[Senate Hearing 115-50]
[From the U.S. Government Publishing Office]
S. Hrg. 115-50
SECONDARY SANCTIONS AGAINST CHINESE INSTITUTIONS: ASSESSING THEIR
UTILITY FOR CONSTRAINING NORTH KOREA
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
NATIONAL SECURITY AND INTERNATIONAL TRADE AND FINANCE
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING HOW CHINESE BANKS, BUSINESSES, AND PERSONS PROVIDE NORTH
KOREA WITH DIRECT AND INDIRECT ACCESS TO FINANCIAL MARKETS AND
RESOURCES, ALLOWING PYONGYANG TO EVADE OR MITIGATE INTERNATIONAL
SANCTIONS
__________
MAY 10, 2017
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available at: http: //www.fdsys.gov/
______
U.S. GOVERNMENT PUBLISHING OFFICE
26-242 PDF WASHINGTON : 2017
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Publishing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada JON TESTER, Montana
TIM SCOTT, South Carolina MARK R. WARNER, Virginia
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
Gregg Richard, Staff Director
Mark Powden, Democratic Staff Director
Dawn Ratliff, Chief Clerk
Cameron Ricker, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on National Security and International Trade and Finance
BEN SASSE, Nebraska, Chairman
JOE DONNELLY, Indiana, Ranking Democratic Member
BOB CORKER, Tennessee MARK R. WARNER, Virginia
TOM COTTON, Arizona HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota BRIAN SCHATZ, Hawaii
DAVID PERDUE, Georgia
Ammon Simon, Subcommittee Staff Director
Klon Kitchen, National Security Advisor
Nick Catino, Democratic Subcommittee Staff Director
(ii)
C O N T E N T S
----------
WEDNESDAY, MAY 10, 2017
Page
Opening statement of Chairman Sasse.............................. 1
Opening statements, comments, or prepared statements of:
Senator Donnelly............................................. 9
WITNESSES
Adam J. Szubin, Distinguished Practitioner-in-Residence, Johns
Hopkins University, School of Advanced International Studies;
Of Counsel, Sullivan & Cromwell; and Former Acting Secretary of
the Treasury and Acting Under Secretary of the Treasury for
Terrorism and Financial Crimes................................. 2
Prepared statement........................................... 27
Juan C. Zarate, Chairman and Cofounder, Financial Integrity
Network; Chairman and Senior Counselor, Center on Sanctions and
Illicit Finance; Former Deputy Assistant to the President and
Deputy National Security Adviser for Combating Terrorism; and
Former Assistant Secretary of the Treasury for Terrorist
Financing...................................................... 3
Prepared statement........................................... 31
(iii)
SECONDARY SANCTIONS AGAINST CHINESE INSTITUTIONS: ASSESSING THEIR
UTILITY FOR CONSTRAINING NORTH KOREA
----------
WEDNESDAY, MAY 10, 2017
U.S. Senate, Subcommittee on National Security and
International Trade and Finance,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met, at 10:07 a.m., in room SD-538,
Dirksen Senate Office Building, Hon. Ben Sasse, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN BEN SASSE
Chairman Sasse. The hearing will come to order.
I would like to welcome everyone to this meeting of the
National Security and International Trade and Finance
Subcommittee of the Banking Committee. I am pleased to be
joined by my colleague and friend and our Committee's Ranking
Member, Senator Joe Donnelly, from Indiana, as well as other
Members of the Subcommittee here today, as we seek greater
understanding of how so-called secondary sanctions might be
used to counter North Korean belligerence and Chinese support.
I am going to offer a more complete opening statement, and
Senator Donnelly is going to offer a more complete opening
statement later in the hearing. We are going to be a little bit
unorthodox in our timing because of some of the things that are
happening on the Senate floor this morning that may prohibit
the Committee from meeting at some point in the course of our
hearing. So even though both of you have excellent opening
statements that are filled with content that I think we will
want to unpack--I do not think we want them just for the
record; we would like to hear longer opening statements from
you two--would you be willing to confine yourselves to maybe 3
minutes each just as a kickoff so we can get to some questions
from some Democratic Members that are going to be called to
another caucus meeting shortly? So I think we will go a little
bit out of order in our questioning, if each of you could just
have maybe 3-minute opening statements.
Great. I will give very brief biographies of the two of
you.
Adam Szubin is currently the senior practitioner-in-
residence at Johns Hopkins University School of Advanced
International Studies. He is also the former Acting Secretary
of the U.S. Treasury Department as well as the Acting Under
Secretary of the Treasury for Terrorism and Financial Crimes.
Welcome, Mr. Szubin.
Joining him today is the Honorable Juan Zarate, chairman of
the Financial Integrity Network, chairman and senior counselor
of the Center on Sanctions and Illicit Finance, former Deputy
Assistant to the President and Deputy National Security Adviser
for Combating Terrorism, and the former Assistant Secretary of
the Treasury for Terrorist Financing. Welcome, Mr. Zarate.
Gentlemen, both your written statements will be included in
the record later, and after Senator Donnelly and I make
statements, subsequently we will let you make opening
statements again, but maybe just 2 or 3 minutes from each of
you.
Mr. Szubin, welcome and thanks for being here.
STATEMENT OF ADAM J. SZUBIN, DISTINGUISHED PRACTITIONER-IN-
RESIDENCE, JOHNS HOPKINS UNIVERSITY, SCHOOL OF ADVANCED
INTERNATIONAL STUDIES; OF COUNSEL, SULLIVAN & CROMWELL; AND
FORMER ACTING SECRETARY OF THE TREASURY AND ACTING UNDER
SECRETARY OF THE TREASURY FOR TERRORISM AND FINANCIAL CRIMES
Mr. Szubin. Thank you very much. Chairman Sasse, Ranking
Member Donnelly, Members of this Subcommittee, it is a true
honor to be here. This is my first time testifying outside of
the Government. I think it is fitting given our relations over
the 13 years I had in Treasury, and it really is an honor to be
back.
I am often asked a pretty core question at this moment,
which is whether, as with Iran, the international community
could generate enough sanctions pressure to force a North
Korean Government to the table to negotiate a peaceful and
verifiable end to its nuclear weapons program. It is obviously
an immensely difficult question, but I do believe the answer is
a qualified ``yes.''
Let me just share my top-line assessments, and then I will
obviously yield in the interest of time.
First, North Korea is not self-reliant or ``sanctions-
proof.'' Its leadership depends upon access to foreign imports
and international banking services, and that access can be
disrupted.
Second, sanctions leverage over North Korea is concentrated
in one country: China. If China is prepared to take a
qualitatively tougher stance on sanctions against North Korea,
sanctions have a chance to succeed. If not, they do not.
Third, despite years of high-level international attempts,
China has thus far resisted more than incremental enhancements
to its sanctions posture. China does harbor serious concerns
about Kim Jong-un and their nuclear program, but a collapse of
the North Korean regime and the chaos that it would unleash on
China's border poses a far greater threat in China's eyes.
For that reason, U.S. sanctions alone will not force China
to adopt a sufficiently aggressive approach no matter how
draconian and costly those sanctions become. China will not be
strong-armed into a course of action that it believes imperils
its own national security.
For that reason, serious and high-level engagement with
China will be needed to set out a way forward, to include an
intensive pressure campaign, and the various scenarios that
could follow from it, including potential leadership change in
North Korea.
China will not roll the dice when it comes to the fate of
its impoverished nuclear-armed neighbor. Concerns over
stability will be paramount, but I believe that our interests
can be reconciled with China's.
What is needed here is a massive diplomatic investment and
multilateral engagement to marshal a campaign, including China
and other countries around the world, both the like-minded and
the resistant. Having participated in a comparable campaign
with respect to Iran, I would urge both the Administration and
Congress to staff key leadership positions at the State
Department and the Treasury Department quickly, including
confirming Sigal Mandelker, who has been nominated to serve as
the next Under Secretary for TFI. I know her to be an
intelligent, experienced, and strong leader. And I believe that
it would be counterproductive in the extreme to deplete our
Foreign Service Corps at a time when we need them so urgently,
both on this issue and the whole range of national security and
foreign policy threats we face.
To conclude, even with a concentrated and strategic
efforts, we obviously cannot guarantee that a diplomatic effort
powered by new sanctions pressure will succeed, but I believe
that it has a real chance to do so, and I am not aware of a
better alternative. Faced with this ever-growing menace, it is
our duty to put all of the considerable talents, intelligence,
and energies of the U.S. Government behind this effort.
Thank you again for having me to testify.
Chairman Sasse. Thank you, Mr. Szubin.
Mr. Zarate.
STATEMENT OF JUAN C. ZARATE, CHAIRMAN AND COFOUNDER, FINANCIAL
INTEGRITY NETWORK; CHAIRMAN AND SENIOR COUNSELOR, CENTER ON
SANCTIONS AND ILLICIT FINANCE; FORMER DEPUTY ASSISTANT TO THE
PRESIDENT AND DEPUTY NATIONAL SECURITY ADVISER FOR COMBATING
TERRORISM; AND FORMER ASSISTANT SECRETARY OF THE TREASURY FOR
TERRORIST FINANCING
Mr. Zarate. Chairman Sasse, Ranking Member Donnelly, and
distinguished Members of the Subcommittee, it is really an
honor to be here today. Thank you for the invitation. I will
tell you it is an honor to be testifying next to my very good
friend, former colleague, and one of the great professionals in
this field, Adam Szubin, somebody for whom I have enormous
respect. And I expect him to take all the hard questions, Mr.
Chairman.
[Laughter.]
Mr. Zarate. Mr. Chairman, as you and I discussed and as we
know, this is a timely and important hearing. What was once
seen solely as a threat from North Korea to peace and stability
on the Korean peninsula and in the region has now become a
looming, potentially direct threat to the U.S. homeland. All
the while North Korea tests ballistic missiles and increases
the pace of its nuclear program, it is also proliferating its
technology for profit, engaging in illicit finance and
commercial activity, exploiting forced labor and human rights
abuses to make money for the regime, and even using cyber tools
to attack financial infrastructure.
This is also a moment to challenge the orthodoxies because
of the urgency of the task at hand, and I agree with Adam that
this is a moment to think about a renewed financial pressure
and economic campaign against North Korea that has as its
centerpiece the change in the Chinese calculus with respect to
their interests.
Now, this is not easy. The Chinese have been pressured in
the past. They have showed glimmers of wanting to cooperate,
including recent rejections of coal imports from North Korea.
But the Chinese have a different strategic interest, and our
interests and theirs have not aligned with respect to the use
of financial pressure in an existential way against the regime
in Pyongyang.
I think this is a moment for China to assume its role as a
great power, to be able to influence its North Korean ally.
This Administration and this Congress will have to grapple with
how best to obtain, to a certain extent coerce, and sustain
Chinese cooperation in order to maximize pressure on North
Korea. And, ultimately, we have to change the calculus in
Pyongyang to either slow or stop the pace of its nuclear
program.
But the linchpin here is the Chinese calculus.
Unfortunately, this has been the third rail of the sanctions
debate. There has been an uneasiness with a willingness to
pressure China or to pursue efforts that touch the Chinese
economy or Chinese interests too directly. I think that
calculus has to change. In many ways, China becomes the
linchpin for these efforts, and as we see with all of the
illicit networks that are exposed, there is inevitably a
Chinese link, Chinese facilitation, Chinese networks, Chinese
agents.
Any effort, whether it is to apply secondary sanctions,
which would apply to those actors that are not doing business
directly with the U.S., do not have a U.S. nexus, or other
financial measures, has to put at risk Chinese interests, or at
least make clear that Chinese interests are going to directly
or indirectly be impacted by their relationship with North
Korea and the illicit activity engaged in. And I would argue,
as my testimony lays out in greater detail, that secondary
sanctions are only one part of a panoply of steps that can be
taken to sensitize the environment, to make the reputational
risk and the real risk of doing business with North Korea ever
more dangerous, ever more difficult for the Chinese. The more
the Chinese realize that their interests are directly impacted
by what North Korea is doing, be it on the nuclear file, on the
missile testing program, on the illicit financing activity, the
more likely it is that the Chinese will change their behavior
and change their calculus.
As I said, China has the opportunity to prove its role as a
great power and to use its influence with Pyongyang. The clock
is ticking in many ways, and an effective financial pressure
campaign with China on side is one way of potentially helping
to slow, if not stop, the clock.
Thank you, Mr. Chairman.
Chairman Sasse. Thank you, Mr. Zarate.
Senator Donnelly has agreed to temporarily defer to
Senators Heitkamp and then Cortez Masto. Senator Heitkamp.
Senator Heitkamp. Thank you so much, Mr. Chairman. This is
a Committee that I had the honor of being the Ranking Member on
last Congress, and I will tell you it tends to be incredibly
bipartisan. And I want to pledge to both of you my support and
anything that I can do as you advance this discussion and this
agenda, because nothing is more important. Really, it is
incredible that the Banking Committee has this responsibility,
and it is a responsibility that is absolutely critical to
national security.
I want to turn to Mr. Szubin and Mr. Zarate. I want to say
just on the record that for some reason the job that you two
have held attracts absolutely the best and brightest in public
service in America, people whose intellect and capability could
be earning riches on Wall Street, but yet you serve our country
in this very strategic and absolutely essential role of
monitoring and implementing sanctions. And I want to thank both
of you from the bottom of my heart for your public service. You
are true patriots, and your appearance today reinforces that.
I think there is a lot of cynicism--Mr. Szubin, I am going
to start with you. There is a lot of cynicism about whether you
can, in fact, achieve this result without China participating
and a lot of cynicism about whether China will play the role
of, yes, we are on board, yes, we are on board, but yet we do
not see the kind of activity that we need to see given the
regional threat that North Korea presents.
North Korea's interest is obviously in preventing regime
change. You know, that probably is pretty consistent across the
board in all of world Governments. But this is a very dangerous
regional development, and I am wondering, how do you assess the
likelihood of success that China will, in fact, play a critical
and important role going forward?
Mr. Szubin. I think that is the question of the hour,
Senator Heitkamp, and----
Senator Heitkamp. But I wanted an answer, not a repetition
of the question, Mr. Szubin.
[Laughter.]
Mr. Szubin. I am not going to be repeating the question. I
would not dare.
I think we have a chance, and as I put forward in my
written statement, China does not start with an opposing set of
interests to our own here. China, I think, is made quite
nervous by the behavior of this young dictator in Pyongyang. He
has gone out----
Senator Heitkamp. Can I ask you, do you think they feel the
urgency that we feel at this point?
Mr. Szubin. Probably not quite, and Kim Jong-un has called
out the U.S. as his leading enemy and has a stockpile of
nuclear weapons. So, of course, we feel that urgency in a
different way from China.
But China, I think, would be very glad to see a solution to
the nuclear threat to global security. It comes with a lot of
headaches for China, including the deployment of THAAD in South
Korea and a lot of military attention from the U.S. right off
of China's shores. On top of that, I think China would be happy
to see a more stable leadership posture out of Pyongyang.
So we have a lot of shared interests, but right now the key
impediment, I think, to further Chinese cooperation is their
fear of a regime collapse. And a regime collapse is a much
greater threat to China given the level of poverty in North
Korea, the level of chaos that would unleash right on their
border, than anything else that we are talking about today.
So this is the key conversation to be had between really
senior members of our Government and China's Government, is not
just how do we turn the pressure up, how do we start pushing
toward nuclear negotiations, but what does that pressure look
like and what are the next three steps after the pressure gets
that high, because China is not going to head into this without
knowing those answers.
Senator Heitkamp. Do you think secondary sanctions will be
viable in this situation?
Mr. Szubin. I think secondary sanctions ought to be
considered if the need arises, and the reason I put it that way
is they are just a sanctions tool like any other. We saw in the
Iran context how powerful they could be, but they were
marshaled to a broader strategic efforts with diplomacy that
was really substantial over a period of years, and they
followed on to a serious of primary sanctions moves that really
had Iran quite isolated.
So at the right time, as part of a strategic diplomatic
campaign, secondary sanctions may be needed in this context.
But I do not think that time is now.
Senator Heitkamp. OK.
Mr. Szubin. I think they need to be--they need to be linked
to a campaign and not be set out in advance of a campaign.
Senator Heitkamp. Mr. Chairman, I want to be respectful of
your great generosity, so I will close there. But I can expect
that we will be able to file some written questions.
Chairman Sasse. Absolutely. Thank you.
Senator Heitkamp. Thank you, Mr. Chairman.
Chairman Sasse. Senator Cortez Masto.
Senator Cortez Masto. Thank you, Mr. Chairman and Ranking
Member. I appreciate that.
Can I follow up then? Because this was a similar line of
questioning that I had as well with respect to secondary
sanctions. I am going to pose this to both of you. What do you
both understand to be the Trump administration's strategy to
halt North Korea's missile program and the role that the
secondary sanctions should play?
Mr. Szubin. I cannot speak, Senator, to the Trump
administration's strategy here. Obviously, I am now on the
outside and am not a part of those discussions. I was a part of
the last two Administrations' discussions on North Korea, and
typically there is a focus on how do we turn the pressure up to
a level where North Korea is forced to the table in a way that
they have not yet been to date to engage in multilateral
negotiations over their nuclear program. That is obviously a
very tall order.
