Tag: Sanctions

Iran is preparing to hand the Kremlin the blueprints for its most effective weapon against the West: the underground financial network it relies on to evade sanctions. 

For years, the Islamic Republic has frustrated American efforts to isolate it and starve its economy by constructing a parallel universe of front companies and foreign banks — including major financial institutions based in Europe and the U.S. — that Iranian companies use to evade international controls and conduct business abroad. 

As Russia faces increasing international isolation over the war in Ukraine, Iran, which is already providing Moscow with weapons, has offered to share its expertise in the art of sanctions evasion, Western diplomats say. A series of recent meetings between senior Russian and Iranian officials, including Iranian central bank chief Ali Salehabadi and Deputy Economy Minister Ali Fekri, involved laying the groundwork for that collaboration, the diplomats argue.  

If Moscow manages to copy the Iranian system it could hope to blunt the impact of many of the sanctions it faces, especially in its oil and gas sector, which forms the backbone of its economy. Such a system would give Russian President Vladimir Putin much more flexibility — and time — to continue to wage his war against Ukraine by keeping oil revenue flowing. 

“Anyone interested in changing the Russian state of mind should understand that paralyzing the Russian-Iranian financial abilities is essential,” one of the Western officials said. 

The diplomats who issued the warning on sanctions evasion techniques also noted that Western banks, such as Germany’s Commerzbank and Deutsche Bank, as well as Citigroup in the U.S., played a role in helping Iran continue to rake in export earnings through underground transactions. The risk is that the same Western banks — either wittingly or unwittingly — could be sucked into the same style of trade by Russia.

Trans-Caspian comrades

Over the summer, Tehran and Moscow held talks about using Iran as a backdoor for Russian oil once Tehran and world powers went back to a nuclear deal, under which the Islamic Republic would rein in its atomic program in return for sanctions relief. But amid the Iranian regime’s brutal crackdown on protestors in recent weeks and growing skepticism about renewing the accord in Washington, the likelihood of a breakthrough has faded.  

Relations between Russia and Iran, which collaborated in Syria to support the regime of Bashar al-Assad in that country’s civil war, have intensified on other fronts, however. Iran has become a major supplier of the “kamikaze” drones Russia is using in Ukraine, for example. Meanwhile, Tehran asked the Kremlin for help in advancing its nuclear program, CNN reported last week, citing U.S. intelligence. 

Iran has decades of experience in finding ways to avoid American sanctions but made particular strides since 2018 after U.S. President Donald Trump withdrew from the nuclear deal and reimposed restrictions. Trump argued that the arrangement with Iran was insufficient to prevent Tehran from building a bomb. European countries, led by Germany and France, objected to the U.S. decision but were powerless to stop it. 

Even before Trump’s move, however, European banks and companies had been reluctant to reengage with Iran because many U.S. sanctions remained in place and most firms assessed the risk of U.S. legal exposure as too high. 

Iran’s remedy was to go underground.  

A cache of recent transaction data reviewed by POLITICO between Iranian clearing houses and foreign-registered front companies controlled by the regime suggests that the volume of sanctions-evading transactions handled by the network is at least in the tens of billions of dollars annually. The data, authenticated by Western officials, underscores the degree to which Iran succeeded in circumventing the so-called “maximum pressure campaign” Washington initiated in 2018. 

“This explains how Iran won the maximum pressure campaign,” one of the Western officials said.

It might also explain why Iran, despite significant concessions by the administration of U.S. President Joe Biden, resisted re-entering the nuclear deal. The talks reached a stalemate even before the recent surge in protests in Iran.

While American sanctions have taken a toll on Iran’s economic output, Tehran’s shadow financial network has ensured the economy continues to fire, if not on all cylinders, then at a pace that keeps it moving, while also securing the elite’s privileges. Though inflation and unemployment in Iran are high — factors that have contributed to unrest — its economy has recently shown signs of life, growing by more than 4 percent in the last fiscal year alone, according to the World Bank. 

