New Iran Sanctions Threaten Foreign Banks’ Access to the United States, Impose Strict Measures on Financial System of Iran

January 4, 2012

Overview

On December 31, 2011, President Obama signed into law new sanctions against Iran.  The new measures (1) enable the President to deny foreign banks access to the US  financial system if they are found to be doing certain business with Iran, (2) enhance restrictions on Iran’s financial sector, and (3) freeze the assets of Iranian financial institutions.  Section 1245 of the National Defense Authorization Act for 2012, H.R. 1540 (NDAA), which establishes policy for the military and related programs, serves as the vehicle for these measures. 

The significance of the new sanctions is clear.  For the first time, the US is targeting third-country foreign financial institutions, including central banks, that conduct “significant” or petroleum-related business with the Central Bank of Iran (CBI) or other Iranian financial institutions.  Because the CBI is the primary financial conduit for Iran’s petroleum-related transactions, and because Iran is the world’s third-largest exporter of crude oil, the risks posed to foreign financial institutions are considerable.  Notably, the new sanctions require no separate and additional nexus to the United States market as a pre-condition for the imposition of sanctions.

This measure follows the publication of a November 8, 2011 International Atomic Energy Agency (IAEA) report describing Iran’s nuclear activities in potential violation of its commitments under the Nuclear Non-Proliferation Treaty.  As described in our previous advisories, immediately following the IAEA’s report, the United States, the United Kingdom, Canada and the European Union expanded existing sanctions on Iran.[i]   The NDAA, by potentially imposing secondary sanctions on other countries’ financial institutions for engaging in any “significant financial transaction” or petroleum-related transaction, goes considerably further than these previous efforts.

Denial of Foreign Banks’ Access to the US Financial System

The most far-reaching aspect of the new sanctions is a requirement that the President forbid the opening and prohibit or impose “strict conditions” on the maintenance of US correspondent or payable-through accounts[ii] by third-country foreign financial institutions[iii] that the President determines have knowingly “conducted or facilitated any significant financial transaction” with the Central Bank of Iran (CBI) or Iranian financial institutions that have been listed as Specially Designated Nationals (SDNs) by the Secretary of the Treasury.  See NDAA § 1245(d)(1)(A).  The provision comes into effect 60 days following the enactment of the NDAA.

One limitation is that the provision only allows such prohibitions or strict conditions on government-owned or controlled banks, including central banks, if such banks engage in transactions involving the sale or purchase of petroleum or petroleum products to or from Iran.  This section provides for a 180-day grace period after the NDAA’s enactment after which such transactions are sanctionable. NDAA § 1245(d)(3).

Further, out of concern over possible increases in global oil prices and the ability of foreign financial institutions to avoid transacting with the CBI given other states’ reliance on Iranian oil, the NDAA requires several findings to be made before foreign financial institutions can be sanctioned for involvement in the purchase of Iranian petroleum and petroleum products.  No later than 60 days after the NDAA’s enactment, the Energy Information Administration, an independent government agency, along with the Departments of State and Treasury and the Director of National Intelligence, must submit a report to Congress on the availability and price of petroleum and petroleum products produced outside of Iran during the past 60 days.  No later than 90 days after the NDAA’s enactment and every 180 days thereafter, the President must determine from these reports whether the quantity and price of petroleum and petroleum products produced outside Iran are sufficient to allow buyers of Iranian petroleum and petroleum products to “significantly” reduce their purchases from Iran.  If the President so finds, then the foreign banks’ conduct or facilitation of financial transactions pertaining to Iranian petroleum commodity purchases or sales can trigger the sanctions pertaining to correspondent and payable-through accounts.  The sanctions apply to such transactions occurring 180 days or more after the NDAA’s enactment.  

Exceptions and Waivers to the Imposition of Third Party Foreign Financial Institution Sanctions

The NDAA creates an exception to the application of these sanctions if the President reports within 90 days of the initial availability determination and every 180 days thereafter that the country with primary jurisdiction over the foreign financial institution has significantly reduced its purchases of Iranian crude oil from the time of the last report. §1245(d)(4)(D).  Another exception exists for conducting or facilitating transactions for the sale of food, medicine or medical devices to Iran.  §1245(d)(2).

In addition, the NDAA allows the President to waive the imposition of sanctions for a renewable period of 120 days on national security grounds.  To do so, the President must submit a report to Congress justifying and explaining any international cooperation the President expects to receive as a result of such a waiver. §1245(d)(5).

