Isolating Iranian Banking Activities

By Jonathan Winer

The recent reports this week of further withdrawal from the Iranian market by London-based HSBC and Swiss-based UBS and Credit Suisse represent the latest consequences of growing U.S. pressure to bring about Iran's financial isolation. But they also reflect the underlying reality that Iran has placed no meaningful money laundering controls on its banking system. As a result, no banking anti-money laundering and terrorist finance compliance officer at any bank doing business with Iran is in any position to make a meaningful assessment that a particular transaction or account is not at high risk of money laundering, terrorist finance, or being related to illegal proliferation.

Over the past several months, U.S. officials have traversed the world alerting foreign governments and foreign banks to the reality that Iran's lack of controls on its financial system means that in practice, it is impossible to know the ultimate ownership or purpose of any Iranian transaction, due to the impractically of carrying out meaningful "know your customer" or other controls on the assets at their origin.

On September 8, the U.S. Treasury Department issued a regulation prohibiting U.S. financial institutions from handling any assets, directly or indirectly, relating to Iran's Bank Saderat, based on evidence of its support for terrorist finance activities relating to Hamas, Hezbollah, Islamic Jihad and other terrorist groups. Iran threatened to shift its assets out of U.S. dollar reserves, but the U.S. pressure has continued unabated.

Further pressure to isolate Iran's ability to use the global banking system is inevitable, in light of Iran's comprehensive disregard of international standards governing money laundering controls, and its risk of abuse by Iranian intelligence agencies, Iranian foundations (the "bonyads," heavily used by Iran for proliferation activities over many years), and the reality that substantial Iranian financial assets held abroad are the proceeds of corruption by the country's elites, held as rainy-day funds.

Iran has drafted, but not yet enacted, both an anti-money laundering (“AML”) and terrorist financing law. Enactment has been prevented to date by opposition from Islamicist elements of the government, and likely by the continuing need of the Iranian presidency to avoid accountability for financial transactions involving the country’s major foundations. The Central Bank of Iran (“CBI”) has issued AML regulations that cover such issues as suspicious reporting, but implementation remains doubtful, as Iran lacks an administrative structure for dealing with these crimes. Moreover, there is no evidence to suggest that AML and terrorist finance legal frameworks and enforcement authorities currently in place, such as the CBI regulations, have been implemented in practice. Accordingly, they appear to be formal systems only, existing primarily to demonstrate formal adherence to international standards, rather than as real controls.

AML systems are supposed to require financial institutions not to handle the proceeds of corruption. Yet very substantial portions of Iran's economy have been controlled for the benefit of a small number of elite families. Allegations include corruption relating to the foundations and corruption involving major government procurement, especially involving contracts for purchases of foreign goods and services. Numerous public reports state that Iran continues its efforts to acquire nuclear technologies through front-companies for the government, including the country’s largest foundation, Bonyad Mostazafan and Janbazan Foundation. That foundation and related Iranian entities have also been reported to fund Hezbollah and its terrorist activities.

The benefits to senior political and religious leaders of the lack of oversight of their financial activities under the current system likely continues to be an important factor in the country’s failure to date to create meaningful limits on money laundering taking place in both its formal and informal banking systems. In practice, these systems remain highly vulnerable not only to state-sponsored illicit finance and “gray market” financial transactions, but to abuse by those engaged in weapons trafficking, drug trafficking, commodities smuggling, human trafficking, and cyber crime among other illegal activities.

Added to this situation is the vast scope of Iranian capital flight, which begins with visible Iranian investment in the real estate markets of the UAE, which extends to similar such investments in Venezuela and Ontario, Canada. In none of these cases is it possible for any non-Iranian institutions handling the funds to know with any reasonable certainty the source of the funds -- clean or corrupt. Determining whether the particular transactions are at risk of being related to proliferation or terrorist fundraising is equally impossible, given the reality that none of Iran's financial activities can transparently be sourced back to audited financial reports of the kind applicable to normal bank customers, whether individual, corporate or governmental.

Arab Bank was forced out of the United States after it was found to have handled funds for Hamas, subject to sanctions and class action litigation. Any bank that currently handlies Iranian funds has no way of knowing its level of risk from those funds. If they turn out bad, the defense by the bank that it didn't know the funds were dirty is likely not to go very far in warding off potentially largely liability.

It is the recognition of these kinds of risks, not just U.S. pressure, that is driving the banks that have named publicly to pull out of providing services to Iran.

It will be interesting to see in the weeks to come whether the banks that continue to provide Iran services will find ways to meet their "know your customer" obligations regarding any Iranian transactions, or will have to conclude in the end that separating themselves from Iranian business is essential to limiting risk and lowering the threat of liability to a commercially and reputational reasonable level.

Those still doing business with Iran may also consider whether they need to provision against further enforcement risk, given recurrent allegations in 2006 that the U.S. Department of Justice is continuing to look at the Iran-related activities of several banks, including HSBC, Standard Chartered, and BNP Paribas. Given U.S. pressure, and the growing understanding of Iran's complete absence of AML controls, the probability of other countries choosing in the near-term to limit risk by limiting Iranian access to their financial system should not be discounted.

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