Chasing the Smugglers
States are turning toward the banking sector to help enforce export controls. But following the money is easier said than done.
The M600, manufactured by Moore Nanotechnology Systems in New Hampshire, is one of the world’s most precise Jig Grinders. Its spindle reaches speeds of 60,000 rotations per minute and can grind metal to sub-micron levels of accuracy, all without the need for human intervention. The M600 is, quite simply, the Rolls-Royce of drilling holes. It can be used to create all kinds of metal contraptions, from televisions parts to molds for credit cards.1 But, in the wrong hands, precision jig grinders can serve a more dangerous purpose: building nuclear weapons.2
Such “dual-use” technology, which has both civilian and military applications, is of great concern to the U.S. and its allies.3 They fear that various dual-use items, ranging from basic metal pipes to advanced microchips, can be repurposed against them by enemy actors. This is an ancient concern. The Roman Empire, for instance, forbid the export of weapons.4 But a more direct precedent to the modern era is the Dutch Republic of the 16th century, which required merchants to obtain ‘passports’ to ship certain strategic goods to foreign lands.5 This is similar to contemporary export control regimes, in which special licenses must be obtained before selling sensitive items abroad. Some items, however, can’t be sold at all. The EU has a disturbingly detailed list of torture devices banned from export, including guillotines, airtight vaults, and whips fitted with cat o' nine tails.
Russia’s invasion of Ukraine, and, more generally, the rise of China as a challenger to American hegemony, have triggered an unprecedented expansion of export control regimes. One example is the Global Export Control Coalition. Its 39 member states, led by the US and other members of the Five Eyes intelligence alliance, have collaborated on new lists of items deemed too sensitive for Russian export.6 The US has also taken steps to reduce China’s access to advanced semiconductor equipment and microchips capable of powering artificial intelligence.7
Like a fine wine pairing, these controls have been complemented by fresh rounds of economic sanctions. The lists are long. Large portions of the Russian economy are now off-limits. And don’t even think about trying to export guillotines or spiked shields from Europe to the China National Nuclear Corporation.8 Those days are long gone. And, indeed, today’s packages of sanctions and export controls constitute some of most comprehensive examples of economic statecraft in modern history. But defining such restrictions is one thing. Enforcing them is another.
Leaks in the Ship
In June 2022, Latvian and Estonian police arrested three individuals at the request of the U.S. Department of Justice.9 The DOJ alleges that this group conspired to smuggle a precision jig grinder to Russia. Their scheme was simple: export the jig grinder from Connecticut to Latvia, where it would then be re-exported to Russia for use in military applications. Authorities intercepted the jig grinder in Riga. But this is only a drop in the bucket. For every successful seizure, there are enormous volumes of dual-use goods evading sanctions and export controls.
The Financial Times, analyzing public trade data, found that approximately one billion USD worth of dual-use goods shipped from the EU to Kazakhstan, Kyrgyzstan, and Armenia disappeared in route. The implication is clear. Prohibited goods are making their way to the Caucasus and Central Asia, often referred to as the CCA, where they are then being smuggled into Russia. Research by Heli Simola of the Bank of Finland corroborates that, between the first halves of 2021 and 2023, EU exports of high-priority battlefield items to the CCA rose by 145%. CCA export of those items to Russia, in turn, rose by almost 1,500%.