Freezing of Assets of Iranian Financial Institutions

Section 1245(c) of the NDAA requires the President to block and proscribe all transactions in the property and interests of property of Iranian financial institutions in the United States, or that come within the control of the United States or a US person.  This provision, invoking the authority of the International Emergency Economic Powers Act, 50 U.S.C. §1701 et seq. (IEEPA), appears to have an effect similar to designating all Iranian financial institutions as Specially Designated Nationals.  Although US financial institutions are not allowed to conduct business with Iranian banks, the provision is significant because not all Iranian banks are actually listed as SDNs.  Thus, while such Iranian banks could not be transacted with directly, their property was not previously subject to an asset freeze.

Designation of Iran’s Financial Sector as a Jurisdiction of Primary Money Laundering Concern

Another provision of the NDAA designates the entire Iranian financial sector, including the CBI, as a Jurisdiction of Primary Money Laundering Concern under Section 311 of the Patriot Act, 31 U.S.C. § 5318A, due to its efforts to finance illicit nuclear activities and international terrorism, deceive responsible financial institutions, and evade sanctions.   This provision of the NDAA codifies the Treasury Department’s previous designation of Iran as such a jurisdiction on November 25, 2011.  The Treasury Department’s Section 311 designation is discussed further in our November 2011 advisory.

Multilateral Diplomacy and Implementation

The NDAA further instructs the President to continue diplomatic efforts to convince nations purchasing Iranian oil to persuade Iran to limit its use of petroleum revenues to non-luxury consumer goods and to prohibit Iran from purchasing military or dual-use technologies.  The President is also requested to encourage petroleum-producing countries to increase their crude oil production so as to mitigate any price increases arising as a result of the NDAA’s sanctions. § 1245(e).  Under § 1245(g) of the Act, the President is empowered to implement and enforce its provisions under authorities granted under IEEPA, including through the application of IEEPA’s penalty structure.

Observations

Imposition of Sanctions

The new Iran sanctions of the NDAA represent a compromise between the Congress and the Administration, which had expressed skepticism of such legislative action.  Administration officials had indicated their view that the measure, at least as initially drafted, risked boosting Iran’s oil revenue, alienating allies and unduly restricting the President’s flexibility to conduct foreign affairs.  The original Senate provision, for instance, allowed waivers only upon a finding of a “vital” national security interest (as opposed to the current “national security interest”) and flatly prohibited the opening or maintenance of correspondent and payable-through accounts for subject banks (as opposed to allowing the option of “strict conditions”).  As passed, the new sanctions thus provide for greater Presidential discretion.

Yet this history leaves open the question of how vigorously the new sanctions will be administered.  As with other Iran sanctions legislation, Congress has often appeared to be more aggressive than the President.  For instance, as our previous advisory discusses, the Iran Sanctions Act of 1996, authorizing the President to sanction firms investing in Iran, resulted in the first imposition of sanctions in October 2010.  In addition, while signing the bill, the President issued a signing statement in which he expressed the view that § 1245 could interfere with his constitutional foreign affairs authorities, and that in the case of conflict the Administration may treat the provisions as “non-binding.”  How aggressively any Administration will invoke these new authorities and under what conditions will thus be a closely-watched question.

Definition of Key Terms

Also unclear are certain key terms of §1245, several of which, such as “strict conditions” and “significant financial transactions”, are undefined in the NDAA.  It is possible that such terms will be substantially similar to the same terms as used in the Iranian Financial Sanctions Regulations, 31 C.F.R. 561.  This is because §1245 of the NDAA and the IFSR identify similar sanctionable financial activity, appear to share the same definition of foreign financial institutions, and employ similar sanctions for engaging in proscribed behavior. 

As described in further detail in our advisory on the IFSR, “strict conditions”, as defined in 31 C.F.R. 561.201(b), can include, but are not limited to: 

  • Prohibiting trade financing through a foreign financial institution’s account

  • Restricting the types of transactions that may be made through foreign financial institutions’ accounts, such as allowing only personal remittances

  • Imposing monetary limits on transactions processed through the account

  • Requiring approval from the US institution for all transactions

As for the meaning of a “significant financial transaction” that could trigger sanctions, 31 C.F.R. 561.403, is potentially instructive.  Factors that may influence such a consideration include:

  • The size, frequency and number of transactions

  • The nature, type, complexity and purpose of the transaction or service

  • The degree of awareness and pattern of conduct

  • Whether they are part of a pattern of conduct or the result of a business strategy

  • The impact of the transaction or service in light of the goals of the legislation

  • The use of deceptive practices

Other important interpretive questions, however, such as what constitutes a “significant” reduction in Iranian crude purchases, appear to remain subject to future decision-making.