While Iran’s oil exports have roughly halved under the sanctions to about 1 million barrels per day, it has succeeded in maintaining robust trade in other areas, such as petrochemicals and metals. At about $100 billion last year, Iran’s foreign trade reached its highest level since the U.S. reimposed sanctions. Despite the drop in oil volumes, the country has recently benefited from rising prices, with export revenue last year more than doubling to about $19 billion. What’s driving Iran’s oil recovery, according to the World Bank, are “indirect exports to China.” 

Iranian oil is attractive to China, mainly because it’s relatively cheap. The illicit nature of sanctioned Iranian crude means it sells at a steep discount to market prices.   

Financial frontmen

That’s where Iran’s secret network of front companies comes in. 

The oil itself is fairly easy to deliver under the radar by using ship-to-ship transfers in open water and then blending it in foreign ports with other crude to disguise its origin. The greater difficulty for Iran is getting paid for the sales without triggering red flags in the international financial system, which from a regulatory perspective is dominated by the United States. Instead of selling the oil directly to the end buyer, it is sold via front companies, often to other front companies.  

Just last week, the U.S. sanctioned the members of what it described as an Iranian-backed oil smuggling ring that Washington accused of funneling money to Hezbollah, the Lebanese-based terror group supported by Tehran. 

“The individuals running this illicit network use a web of shell companies and fraudulent tactics including document falsification to obfuscate the origins of Iranian oil, sell it on the international market, and evade sanctions,” Brian Nelson, a senior official at the U.S. Treasury involved in the investigation, said in a statement announcing the new sanctions.

The ability to quietly finance terror is only one of the myriad benefits Iran draws from its underground financial system, however. The biggest advantage is that it gives the country’s battered economy access to hard foreign currency without a single dollar entering Iran’s own banking system. Though most of the funds generated through the network remain abroad, local companies can use the revenue they generate there as collateral at home. 

Iran’s surreptitious financial system is built on what are known in the country as “money exchange houses.” The organizations, which number in the dozens, are Iran-based clearinghouses that operate a network of front companies abroad, typically registered in China, UAE and Turkey. The houses are under the close supervision of the regime.

If an Iranian firm needs to undertake a foreign transaction prohibited by sanctions, its local bank can turn to one of the houses to filter the payment through a labyrinth of front companies, making it extremely difficult to trace the true origin, Western diplomats say. 

Sanctions smokescreen

A less-known aspect of this underground trade is the central role played by major Western banks. Many of the transactions, which involve everything from oil to scrap metal, are denominated in either euros or dollars. That means that settlement, the final step in the transaction, requires the involvement of a European or U.S. bank, depending on the currency. 

According to Iranian exchange house data reviewed by POLITICO, major EU-based banks, such as Germany’s Commerzbank and Deutsche Bank as well as U.S. banks, including Citigroup, have been used by Iran to settle these transactions. Under U.S. sanctions rules, domestic banks and foreign banks that do business in the U.S. are prohibited from conducting almost all financial dealings that involve Iran. 

The diplomats said the exchange data showed illicit Iranian export earnings being swilled through the international banking system, but there is no evidence the banks were aware that those transactions were part of Tehran’s scheme to keep the oil income flowing. If the front companies named in the transactions haven’t been specifically designated by the U.S. government, the banks often fail to detect the suspect activity.

Although banks have stringent due diligence requirements to trace the origins of funds, the Iranians have become masters at hiding where cash comes from. Nothing on the clearing data reveals an Iran connection. The transactions in question often involve the same group of companies and banks, based in China, Turkey the UAE, Singapore and India, and range in value from a few thousand dollars to millions. 

The lion’s share of transactions passes through the United Arab Emirates, the diplomats said. The UAE’s proximity to Iran and light-touch regulatory environment make it an attractive place for Tehran to conduct business, they said. Those same attributes have also put the country in the sights of European officials. In the coming days, the European Commission is expected to place the UAE on its list of “high-risk” countries concerning money laundering and the financing of terrorism

One of the companies that appears frequently in the transaction records is Hong Kong-registered Hua Gong HK Trading Ltd. It was founded in October of 2018, shortly after the U.S. began to reintroduce sanctions against Iran. Western diplomats say the firm is a front company operated by Tahayyori Guarantee Society, one of Iran’s biggest exchange houses.  