Does this mean export controls and sanctions aimed at Russia are ineffective? That’s complicated. Policymakers often fail to establish the precise objectives of sanctions, making it difficult to measure whether they “work.”10 The same report by Simola finds that, though Russia is able to acquire dual-use goods via third countries, they are also paying steep mark-ups on those items. If these costs eventually make it prohibitively expensive for Russia to continue its invasion of Ukraine, perhaps it does not matter that massive quantities of dual-use goods are evading controls.11
But I am skeptical. The data seems to indicate that Russia is able to substitute many of its former exports via third-country supply chains and direct trade with China. Further, we can only see official customs data. This does not capture the large quantities of dual-use goods that are undoubtedly being smuggled to Russia through international trade routes. And, indeed, as I sit writing this post in The Hague, there is a very real chance that precision jig grinders or advanced radio equipment bound for Russia are hiding just a few miles away in the ports of Rotterdam. Thus there is good reason to believe that real evasion rates are much higher than estimated. And if those rates are so high as to render export controls ineffective, it is natural to question whether they are worth the costs they impose on innocent parties.12
Authorities on both sides of the Atlantic have acknowledged these issues. The US has sanctioned various actors alleged to form part of supply chains for evading export controls.13 And the EU is working to do what it does best: harmonize. It has set out new rules for exporters to maintain lists of dual-use goods and obtain authorizations for certain products. Another EU law will correct the concerning fact that sanctions evasion is not a criminal offense in some member states.14
But there was another step recently taken by U.S. authorities that deserves greater attention, one that seeks to improve the enforcement of export controls through a more subtle mechanism: following the money.
Following the Money
Smuggling dual-use goods is not just a matter of, say, hiding explosives in shipping containers between packages of milk powder.15 There is also the money. Funds have to change hands between different actors in the illicit supply chain, almost always through financial intermediaries.
Recognizing this fact, policymakers began placing pressure on banks in the early 2000s to employ their Anti-Money Laundering, or AML, controls to detect illicit activity occuring through international trade.16 The initial focus was on preventing terrorists from obtaining weapons of mass destruction. But monitoring for export control violations remained an obscure area of compliance, one that sat in the awkward space between legal obligations and best practices. In the US, for example, the form used by banks to report suspicious transactions did not, until recently, have a box to tick indicating that it related to export controls.17
This is now changing. In November, FinCEN, a department of the U.S. Treasury focused on financial crime, issued a joint notice with the Commerce Department on export control violations. The notice was aimed squarely at financial institutions, outlining certain red flags to look out for. This includes, for example, clients overpaying for goods or using atypical shipping routes.
But relying on financial institutions to detect export control violations is, to say the least, a problematic mechanism. As Maria Shagina recently summarized in an excellent op-ed for Foreign Policy:
“Merely shifting the compliance burden onto financial institutions will not automatically lead to fewer export control violations. Banks lack in-house technical expertise on weapons components, and while compliance departments are good at implementing know-your-customer rules, the software systems they employ are notoriously bad at identifying dual-use goods and capturing violations.”
Dr. Shagina is spot-on. But I think she is actually underselling her point. Asking private firms to follow the money of export violations is littered with pitfalls and practical challenges. And leaning too heavily on this mechanism could actually reduce the efficiency of law enforcement efforts. There is no better way to understand this than to put yourself in the shoes of the average compliance officer. Specifically, an officer at a hypothetical mid-sized bank specializing in trade finance.
FML Bank: “Connecting Business for a Better World”
The coffee machine is, as ever, broken. Milk is spewing from the wrong hole and there is a sticky brown substance growing in the spillover tray. After climbing to a different floor to use their machine, you saunter back to your desk, one of many within a grey, open-plan room filled with fluorescent light. You are not, of course, sitting in the bank’s flashy downtown headquarters. That’s for clients. Compliance has been placed in a separate building outside the city center, where your best view is a carpark and a line of perfectly spaced out trees.
Your first email is about Know-your-customer, or KYC, reviews, the process by which due diligence is performed on clients. There is a backlog. Hundreds of clients were supposed to have their annual reviews completed months ago. But you do not have enough analysts to process the volume. And those that you do have are unmotivated, bored by the monotony of this repetitive task.
They are also frustrated by the lack of procedural clarity. Do we need to get passports for all of the directors? What if the organizational structure chart is in Spanish? How much detail do we need for the Source of Wealth narrative? You wish you knew the answers to these questions yourself. But every email you send to your superiors seeking more clarity sinks to the bottom of the ocean with no reply.