Senator Cortez Masto. And part of that is making sure we,
like you said, completely staff up the State Department and
putting that pressure on through diplomatic channels. Isn't
that correct?
Mr. Szubin. That is absolutely right. And it was essential
in the Iran context. There is a lot of attention that is given
to the work of our former office, the Treasury Department, the
intelligence agencies, in terms of getting really effective,
crippling sanctions in place on Iran. And what is sometimes
neglected is how much diplomatic outreach was needed to make
those sanctions work and to make them stick. That was hundreds
of thousands of hours of visits to different capitals,
everywhere from Azerbaijan to Singapore, to ensure that
bankers, traders, and regulators were enforcing the sanctions
in a tough, meaningful way. And it was a huge effort that
requires diplomacy.
Senator Cortez Masto. OK. Mr. Zarate.
Mr. Zarate. Senator, obviously I am not part of the
Administration, but I think you can divine two core themes and
changes in the Trump administration policy in North Korea. The
first is a sense of urgency with respect to this issue. You
have heard Director Pompeo from the CIA talk about this. This
is now an urgent direct problem that is being treated as a
front-burner national security issue, which is adding
diplomatic attention and urgency to the issue.
The second is placing the onus squarely on China to try to
resolve these issues. Even the President's tweets have been, I
think, an attempt to do that in perhaps a clever way. But, in
any event, I think the overarching theme is, Can you persuade
China in a cooperative way to influence North Korea in a way
that they have not to date? And I think that is the overarching
thematic change.
How they go about doing that, whether or not secondary
sanctions should be a part of that, I think is yet to be seen.
I have not seen an articulation of this from the
Administration.
Where I would agree with Adam, but then also disagree, is
there is no question this has to be part of an overarching
strategy. It has to fit into a strategy. We have to understand
what we are trying to achieve with the financial and economic
measures and use the full complement of them and choreograph
them properly.
Where I perhaps disagree slightly is I do think this is a
moment to actually have the secondary sanctions in place, not
to necessarily apply them, but to have the authority available
both to signal to the marketplace that this is a potential risk
of doing business directly or indirectly with North Korean
entities, and also to begin a signaling mechanism, a financial
diplomatic message to Beijing that we are upping the ante, that
this is a more urgent, a more serious dimension of how we are
going to do this. This is not going to be how we have treated
the Chinese dimension of North Korea in the past.
And so I think, at a minimum, as a signaling mechanism, it
is incredibly powerful, and it begins to open the aperture for
diplomacy, for discussions with the private sector, for
targeting of actors, and we see over and over again--the Wall
Street Journal just this past weekend revealing ties between
known Chinese entities with a presence in the U.S. and North
Korean agents and networks. Those are the kinds of things that
will be accelerated and exposed if you have secondary sanctions
plus other measures in place.
Senator Cortez Masto. And following up on that, and I just
have a minute left, but as we talk about secondary sanctions,
do you see a difference between applying that pressure on
smaller Chinese banks versus the larger Chinese financial
institutions and what implications that means for our financial
market?
Mr. Zarate. I think secondary sanctions applied to the
Chinese banking system, it is very difficult, for three
reasons, and Adam lays this out very neatly in his testimony.
But I think the first is the Chinese learned a lesson after
2005 when we applied Section 311 authorities against Banco
Delta Asia where the major Chinese banks, to include Bank of
China, had exposure to North Korea. And so after that lesson,
they realized it was probably not a good idea for the four
major banks in particular to have exposure to North Korea.
And so what you have seen since then has been a
concentration of the kind of financial and commercial activity
with North Korea, especially in the northeastern part of the
country, concentrated with smaller institutions, smaller
brokers, money service businesses, in a way that has isolated
that activity from the major banks. That means there is less
connectivity to the U.S., and secondary sanctions are most
helpful when there are entities being targeted that want access
to U.S. markets or facilities.
The fact that that is the case, though, does not undermine
the credibility and strength of the potential secondary
sanctions for two reasons. One is you have unknown connections
to North Korea still, and even these institutions, these big
four Chinese banks, may not understand or may not even see the
exposure that they have to elements of the North Korean
network. So that is one issue.
The second is secondary sanctions are going to apply not
just to banks but to other commercial actors, and at a time
when China is very much trying to expand the reach of its
banks--I just got back from the Southern Cone where, you know,
you see the big towers of the Chinese banks in places like
Buenos Aires and Santiago, Chile, and they are worried about
their commercial brands around the world, Huawei and others.
The reputational risk attached to what North Korea represents
across the board is quite significant.
Maybe if I can leave you with this one thought: We have
consistently underestimated the power of these tools, leveraged
properly and appropriately with diplomacy and strategy, but I
think we have to test and probe whether or not these tools can
be used in a more aggressive form to change the Chinese
calculus, because I actually think we can. And I think if it is
done well and smartly, we can change the dynamics.
Senator Cortez Masto. Thank you. Thank you very much.
Thank you, Mr. Chair.
Chairman Sasse. Thank you. Senator Donnelly and I will
return to opening statements at this time.
Just very briefly, we are obviously here because of new
threats from an old foe. Since 1950, North Korea has been an
aggressive and disruptive player in Asia, and its new leader,
Kim Jong-un, appears committed to continuing and extending this
tradition.
After assuming leadership of the hermit kingdom in 2011,
Kim Jong-un has oppressed his own people, killed his real or
perceived opposition both inside and outside North Korea,
provoked and attacked our South Korean allies, and even
threatened to strike the United States with a nuclear weapon.
To the comments that have been made, there is not a more
critical global national security issue than this. This is
crazy and cannot be allowed to continue.
Earlier this week, Pyongyang even referred to our colleague
Senator Cory Gardner as ``human dirt'' and accused him of
having lost not only all human judgment but also all body hair.
I have no idea what that meant.
Kim Jong-un's patrons in Beijing have him on a very long
leash. His behavior, at least in part, is enabled by numerous
Chinese institutions and individuals who allow North Korea to
bypass the international sanctions regimes that exist by
providing them with both direct and indirect access to
international markets via shadow banks, illicit networks, and
other illegal mechanisms.
That brings us to the point of today's hearing and I think
the two central questions before us, and they are: Is it
possible and is it advisable to employ secondary sanctions
against these Chinese institutions and individuals in an effort
to further turn the sanctions screw against North Korea? And as
the three of us discussed prior to today's hearing, I think we
will probably toggle across three different topics. One of them
is that most narrow proximate question of should the U.S.
Government move toward secondary sanctions, and should the
Senate and the Congress be moving to give new tools to the
Administration to advance that agenda, to take action against
these Chinese institutions that are enabling North Korean
behavior? Bucket one.
Bucket two, where does North Korean international money
come from? What percentage of that is Chinese? And what do we
know about the decision-making processes inside China, which
would then further enable the Senate and the Congress and the
Administration to make calculations about whether or not North
Korean behavior could be influenced via secondary sanctions
against these Chinese institutions?
And then third, and more broadly, a whole range of
questions that the two of you, given the expert positions you
have held in the past, might be able to bring to bear and use
to tutor us on analogous situations in the past about how
secondary sanctions regimes work in situations that might be
analogous in some way to this? So I look forward to both of
your testimony.
Senator Donnelly.
STATEMENT OF SENATOR JOE DONNELLY
Senator Donnelly. Thank you, Chairman.
I want to start by thanking the Chairman for calling this
hearing. North Korea poses one of the most dangerous and
pressing threats to the United States' national security. We
have to dramatically increase our diplomatic and economic
pressure on the regime to abandon its nuclear weapons.
I also want to join the Chairman in welcoming our
witnesses. You are extraordinary leaders for our country. You
have done amazing work to keep our citizens safe, and that is
why we have turned to you today, is because of the faith we
have in both of you. You have an admirable record of public
service and formidable expertise on the subject at hand.
Today's hearing will tackle the critical question of
whether and how we can reverse decades of failed efforts to
counter the North Korean threat. There are two key points we
should emphasize, I think.
First, the common perception that North Korea is just a
hermit kingdom, cutoff from the global economy and
international financial flows. That is deeply misleading. North
Korea does billions of dollars in international trade, and
North Korean exports nearly tripled in value in the last 9
years after the first U.S. sanctions were imposed. As those
sanctions have escalated, North Korea has responded by
developing evasion techniques that are increasing in size and
sophistication.
Second, China is the linchpin. They are the key to any
international sanctions efforts. They account for more than 90
percent of North Korea's trade. While there has been some
limited progress in China's participation in international
sanctions, they must do more if we hope to have an impact on
Kim Jong-un's strategic calculus.
Secondary sanctions are a logical tool for pressuring China
to do more, but a tool that must be wielded carefully, and I
look forward to hearing your views and recommendations on that
topic.
I will close by saying that as the Ranking Member of this
Subcommittee, which deals with U.S. and foreign nuclear forces
as well, I have studied the situation in North Korea closely
and been briefed on options for U.S. military action. Those
have been some of the most sobering briefings of my career, and
I pray for the sake of our armed forces and, frankly, the world
that we will never have to put those plans into action.
I am concerned that we need to focus on this critically, as
we are trying to do today, and I hope this hearing will help
lay the groundwork for cooperation between Congress and the
White House that we tackle this threat together, not as
Democrats and Republicans but as Americans making sure that
everyone in our country and all of our friends and allies are
safe as well.
Thank you, Mr. Chairman.
Chairman Sasse. Thank you, Senator Donnelly, and I would
like to publicly thank you as well for the work that we did in
preparing for this hearing. There is a long tradition that this
Subcommittee has been very bipartisan and nonpartisan. One of
the places that the Senate works much more effectively that is
not always that visible to the public is when we are in the
SCIF together getting briefings. There is much less awareness
of people's partisan labels when they are in there being
briefed on national security and global security issues. And
the Ranking Member and I have been briefed on these topics both
here on the Hill and in a SCIF at the White House on some of
these topics. And when you are there, they are not really
Republicans and Democrats. They are American patriots who are
worried about the future and whether or not we have a clear
enough strategy.
So I know that both of you have conducted yourselves that
way across the last two Administrations, and so we are grateful
for your time.
Earlier we gave you truncated opportunities for opening
statements. I want to give each of you the opportunity to
expand a little bit if you would like and if you do not have
anything that you want to pull directly from your statement.
And, again, thank you for both of them. They were long and
meaty and helpful tutorials for us.
I think it would be useful then maybe for you to also give
us a sense of if you were going to give us--for our colleagues
who either were here briefly or will not attend today's
hearing, if you were going to give three or four takeaways of
what you would like Senators on the Banking Committee to
understand about the sanctions options before us with regard to
North Korea, I think we would love to have your takeaway
insights as well as anything you want to extract from your
opening statement. Mr. Szubin.
Mr. Szubin. Well, thank you very much, Chairman Sasse, and
thank you to both of you for the kind words and, to Ranking
Member Donnelly, for your support. I was a recipient, a
beneficiary of the bipartisan support of this Subcommittee and
the Committee as a whole in my years at Treasury, and that
bipartisan support unquestionably made for a stronger sanctions
posture and allowed our sanctions to have a massive impact
abroad. It was not seen as a wedge issue; it was seen as a
united front. And I very much hope that continues.
I do not need to pull more from my written testimony, but I
do want to come back to, I think, the central issue of the day.
I think Juan and I are actually extremely close across the
board on the need, first, to put this issue front and center
with China. There are so many issues that we deal with when it
comes to that bilateral relationship, whether they are
economic, trade, currency, whether they have to do with
geopolitical issues, the South China Sea. And I think it is
time, if not past time, to put this issue as our paramount
priority. China needs to understand that this is not one among
many. This is first. And an intensified sanctions campaign I
think has to be part of that. It is not that I think we need to
be cautious when it comes to sanctioning Chinese entities. The
caution I was talking about was before deploying a new stage,
which is secondary sanctions, but there is quite a lot of
authority and heft to the tools that the U.S. Administration
has right now thanks to Congress to go after North Korea's
activity in China and elsewhere, just using the current
authorities on the books. And I would like to see that stepped
up, and I would like to see the diplomacy and the high-level
diplomacy with China stepped up.
In terms of the when, to my mind, we need to be guided by
Secretary Tillerson, and when there is a signal from the
Secretary of State that these tools would be net more helpful
at this point to unsheathe than damaging, then I think that is
the right time. And it is going to be very difficult for me as
an outsider or for any outsider to judge where we are in the
conversation with China.
But I do agree that it is not just going to be a carrot
conversation. There is going to have to be both carrot and
stick.
Chairman Sasse. Mr. Zarate.
Mr. Zarate. Mr. Chairman, thank you, and I want to thank
the Ranking Member as well for the kind thoughts and echo
Adam's thanks.
I do think Adam and I are closely aligned. There may be
some nuance in opinion here as to how to think about this, but,
you know, maybe I can provide three insights, pulling a bit
more from the testimony. And, Senator Donnelly, you pointed to
this.
I think one thing this Committee needs to continue to be an
evangelist for is the idea that the orthodoxy that North Korea
cannot be impacted by financial and economic measures is just
not true; in addition to the idea that we have sanctioned
ourselves out of doing things to North Korea, that is not true
either.
And so just the very notion that we should be thinking
creatively about what those tools and strategies could look
like is really important. It is the point of this hearing, and
I commend the Chairman and Ranking Member for calling this.
At the same time, these measures are not silver bullets,
and I think one of the follies of some of the literature and
discussion around these issues and the role of sanctions,
especially in the wake of the relative success on Iran, which
credit Adam and Stuart Levey and Danny Glaser and Chip Poncy
and others, is the fact that when you are dealing with
fundamental issues that relate to regime survival, which is
really what we are talking about with Pyongyang, sanctions
alone and as a stand-alone strategy and campaign will not do
it. There has to be a collection of tools and influence that
are brought to bear, including with respect to the Chinese
calculus. The Chinese calculus is not going to be altered
simply because one of the Chinese banks is threatened with a
sanction by the U.S. That is not going to alter fundamentally
their position. So it has to be a collective set of strategies
and tools that are brought to bear.
Where I maybe differ with Adam a bit--and this is where I
have been somewhat critical with sanctions policy in the past--
is I think we have got to get away from the idea that sanctions
need to follow neatly from the diplomacy we are engaged in, and
the financial pressure campaign has to be sort of geared toward
moments of diplomacy. I think one of the problems of our North
Korea policy to date has been that we have been in start and
stop mode. At every moment of a new test, every moment of North
Korean belligerence, we then impose new sanctions. We then
think about a new stage of pressure.
I think we have to think differently about this. I think we
have to have a constant and consistent pressure campaign that
in some ways is parallel and complementary to our diplomacy,
but independent from those stages of diplomatic discourse. And
part of the reason you want to do that is to make these tools
effective, you actually have to condition the environment. They
have to be used consistently. You have to weed the garden at
all times, and you have to continue to up the pressure. That is
in part what the success of the Iran campaign demonstrated. It
was a consistent set of actions that over time constricted the
Iranian economy. That is what works. In this case, you have
less time. In this case, the dynamics are different. But, in
any event, you need a consistent pressure campaign.
And, finally, I think the one thing that this Committee
could help drive is creativity and imagination around how you
change the Chinese calculus. I think one of the orthodoxies we
have had all along is that the interests are too divided, that
the Chinese cannot be influenced. I do think there were
glimmers in the past of Chinese interests changing or their
calculus being altered by their own self-interest. This is not
a matter of getting them to want to advance U.S. interests. It
is a matter of affecting fundamental Chinese interests. And
when it comes to the health and security of their banking
system, their economy, this is critical. The Politburo just
last month held a study group, issued a study group on
financial security. This matters to the Chinese. They worry
about human rights and human rights blowback and reflection on
them. That is a connection to the North Koreans that they do
not like. They worry about corruption and the taint of
corruption tied not only internally but also to North Korean
activity. That is a lever to use.
And so there is a whole dimension of things that the
Chinese care about fundamentally that we can then use as
levers, not to attack the Chinese but to demonstrate we are
going to pressure the North Koreans. And if it happens to
affect the Chinese and Chinese interests, so be it. And I think
this Committee can help, especially with this hearing, to drive
the opening of that imaginative aperture to think about what
those tools are.
Chairman Sasse. Thank you. Very helpful.
We are going to go to Senator Rounds.
Senator Rounds. Mr. Chairman, first of all, thank you for
holding this Subcommittee hearing today, and thank you for the
courtesy of allowing me to step up in line in the timing.
As you know, gentlemen, in 2012, the U.S. Treasury
sanctioned the Bank of Kunlun, a Chinese bank, which was one of
two foreign banks subjected to secondary sanctions under the
Comprehensive Iran Sanctions and Divestment Act, or CISADA,
which was due to significant transactions with sanctioned
Iranian banks.
My question is: Did the U.S. Treasury action adversely
affect the U.S.-China relationship?
Mr. Zarate. Senator, based on my knowledge, not at all.
