sanctions is one such measure. The sanctions can be classified into restrictions on trade in goods and technology, restrictions on access to assets and financial services, and restrictions on the activities of individuals and organizations subject to sanctions.

Economic sanctions are an effective measure to support diplomatic negotiations. For example, with regard to North Korea, the asset freeze of 25 million dollars held by that country at Banco Delta Asia, a bank in Macau in 2005, as part of the U.S. financial sanctions against North Korea, is presumed to have been one of the factors that led to an agreement with North Korea that included the closure and suspension of activities at the nuclear facilities in Yongbyon (Note 1). Moreover, the strengthening of the economic sanctions by the United Nations Security Council in 2016 and 2017 is also presumed to have been a factor behind North Korea's policy shift toward dialogue in 2018 (Note 2). Economic sanctions are an important tool for Japan to counter national security threats. On the other hand, illicit exports and money transfers from Japan to North Korea continue. Regarding export controls and the restriction on money transfers, Japanese competent authorities and companies in relevant industries have accumulated knowledge. However, such knowledge is not always shared with other government agencies or companies. To strengthen the efficacy of economic sanctions, it is necessary to create inter-agency and cross-industrial information-sharing mechanisms.

2. Tracking Payments to Detect Illicit Trades

When countries subject to economic sanctions attempt to procure prohibited items, various methods are employed to conceal the procurement routes. One example is an "indirect export." For instance, if Country A is to procure a prohibited item from Country X, the item would be exported to Country B first and then be transported by land to Country A later. It is difficult for the company in Country X to know in advance whether the product in question is intended to be ultimately exported illicitly to Country A unless prior insider information is obtained from some source or another. Close examination of the payment information could reveal "red flags." In one actual case of an indirect export to North Korea, after an export contract from Country X to Country B was concluded, a company in Country Z joined the transaction to pay for the exported items. The president of the paying company was found to be a person doing business in North Korea.

As a general rule, the procurement of goods is likely to entail some form of payment, which should involve a transfer of funds. Therefore, if we pay close attention to the flow of money that is associated with the flow of items, it may be possible to find connections to countries subject to economic sanctions that would remain invisible if we only focused on the movement of goods.

3. Using Security Trade Control Wisdom to Detect Financial Risks

In recent years, it has become increasingly difficult to monitor international fund transfers. Recent trends including the advance of virtual assets and avoidance of U.S. dollar-based money transfers adversely affect the efficacy of traditional money transfer monitoring systems that rely on the U.S. dollar (Note 3). Furthermore, informal networks of fund transfers that do not use the ordinary financial institutions' international money transfer systems (alternative value transfer systems) are being used to make illicit money transfers.

On the other hand, the importance of monitoring financial activities, which is currently an important tool from the viewpoint of national security, is widely recognized, as indicated by the addition of terrorism financing in 2001 and proliferation financing in 2012 to the mandate of the Financial Action Task Force on Money Laundering (FATF), which was originally established as a framework for international cooperation in the fight against money laundering.

Put simply, money laundering, terrorism financing, and proliferation financing can be compared as follows.
(1) Money laundering (the problem is the fund source): The process of disguising funds acquired through illegal means as legitimate revenue. The funds ultimately return to the original fund owner.
(2) Terrorism financing (the problem is the fund recipient): The act of providing funds acquired through legal and illegal means to terrorists.
(3) Proliferation financing (the problem is the usage of funds): The act of providing financial services or funds acquired through legal and illegal means for the production, development and procurement of missiles and weapons of mass destruction.

The methods used in the above three categories of activity have some common features (Note 4), but because of differences in the nature of these activities, financial institutions should evaluate them against different criteria when they conduct customers' risk assessments. For example, art dealers and luxury yacht brokers have a high risk of being used for money laundering conducted through high-value transactions (Note 5). Meanwhile, financial institutions and companies in regions where significant trade occurs with countries that have developed weapons of mass destruction may have higher risk of being used for proliferation financing. However, a tailored risk assessment based on the three different illicit financial activities is apparently one of the remaining challenges for Japanese financial institutions (Note 6).

While monitoring financial activities is becoming increasingly difficult, the scope of financial activities that should be monitored is expanding into areas that cannot be covered by financial institutions alone, including terrorism and proliferation. One possible way of dealing with this situation is for financial institutions to adopt strategic export control screening methods. Furthermore, examining money transfer and payment information used in illicit procurement cases may provide information that could lead to the discovery of other illicit financial networks.

In response to the results of FATF's Fourth Mutual Evaluation of Japan, published in 2021, a policy council on anti-money laundering, terrorism financing, and proliferation financing was established within the Japanese government. This council should not only deal with those illicit financial activities solely among finance related parties, but also promote cooperation between competent authorities that are responsible for security trade control to establish strategies to counter illicit financial activities that are particularly closely related to trade (e.g., money laundering using trade (Note 7) and proliferation financing).

4. Conclusion

Vigorous enforcement of economic sanctions is an essential activity of economic security: not only to counter Japan's national security threats, but also to protect the citizens and companies from illicit activities. Ensuring enforcement, however, is not easy. Information sharing is vital to identify risks. The government should establish a framework to promote information sharing among competent authorities and industries.

December 27, 2021
  1. ^ A statement by IHARA Junichi, Deputy Assistant Minister of the Foreign Ministry Secretariat, to a question in a Diet session, the Minutes of the 166th Meeting of the House of Representatives Committee on Economy, Trade and Industry, No. 12, p. 2 (May 23, 2007).
  2. ^ TAKEUCHI Maiko, "Efficacy of UN Sanctions on North Korea—Effectiveness and Challenges," The Journal of International Security, Vol. 48., No. 2 (September 2020), pp. 24-25.
  3. ^ U.S. Department of Treasury, The Treasury 2021 Sanctions Review, October 2021.
  4. ^ For example, various methods of concealing the sources of assets and money transfers (e.g., using a complicated transfer route) are used not only for money laundering but also for terrorism and proliferation financing.
  5. ^ Purchasing a painting or a luxury yacht with illicitly acquired funds and transferring the purchased goods overseas for concealment or resale is a common technique of money laundering.
  6. ^ In a survey that the author conducted with financial institutions, among other organizations, the number of respondents who said they were conducting risk assessment regarding terrorism and proliferation financing was smaller than the number of respondents who said they were doing so regarding money laundering. Multiple respondents commented that in the customer due diligence process, they heavily rely on "name screening," i.e., checking the names of companies and individuals against the list of entities registered in the computer system (in this case, other risk factors may be disregarded, and the names of companies and individuals that are not registered in the system could be overlooked).
  7. ^ Examples of money laundering methods using trade ("trade-based money laundering") include transferring funds by purchasing products with a wide price range, such as electronic products, at inflated prices to transfer value to the seller (disguising as a legitimate transaction).

January 18, 2022