Implications for Trade Sanctions Reform and Export Enhancement Act and Other Licensed Transactions

The requirement in §1245(c) that the President block all property and interests in property of Iranian financial institutions and prohibit all dealings with them raises questions about how US persons will be able to conduct transactions under the Trade Sanctions Reform and Export Enhancement Act, 22 U.S.C. 7201 et seq (TSRA), or other dealings for which they have received a license, or that are exempt from other prohibitions on trade with Iran.

Currently, TSRA allows US persons to apply to the Treasury Department, Office of Foreign Assets Control (OFAC) for licenses to export agricultural products, medicines and certain medical devices to Iran and to engage in transactions, including financial transactions, ordinarily incident to such sales. Other licenses are also available, as are exemptions to the Iranian Sanctions Regulations, 31 C.F.R. 560, that allow for certain transactions without a license. While it does not appear that it was Congress’ intent to repeal these exemptions or revoke licensed transactions, this issue is not specified in the NDAA.

Additional Sanctions Likely Forthcoming

The US House of Representatives has recently passed additional measures targeting Iran, including denial of visas to Iranian government officials with ties to terrorism (H.R. 1905) and an extension and strengthening of non-proliferation sanctions (H.R. 2105).  The US has also continued to engage in diplomatic efforts to enhance multilateral and additional bilateral sanctions on Iran.  Although the NDAA’s far-reaching provisions may not be welcomed by all countries the US seeks to convince in joining these efforts, it is possible that they may have their intended effect, and may help spur countries to impose additional restrictions on conducting business with Iran.  The European Union, for instance, recently announced that it has decided, in principle, to impose an embargo on Iranian oil. Iran’s continued nuclear activities are themselves likely to cause considerable additional concern in the international community as well.  These dynamics suggest that while the NDAA’s provisions may be the latest and strongest measures against Iran, they will not be the last.

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We will continue to keep you apprised of developments regarding sanctions against Iran. If you have questions about this advisory or related sanctions questions, please contact Ed Krauland at 202-429-8083, Rich Verma at 202-429-6452, Meredith Rathbone at 202-429-6437, Jack Hayes at 202-429-6491, Julia Court Ryan at 202-429-6418, or Michael Lieberman at 202-429-8064 in our Washington, DC office, or David Lorello at +44 20 7367 8007 in our London office.



[i] The United States had also previously issued a similar set of sanctions, the Iranian Financial Sanctions Regulations, 560 C.F.R. Part 561 (“IFSR”), pursuant to the Comprehensive Iran Sanctions, Divestment and Accountability Act, P.L. 111-195 (July 1, 2010).  As described in our previous advisory, the IFSR authorizes the Treasury Department to prohibit a non-US bank from having/maintaining a correspondent or payable through account with a US bank, or place certain “strict conditions” on any such existing account of a non-US bank for facilitating Iran’s efforts to obtain weapons of mass destruction (WMD) or WMD delivery systems, or international terrorism; or facilitate significant transactions or financial services for the Islamic Revolutionary Guard Corps (IRGC). 

[ii] These terms are defined according to 31 U.S.C. §5618A.  A “correspondent account” is one that is “established to receive deposits from, make payments on behalf of a foreign financial institution, or handle other financial transactions related to such institution”.  A “payable through account” is one that is “opened at a depository institution by a foreign financial institution by means of which the foreign financial institution permits its customers to engage, either directly or through a subaccount, in banking activities usual in connection with the business of banking in the United States,” including a transaction account as defined in section 19(b)(1)(C) of the Federal Reserve Act.

[iii] Under the Iranian Financial Sanctions Regulations, 31 C.F.R. 561.308, applicable here, this term has been defined to include, but not be limited to: depository institutions, banks, money service businesses, trust companies, securities brokers and dealers, commodity futures and options brokers and dealers, securities and commodities exchanges, clearing corporations, investment companies, employee benefit plans, and holding companies, affiliates, or subsidiaries.