There were certainly diplomatic objections from the Chinese,
but at the end of the day, based on what I know from the
outside, based on what David Cohen, the former Under Secretary
of the Treasury, has written, the Chinese actually told Kunlun
Bank to stop its activities. Kunlun Bank remains designated
under that authority. I do not know what the current status of
its activities looks like, but the Chinese certainly objected
diplomatically, but they reacted the way that we would have
hoped. That also matched the activities and their reaction in
2005 when the Treasury designated Banco Delta Asia in Macau as
a primary money-laundering concern, where there was a lot of
diplomatic objection and tension and arguments that this was an
infringement on their sovereignty based on a unilateral U.S.
action. But at the end of the day, they wanted to protect their
reputation; they wanted to protect the perceived integrity of
their major banks; and they cleaned up the North Korean
activity that was at least present obviously in places like
Bank of China and some of the other major banks.
Senator Rounds. Mr. Szubin.
Mr. Szubin. Thank you, Senator. Having been on the inside--
and I do not want to talk about internal diplomatic
conversations--certainly it was a sensitive issue in the run-up
to that. It is an issue that we broached with the Chinese
repeatedly to share our concerns about what was going on with
Bank of Kunlun, such that when the sanction was actually taken,
it did not come as a surprise. And I think there were steps
then taken by China to be able to address the conduct, as Juan
has said.
But we also have to distinguish between a bank like Kunlun,
which is a tiny regional bank that had next to no dealings with
the U.S. markets and the U.S. dollar, and, you know, one of the
largest banks in China at the other end of the spectrum. Right
now, the four largest banks in China are also by assets the
four largest banks in the world. And their dealings in the U.S.
dollar, their investments in the U.S. and in the international
markets are substantially different from what we are talking
about with Bank of Kunlun. And the evidence for that is Bank of
Kunlun continues to exist even having been subjected to
secondary sanctions. It was not a death sentence for Kunlun
Bank. Kunlun Bank was happy to tailor its services to Iran and
other secondary or tertiary players.
I do not think we need to shy away from pressuring Chinese
banks over conduct with North Korea. To the opposite, I think
we need to very much hold their feet to the fire. And I think
we need to hold the feet of the Chinese Government to the fire.
One of the other differences, though, from the Iran
campaign to the North Korea situation is Iran conducted and
still conducts its banking business like a country. It opens
correspondent accounts for its major banks in other major
banks, and then it routes its commerce in foreign exchange
through those correspondent accounts.
And so you had a pretty easily identifiable set of access
points that could be turned off and that we were going around
the world, frankly, urging countries to turn them off. And
Kunlun did not comply. Kunlun faced secondary sanctions.
North Korea does not conduct its banking business like a
country anymore. It conducts its financial business overseas
like a criminal cartel, frankly. It uses front companies, so
there is no correspondent account for the second bank of North
Korea that is open that a Chinese bank could just turn off.
What is required is sort of a criminal forensic and
intelligence full-court press to ferret out who those front
companies and agents are and to shut them down and then to
continue to turn the screw, because North Korea will not sit
still to just watch its access points cut. It will find new
access points.
For that reason, I am not only describing what will need to
be a very intensive push by our Government, but also by China
on the enforcement side, and by Chinese banks. We need to
somehow enlist their cooperation, and that might involve some
arm-turning, twisting. It might also and I think necessarily
will involve discussions about where this is all headed.
But through a combination of devices, we need to get China
to care about this issue nearly as much as we do. Otherwise, we
are not going to succeed in that cat-and-mouse game of forcing
North Korea's dirty money out of China.
Senator Rounds. Thank you, gentlemen.
Thank you, Mr. Chairman.
Chairman Sasse. Senator Donnelly.
Senator Donnelly. Thank you, Mr. Chairman, and I want to
thank both the witnesses.
You had talked about getting their attention, that this is
critical to us. And if you had two or three key ideas that you
said here are the two or three that I would say do most, to
each of you, what would they be?
Mr. Szubin. If I were advising the Secretary of State, I
think the conversation that we are having today, the focus of
Congress and this Committee on secondary sanctions, could be an
extremely useful opening to the type of very serious
conversation that I think they want to have and that we need to
have.
Senator Donnelly. And what do you think would be the first
secondary sanctions that you would say this would be critical
and this would be critical?
Mr. Szubin. I am talking here about the threat on the
horizon that Congress seems to be headed in this direction,
that we, the Administration, may not be able to stop them, and
there is always this sort of good cop/bad cop routine that
plays out with diplomacy. When those secondary sanctions come
into effect, we want to see major Chinese banks with clean
hands, not having any North Korean dirty accounts on their
books, so that this is really going after the small rogue
actors as opposed to the international-facing, most reputable,
first-tier banks in China.
So, to me, that is a conversation that I think could bear
real fruit right now, and you do not need to enact secondary
sanctions to have it.
Senator Donnelly. Mr. Zarate.
Mr. Zarate. I think Adam is absolutely right. I think the
mere threat of secondary sanctions and the potential to have a
conversation with the Chinese to say, ``Look, this is not
intended to attack your entire banking system, nobody wants
that.'' What we are trying to do is identify rogue, illicit
financial behavior, activity that violates international norms
and principles, to which China subscribes, at a time of
heightened expectations globally about what the banking world
is supposed to be doing. We have all seen the billion dollar
fines of the major global banks around the world. This is a
time of heightened expectation with respect to transparency and
accountability and traceability in the international financial
system. This is a demand of the Chinese system, and to Adam's
point, I think putting that conversation to them is very
important. And I would say that could be amplified and
suggested to them in very material ways.
So I think in addition to potential secondary sanctions,
you could use Section 311 of the PATRIOT Act yet again. Section
311 has been used against the jurisdiction of North Korea and
financial institutions from North Korea. But as Adam said, it
is very hard to play Whack-A-Mole with the North Koreans. They
are changing names, they are changing shipping registries, they
are changing agents all the time. So that is difficult, and
that is not the most efficient way.
Senator Donnelly. A lot of the times in our country, some
of the smaller banks work with the larger banks as--they are
kind of like the fortress bank for them. Does that go on in
China as well? And is that the kind of thing that we can look
and say, look, you have this bank, this one, this one that are
all involved in North Korea, and you are the ones that they
work through? Is that something that would help?
Mr. Zarate. Absolutely. And, in fact, when I mentioned the
indirect risk to the major Chinese banks, the four major global
banks, that is exactly what I was referring to, which is their
own counterparty and affiliate risk that exists given their
connectivity within the Chinese system, again, that they may
not even be aware of. We have seen this with responsible
Western banks that often do not understand what risk even
exists within their systems or their account holders. So there
may be this risk.
And so the conversation to be a legitimate one, to say,
look, you need to understand as a responsible international
player, as a responsible bank, where you have this risk. And
whereas going with the 311 was exactly this, Senator, which is
to have a Section 311 action that designates all North Korean
financial and commercial activity as a class of transactions
that is a primary money-laundering concern. This is not about a
particular financial institution. It is about anything that
touches the North Korean system or any potential transaction.
What that does is it forces responsible banks to actually
have to do a lot more due diligence, a lot more investigation
around what their risk looks like, and that in some ways is
marshaling then the major Chinese banks which have an interest
in doing this right, or at least not being affected by the
reputational taint, to do this.
Two other quick ideas, though, I think are important. I
think we should launch an anti-corruption initiative using the
anti-kleptocracy resources that the prior Administration put in
place, some of the efforts that the Bush administration put in
place when I was at the White House, to actually make the issue
of corruption on the part of the North Korean regime something
that is somewhat dangerous and potentially revealing on the
Chinese side. That would get the Chinese attention given
Chinese internal dynamics on corruption. So having a focus on
corruption itself in the North Korean context has a potential
to impact Chinese thinking about their threats.
The last thing I would say on shipping, I think we can do a
lot more--and you have seen this from the private sector--to
map the networks that are used by North Korea to proliferate
and to engage in activity. The reason that is interesting and
important is that inevitably reveals the financial networks,
the conduits that they are using throughout Asia, especially in
China. It also raises the specter of a more aggressive
interdiction campaign, perhaps by the U.S., South Korea, Japan,
Australia, where maritime resources are going to be in places
that the Chinese are not going to be very comfortable with. And
so my argument here is let us use elements of international
norms and principles that the Chinese and Chinese responsible
entities are going to be sensitive to to actually begin to
shift Chinese calculus and behavior. And if you did things like
that--and there are other ideas in my testimony, and I know
Adam has other ideas, too--I think you could begin to reshape
the way the Chinese think about this. This is actually more of
an existential risk to them as a responsible global player than
ever before.
Senator Donnelly. OK. Thank you.
Chairman Sasse. Senator Perdue.
Senator Perdue. Thank you. And thank you, guys. I think
this is an extremely critical topic at a really tough time
right now.
I have got a question about the validity of the sanctions,
and I am concerned about that the game has changed. Mr. Zarate,
you brought up Banco Delta Asia in your testimony, and you talk
about it being an example of how sanctions work. My question is
that things have changed since that time. You know, China is
seeking an alternative to the U.S.-created global system. And
so with their growth and our debt and our negative current
account, their trade conversations over there with their
consortium they are trying to build, do you think that these
sanctions today would have the same pressure on these financial
institutions that it did in the past? Or would this begin to
accelerate their effort to find alternatives to the U.S. model
and the dollar as a reserve currency? I mean, we have taken
sanctions for granted for so long that, of course, the U.S. is
the biggest 800-pound gorilla in the world and sanctions will
work. Well, I am not so sure that that is going to be forever
true, and I am really concerned about the intransigence that we
perpetrated on our financial balance sheet is putting that in
jeopardy.
Would you both respond to that quickly?
Mr. Zarate. Senator, you raise a really important and
fundamental point. You are right, this is not 2005, and the
Chinese have adapted to the Banco Delta Asia action. I think
the Chinese have a dual strategy. One is to play in the
existing economic and financial order and to become big players
in that, and they are doing that. In that context, they have to
play by international norms and rules, and in many ways, we are
still the largest proponent of that. They are in theory
cooperative partners in that. And in that realm, that is where
we can affect them most. If they want to----
Senator Perdue. Would you agree that that is changing over
time? It has changed since 2005, as you just said. It is going
to change over the next decade as well.
Mr. Zarate. Absolutely. And it is not static, of course.
And their leverage over us in many ways, their size, not just
of their banks but of their economy, their ability to dictate
new rules of the road, leads to the second strategy, which is
your point: Can they begin to change the rules in a way that
puts China at the center or at least allows them to dictate
better what the rules are? You have seen this with intellectual
property, with our technology companies. You have seen it
certainly with alternate payment systems, UnionPay. They do not
rely on Visa and MasterCard. They have got their own.
And so they are trying to develop a parallel structure, and
you are right, there is a potential that anything we can do can
accelerate that. But for now, they are still trying to play in
the existing structure, and they want to be seen as legitimate
players. And it is based on those principles and norms that
they have subscribed to that I think we have the greatest
strength. And that was the linchpin with BDA.
Senator Perdue. Right.
Mr. Zarate. The reason they could not object was they
realized that what BDA was doing was anathema to international
norms and principles, their own laws. And if we can continue to
drive that kind of a theme and that kind of a strategy, I think
we are likely to be more effective than not.
Senator Perdue. Mr. Szubin.
Mr. Szubin. Senator, I think you raise a really important
point, and it is obviously not a point just about North Korea
on sanctions in this context, but the broader threat horizon
and how sanctions are used over the coming decades.
For now, our leverage is still supreme, and China does not
have an alternative, no country has an alternative to the
international financial system as it is set up where the U.S.
dollar is the primary currency and the U.S. banking system is
the most pivotal, it is the fulcrum.
So I do not think our sanctions leverage has today, in
2017, diminished in a material way from where it would have
been a decade ago. But I think our use of sanctions over the
last decade has certainly prodded and prompted a change in
thinking on the part of countries like China, non-aligned
movement countries, about, wait a minute, how dependent can we
afford to be on this Western framework? And the more we use
secondary sanctions as a tool--and I do see a line between
secondary sanctions and primary sanctions, and I can explain
why if there is interest. But the more we use secondary
sanctions as a tool, where we are in the most blunt way saying
to countries around the world you do business with X, or you do
business with us, period. It is not about conduct. It is not
about hosting missile transactions or terrorist transactions.
You are going to do business with a bank in that country, you
are done. The more we are going to be seen as using our
financial primacy as a weapon and cramming our foreign policy
down the throats of other countries by force of that weapon.
So I think we need to be very, very careful in the use of
that tool. That does not mean we do not ever use it. It just
means we have to be deliberate.
Senator Perdue. But the way we use it today is different
than the way we have used it in the past because of all the
things you both have said.
One last question. I am out of time. But the shadow banking
system really concerns me. I think at the end of last year, the
public banking system had about $33 trillion directionally. I
think that is correct. The shadow banking system estimates are
as high as $9 or $10 trillion, so it is a significant part of
their overall banking system that I do not think we can get to.
So the question is: Is North Korea playing in that shadow
banking area today?
Mr. Szubin. North Korea, as I mentioned earlier, Senator,
is going to use any opening it can find to move money.
Senator Perdue. Are they in it today?
Mr. Szubin. Yes. I mean, depending on how you want to
define shadow banking, absolutely. They are using cash
couriers. They are using ancient ways of moving money that
predate the banking system. But they are also using and,
frankly, dependent on modern banks, and the reason I say that
is they have got billions of dollars of import needs every
year. In order to pay for that, you are not going to be able to
have a cash courier or a shadow bank arrange for a payment to a
reputable exporter. The reputable exporter wants to see a wire
payment show up from a bank, and they are not going to be paid
in North Korean currency. I can assure you there is no exporter
anywhere in the world who wants to be paid in North Korean
currency.
So that is a vulnerability for North Korea. It means it has
to be earning foreign currency, reputable currency, into
reputable bank accounts, and that is a vulnerability that, as
Juan was saying earlier, I think we have yet to fully exploit.
That leverage is there, and so this myth that North Korea is
somehow isolated, a pariah kingdom, and, therefore, sanctions-
proof is not the case.
Senator Perdue. Right. Thank you both.
Thank you.
Chairman Sasse. Thank you.
Could we go back and get a little bit of a level set on the
North Korean economy more generally? Let us talk about GDP and
about essentially imports and exports. And I understand, I
think, some of your testimony said that about 90 percent of
their trade is with China. But help us understand all the ways
that they are using an international banking system for so that
we can sort of tailor down our understanding of how targeted
these secondary sanctions against Chinese financial
institutions might be. And both of you having a discussion and
to the degree you differ on anything, that would help flesh out
stuff for us as well. So I will throw it to both of you.
Mr. Szubin. Of course, Senator. So the estimates here are
pretty rough, and I think the best economists who are looking
at this issue acknowledge that the estimates are going to vary
pretty wildly. This is not, you know, a country like Mongolia
or Belgium where you might have regular IMF visits, who are
doing metrics, and as I said earlier, North Korea's banking
system and import-export system sometimes looks more like that
you would see of a criminal organization than that of a
country.
But with all of those caveats, the estimates I have seen
are between $3 and $5 to $6 billion a year in imports and
something around that level in terms of their exports. That is
pretty significant. The major imports are petroleum, coking
coal, and textiles. Their major exports are minerals, with coal
being No. 1, but a number of other minerals both more high
value, like rare earth type, and then more basic minerals being
right behind it. And North Korea, of course, is also selling
its weapons to a number of countries around the world, and that
is dangerous both as a source of revenue but, of course, the
missile technology that they are peddling itself.
For all of these sales, and anytime you are getting above
the tens of millions of dollars, you need access to the banking
system. So that is that reliance that we have been talking
about, and that presents a vulnerability.
When you talk about China, I have seen estimates of more
than 50 percent, estimates of 75, estimates as high as 90
percent in terms of how much trade. Certainly when you look at
their largest source of export revenue, coal sales, the portion
that is derived from China is over 75 percent. And China we
have seen suspend those purchases temporarily, sometimes for a
few months, sometimes for a few weeks, or just bring those
imports down. But that leverage is in China's hands, and China
is aware of that. I do not think that is a point that is lost
on China.
So the truth is not that North Korea is sanctions-proof
but, in fact, that North Korea has, to its own detriment, put
all of its eggs in one basket or many of its eggs in one
basket, and that is China, which makes it very much vulnerable
to sanctions pressure.
All of this comes back, though, to the key question we have
been discussing earlier, which is: How do you get China to
exert that pressure in a far more meaningful way than they have
to date? And they have played with the dial. They have turned
it up. They worked with us on not only drafting but sponsoring
U.N. Security Council resolutions to sanction North Korea. So
they have not been immovable on this, but they also have not
come anywhere close to the level of pressure that it is going
to take.
And to my mind--and I am not a foreign policy expert, but
to my mind, the central hesitation on their point is stability.
They like the status quo, as bad as it is, as unpleasant as it
is, more than they are willing to deal with these very ugly
scenarios of regime collapse. And that is a conversation that
we need to have with China. What is our end game here? What is
our, the U.S. Government's, end game? Yes, we know we want to
put pressure on North Korea to bring Kim Jong-un to the table.
