Argument

The United States Is Going After China’s Banks

Using the financial 'death penalty' may be dangerous overreach.

A investor monitors stock prices at a securities company in Hangzhou in China's eastern Zhejiang province on October 18, 2018.
A investor monitors stock prices at a securities company in Hangzhou in China's eastern Zhejiang province on October 18, 2018. STR/AFP/Getty Images

In the ongoing U.S.-China trade war, the treatment of Chinese tech giants such as Huawei and the plight of U.S. soybean farmers headlines the news. But the impact of a recent court ruling in Washington could open an expansive new front: China’s banks, and the thousands of businesses that depend on them.

On March 18, a federal court in Washington ordered Chinese financial giant Shanghai Pudong Development (SPD) Bank and two other Chinese banks to comply with a subpoena issued under the USA Patriot Act, and hand over to U.S. authorities bank records of a Hong Kong company linked to violations of U.S. sanctions on North Korea.

On June 25, the court found the banks in contempt for refusing to comply. The contempt order empowers the U.S. treasury secretary and the attorney general to terminate SPD Bank’s U.S. correspondent accounts. That step, pursuant to Section 319 of the Patriot Act, would end SPD Bank’s ability to conduct U.S. dollar-denominated transactions. In a global financial system still dominated by the almighty U.S. dollar, that sanction is known as a financial “death penalty.”

This wouldn’t be the first time the United States has used its financial dominance against a rival. Iran was cut off from the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the international transfer system, as part of U.S. sanctions. But this time, the fallout will not be limited to SPD Bank or the financial sector. The ruling has given the administration of U.S. President Donald Trump a powerful new weapon for its all-tools approach to China policy—leveraging all available authorities, including law enforcement, regulatory, and diplomatic means, to advance U.S. national-security and foreign-policy interests.

In February 2018, FBI Director Christopher Wray summed up the spirit behind the all-tools approach when he described China as a “whole-of-society threat” that requires a “whole-of-society response” from the United States. The idea behind this strategy, also referred to as “whole-of-government,” is that executive-branch agencies should get out of their silos and look beyond their own agency’s authorities and interests in resolving national-security problems beyond U.S. borders.

For example, in order to reach a Chinese company alleged to have violated U.S. laws, the Department of Justice would normally resort to a process known as “mutual legal assistance” to request assistance from the Chinese authorities to conduct the investigation and hope that the Chinese company might someday appear in a U.S. court. But the all-tools approach provides new angles of attack by blurring the distinction between different functions of the government: National security is trade is technology controls is financial regulation is law enforcement.

One of the most powerful tools to date has been the Commerce Department’s Entity List, an export control tool that prohibits exports of U.S. goods and technology to an entity that Commerce believes has or may act “contrary to the national security or foreign policy interests of the United States.” Consider Chinese telecom giant ZTE, an early example of the strategy in action. In March 2016, the Commerce Department placed ZTE on the Entity List based on its pattern of shipping goods of U.S. origin to Iran and North Korea in violation of U.S. sanctions and export control laws. The listing severed ZTE’s access to badly needed U.S .equipment and supplies, quickly bringing the company to the negotiating table.

The Commerce Department lifted the Entity List restrictions only after ZTE cooperated with a broad U.S. government investigation, eventually resulting in a $892 million settlement that combined penalties by the departments of Commerce, Treasury, and Justice. (The Commerce Department added an additional penalty of $1 billion and an intrusive compliance-monitoring arrangement in a second episode after ZTE violated terms of its plea agreement.) Using a regulatory mechanism like the Entity List to compel a foreign company to cooperate with a criminal investigation was virtually unheard of prior to ZTE, but it has since become de rigueur.

China has been the most frequent target of this silo-breaking approach. In support of U.S. national-security and economic goals, the Justice Department announced its China Initiative in November 2018, prioritizing the investigation and prosecution of Chinese companies’ theft of trade secrets, overseas corrupt practices, and potential threats posed by the Chinese sections of U.S. supply chains. In addition to the Entity List—which was also used against other Chinese tech giants such as Huawei and Fujian Jinhua—the Commerce Department has also increasingly employed the “Unverified List” (another export control tool that imposes strict licensing requirements on certain recipients of U.S.-origin goods and technology) to closely scrutinize how Chinese entities use U.S. goods. At the same time, the Commerce Department is overhauling U.S. export controls for “emerging and foundational technologies,” an effort likely to impose significant new limits on Chinese access to U.S. technology, and a multiagency committee has new powers to stringently review Chinese investments in the United States and block those that raise national-security concerns.