Hua Gong transactions over the past year reviewed by POLITICO passed through both Deutsche Bank and Citibank via Chinese banks. The recipients of the funds it transferred included firms in Hong Kong, Italy and Singapore. 

POLITICO was unable to reach Hua Gong for comment.

POLITICO also contacted the Western banks and asked about the Iranian exchange house data. The European banks in question declined to comment on whether they were aware that Iranian entities were behind the transactions highlighted.  

“Commerzbank AG takes its obligations and responsibilities under applicable sanctions laws and regulations seriously,” the Frankfurt-based lender said in a statement. “The bank has implemented measures in line with industry standards to ensure that its activities are conducted in compliance with applicable sanctions, including those implemented by the U.N., EU, U.S. and U.K.”

Deutsche Bank adopted a policy 15 years ago to reject “any business with parties in Iran,” a spokesman said, adding that the bank also applies “strict controls globally to prevent and detect evasion of sanctions, wherever possible.”

A spokesman for Citigroup said the New York-based bank “takes financial crimes compliance very seriously, diligently monitoring and adhering to guidance from relevant governments and other verified sources to assist in protecting the international financial system from abuse by illegitimate front companies or other illicit actors.”

Hard to police

Yet executives close to the banks say privately that policing is easier said than done. The banks have invested billions in sophisticated computer systems to root out suspect transactions and have hired armies of financial crimes specialists. Still, the Iranians are often one step ahead of them.

“It’s difficult to know when we’re being abused,” an executive at one of the banks acknowledged. “The people that do this professionally know the jurisdictions that don’t cooperate with U.S. authorities, so there’s regulatory arbitrage here as well.” 

It’s not clear to what degree the specific transactions reviewed by POLITICO may have breached American sanctions.

A spokeswoman for the U.S. Treasury did not comment on the specific banks cited by POLITICO, but said that the authority has a long record of closely monitoring compliance with American sanctions against Iran and Russia and would continue to do so, including where it concerns financial institutions.

“Treasury will continue to target these sanctions evasion efforts to hide and move money through the international financial system, and financial institutions should continue to be vigilant against such schemes,” she said.

Violating U.S. sanctions has been extremely costly for European banks in the past. In 2014, for example, France’s BNP was fined $8.9 billion for running afoul of American sanctions against Iran and other countries. 

The EU lifted most financial sanctions against Iran as part of the 2015 nuclear deal, which European powers continue to observe. Nonetheless, for the most part, European banks have steered clear for fear of exposure to U.S. sanctions. 

While national regulators in Europe are responsible for overseeing their banks, it’s up to the European Central Bank as steward of the common currency to police euro-denominated transactions that run through its settlement system, known as TARGET2. 

Critics accuse the central bank of turning a blind eye to abuse of its settlement system. Asked by POLITICO how the ECB policed its settlement network and if the bank was aware of illicit activity involving Iranian front companies and eurozone banks, a spokesman said: “The ECB enforces EU sanctions, and not sanctions imposed by non-EU jurisdictions. As regards EU sanctions, the ECB ensures that TARGET2 does not settle transactions that fall under the sanctions.”

Yet even if undertaking financial transactions with Iranian interests isn’t a violation of EU sanctions, European regulations aimed at combating money laundering require banks to conduct thorough checks into the identity of their customers, a standard called “know your customer.” The EU’s deficiencies in that regard have been apparent for years. In September, the European Banking Authority, which coordinates regulation in the sector, said that officials across the region “need to do more” to combat illicit activity in Europe’s financial system.

Until that happens, Western diplomats say, Iran will continue to use Europe’s financial infrastructure without fear of detection, an example they say Russia is bound to follow.  

 “This is not a loophole in the wall,” one of the officials said. “There is no wall.”