But let us say we turn the heat up very, very high and he
refuses to come to the table. Let us say he is committed to
this to his death. What does the pressure campaign look like
then? And how are we ensuring that we are not looking at a
total regime collapse? If we are looking at leadership change,
which is different from regime collapse, how are we navigating
those waters? And how are we going to work with China to ensure
that their nightmare scenario is not realized?
I think we have overlapping interests here, or at least
reconcilable interests. I think there is room for that
conversation to be fruitful. But that is going to be a sine qua
non of any successful campaign involving real China cooperation
on turning these screws up.
Chairman Sasse. Very helpful.
Mr. Zarate.
Mr. Zarate. Mr. Chairman, I think one way of thinking about
the North Korean economy is in three buckets. One is their sort
of what would be called ``normal trade'' with China; that is to
say, trade in coal, largely, but as Adam said, more and more
with other minerals being extracted. I gave the estimate in the
testimony based on one expert that 90 percent of trade with
North Korea is China-dependent. As Adam says, that is an
approximation, and I do not think we have an exact number. But
there is a form of formal elements of the economy that are
functioning. In fact, if you look at the first quarter numbers
for this year, it appears that you have an increase in trade
with China, according to some of the experts, by over 35
percent. And so that trade is real. It uses agents and
companies and financial institutions to actually do the trade,
as you would imagine normal trade. And so there is kind of an
ecosystem around that.
There is the ecosystem around the illicit financing and the
sanctions evasion and the smuggling, which we all know about.
As Adam said, North Korea is known as the ``Mafia State,'' you
know, the ``Sopranos State,'' and very much acts in that way.
And so they change front companies, they change agents, they
change ship registries. The recent U.N. Panel of Experts report
indicates that they are growing more sophisticated in terms of
how they are engaging in these network operations and moving
money, materiel, and arms around the world, to include in
Africa now. And so there is an entire illicit economy that
feeds the regime and gives it sustenance.
And then there is a third element that is important,
especially from a human rights perspective, which is their use
of slave labor or forced labor, both within the country and
then outside of the country. And most people who do not
concentrate on North Korea would not realize that there are
estimates of maybe over 50,000 forced laborers working around
the world, being paid but where the pay is actually going
straight back to the North Korean regime. Some of the estimates
is that this goes up to $2 billion per annum, per year, worth
of income. These are laborers of all sorts in places that you
would not anticipate, places like China, of course, but also
Qatar, Poland, other places where these are forced laborers,
and their pay is going right to the regime.
And so there are these ecosystems of an economy in which
the North Korean regime uses all elements of the financial
system, to Adam's point, formal and informal, as a way of
moving money in and out of the country as needed and largely
trying to pull capital in so that the regime can strengthen
itself, strengthen its own economy, and ensconce the regime.
A final point that is important and interesting is recent
articles about sort of the flourishing of more of a private
sector in North Korea. There is a bit more of what we could
call a private sector economy in North Korea. That is
interesting to watch because I think a lot of that is being
amplified and affected by some of this cross-border trade with
China. And so China maybe could impact some of those
developments as well if they understand how that is evolving.
But as Adam indicated, it is a difficult question as to how you
think about Chinese touch points in each of those ecosystems.
But that is one way of thinking about it.
Chairman Sasse. Thank you. Very helpful. In a subsequent
round, I want to come back to this. It was in your testimony as
well as the slave and forced labor. But one more thing before
we go to Senator Donnelly. You said maybe we have not had a
level set at any point in this hearing on the extant primary
sanctions regime that exist. And so when you distinguish among
the three buckets of trade that they have, first of all, the $3
to $6 billion estimate--and I know that we do not really have
great numbers on this, but what share of GDP would we think
their import-export number is? How large is the total North
Korean economy?
Mr. Szubin. I am not sure. I believe the estimates are $20
to $30 billion.
Chairman Sasse. OK, so a significant share of their economy
is import-export. And given the current sanctions regime--and I
understand all the caveats that both of you have given, and I
think you have tried to be delicate, and I think we are not
trying to beat anybody up here that a new Administration does
not have clarity of a long-term strategy vis-a-vis North Korea
and that you could try to bring the Chinese along at this
stage, but it is perplexing to think that the Chinese are
worried about these same set of problems, and yet your point
about the four large banks and the way that you would insulate
them from potential exposure to a sanctions regime by allowing
the smaller banks to do this and that not necessarily being
something that we could target in a way that could affect
larger decision making, is any of the extant trade that is
cross-border something that is potentially violative of the
primary sanctions regime? So besides the financial institutions
question that are the subject of this hearing, at the level of
primary sanctions, is there already cross-border Chinese-North
Korean trade issues that should also be on our docket for
discussion here?
Mr. Szubin. Yes, absolutely. And that is what I was
alluding to, perhaps too indirectly, in my testimony, talking
about existing authorities providing a lot of leverage right
now. And it is not just U.S. sanctions, U.S. primary sanctions.
Interestingly, the U.N. Security Council resolutions provide a
lot of leverage. If those were being implemented as they are
written, you would see massive impacts, massive pressure on
North Korea.
So, you know, sometimes it is not a question of what new
tool do we need, but how do we use the existing tools which are
binding on countries? And China is not just a member State of
the U.N. They are a co-drafter of these resolutions. How do we
get better implementation? And the resolutions target each one
of North Korea's major sources of export revenue, which you
have been asking about today. They target their coal sales.
They target forced labor, as Juan was talking about. They
target banking access. And, of course, as with any resolution,
there is room to interpret it more expansively and room to
interpret it more narrowly. So when a U.N. Security Council
resolution says there is a prohibition on offering
correspondent banking services to North Korea, you could
interpret that in a very narrow way and say, well, North Korea
does not use correspondent banking, and so there is nothing
here. Or you could interpret it in a robust and meaningful way
and say, What are the de facto access points that North Korea
is using as its correspondent banking beachheads in China, and
how do we cut them off? And there is a lot of room to enlist
China's help, forgetting about any U.S. sanctions, just under
the U.N. Security Council umbrella.
Mr. Zarate. It is a really important point that Adam just
made. The interpretation of existing sanctions is really a
critical question, and the Chinese have traditionally viewed
these Chapter 7 obligations in the context of the U.N.
sanctions in a very limited way.
The other good example is in the shipping context where
suspect cargo and shipping moving in and out of North Korea,
especially that tied to weapons of mass destruction programs,
are subject to interdiction. The Chinese read that very
narrowly. What is suspicion? How do you define it? How do you
evidence it? That is an area where a more robust
interpretation, as I was indicating to Senator Donnelly, in
terms of shipping interdiction could be incredibly powerful and
based on international existing sanctions that the Chinese have
agreed to.
There is also the role--and we have seen this with some of
the revealed networks that have touch points with China. There
is also a role for greater just investigation and analysis
around what these corporate structures and networks look like.
There is a lot of work being done in the private sector. Sayari
Analytics has been cited in the press. C4ADS has put out
important reports.
Just looking at ownership and control interests, that alone
has been very revelatory, and that is based on existing
sanctions. And as Adam indicated, the last Executive order
signed--he probably fashioned it himself when he was at the
Treasury--in 2016 was sort of a potpourri of delicts that North
Korea was being targeted for: human rights, cyber, other
activities. And so we do have authority. The question is: How
amply and aggressively do we apply it? And can we draw that to
the international obligations and then, frankly, compel the
Chinese to come along with us?
Chairman Sasse. Yes, thank you, and how we rank order
those, back to Senator Donnelly's great opening questions about
if you were doing two or three things, how would you rank order
the narrow or broader interpretations of extant primary
sanctions and this new secondary sanctions bucket we are
considering today.
Senator Donnelly.
Senator Donnelly. Thank you, Mr. Chairman.
One of the things you hear about North Korea is that they
would rather have their people eat grass than give up any part
of their nuclear program, any part of their weapons program. So
when you look at this, how do you change their calculus? If
China cooperates more with us, that they look and they go--is
there a push point for North Korea where they say, you know,
now we probably have to come to the table a little bit more? Or
do they look and go we just do not care? And basically the only
way you stop them is having them run out of resources. Mr.
Szubin.
Mr. Szubin. You know, to an intelligence analyst, I think
that is often the $64,000 question, the leadership decision-
making calculus. And I personally suspect that Kim Jong-un may
be immovable on this, by which I mean, yes, he would rather see
his people eat grass, starve, see widespread famine before he
relinquishes his nuclear weapons. And it is not entirely
irrational if you put yourself in his shoes. He believes that
they are the guarantor of his survival, and that if he gives up
the program, he will be done away with.
The truth, though, is because of the vulnerabilities, the
reliance that he has on international export earnings--and one
of the best examples of this is the patronage system--that
keeps him in power. His ability to buy off other North Korean
elites in the military and the intelligence services, just the
sort of aristocrats or oligarchs, as you will, of North Korea,
he needs access to foreign export earnings for that and foreign
luxury goods for that.
But what if that dries up? How dedicated are those people
to their beloved leader? I do not think very. And so he faces a
real vulnerability, a real risk of losing his control over the
leadership. That may be what is required before a North Korean
Government comes to the table.
But I do believe that a North Korean Government, not
necessarily this North Korean leader but a North Korean
Government, a person who might succeed him, would see the
tradeoff as not only necessary but compelling, the tradeoff
being your question: giving up their nuclear weapons, coming
into compliance with international resolutions when it comes to
their nuclear program, in exchange for allowing them some form
of access to international trade and international currency
and, therefore, survival.
Senator Donnelly. Mr. Zarate.
Mr. Zarate. Senator, you ask the fundamental question with
respect to what is the strategic purpose of a financial
pressure campaign, and I think there are several answers here
that do test the proposition that this can be an effective tool
to change Pyongyang's decision making. And I think ultimately
this is a regime, as Adam said, that is focused on its own
survival; it is focused on the development of a nuclear and
missile program that ensconces its internal power as well as
its deterrent capability externally; and it is not going to
give that up unless there is a sense of existential threat to
the regime itself.
But I think sanctions, and effective sanctions, and a
financial pressure campaign can do several things. There is a
material dimension. You can make it harder for them to actually
acquire the things that they need to advance in their programs.
Very hard to do, but if done effectively, you can at least slow
the progress and clock. And we have seen that with other
sanctions programs.
Second is you can affect the decision making. These leaders
have budgets to deal with. If they have less income coming in
because the sanctions are proving more effective, they are
going to have to make a decision, whether it is feeding their
people or developing the next version of the nuclear program.
And so forcing them to actually make these hard decisions and
to stress them internally is part of the goal.
Affecting their sense of regime stability, to Adam's point,
the patronage system regime stability, it is part of the reason
one of the recommendations I have is we should announce that we
are going to engage in a leadership asset hunt from the get-go.
It may not be that there is much we can actually find, but just
signaling that we are willing to do that, to use the elements
of the international system that we have built over time, that
we usually reserve for when a bad regime collapses or when
there is a failed State or something, let us use that ex ante,
let us use it before the fact to say we are going to try to
find where the leadership is stealing assets from its people,
we are going to try to capture it and preserve it as a way of
dealing psychologically with this issue, and perhaps even
affecting the Chinese, and then having the Chinese actually
change their behavior. That could have an impact in Pyongyang.
The Chinese are the lifeline, the backstop for North Korea,
diplomatically, economically. If that begins to change in more
dramatic, fundamental ways, that could impact what happens in
Pyongyang. We just do not know. And I think Adam's caution
about being careful about where we go is right. I also think we
have to explore what we can potentially do, because if we
continue to wait, I think we know where we are going to end up.
We are going to end up with a North Korean regime that has a
nuclear capability, has potentially intercontinental ballistic
missiles, has multiple missile platforms by which they can
potentially threaten and attack U.S. interests, not just in
Guam and Hawaii but in San Francisco and New York. And that is
an unacceptable position to be in.
And so I think we have got to be a little bit of risk
takers here and a bit more aggressive than we have been in the
past in terms of what we try to do influence their decision
making.
Senator Donnelly. Thank you.
Chairman Sasse. Could we go back to this question of slave
or forced labor, both inside and outside the regime? Tell us a
little bit more on how it works inside the regime for sure, but
also abroad, how do they have certainty that they will get
these assets back? What is the command-and-control structure of
those remittances?
Mr. Zarate. Mr. Chairman, the internal dynamics I do not
pretend to know well. The reality is the North Korean regime
uses different types of forced labor internally--prison labor,
forced labor, for generating billions of dollars of product,
commerce, revenue internally to the North Korean economy. I do
not have details as to how they actually run that from a
security perspective, but it is not a pleasant regime in that
regard, and certainly it is a command economy in all the senses
that that means.
I have a bit more familiarity with what is happening on the
outside, which is that the North Koreans have purposefully in
essence sold their labor into foreign markets cheaply to serve
across the board in terms of a variety of labor and service
sectors, everything from working in shipyards to construction
to even a little bit higher-end kind of labor in pockets around
the world. Part of that is to not only sort of gain revenue,
but also gives them some influence and allows them to operate
in countries around the world where they otherwise would not
have a presence.
And so there has been recent news reports, for example, of
the North Korean workers' presence in Poland, workers that are
working in the shipyards. Vice News did a big report on this.
And, in essence, what is done is these are forced laborers;
they work in what are considered to be inhumane conditions.
They are paid for their labor. That pay does not go straight to
them, straight to their bank account, straight to their family
members. It is not part of some remittance scheme where they
send it back to their wife or grandmother or whomever. The
payment actually goes back into a North Korean account, back
into North Korea. And in some cases, based on what I have read,
there are additional commissions paid for purposes of payment
to the Government. So it is not just the pay for the labor. It
is a commission for the State itself that then goes back into
the coffers.
Mr. Chairman, in fairness, I do not pretend to know how
some of that is financed, but I imagine, as Adam indicated,
there are elements of the financial system that are used as a
way to facilitate the movement of the money back into North
Korea. And, again, as I indicated earlier, this is to the tune
of $1 billion, some estimates over $2 billion worth of revenue,
and it is why I think we should have a concerted effort--we
have had sanctions on the books to date on this, but a
concerted effort to tie the forced labor and human rights
abuses to their financing as a way of understanding what the
financial networks are and as a way of adding to the
international taint of doing any business with the North
Koreans. It is almost unimaginable that you would have this
scheme operating in legitimate countries around the world.
There should be an end to it. The labor should not be
exploited, obviously. And certainly there should not be
payments and commissions being paid back to the North Korean
regime. That is an area of focus that I think not just people
like us who care about sanctions would focus on. This is
something the human rights community around the world should be
heavily focused on as well.
Chairman Sasse. Mr. Szubin.
Mr. Szubin. The only thing I would add is my understanding
is they typically are sending one member of a family only in
situations where family members stay behind so that there is
leverage to ensure that that person does not defect or run
away, and it is that leverage that incents the enforcement
mechanism to keep the forced labor in place and to keep them
earning.
I think that the more knowledgeable, sophisticated human
rights people who have looked into this have come away with the
conclusion that it is, as Juan says, an appalling practice. It
is not a situation where you can really argue both sides, that
this is a financial lifeline for these families. Far from it.
The other thing I would note is North Korea does not need
to repatriate these funds. It actually needs money located in
third countries for its imports. And so oftentimes it can just
accumulate money, whether in the Gulf, whether in Eastern
Europe, whether in China, whether in Southeast Asia, and then
use that to finance its imports. But as Juan says, those are
funds, those are accounts, those are front companies that we
and our allies should be targeting.
Chairman Sasse. Really helpful. We are under constraints
because of some Senate objections on the floor that we have to
conclude the hearing at this time. But I think there are a
number of us on this Committee who would like to return to you
and ask those targeted questions about what you would rank
order, if Secretaries Mnuchin and Tillerson came together and
asked your counsel, and how nuanced the new Under Secretary's
team will be as they are getting stood up. I think there are a
number of people in both the Article I and Article II branches
that are grateful for your past work, but would also benefit
from your present and future counsel.
So thank you both for being here today. This hearing is
concluded.
Mr. Szubin. Thank you, Chairman.
Mr. Zarate. Thank you, Mr. Chairman.
[Whereupon, at 11:27 a.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF ADAM J. SZUBIN
Distinguished Practitioner-in-Residence, Johns Hopkins University,
School of Advanced International Studies; Of Counsel, Sullivan &
Cromwell; and Former Acting Secretary of the Treasury and Acting Under
Secretary of the Treasury for Terrorism and Financial Crimes
May 10, 2017
Chairman Sasse, Ranking Member Donnelly, and Members of this
Subcommittee. In my years at Treasury, I testified before Members of
this Committee more than any other, and I am honored to present my
first testimony as a private citizen before you today. Thank you for
convening this hearing on such an important and timely topic and for
inviting me to testify today. More broadly, thank you for your
longstanding bipartisan support to my former office, Treasury's Office
of Terrorism and Financial Intelligence (TFI). On that note, I would
respectfully urge that you move deliberately but quickly to confirm
Sigal Mandelker, who has been nominated to serve as under secretary
overseeing this office, including Treasury's intelligence, sanctions,
and money laundering authorities. It is critical that TFI have a
confirmed under secretary in place, and I know Sigal to be an
exceptionally intelligent, experienced, and strong leader.