The Treasury Department is also an important player, given its authority to enforce sanctions regimes. The department employs a variety of means to force closure of U.S. correspondent accounts for foreign banks—in other words, impose the financial “death penalty.” It can apply so-called secondary sanctions on foreign banks for doing business with sanctioned entities. It can also designate a foreign bank as a “primary money laundering concern” under Section 311 of the Patriot Act, as it did in 2005 for Banco Delta Asia and in 2017 for Bank of Dandong, two smaller Chinese banks found to be facilitating transactions with North Korea. As China accounts for up to 90 percent of North Korea’s limited trade with the outside world, the Treasury Department’s enforcement of North Korean sanctions violations regularly entangles Chinese entities—as can be seen with SPD Bank.

But imposing the “death penalty” under these measures requires a reasonable basis for the action: for example, showing that the foreign bank was knowingly involved in the underlying violation or facilitated it. The recent Washington court ruling opens a more direct and expedient path and dramatically increases the breadth, reach and potential frequency of using this tool. Under Section 319 of the Patriot Act, it is not necessary to show the company knew it was violating sanctions; any foreign bank could lose its access to U.S. dollar end transactions when its only transgression is refusal to comply with a Patriot Act subpoena.

It is hard to overstate the potential implications of a readily available, broadly applicable new tool to impose the financial “death penalty.” Thus far, the “death penalty” has been rarely applied, and mostly to tiny banks—for good reason. Even the threat of cutting SPD Bank and the other two Chinese banks, each of which holds around a trillion dollars in assets, out of U.S. dollar transactions will likely cause a flurry of repositioning. Actually following through with the so-called death penalty may well throw segments of the global banking system into chaos.

To be sure, neither the U.S treasury secretary nor the attorney general has yet requested the “death penalty” against SPD Bank. And U.S. officials may face challenges in replicating the Washington court’s factually dependent ruling when a foreign bank challenges enforcement of a subpoena. But there is every indication that this newly available, more direct, and quite forceful tool for securing Chinese bank records will be put to use. US officials are under enormous pressure to further the Trump administration’s China agenda. And the U.S. government is frustrated with China’s refusal to cooperate through the formal process of mutual legal assistance. As the Washington court opinion revealed, in the past 10 years, only 15 of about 50 requests for Chinese bank records were honored and most of the 15 responses were late, incomplete, or otherwise unusable. It will be hard for U.S. officials to resist sidestepping that cumbersome process to force faster, more complete responses in support of its China-related investigations.

But this easier application of the financial “death penalty” comes with a significant risk: Chinese financial institutions could choose to opt out of the U.S. financial system. That end result is not far-fetched; a version of it is currently unfolding in Europe. Frustrated by U.S. efforts to reimpose Iranian sanctions by using the long reach of U.S. jurisdiction, European countries are in the process of establishing a separate entity to sidestep SWIFT, the longstanding Belgian-based but U.S.-influenced financial clearinghouse.

China may well do the same, establishing alternative channels of its own to stand apart from U.S. dollar-denominated transactions and diminishing the primacy of the U.S. dollar in the process. If China does manage to build a viable alternate financial ecosystem, it would diminish the importance of American banks around the world—the very source of the strength of U.S. economic sanctions.

The “death penalty” may yet be imposed on SPD Bank, but the imposition of that sentence could well spark further reconsideration of the role of the U.S. dollar in the global financial system. Given the risk, the financial “death penalty” must be applied judiciously and in a disciplined manner. Unfortunately, restraint has not been the calling card of the Trump administration. If U.S. officials are too zealous in using this new tool to further their enforcement agenda in China or elsewhere, the world may come to see the use of the “death penalty” as an unjust political tool, and another example of U.S. jurisdictional overreach. Other nations may move to distance themselves from the U.S. financial system—and in the process, weaken the place of the United States in the world.

 

Beau Barnes is an attorney at Kobre & Kim LLP based in Washington DC, with a practice focus on national security, economic sanctions, export controls and economic espionage.

Nathan Park is an attorney at Kobre & Kim LLP based in Washington DC, and an expert in East Asian politics and economy.

Wade Weems is an attorney at Kobre & Kim LLP based in Shanghai, China. He was a former U.S. Department of Justice prosecutor in the National Security Division in the Counterintelligence and Export Control Section.

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