Regardless, the Head of Compliance is pressuring you to speed things up. She has to provide a quarterly presentation to the executives, and if compliance is behind again there is going to be a shit show. Perhaps, she suggests, there is a way to reclassify the client risk ratings to juice the numbers. You roll your eyes, knowing that this will only kick the can down the road. Besides, you have a more urgent issue to discuss. One of the bank’s relationship managers, the staff who handle client business, has physically threatened your analyst for asking too many questions. Emails will be sent. But he is a top earner, so nothing will happen.
After having a tuna sandwich, you turn to screening. This is the step where you are supposed to screen clients and related parties against databases to identify whether they may have sanctions exposure. Because FML Bank specializes in trade finance, you have bought special software that scans documents, such as letters of credit, for signs of dual-use goods or other risk factors. The system is, however, producing tons of false positives that are wasting time and resources. You are also finding that the system is unable to interpret many of the trade finance documents because the scans are blurry or formatted strangely. Making matters worse, you just found out that the software’s list of dual-use items is out-of-date.
The transaction monitoring system is also a mess. International bodies like the FATF have issued “typologies” that describe signs to look out for. But these are often vague and difficult to implement in practice. You end up looking for basic red flags like clients who are suddenly making large payments to unknown parties. But when your analysts ask the relationship managers for context, they explain it away as simply “market conditions.” Your boss pressures you to accept this, as it will help boost the number of resolved alerts. When you do escalate an alert, it goes to a committee that includes a representative of the business unit. You are never told of the outcomes. All you can see is that the client continues to operate as usual.
Back to Reality
FML Bank is not an anomaly. Numerous banks have been fined for having insufficient controls in place to monitor for sanctions violations. And in some cases, banks have been found to be complicit in helping their clients evade detection. BNP Paribas, for example, was fined $8.9 billion for, among other things, intentionally helping their clients mask the involvement of sanctioned entities.
And while some large institutions have hired expertise in dual-use goods, it is worth remembering that this is a very small percentage of the industry. There are thousands of smaller banks involved in trade finance that lack basic AML controls, let alone the capacity to track shipping routes. The idea that these firms should be capable of deciphering the difference between propulsion engines is laughable.
But it is not just a matter of ineffectiveness. If regulators continue to apply export control rules to financial institutions, they will be put in a position of having to enforce those rules through costly monitoring exercises. Further, financial institutions may start engaging in ‘defensive reporting,’ in which they flood law enforcement with unhelpful reports that waste time and energy.
Thus rather than applying blanket expectations that cannot be fulfilled, policymakers should be more precise about how they “follow the money.” One group of scholars creatively suggests, for example, that marine insurance companies are in a better position than banks to spot signs of export violations. Such proposals deserve greater consideration. If designed carefully, they may help transform export controls from a blunt tool to the precision jig grinder of economic statecraft.
As alleged by the U.S. Department of Justice (DOJ) in United States v. Romanyuk et al. To be clear, the DOJ refers only to a precision jig grinder manufactured by a company in Connecticut. It does not specify which grinder; Moore Nanotechnology Systems’ M600 is referenced here only as an example of the technology.
Jig grinders appear to fall under Category 2 - Materials Processing of the U.S. Department of Commerce’s export control list. But please do correct me if I’m wrong, jig grinder export control experts of the world.
Joop Voetelink, International Export Control Law—Mapping the Field (p. 70).
Michiel de Jong, Arms Exports and Export Control of the Dutch Republic 1585–1621.
I like to think of this as the Turducken of sanctions/export control violations. Extra credit to anyone who notices this entity is on the non-SDN list.
This view was expressed by Daniel Fried, former Assistant Secretary of State for European and Eurasian Affairs, to Newsweek: “Export controls always work imperfectly. Period. But they don't have to work perfectly to be effective…An imperfect, leaky sanctions regime nevertheless imposes a cost on the Russian economy, and the military in particular.”
Another area with a huge literature. Nicholas Mulder provides a recent summary of the issue with respect to sanctions in Foreign Affairs.
That would be Estonia and Slovakia. If you are thinking about exporting torture devices to sanctioned Chinese entities, I guess these are lowest risk places from which to do so. Not legal advice!
The Lawfare Podcast: Assistant Secretary Matt Axelrod on Enforcing Export Controls