I am often asked whether--as with Iran--the international community
could generate enough sanctions pressure to force the North Korean
Government to the table to negotiate a peaceful and verifiable end to
its nuclear weapons program. It is of course an intensely difficult
question, as it requires assessments of notoriously opaque issues, such
as the internal thinking of North Korea's leadership, its internal
power dynamics, and possible succession scenarios. That said, I believe
the answer is a qualified ``yes.'' Whether new secondary sanctions
legislation is needed or advisable at this stage is a related but
separate question that I will take up in turn.
My topline assessments are as follows:
1. North Korea is not self-reliant or ``sanctions proof.'' Its
leadership depends upon access to foreign goods and
international banking services, the denial of which would
quickly build substantial pressure on its leadership.
2. Unlike in Iran's case, which enjoyed diverse access to the
international marketplace, sanctions leverage over North Korea
is concentrated in one country--China. If China is prepared to
take a qualitatively tougher stance on sanctions against North
Korea, sanctions have a real chance to succeed. If not, they
have none.
3. Despite years of high-level international attempts, China has
resisted more than incremental enhancements to its sanctions
posture. China is risk averse when it comes to North Korea, and
for understandable reasons.
4. U.S. sanctions alone will not force China to adopt a
qualitatively tougher approach, no matter how draconian and
costly those sanctions become. China is exponentially more
concerned about the fate of North Korea than it is about Iran,
and China will not be strong-armed into a course of action that
it believes imperils its national security.
5. Serious and high-level engagement will therefore be needed to
assure China that (1) this issue is paramount for the United
States, above other commercial and geopolitical priorities; (2)
the proposed sanctions campaign against North Korea is aimed at
enabling nuclear diplomacy not regime collapse; (3) our
interests in this diplomatic effort overlap with and are
reconcilable with China's national security interests,
including maintaining stability on the Korean peninsula.
6. As part of a stepped up sanctions effort around targeting North
Korea's activities around the world, the U.S. will almost
certainly need to sanction complicit Chinese entities, both to
combat sanctions abuse and to demonstrate our seriousness of
purpose. The Administration has ample authorities to do so
already. If new legislative authorities become necessary down
the road, it is important to introduce them only once the
strategic and diplomatic groundwork has been laid.
To begin, all experts agree that the threshold of pressure that
will be needed to even bring North Korea to the negotiating table is
extraordinarily high. Kim Jong-Un doesn't just see his nuclear weapons
program as one pillar of his country's national security. He sees it as
the primary guarantor of his regime and his personal survival. The only
conceivable scenario in which Kim Jong-Un would consider negotiating
over his nuclear weapons program is if he believes that--unless he does
so--he is at risk of a near-term loss of power. This means that the
required threshold of sanctions pressure will be high and cannot be
expressed as an incremental add-on to the status quo. I will return
below to what the requisite level of pressure would look like in
practice.
Some experts believe, however, that even if the sanctions pressure
reaches the point where Kim Jong-Un fears for his hold on power, he
would persevere and risk being deposed rather than give up his nuclear
weapons and, in his mind, guarantee his demise. That assessment may
well be correct. If so, the global community needs to see a different
leader in Pyongyang, one who is willing to address the security
concerns of the international community. Either way, it will be
necessary to build international pressure to the point where it
threatens leadership change.
Because I am unable to predict Kim Jong-Un's internal calculus, I
framed my central question not around his personal decision making, but
rather whether international pressure could force a North Korean
Government to the table to negotiate a verifiable end to its nuclear
weapons program. Faced with suffocating international pressure, I do
believe that a North Korean leader would be willing to negotiate the
disposition of the country's nuclear weapons in exchange for survival
and some form of diplomatic and economic re-integration.
It is vital to remember here, as elsewhere, that toughened
sanctions in and of themselves are not a strategy. Massive diplomatic
investment and multilateral engagement will be needed to marshal a
successful effort, and it will require enlisting likeminded and
resistant countries. Having participated in a comparable campaign with
respect to Iran, I would urge the Administration and Congress to staff
leadership positions at the Treasury and State Departments quickly. And
I believe that it would be counterproductive in the extreme to deplete
our foreign service corps at a time when we need them so urgently--both
on this issue and the whole range of national security and foreign
policy threats we face.
What would a sufficiently tough sanctions program look like and how
would it be obtained? The good news here is that--contrary to some
observers--North Korea is not somehow ``sanctions proof.'' It is highly
isolated but it is not self-reliant. In fact, in many ways, its
isolation renders it more vulnerable to sanctions pressure than Iran
was in the mid-2000s when we commenced our pressure campaign.
North Korea's anemic economy requires imports of petroleum, coking
coal, and textiles. Its antiquated industrial and communications
sectors require significant imports of machinery, equipment, and
expertise. On top of the general economic needs of the country, Kim
Jong-Un depends upon a system of patronage to purchase the loyalty of
senior political and military officials, for which he needs to import
foreign luxury goods such as cars, technology, and high-end
consumables. In the aggregate, these imports and purchases are
estimated at approximately $5 billion a year. None of them can be
bought using North Korean currency; no exporter outside of North Korea
will accept payment in North Korean won. All of this means that the
leadership of North Korea must (a) continuously generate new foreign
currency earnings through the sales of minerals, weapons, counterfeit
goods, etc.; (b) receive payment for those exports in foreign bank
accounts via the international banking system; and (c) pay for and
arrange for the delivery of needed imports.
A North Korean leader depends on all three of these elements, both
to stave off a broader economic collapse and to maintain the loyalty of
his inner circle. The first two elements are the most exposed to
sanction pressure. I assess, then, that a stepped up sanctions campaign
would need to target North Korea's foreign currency earnings--for
example by dramatically reducing North Korea's sales of coal and other
minerals--and would need to disrupt North Korea's access to the foreign
bank accounts it currently enjoys.
Multiple U.N. Security Council resolutions, binding on all U.N.
member States, have already targeted North Korean exports, imports, as
well as its financial activity and now prohibit the purchase of North
Korean coal and minerals and the maintenance of correspondent accounts
for North Korean entities.
In terms of implementation, the key question is and has always been
China. To bring the pressure up to the threshold required, we must find
a way to enlist the cooperation of the Chinese Government and the
compliance of Chinese private actors. This is not a hopeless task.
China is not comfortable with either Kim Jong-Un or with North Korea's
burgeoning nuclear and ballistic missile capabilities. Indeed, the
North Korean leader has at times gone out of his way to provoke China's
leaders, snubbing Chinese diplomats, timing provocative missile
launches to the Chinese New Year celebration, and murdering senior
North Korean officials who had good relations with China. China would
also strongly prefer that North Korea not have a nuclear weapons
program, both because of the instability it engenders in the region and
because it has justified a robust U.S. military presence just off
China's shores, including the recent deployment of the THAAD anti-
missile system in South Korea. I believe that China would breathe a
huge sigh of relief if it could successfully resolve the world's
concerns over North Korea's nuclear weapons program.
We have seen China act on those concerns, including in the realm of
sanctions. China has not just acquiesced in the last two U.N. Security
Council resolutions targeting North Korea, it has co-sponsored them
with the United States. The resolutions have had real teeth, including
new mandatory sanctions against North Korea's exports of coal, its
import of luxury goods, and its ability to bank. And China has
periodically acted against individual agents and entities in China,
when pressed firmly by the United States. This includes Ma Xiaohong and
the Dandong Hongxiang Industrial Development Company, an important
North Korean facilitation network that was targeted by the U.S. Justice
Department, sanctioned by the Treasury Department, and ultimately
investigated by Chinese authorities for ``serious economic crimes.''
That said, China's implementation of the U.N. sanctions has been
spotty and decidedly incomplete. Time and time again, we have seen
China pull back from implementing the toughest measures, whether at the
level of broad economic measures or targeting specific sanctions
evaders in China.
The problem is that, as much as China may dislike Kim Jong-Un and
his nuclear program, there is an alternative that is far worse from
China's perspective, which is North Korean regime collapse. Even an
erratic Kin Jong-Un is preferable to a regime implosion, which could
immediately trigger an outpouring of millions of indigent refugees
across China's border, a struggle for control over North Korea's
military and nuclear programs, and the potential prospect of
reunification of the Korean peninsula under a South Korean Government,
bringing a close U.S. military ally to China's borders.
It is important to recognize, then, that China will not ratchet up
the pressure on North Korea to anything close to a leadership-
threatening level unless it understands what comes next and views the
scenario/s as acceptable. China will not ``roll the dice'' when it
comes to the fate of its impoverished, nuclear-armed neighbor, and
concerns over stability will be paramount.
Threatening and/or imposing U.S. secondary sanctions against
Chinese targets may change the conduct of individual Chinese entities
or banks from afar, then, but it will not bring about the kind of
comprehensive and sustained crackdown by Chinese authorities, traders,
bankers, and businesspeople that is required to bring North Korea to
the table. That type of sanctions pressure will only be obtained when
the Chinese Government agrees to apply it.
I want to pause here to address two counter-arguments that I hear.
First, we forced China to cut its oil imports from Iran using secondary
sanctions, so secondary sanctions should work in this context as well.
Second, even if the Chinese Government doesn't agree, Chinese
businesses and banks will comply with secondary sanctions because,
given a choice between doing business with the United States or North
Korea, all banks and businesses will choose the United States.
The arguments are flawed for a few reasons. First, the stakes for
China were dramatically lower in the Iran case. If the sanctions
pressure worked and an international solution to Iran's nuclear program
was reached, that would be good for China. If the sanctions fell short,
China had played a responsible role in the international community. If
sanctions over-achieved and provoked instability in Iran, China was not
a primary or even secondary stakeholder. Put simply, Iran plays a
minimal role in China's geopolitical outlook compared to North Korea.
Second, while it is true that we won grudging Chinese acquiescence
to curtail imports of Iranian crude oil, months of painstaking
diplomacy were needed and what China did was easier and more limited
than what we will need them to do here. China reduced its crude oil
imports from Iran by a certain percentage every 6 months as it lined up
alternate sources for its crude oil. And it escrowed Iran's oil
earnings for use in bilateral Iran-China trade only--notably, a
restriction that hurt Iran but benefited Chinese exporters. We will
need far more extensive and proactive cooperation here. Iran was
conducting its business with China largely in the ordinary way. Iran's
correspondent accounts were easily identifiable and oil tankers cannot
be smuggled across a border. North Korea conducts its banking activity
and trade more like a criminal organization than a country--through
cut-outs and agents, such as front companies posing as ordinary Chinese
trading or business enterprises. This means that a large bank in China
may be hosting millions of dollars of North Korean financial activity
without any direct relationship with a North Korean person and,
potentially, without knowing it. The type of rigorous investigative and
enforcement effort that will be required to police North Korean covert
banking activities and smuggling far outstrips what China did in the
Iran context.
Third, secondary sanctions are a blunt and unpredictable instrument
and their application carries broad risks for the U.S. and our allies.
To focus on the banking arena, as noted above, North Korea generally
conducts its financial activities surreptitiously through cut-outs. As
such, the Chinese banks involved fall along a spectrum of awareness. In
some cases, they may indeed be complicit, and looking to facilitate
North Korean activity for a profit. In many cases, they may be hosting
North Korean transactions without knowing it, but where we would assess
that they could be doing more to detect and prevent this activity.
Finally, there are instances where Chinese institutions are practicing
all due care and are nevertheless still being abused, as large and
careful U.S. and European banks will have criminal proceeds moving
through their institutions under the names of agents and front
companies. Secondary sanctions are an extremely blunt instrument to
respond to such a spectrum of conduct. In practice, their use means
that a target is completely severed from the U.S. financial system, a
condition that--for an internationally active bank--is generally
tantamount to a death sentence. That power and lack of adjustability is
both a strength and a limitation.
In this context, we should note the types of entities we are
discussing. The four largest banks in China are the four largest banks
in the world, each larger than JPMorgan Chase by assets. Yes, they are
inextricably dependent on access to the U.S. financial system but the
dependencies run both ways. They hold several trillion dollars of
assets in our markets and at our largest institutions. By comparison,
Lehman Brothers before its collapse was only one-seventh as large. The
implosion of one of the world's largest financial institutions is not
something to be trifled with. It would send shock waves through the
international financial system and trigger large and unpredictable
fall-out. And none of this is to consider the inevitable response and
counter-sanctions from China.
The fourth error made in assessing the viability of secondary
sanctions is that, with some targets, they may have little to no
impact. A trading firm or coal importer in Dandong province that does
tens of millions of dollars of business with North Korea may do no
business with the U.S. or Europe. Forcing a choice between doing
business with North Korea or the United States may be an easy one for
that firm, and not in the direction that we would like.
For all of these reasons--and other longer-term costs and risks
that time does not allow me to address here--we need to be
exceptionally judicious in our use of secondary sanctions. And creating
the authority just to have it available carries risks as well. As a
sanctions practitioner, I believe that we do ourselves and our
credibility major harm if we unsheathe this powerful weapon without
understanding if and how we are prepared to use it. America has had
major successes in its use of sanctions in the last decade, but one of
the reasons for those successes is that we do not bluff. Were we to
depart from this practice, we would see our sanctions credibility
undercut, not just in this context, but across a whole range of vital
national security and foreign policy portfolios.
A comparison with the use of secondary sanctions vis-a-vis Iran is
instructive. In that context, the Bush and Obama administrations had
aggressively deployed primary sanctions for years to target those
entities colluding with Iran, and brought costly enforcement actions
against global banks that were evading our sanctions. The
Administrations coupled these actions with an extensive outreach
campaign, approaching Governments, banks, and businesses to ensure that
they understood the gravity of Iran's conduct, the primacy of this
issue for the United States, and the risks of a lax approach to Iran.
In response, the world's first-tier banks exited their Iran business
and every relevant jurisdiction began to subject its Iranian trade to
careful scrutiny and diligence.
Congress then turned the heat up considerably in 2010, with a
series of secondary sanctions bills. The Administration worked with
Congress to refine those bills, ensuring that they included aggressive
but attainable thresholds and sufficient discretion and waivers to
allow the Administration to use them effectively across a range of
countries and circumstances. And the Administration was staffed and
ready to immediately deploy senior officials to every corner of the
world upon passage. The result was the most effective sanctions
campaign the world had ever seen, as Congress's secondary sanctions
dramatically amplified the work that the Administration had underway.
Second- and third-tier banks that had picked up the Iran business as it
was shed by their larger competitors suddenly exited. Iran's crude oil
exports dropped by 40 percent. And Iran's leadership saw only one way
out--through negotiations over its nuclear program. The outcome is
remembered clearly, but we also need to remember the preparation and
work that allowed it to succeed. That groundwork has not yet been laid
in the case of North Korea.
My conclusion then, is that we cannot unilaterally sanction China
into imposing the type of sanctions pressure necessary to change North
Korea's course. We will need to win China's cooperation. This will
require serious diplomacy, and both carrot and stick. As part of that
effort, I suspect that we will need to sanction Chinese entities that
are knowingly doing business with North Korea, both to show China that
we are serious and to combat sanctions evasion. The Administration has
the authorities to do that already. But the key to success will be
high-level diplomacy to take up and work through China's interests and
reconcile them with our own.
There is enough overlap between China's interests vis-a-vis North
Korea and our own concerns with North Korea's nuclear program to allow
for a mutually acceptable approach. And there are many incentives and
irritants in our bilateral relationship with China that could be used
to facilitate this diplomacy. But China must know that we have thought
through the steps that follow after crippling pressure is applied, and
that China's core national security interests will be protected. From
China's side, it would be helpful if China identified one or two senior
officials who could speak for President Xi on addressing the North
Korean nuclear threat, across the range of diplomatic, strategic, and
financial facets involved.
Against such a diplomatic backdrop, a range of sanctions approaches
could be drawn up. As noted earlier, I see the primary targets as North
Korea's access points to the international financial system and its
export earnings, primarily from the sale of coal, minerals, and
weapons. A campaign plan could be structured and staged in various ways
to dramatically increase the pressure against North Korea. If the
international community were to fully cut off North Korea's coal
exports alone, it would drop the country's foreign revenue earnings by
more than one-third immediately.
The U.S. Administration is already well-armed with sanctions
authorities to play a leading role in such a global sanctions effort.
The Treasury Department has broad and flexible authorities to sanction
businesses, trading firms, and banks anywhere in the world that are
facilitating North Korea's activities or providing North Korea's banks
with surreptitious access to the global financial system. What the
effort will require, though, is senior leadership in the Administration
to lead the charge and the resources and bodies to sustain it. Those
resources will be needed at State, at Treasury, and in the intelligence
community--an effort of this scale and sophistication will necessarily
require a full-court, sustained interagency press. As such a campaign
progresses, the Administration may need additional authorities from
Congress--including potentially secondary sanctions--but such
authorities should be deployed to advance a strategy not in advance of
one.
Of course, even with a concentrated and strategic effort, we cannot
guarantee that a diplomatic effort powered by new sanctions pressure
will succeed. But it has a chance to do so. And, faced with this ever-
growing threat and absent a better alternative, I believe that it is
our duty to put all of our energies into this effort.
Thank you again for inviting me to testify.
______
PREPARED STATEMENT OF JUAN C. ZARATE
Chairman and Cofounder, Financial Integrity Network; Chairman and
Senior Counselor, Center on Sanctions and Illicit Finance; Former
Deputy Assistant to the President and Deputy National Security Adviser
for Combating Terrorism; And Former Assistant Secretary of the Treasury
for Terrorist Financing
May 10, 2017
Chairman Sasse, Ranking Member Donnelly, and distinguished Members
of the Senate Banking, Housing, and Urban Affairs Subcommittee on
National Security and International Trade and Finance, I am honored to
be with you today to discuss the urgent need to pressure North Korea
and the utility of secondary sanctions against Chinese institutions in
such a strategy.
This is a timely and important hearing. The international security
challenge from North Korea has grown more dangerous and direct for the
United States. The regime in Pyongyang remains intent on developing
ballistic missile and nuclear capabilities that will allow it to reach
and threaten the United States directly. In defiance of international
sanctions and pressure, North Korea has quickened the pace of missile
and nuclear tests, demonstrating ever-expanding capabilities and
claiming to have the ability to place a nuclear warhead on the tip of
an intercontinental ballistic missile. Despite recent missile launch
failures, the regime continues its march toward these capabilities.
What was once seen solely as a threat to peace and stability on the
Korean Peninsula and our regional allies has now become a looming,
direct threat to the U.S. homeland.
All the while, North Korea proliferates its technology for profit,
engages in illicit financial and commercial activity, exploits forced
labor to make money for the regime, and has deployed cyber tools to
attack adversaries and the private sector, including U.S. companies and
the banking system. North Korea remains a threat to international
security and to the integrity and stability of the financial system.
The threats from North Korea require a sober, more comprehensive,
and urgent response, including the use of financial and economic tools
and pressure. This in turn requires a more aggressive and imaginative
approach leveraging new tools and mechanisms, including secondary
sanctions against Chinese and other businesses, entities, and networks
still doing business with North Korea.
China is North Korea's economic and diplomatic lifeline, and its
principal interest is ensuring the stability of the North Korean
Government and avoiding regime collapse. As a result, China has
maintained ties with North Korea and been unwilling to bring
overbearing pressure on its ally in Pyongyang. Over the years, North
Korea has found outlets and connectivity to the financial and
commercial system through Chinese banks, companies, and agents--to
circumvent sanctions, serve their economy, and enrich the regime.
Because China remains the regime's backstop, the United States
needs Chinese cooperation and support to slow and stop North Korea's
missile and nuclear programs. The Chinese calculus has not changed in
the past and will not change unless its own interests are fundamentally
threatened or affected. Chinese and American interests do not yet align
with respect to North Korea.
This is a moment for China to assume its role as a great power and
to influence its North Korean ally to stop its nuclear and missile
programs and contain the threats from proliferation. This
Administration and Congress will need to grapple with how best to
obtain, coerce, and sustain Chinese cooperation in order to maximize
pressure on North Korea. Ultimately, the United States must find a way
to change Pyongyang's calculus and the trajectory of their nuclear
program. This testimony addresses how to leverage financial and
economic pressure, including secondary sanctions, to increase the
chances of changing the calculus in North Korea and China and avoiding
conflict.
My testimony has benefited directly from the ongoing work and
contributions of Anthony Ruggiero at the Foundation for Defense of
Democracies, along with the scholarship of Victor Cha and Bonnie Glaser
at the Center for Strategic and International Studies, John Park at the
Harvard Kennedy School of Government, and the Council on Foreign
Relations' Task Force on North Korea led by Chairman Mike Mullen and
Senator Sam Nunn, on which I served.
Core Principles for a Financial and Economic Pressure Campaign
There are fundamental principles that should drive any serious
financial or economic pressure campaign. These principles should inform
the design, choreography, and strategy deployed before launching any
type of sanction or form of economic coercion.
Strategy Matters. To be effective, an attempt to use sanctions or
financial measures of any sort must nest within a coherent strategy and
cannot stand alone. Too often, sanctions have been seen as either the
only retreat for action to address a thorny national security issue or
as a silver bullet that can bend behavior and alter a threat landscape
on its own. For any financial pressure campaign to work, it must be in
service of an understood strategy and complemented by other tools of
statecraft, power, and coercion. In this case, the strategic objective
must be to slow, stop, and ultimately reverse the North Korean nuclear
program and ensure that the regime never has the ability to threaten
U.S. territory with nuclear weapons. The financial strategy must then
follow and be crafted to achieve this core goal, in aid of diplomacy,
coercion, and material disruption of the targeted programs.
Coercive Tools in Concert. The sanctions and economic toolkit must
be seen as part of a broader set of coercive tools that are more
effective when deployed in concert to shape the environment.
Interdiction of suspect North Korean shipping, arrests of those
involved in North Korean illicit financial activity, broad-based
information campaigns to weaken the regime's control of the information
environment, and an aggressive focus on the regime's human rights
abuses are all complementary and functional parts of any campaign to
isolate the North Korean economy. These are also tools that should
target, impact, and deter those who do business or finance the regime's
activities. Sanctions must be seen as part of a broader effort to
disrupt the regime's ability to resource its nuclear and missile
ambitions and access the key elements of the financial and commercial
system.
Constant, Consistent Pressure. For a financial pressure campaign to
work, it must be applied constantly to identify and isolate North
Korea's rogue behavior. U.S. and international sanctions and pressure
in the past have suffered from applying an escalatory model based on
reactions to North Korea's provocations, tests, and violations of
existing sanctions. Such sanctions have been perceived as important
simply in aid of diplomacy. Although that is a critical use of these
tools, in order to be effective, they must be seen as their own form of
pressure, coercion, and disruption that complements our diplomacy. As a
result, the sanctions approaches of the past have been dictated more by
what the regime in Pyongyang does as opposed to what an effective
financial and economic pressure campaign looks like. Any use of
sanctions must be part of a broader campaign to sensitize the
international community and markets to exclude rogue actors involved
with North Korea from the legitimate financial and commercial system.
Like weeding a garden, such work has to be consistent and constant, to
shape market and Governments' behavior.
Conduct-Based Focus. A successful campaign against North Korea that
enlists China and our allies would focus intently on conduct-based
sanctions and measures that target the illicit, dangerous, and
suspicious activities that violate international norms and principles
and put the financial system at risk. A fundamental vulnerability for
North Korea is that it is not only developing nuclear weapons
capabilities in violation of international sanctions, but it is a
criminal State. It is engaged in proliferation, massive human rights
abuses, money laundering, corruption, sanctions evasion,
counterfeiting, smuggling, drug trafficking, and other nefarious and
suspect activities.
These activities are interwoven in how North Korea does business
and should be isolated by the international community--Governments and
the private sector alike--regardless of the state of diplomacy. Such
activities are the subject of sanctions, criminal laws, and financial
regulations. At a time of heightened concern over transparency and
accountability in the financial system, there should be no objection to
doing so, especially in major economies like China, Japan, and South
Korea. As long as the efforts to target North Korean networks and their
financial and commercial infrastructure remain focused on the
activities that violate accepted international norms and principles,
they will prove more effective and be amplified by the actions of the
private sector and actors concerned about real and reputational risk.
Altering the Chinese Calculus. China must play a central role in
pressuring North Korea, but its interests do not align with those of
the United States and it has not been willing to exert existential
pressure against the regime to force it to stop its nuclear program.
For the United States, for too long, trying to coerce China to exert
more pressure on North Korea has appeared as the third-rail of the
sanctions debate. But we have reached a moment where we need to align
U.S. and Chinese interests with respect to pressuring North Korea. We
cannot ignore the role that Chinese actors are playing to evade
sanctions, enrich the leadership, and enable the regime to develop its
dangerous capabilities across the board.
If this is an urgent international security issue, the Chinese
dimension cannot be spared attention, and the Chinese calculus must be
altered. Chinese interests and standing will have to be put at risk
directly and indirectly. Of course, this needs to be a balanced
approach, understanding direct financial and economic confrontation
with China through sanctions will likely prove counterproductive. This
balance can be drawn if China sees itself as a partner in these efforts
and if the campaign is geared toward targeting and isolating rogue
financial and commercial activity and those flouting legitimate
authorities and international norms. Getting the Chinese to realize
that the continued, current path with North Korea is itself creating
regime and regional instability--and putting its own reputation and
economy at risk--will be a difficult but essential element of any
campaign.
U.S. sanctions against North Korea have lacked both a comprehensive
approach of this nature and a willingness to put China's interests on
the table. The U.S. Government's recent strategy of strategic patience
and a prior pattern of lessening financial pressure or rewarding the
regime in Pyongyang in the face of provocation have not forced the
Chinese to make hard choices. The idea of pressuring China to alter its
calculus is difficult, but if the problem of a nuclear armed and
threatening North Korea is growing acute, then we need to apply a more
aggressive approach.
It is in this context that the question of whether and how to use
secondary sanctions and other types of financial tools and measures
arises. Before treating the issue of secondary sanctions, it is
important to understand the nature of North Korean financial activity
and its dependence on the Chinese economic and financial system.
North Korean Financial Activity and Chinese Connectivity
For years, the North Korean regime has found creative and often
devious ways to run its economy. They have raised and moved capital
into the Hermit Kingdom in order to prop up the regime and develop an
expensive nuclear and missile program. It has adapted to sanctions and
attempts to isolate the regime financially and commercially--relying on
the Chinese economy, including Chinese banks, networks, and brokers,
for most of its trade and connectivity to the commercial and financial
world. The North Korean regime has consistently leveraged commercial
relationships to its advantage and worked around existing sanctions and
restrictions. Much of this has involved illicit financial activity and
schemes to raise money for the Government.
The North Korean schemes outside their borders rely heavily on
front companies, layered transactions, opaque ownership structures, and
trusted or corrupt relationships, making it difficult for legitimate
banks and compliance systems to detect and stop its nefarious
activities. The United Nations has issued annual reports that detail
North Korea's aggressive efforts to evade financial sanctions. \1\ In
2011, the Financial Action Task Force called for its members to impose
countermeasures on the Kim regime due to its significant lack of anti-
money laundering and counter-terrorism finance controls. \2\ Last year,
the United States Treasury labeled North Korea a jurisdiction of
``primary money laundering concern,'' ordering that the country be cut
off from the U.S. financial system and prohibiting foreign banks from
providing indirect access. \3\ In the designation, the Treasury
Department described North Korea's financial activities as a ``threat
to the integrity of the U.S. financial system.'' \4\
---------------------------------------------------------------------------
\1\ United Nations Security Council, ``Reports of the Panel of
Experts Established Pursuant to Resolution 1874 (2009)''. (https://
www.un.org/sc/suborg/en/sanctions/1718/panel_experts/reports)
\2\ Financial Action Task Force, ``Public Statement--24 February
2017'', February 24, 2017. (http://www.fatf-gafi.org/publications/high-
riskandnon-cooperativejurisdictions/documents/public-statement-
february-2017.html)
\3\ U.S. Department of the Treasury, Financial Crimes Enforcement
Network, ``Finding That the Democratic People's Republic of Korea Is a
Jurisdiction of Primary Money Laundering Concern'', 81 FR 35441, June
2, 2016. (https://www.fincen.gov/sites/default/files/shared/2016-
13038(DPRK_Finding).pdf)
\4\ U.S. Department of the Treasury, Financial Crimes Enforcement
Network, ``Finding That the Democratic People's Republic of Korea Is a
Jurisdiction of Primary Money Laundering Concern'', 81 FR 35441, June
2, 2016. (https://www.fincen.gov/sites/default/files/shared/2016-
13038(DPRK_Finding).pdf)
---------------------------------------------------------------------------
The U.N. Panel of Experts has investigated Pyongyang's financial
activities, noting that ``circumvention techniques and inadequate
compliance by Member States are combining to significantly negate the
impact of the resolutions.'' \5\ The Panel reported that North Korea
generates ``significant revenue'' from its financial networks with most
denominated in U.S. dollars, euros, and renminbi. \6\
---------------------------------------------------------------------------
\5\ United Nations Security Council, ``Report of the Panel of
Experts Established Pursuant to Resolution 1874 (2009)'', S/2017/150,
February 27, 2017. (http://undocs.org/S/2017/150)
\6\ Ibid.
---------------------------------------------------------------------------
The regime generates profits from all forms of illicit activity--
from counterfeit cigarette smuggling to proliferation. The U.N. Panel
of Experts noted that North Korean proliferation networks are expanding
and blending to include arms trafficking in Africa and the manufacture
and trade of military technologies. Such networks rely on trusted and
sophisticated agents able to move people, goods, and money undetected
across borders. Those networks and agents are growing more
sophisticated in masking and layering corporate identities and records
and play within the seams of the international system.
The North Koreans are profiting from their human rights abuses.
Within the country, unpaid labor earns around $975 million for the
Government each year, according to Seoul-based NGO Open North Korea.
\7\ The report estimates that 400,000 people make up the lowest class
of forced laborers, or dolgyeokdae, who are put to work on construction
projects throughout the country.
---------------------------------------------------------------------------
\7\ Steven Borowiee, ``North Koreans Perform $975 Million Worth of
Forced Labor Each Year'', Los Angeles Times, October 6, 2016. (http://
www.latimes.com/world/asia/la-fg-north-korea-forced-labor-20161006-
snap-story.html)
---------------------------------------------------------------------------
The regime also profits handsomely from forced labor outside its
borders. U.N. Special Rapporteur on Human Rights in North Korea Marzuki
Darusman estimated that there are approximately 50,000 North Koreans
abroad, earning between $1.2 billion to $2.3 billion per year for the
DPRK. \8\ Countries like China, Poland, Qatar, and others allow their
companies to use such labor and to make arrangements to pay North
Korea. \9\
---------------------------------------------------------------------------
\8\ Christian Vonscheidt and Miriam Wells, ``Cash for Kim: How
North Koreans Are Working Themselves to Death in Europe'', VICE News,
May 23, 2016 (https://news.vice.com/article/cash-for-kim-how-north-
koreans-are-working-themselves-to-death-in-europe); Edith M. Lederer,
``U.N. Investigator: North Koreans Doing Forced Labor Abroad To Earn
Foreign Currency for Country'', AP, October 28, 2015. (https://
www.usnews.com/news/world/articles/2015/10/28/un-investigator-north-
koreans-doing-forced-labor-abroad)
\9\ VICE News discovered that 14 Polish companies have used North
Korean workers between 2010 and 2016. The workers were supplied to
Polish companies Armex and Alxon by the Korea Rungrado General Trading
Corporation. Working conditions in these shipyards meet the definition
for forced labor, as laid out in the European Convention on Human
Rights and the International Labor Organization. (Christian Vonscheidt
and Miriam Wells, ``Cash for Kim: How North Koreans Are Working
Themselves to Death in Europe'', VICE News, May 23, 2016. (https://
news.vice.com/article/cash-for-kim-how-north-koreans-are-working-
themselves-to-death-in-europe))
---------------------------------------------------------------------------
The workers are used in industries like shipyards, surface
construction, furniture production, agriculture, metalworking,
medicine, and finance. Wages are paid in foreign currency directly to
the DPRK as a method of bypassing U.N. sanctions. \10\ Workers are paid
between $120 and $150 per month, but the employers ``pay significantly
higher amounts'' directly to the North Korean Government. \11\
---------------------------------------------------------------------------
\10\ Christian Vonscheidt and Miriam Wells, ``Cash for Kim: How
North Koreans Are Working Themselves to Death in Europe'', VICE News,
May 23, 2016. (https://news.vice.com/article/cash-for-kim-how-north-
koreans-are-working-themselves-to-death-in-europe)
\11\ Jethro Mullen, ``North Korea Believed To Earn a Fortune From
Forced Labor Overseas, U.N. Says'', CNN, October 29, 2015 (http://
www.cnn.com/2015/10/29/asia/north-korea-un-forced-labor-overseas/);
Edith M. Lederer, ``U.N. Investigator: North Koreans Doing Forced Labor
Abroad To Earn Foreign Currency for Country'', AP, October 28, 2015.
(https://www.usnews.com/news/world/articles/2015/10/28/un-investigator-
north-koreans-doing-forced-labor-abroad). The Leiden Asia Center
estimates that between 70-100 percent of the earnings go directly to
the DPRK.
---------------------------------------------------------------------------
With all this, China remains North Korea's most important economic
and trading partner. China accounts for approximately 90 percent of
North Korea's total trade volume, and Chinese-North Korean trade was up
37.4 percent in the 1st Q of 2017 when compared to 2016. \12\ China has
benefited from access to North Korean coal and minerals while North
Korea has used Chinese networks and its economic system, in particular
broker relationships and access to financial institutions, as a way of
accessing hard capital and driving its economy.
---------------------------------------------------------------------------
\12\ Eleanor Albert, ``The China-North Korea Relationship'',
Council on Foreign Relations, April 26, 2017. (http://www.cfr.org/
china/chinanorth-korea-relationship/p11097)
---------------------------------------------------------------------------
Unfortunately, China has allowed its economy to be used by North
Korea to evade sanctions and engage in illicit activity. In most cases
when a new North Korean sanctions evasion network is revealed,
inevitably it has a nexus to or in China. Given Beijing's robust
security services and sensitivities to exposure to North Korean
activity, it is hard to believe the Chinese leadership is not aware of
such exposure to North Korea and the Kim regime's activities.
Recent examples of how North Korea's financial and commercial
activities are intertwined with the Chinese economy and financial
system are illustrative:
Limac-Ryonbong Joint Venture: This past weekend, the Wall
Street Journal reported that Limac Corp, a Chinese State-owned
company, has maintained a joint venture since 2008, with a
North Korea's Ryonbong General Corp, which has been under U.S.
sanctions since 2005, for its involvement with weapons of mass
destruction. \13\ The North Korean firm has reportedly ``tried
to procure chemicals for solid-fuel for rockets'' in the past,
and several of its employees were sanctioned as recently as 6
weeks ago by the Treasury Department. \14\ Meanwhile, the
Chinese firm maintains a U.S. affiliate, and records show that
in 2013, it shipped Canadian nuclear-power equipment to China
via the U.S. \15\ This represents just one node of the China-
North Korea nexus. Sayari Analytics (which discovered the link)
``says it has identified more than 600 Chinese companies that
trade with North Korea.'' \16\
---------------------------------------------------------------------------
\13\ Jeremy Page and Jay Solomon, ``Chinese-North Korean Venture
Shows How Much Sanctions Can Miss'', Wall Street Journal, May 7, 2017.
(https://www.wsj.com/articles/chinese-north-korean-venture-shows-how-
much-sanctions-can-miss-1494191212)
\14\ Ibid.
\15\ Ibid.
\16\ Jeremy Page and Jay Solomon, ``Chinese-North Korean Venture
Shows How Much Sanctions Can Miss'', Wall Street Journal, May 7, 2017.
(https://www.wsj.com/articles/chinese-north-korean-venture-shows-how-
much-sanctions-can-miss-1494191212)
The Dandong Hongxiang Network: Dandong Hongxiang Industrial
Development Co., Ltd and four Chinese individuals created a
mechanism to help North Korea evade financial sanctions. \17\
The network was exposed in August 2016, in a ground-breaking
study, In China's Shadow, published by the Center for Advanced
Defense Studies (C4ADS) and the Asan Institute for Policy
Studies. \18\ The Justice Department filed an indictment
against the company and four individuals shortly after the
publication of the C4ADS-Asan study. \19\ From 2009 to 2015,
the network allegedly routed at least $75 million through the
U.S. financial system, and from June to August 2016, the
network routed $8 million through the U.S. financial system.
The Treasury Department also designated the four Chinese
nationals and Chinese companies in September 2016, in
coordination with the public unsealing of the indictment. \20\
---------------------------------------------------------------------------
\17\ The four individuals are: Ma Xiaohong, a Chinese national who
resides in Dandong, China, and was the majority owner (80 percent) of
DHID; Zhou Jianshu, a Chinese national who also resides in Dandong and
was the general manager of DHID working directly for Ma; Luo Chuanxu, a
Chinese national who is the financial manager of DHID and an assistant
to Ma and Zhou; and Hong Jinhua is a Chinese national who also resides
in Dandong and was the deputy general manager of DHID working for Ma.
U.S. Department of Justice, Press Release, ``Four Chinese Nationals and
China-Based Company Charged with Using Front Companies To Evade U.S.
Sanctions Targeting North Korea's Nuclear Weapons and Ballistic Missile
Programs'', September 26, 2016. (https://www.justice.gov/opa/pr/four-
chinese-nationals-and-china-based-company-charged-using-front-
companies-evade-us)
\18\ ``In China's Shadow'', The Asan Institute for Policy Studies
and C4ADS, August 2016. (https://static1.squarespace.com/static/
566ef8b4d8af107232d5358a/t/57dfe74acd0f68d629357306/1474291539480/
In+Chinas+Shadow.pdf) U.S. Department of Justice, Press Release, ``Four
Chinese Nationals and China-Based Company Charged With Using Front
Companies To Evade U.S. Sanctions Targeting North Korea's Nuclear
Weapons and Ballistic Missile Programs'', September 26, 2016. (https://
www.justice.gov/opa/pr/four-chinese-nationals-and-china-based-company-
charged-using-front-companies-evade-us)
\19\ U.S. Department of Justice, Press Release, ``Four Chinese
Nationals and China-Based Company Charged With Using Front Companies To
Evade U.S. Sanctions Targeting North Korea's Nuclear Weapons and
Ballistic Missile Programs'', September 26, 2016. (https://
www.justice.gov/opa/pr/four-chinese-nationals-and-china-based-company-
charged-using-front-companies-evade-us)
\20\ U.S. Department of the Treasury, ``Press Release: Treasury
Imposes Sanctions on Supporters of North Korea's Weapons of Mass
Destruction Proliferation'', September 26, 2016. (https://
www.treasury.gov/press-center/press-releases/Pages/jl5059.aspx)
Global Communications Co (Glocom): Pan Systems Pyongyang, a
North Korean branch of a Singapore-based company, created
Glocom claiming it was a Malaysia-based company to sell
prohibited military equipment. The U.N. Panel of Experts
reported that the company used bank accounts in China to
transfer funds to suppliers located in mainland China and Hong
Kong. \21\ The Panel noted that a ``series of transactions by
Glocom initiated by companies registered in Hong Kong, China,
and cleared through several United States correspondent banks
in New York.'' \22\ The U.N. noted that Pan Systems Pyongyang
is controlled by the U.S.-designated Reconnaissance General
Bureau (RGB), North Korea's intelligence agency, and also
received funds from U.S. and U.N.-designated Korea Mining
Development Trading Corporation, a key proliferation entity.
\23\
---------------------------------------------------------------------------
\21\ United Nations Security Council, ``Report of the Panel of
Experts Established Pursuant To Resolution 1874 (2009)'', S/2017/150,
February 27, 2017. (http://undocs.org/S/2017/150)
\22\ United Nations Security Council, ``Report of the Panel of
Experts Established Pursuant To Resolution 1874 (2009)'', S/2017/150,
February 27, 2017. (http://undocs.org/S/2017/150)
\23\ Ibid.
March 31, 2017 U.S. Designations: The Trump
administration's actions against North Korea's financial
facilitators provided insight into the workings of Pyongyang's
financial network. The designations included the following: Han
Jan Su, the Moscow-based representative of U.S.-designated
Foreign Trade Bank; Jo Chol Song, the Dandong, China deputy
representative of U.S. and U.N.-designated Korea Kwangson
Banking Corporation; Kim Tong Ho, the Vietnam-based
representative of U.S. and U.N.-designated Tanchon Commercial
Bank; Kim Mun Chol, the Dandong-based representative of U.S.
and U.N.-designated Korea United Development Bank; and Kim Nam
Ung and Choe Chun Yong, the Moscow-based representatives for
Ilsim International Bank. \24\ These representatives were
engaged in a variety of conduct including working with RGB on
financial transfers, working with Moscow-based Tempbank that
was designated by the U.S. for its activities with the Syrian
regime, and weapons and missile-related sales. \25\
---------------------------------------------------------------------------
\24\ U.S. Department of the Treasury, ``Press Release: Treasury
Sanctions Agents Linked to North Korea's Weapons of Mass Destruction
Proliferation and Financial Networks'', March 31, 2017. (https://
www.treasury.gov/press-center/press-releases/Pages/sm0039.aspx)
\25\ U.S. Department of the Treasury, ``Press Release: Treasury
Sanctions Syrian Regime Officials and Supporters'', May 8, 2014.
(https://www.treasury.gov/press-center/press-releases/Pages/
jl2391.aspx) U.S. Department of the Treasury, ``Press Release: Treasury
Sanctions Agents Linked to North Korea's Weapons of Mass Destruction
Proliferation and Financial Networks'', March 31, 2017. (https://
www.treasury.gov/press-center/press-releases/Pages/sm0039.aspx)
North Korean Banks in China: The U.N. Panel of Experts
reported that U.S.-designated Daedong Credit Bank (DCB) and
U.S.-designated Korea Daesong Bank (KDB) are operating in China
using representative offices in Dalian, Dandong, and Shenyang.
\26\ The U.N. reported that U.S.-designated Kim Chol Sam
operated a financial network inside China, including millions
of U.S. dollar transactions, without apparent repercussions
from Beijing. \27\
---------------------------------------------------------------------------
\26\ United Nations Security Council, ``Report of the Panel of
Experts Established Pursuant to Resolution 1874 (2009)'', S/2017/150,
February 27, 2017. (http://undocs.org/S/2017/150)
\27\ Ibid.
These are some examples of how the North Koreans continue to engage
in illicit commerce and financing by leveraging their ties, facilities,
and agents in China. More research attention and disclosures of these
kinds of networks will continue from the media and scholars like
Anthony Ruggiero at the Foundation for Defense of Democracies and our
Center on Sanctions and Illicit Finance and analytic firms like C4ADS
and Sayari. The dependency of the North Korean economy on the Chinese
system raises the difficult question of what more can be done to
pressure China to crack down effectively on the regime in Pyongyang.
Killing the Chicken To Scare the Monkey: Secondary Sanctions and Beyond
This Subcommittee has asked to focus on the potential use of
secondary sanctions to impact those entities in China that continue to
do business with North Korea. Secondary sanctions are not a common tool
in the various U.S. sanctions regimes, but they have been employed or
implicated recently in sanctions programs against Iran, Hizballah, and
in the Russia/Ukraine context.
Secondary sanctions entail imposing sanctions or restrictions
against third-country parties for transactions with no U.S. touch
points or traditional nexus. The goal of secondary sanctions with
jurisdictions or regimes is to force a foreign third-party to choose
between doing business in the United States or doing business in the
targeted jurisdiction. Such sanctions apply to all persons (natural and
legal) on a global basis, regardless of the person's connection with
the United States. Those sanctioned are then subject to various
potential penalties that restrict their ability to access the U.S.
market.
In the Iran context, U.S. secondary sanctions primarily targeted
certain sectors and exports directly relevant to the Iranian economy
and prohibited foreign financial institutions from conducting any
significant transactions in Iranian currency. The United States used
these sanctions to restrict Iran's activities and squeeze their
economy. Their greatest effect may have been in the potential
application of such sanctions and the resulting chilling effect on
market and commercial activity--even absent designations.
Secondary sanctions are not without problems or controversy. Other
countries and foreign parties see them as the most aggressive extra-
jurisdictional application of American economic power and influence--
leveraging access to U.S. markets as a tool of coercive economic
statecraft. They are also effective only if they can be credibly
threatened and applied. This is not the case when those engaged in the
activity of concern have no desire to deal with the United States and
no potential exposure making them subject to sanction or financial or
economic isolation. These can also appear to be toothless sanctions if
the categories of potential institutions or sectors targeted are ``too
big to sanction.''
To the Chinese, the potential application of primary or secondary
sanctions to their citizens, companies, or interests will be seen as a
challenge to their sovereignty. Consistently, the Chinese have objected
to any form of unilateral sanctions that fall outside of the auspices
of the United Nations, and any financial or commercial measure that has
the effect of sanctioning a Chinese party will engender a negative
reaction. In addition, China has tended to defend against more
aggressive application of Chapter 7 U.N. sanctions, and it has often
been lax in enforcing sanctions regimes when Chinese interests are at
play, as in the case of North Korea.
In the current context, North Korea appears to rely less on major
Chinese global banks and financial institutions directly for access to
financing and banking services. North Korean financial and commercial
activity has tended to concentrate in recent years with smaller Chinese
banks and entities to facilitate financial and commercial activity and
with many entities with little to no connectivity to the United States.
Even so, more research and analysis is uncovering deeper and more
entangled commercial, transport, and financial ties between the Chinese
and North Korean economies. The direct and indirect exposure by major
Chinese companies and banks to North Korea may not be fully known or
appreciated, perhaps not even to those institutions.
Though Chinese sensitivities have to be kept squarely in mind to
ensure greater cooperation, there needs to be a more comprehensive set
of tools that attempt to squeeze the Kim regime's access to financing
and commercial outlets, sensitizes the markets to the risks of doing
business with North Korea, and begins to demonstrate a willingness to
expose and target key nodes and conduits of North Korean financial and
commercial activity.
In that context, it is appropriate to consider creating secondary
sanction authorities that target those entities--of whatever country of
origin that continue to do business with North Korea in certain sectors
of concern. The mere threat of secondary sanctions--regardless of
sectors identified--would condition Governments and the private sector
to engage in deeper due diligence to understand better where North
Korean agents, networks, and entities are accessing capital and
resources. It would result in North Korean accounts being shut down,
activity locked out of the financial system, and agents attempting to
recast their businesses and identities to avoid scrutiny.
The risk from direct or indirect exposure to North Korea would be a
serious concern for the major Chinese banks--the Industrial and
Commercial Bank of China, Bank of China, China Construction Bank, and
Agriculture Bank of China--trying to establish legitimate and
sustainable footholds in the United States and other Western markets.
Even if these banks did not have direct business ties with North Korea,
they would have to ensure that their counterparties, correspondents,
and clients did not expose them to the threat of secondary sanctions or
enforcement actions in the United States. The risk of being cut off
from U.S. markets would be too great a risk to ignore for legitimate
actors in the banking, shipping, and commercial worlds.
The mere existence of the authority does not mean it has to be used
in each instance of a violation. The authority would open up economic
and diplomatic dialogue with concerned actors that could result in
changed behavior, more information, and the cut off of commercial
relations with North Korea--even without designating any entities. The
use of such authority may ultimately be shaped or constrained by
diplomatic considerations, but this tool could provide diplomatic
leverage that does not currently exist with North Korea and China.
Secondary sanctions authority, though important, would not be the
only step the United States could take unilaterally and in concert with
international partners and the private sector to pressure North Korea,
including in and through China. As with any effective sanctions
program, there needs to be a commitment of analysis, investigations,
targeting, and follow-up--constantly undertaken to counteract the
evasion and masking techniques used by nefarious actors. And such
efforts cannot be left to the United States alone, though it will need
to lead any such effort.
The following are other steps that should be taken to address the
risks from North Korea and catalyze Chinese and other actors to do more
to prevent North Korea from accessing the financial and commercial
system.
North Korean ``Class of Transaction'' 311 Designation. On
November 9, 2016, the U.S. Treasury designated North Korea a
``primary money laundering concern'' and prohibited any
correspondent accounts with North Korean financial institutions
or the facilitation of any transaction from a North Korean
financial institution. This was a very important step and a
signal to the financial community of the seriousness of the
risks to the integrity of the financial system and
international community posed by North Korea. This step should
be amplified by designating any North Korea financial and
commercial transaction or activity as a class of transaction of
``primary money laundering concern'' and requiring specific
enhanced due diligence, information collection, and reporting
tied to any transactions touching North Korean activity--inside
or outside of the country. This would put the onus on financial
institutions, in particular Chinese banks with exposure to the
United States and Western banking systems, to determine if they
have direct or indirect exposure to anything that touches North
Korea. This scrutiny goes beyond designated North Korean banks
or entities--whose names and affiliations may change--and more
broadly to the suspect nature of any transaction that touches
North Korea.
Dynamic Financial Information Sharing With Private Sector.
The U.S. Government, in concert with Japan, South Korea,
Australia, and other allies in Asia, should establish a dynamic
information sharing mechanism with key private sector actors to
explain and share where potential exposure to suspect North
Korean activity lies. Financial intelligence units could be
tasked with compiling data and reports that could be
disseminated, with a goal of targeting and exposing more North
Korean financial and commercial activity more quickly. Banks,
shipping companies, and the insurance sector would welcome more
information that would allow them to comply with relevant
sanctions and understand where risk lies within their
businesses. This could follow other models and platforms being
created in the banking industry to share more specific
information about specific risks and threats.
Regulatory and Enforcement Attention to Chinese Banks.
Authorities in the United States, Western, and Asian countries
have begun to devote more regulatory and enforcement attention
to Chinese banks operating abroad for failure to have adequate
financial crimes and sanctions compliance risk management. This
is an important shift in attention, as Chinese banks seek to
meet international global standards for transparency, sanctions
compliance, and financial crimes risk management. Billions of
dollars of fines against European, American, and other Western
banks have focused the attention of banks to improve their
sanctions compliance. Scrutiny over Chinese banks' lack of
adequate financial controls and a culture of compliance--as has
happened with other global banks--would further sensitize
Chinese institutions to the risks presented by exposure to
North Korea. \28\
---------------------------------------------------------------------------
\28\ Anthony Ruggiero, ``Severing China-North Korea Financial
Links'', Center for Strategic and International Studies, April 3, 2017.
(https://www.csis.org/analysis/severing-china-north-korea-financial-
links)
Anti-Corruption Initiative. The United States should launch
an anti-corruption initiative to investigate and build public
cases against corrupt North Korean actors and those who are
colluding with them, perhaps using a new executive order to
focus targeted sanctions on North Korean kleptocracy. Such
sanctions and any related cases exposed would focus attention
on the amount of wealth and corruption within the regime
leadership and the ties that they have with others outside of
North Korea. The Chinese would be concerned about North Korean
corruption bleeding into their system and implicating Chinese
actors. This would likely prompt greater attention to North
Korean ties and lead to more Chinese actions to shut down
---------------------------------------------------------------------------
illicit or corrupt networks of concern.
Leadership Asset Hunt. In conjunction with this, the United
States should declare that it is launching a leadership asset
hunt for assets stolen and held by the Kim leadership, using
the tools and resources of the intelligence community, law
enforcement, and regulators and working with international
institutions like the World Bank's Stolen Asset Recovery
Initiative. The goal would be to determine how the senior
leadership of the regime in Pyongyang holds and stores its
money outside of North Korea and with whom it is dealing and
operating. This could have direct implications for China and
could expose where North Korea and China maintain existing
financial relationships. This would further shine a spotlight
on suspect ``Politically Exposed Persons'' requiring additional
due diligence and attention by the Chinese and other banking
systems.
Human Rights and Sanctions. The United States should expand
the list of companies and entities subject to sanctions under
Executive Order 13722 (March 15, 2016), including considering
designating those companies employing North Korean workers and
paying their fees directly to the North Korean regime. It
should call on countries currently allowing this practice to
shut it down and push for human rights designations at the U.N.
and a prohibition on paying North Korea for overseas laborers.
\29\ This should be matched with a Treasury advisory to
financial institutions warning against facilitating or engaging
in any transaction related to this forced labor.
---------------------------------------------------------------------------
\29\ Anthony Ruggiero, ``Don't Let North Korea's Nukes Overshadow
Human Rights Abuses'', The Hill, April 28, 2017. (http://thehill.com/
blogs/pundits-blog/foreign-policy/331061-dont-let-north-koreas-nukes-
overshadow-human-rights-abuses)
Shipping: Mapping and Interdictions. The United States in
concert with Japan, South Korea, Australia, and other allies
should coordinate the sharing of North Korean shipping and
transport data--along with private sector actors to track and
map shipping interests doing business with or in North Korean
ports or waters. The mapping and investigation of shipping tied
to North Korea would allow for more robust information sharing
and understanding where the proliferation and trafficking risks
lie and would expose networks and business interests of
concern. This would also enable more robust maritime
interdiction strategies, which would put pressure on those
countries or entities that continue to do business with North
---------------------------------------------------------------------------
Korea.
North Korean Illicit Activities Enforcement Initiative. The
law enforcement and intelligence communities--in concert with
the U.N. Panel of Experts and the private sector--should
concentrate on understanding and exposing North Korea's
continuing illicit commercial and financial activity.
Smuggling, money laundering, arms trafficking, and sanctions
evasion should all be subject to intense investigation and
exposure and should be a priority for law enforcement in Asia
and wherever North Korea engages in commercial activity. An
illicit activity initiative would allow for more disruptions,
designations, and identification where illicit networks are
operating with impunity. This could be done in concert with the
Chinese to underscore the need to attack illicit financing
networks.
Cyber Litigation--Private Rights of Action. To match
existing sanctions targeting those involved in undermining
cybersecurity, Congress should consider providing victims of
North Korean cyberattacks the right to sue and seek damages
from entities and actors that have facilitated or knowingly
benefited from North Korean cyber activity. This is important
as North Korea expands its cyber footprint and attacks. Though
this may not reach into Pyongyang, this right of action would
put private sector actors that deal with North Korean or other
cyber belligerents on notice that they could be subject to
private litigation and suits.
These are just some of the ideas that can be woven into a strategy
that includes secondary sanctions. These tools--if leveraged and
choreographed wisely and in concert--would not only squeeze the North
Korean regime but also compel the Chinese to consider its own ties and
the risks of exposure to North Korea.
Changing the Chinese Calculus
There is reason to believe that the Chinese calculus and behavior
can be affected if North Korean actions and taint threaten the
fundamental interests and reputation of the Chinese economy,
leadership, and system. There are hopeful signs in recent months and
past episodes that provide a window into Chinese thinking and can be
guideposts for any pressure campaign.
China has been willing to exert pressure and crack down on its
trade with North Korea when it has faced public scrutiny over such
ties, or when it wishes to express selective disapproval over North
Korean actions. In September 2016, it was reported that China had
opened an investigation into the Chinese citizen, Ma Xiaohong, who was
indicted by the United States. She ran the Dandong Hongxiang Network,
which had allegedly undertaken half a billion dollars in trade with
North Korea between 2011 and 2015, \30\ some of which ``included
materials that can be used in the production of nuclear weapons.'' \31\
China has reportedly frozen her assets.
---------------------------------------------------------------------------
\30\ James Pearson, ``China Probes North Korea Bank Suspected of
Nuclear Link--South Korea Paper'', Reuters, September 26, 2016. (http:/
/www.reuters.com/article/us-northkorea-nuclear-bank-idUSKCN11W049)
\31\ Jane Perlez and Chris Buckley, ``China Announces Inquiry Into
Company Trading With North Korea'', New York Times, September 20, 2016.
(https://www.nytimes.com/2016/09/21/world/asia/north-korea-china-
inquiry-hongxiang.html?_r=0)
---------------------------------------------------------------------------
In February and April of this year, China curbed its imports of
coal from North Korea, likely in response to recent multiple missile
tests Pyongyang carried out and in the wake of the assassination of Kim
Jong-Un's half-brother in Malaysia via a VX nerve agent. \32\
Furthermore, in May 2013, the Bank of China closed the account
belonging to Foreign Trade Bank, ``North Korea's most important
financial institution'', which had been sanctioned by the U.S. in March
of that year. \33\ These actions do not necessarily signal a
fundamental shift in Chinese policy, but it reflects a willingness to
take actions against North Korean interests and connections in China.
---------------------------------------------------------------------------
\32\ John Ruwitch and Meng Meng, ``North Korean Ships Head Home
After China Orders Coal Returned'', Reuters, April 11, 2017. (http://
www.reuters.com/article/us-china-northkorea-coal-exclusive-
idUSKBN17D0D8)
\33\ Jane Perlez, ``U.S. Sanctions Expected To Hit Small Banks'
Business With North Korea'', New York Times, June 3, 2016. (https://
www.nytimes.com/2016/06/04/world/asia/us-sanctions-expected-to-hit-
small-banks-business-with-north-korea.html)
---------------------------------------------------------------------------
In addition, the Chinese Politburo held a study group last month
focusing on ``financial security,'' signaling that the Chinese
leadership is attaching a high priority to this topic. The United
States could work with the Chinese to focus on protecting the Chinese,
U.S., and broader financial system from the collective threats of
illicit activity, cyberfinancial attacks, and corruption that North
Korea represents, especially to Chinese banks.
In the past, there have been key episodes that demonstrate the
Chinese system's sensitivity to the risks North Korea represents to its
own economy and reputation--and a willingness to cooperate and change
their risk calculus as a result of a changed landscape.
Banco Delta Asia (BDA). In September 2005, as part of a strategic
pressure campaign, the Treasury Department ordered U.S. financial
institutions to close correspondent accounts for a private bank in
Macau--Banco Delta Asia (BDA)--pursuant to Section 311 of the Patriot
Act. This bank--designated as a ``primary money laundering concern''--
was facilitating money laundering, proliferation, and counterfeiting on
behalf of the North Korean regime.
The regulation cut the bank off from the U.S. financial system.
More important, the unilateral regulation unleashed a wave of financial
isolation against North Korea. Banks in China, Asia, and Europe stopped
doing business with North Korea, denying it access to the international
financial system. North Korean bank accounts were closed, its
transnational commercial transactions were canceled, and officials'
financial activities were carefully scrutinized.
This hurt Pyongyang. The North Korean regime scrambled to regain
access to money and accounts around the world while trying to undo the
official damage done to its reputation in the international financial
community. Key State actors, including China, had no incentive to block
the full effect of the market reaction. On the contrary, they did not
want their banks or financial reputations caught up in the taint of
North Korea's illicit financial activity.
This pressure became the primary leverage for the United States to
press for North Korea's return to the six-party negotiating table. Once
the six-party talks reassembled, the financial pressure campaign
against North Korea ended, resulting in a loosening of the financial
squeeze.
Unlike traditional State-based sanctions, this kind of financial
leverage relies more on the risk-based calculus of global financial
institutions than the policy decisions of Governments. For legitimate
financial institutions, there are no benefits to the risk of
facilitating illicit transactions that could bring high regulatory
costs and damage to their reputations if uncovered. If financial
institutions act according to their own interests, targeted actors and
their suspected fronts will be denied access to the facilities of the
international financial system. In this case, the Chinese financial
institutions defended their own interests and reputations, not putting
themselves at risk on behalf of the North Koreans.
Kunlun Bank. On January 31, 2012, the U.S. Department of the
Treasury sanctioned Bank of Kunlun Co. Ltd., a Chinese bank under the
Comprehensive Iran Sanctions, Accountability, and Divestment Act of
2010 (CISADA) for providing ``significant financial services'' to at
least six Iranian banks designated by the Treasury. \34\ Bank of Kunlun
transferred nearly $100 million from accounts it held for Bank Tejarat
and made at least one payment for an affiliate of the Iranian
Revolutionary Guard Corps. \35\ At the time, Chinese Foreign Ministry
Spokesman Qin Gang urged the U.S. to lift sanctions against the Bank of
Kunlun, stating that the imposition of U.S. sanctions ``violates the
norms of international relations and damages China's interests.'' \36\
\37\ Despite the protestations and fears of Chinese backlash, the
Chinese quietly dealt with Kunlun Bank and directed it to stop such
activities.
---------------------------------------------------------------------------
\34\ ``Treasury Sanctions Kunlun Bank in China and Elaf Bank in
Iraq for Business With Designated Iranian Banks'', Department of the
Treasury Press Release, July 31, 2012. (https://www.treasury.gov/press-
center/press-releases/Pages/tg1661.aspx)
\35\ ``Exclusive: Iran Uses China Bank To Transfer Funds to Quds-
Linked Companies--Report'', Reuters, November 18, 2014. (http://
www.reuters.com/article/us-iran-sanctions-china-exclusive-
idUSKCN0J20CE20141119)
\36\ ``China Hits Back at New U.S. Sanctions Over Iran'', Kelly
Olsen, AFP, August 1, 2012. (https://www.yahoo.com/news/china-hits-
back-us-sanctions-over-iran-063058172.html)
\37\ Wayne Ma, ``China Scolds U.S. Over Iran-Related Bank
Sanctions'', Wall Street Journal, August 1, 2012. (https://www.wsj.com/
articles/SB10000872396390444320704577
562330527832056)
---------------------------------------------------------------------------
Chinese Position Shift on Sudan ICC Indictment. At a recent Harvard
Law School panel discussion, the first Chief Prosecutor of the
International Criminal Court (ICC), Jose Luis Moreno Ocampo, provided
an instructive example of a Chinese policy shift during his tenure.
Ocampo noted that the Chinese position regarding the ICC's
investigation of the Bashir regime in Sudan had always been to support
and defend it because President Bashir guaranteed the stability of
Sudan. The Chinese position changed in the face of the Bush
administration's forceful support of the ICC's indictment of President
Bashir of Sudan, leading the Chinese to conclude that Bashir no longer
represented stability and began to explore other options. According to
Ocampo, the Obama administration's consolidation of Bashir's stability
led to the consolidation again of China's support to the regime in
Sudan.
Indeed, the Chinese will not want to react directly to pressure,
but they will understand when their interests are directly affected by
the taint, attention, and illicit activity of the North Koreans. We
have seen this already with the discomfort China has felt and expressed
with the deployment of the THAAD missile defense system in South Korea
and the increased U.S. maritime presence in Asian waters. If the
Chinese see that their interests and credibility will be undermined
fundamentally by connectivity and support to North Korea, the less
likely they are to allow those financial and commercial ties to exist.
If they understand that exposure to North Korea will bring greater
scrutiny to issues like corruption, human rights abuses, and financial
crimes in China and Chinese institutions, then the Chinese calculus
will have to change.
This is a moment of growth and expansion for the Chinese banks and
commercial brands, with many establishing footholds in Western
economies. If protecting the North Korean economy or regime represents
a real threat--direct or indirect--to the credibility and strength of
the Chinese banking sector and the future stability and growth of the
Chinese economy, the Chinese may not elect to maintain suspect
commercial and financial ties with North Korea. The potential
application of secondary sanctions could affect this calculus and move
the Chinese to place more serious pressure on Pyongyang.
Caution and Caveats
When considering secondary or other types of sanctions with respect
to China, policymakers and national security strategists have to take
into account the size and significance of the Chinese economy. The
second largest economy in the world, growing to become the leading
economy in this century, with its deep trading and investment ties in
the United States and the West cannot be isolated or treated as a
target of a maximalist financial and commercial pressure campaign. In
addition, our need to cooperate and compete with--as well as confront--
China in many other arenas, including in the South China Sea and
cyberspace, limits how far we may go with our financial and economic
toolkit.
There are too many costs to U.S. interests if a maximalist approach
were attempted, with boomerang effects on the U.S. economy, trade, and
U.S. and allied interests in China and Asia. China could always
retaliate with sanctions of its own against U.S. interests, as they
have threatened recently after the announced sale of U.S. high-end
military equipment to Taiwan. And China can use its own resources and
economic power to express its diplomatic displeasure, as it has done in
the recent past with Japan by restricting the export of rare-earth
minerals in 2010, allowing bananas from the Philippines to rot in port
in 2012, and placing sanctions on South Korean companies for allowing
the deployment of the THAAD missile defense system in early 2017. \38\
The Chinese dragon knows how to bite and to use financial and economic
tools--in the physical and virtual worlds.
---------------------------------------------------------------------------
\38\ Tom Miles and Krista Hughes, ``China Loses Trade Dispute Over
Rare Earth Exports'', Reuters, March 26, 2014 (http://www.reuters.com/
article/us-china-wto-rareearths-idUSBREA2P0ZK20140326); Andrew Higgins,
``In Philippines, Banana Growers Feel Effect of South China Sea
Dispute'', Washington Post, June 10, 2012 (https://
www.washingtonpost.com/world/asia_pacific/in-philippines-banana-
growers-feel-effect-of-south-china-sea-dispute/2012/06/10/
gJQA47WVTV_story.html?utm_term=.493ab5719154); Elizabeth Shim, ``China
Sanctions, Hacking Threats Eclipse South Korea THAAD Deployment'', UPI,
March 7, 2017. (http://www.upi.com/Top_News/World-News/2017/03/07/
China-sanctions-hacking-threats-eclipse-South-Korea-THAAD-deployment/
9311488902166/)
---------------------------------------------------------------------------
In addition, any new pressure campaign has to consider the
potential for asymmetric attacks from North Korea, especially attacks
on the financial system. North Korea has increased its capabilities and
increased the pace of its probing cyberattacks. The North Korean
hacking group Lazarus has reportedly targeted organizations in 31
countries, including the November 2014 Sony hack in the United States,
the $81 million heist from the Bangladesh Central Bank, \39\ and banks
and broadcasting companies in South Korea. \40\ North Korean hacking
activity has increased this year, with reports that banks in the United
States, Poland's biggest bank lobbying group ZBP, and banks throughout
the world have been targeted by North Korean entities.
---------------------------------------------------------------------------
\39\ Jim Finkle, ``Cyber Security Firm: More Evidence North Korea
Linked to Bangladesh Heist'', Reuters, April 3, 2017. (http://
www.reuters.com/article/us-cyber-heist-bangladesh-northkorea-
idUSKBN1752I4)
\40\ Jim Finkle, ``North Korean Hacking Group Behind Recent
Attacks on Banks: Symantec'', Reuters, Mar 15, 2017. (http://
www.reuters.com/article/us-cyber-northkorea-symantec-idUSKBN16M37J)
---------------------------------------------------------------------------
This is not an attempt to give credence to a heckler's veto.
Instead, this is a cautionary note that any effective action taken in
the financial and economic domain may result in reactions by those
targeted or affected by U.S. actions. The United States--and the
private sector--must be prepared for such a reaction. In addition,
there will be limits to what can be done in this domain, but the United
States should always try to use the most effective and appropriate
means to pressure the North Korean regime. The United States and her
allies should not pull punches just because the effects of those
actions may implicate China. If secondary sanctions can help squeeze
the North Korean regime and help shift the Chinese calculus, then they
should be authorized and used, in concert with other tools.
Conclusion
It is time to test if China and the United States together can
influence the North Korean regime--and stop its march toward nuclear
weapons capabilities that threaten the U.S. homeland. China has the
opportunity to prove its role as a great power and to use its influence
with Pyongyang. The clock is ticking, and an effective financial
pressure campaign with China on side is one way of helping to slow, if
not stop, the clock.