Will enforcement of US sanctions reshape how US-dollar transactions are cleared? 




Banking reforms in the wake of the 2008 global financial crisis have been singularly focused on preventing systemic risk in a market or across markets. Penalties for US sanctions violations that introduce that risk into the US-dollar clearing market would seem a step too far. Restricting US-dollar payments as a basic foreign policy tool should not work at cross purposes with global financial stability goals.

The size of the US economy dictates that a sizeable portion of global products and services are purchased in US dollars. Companies not only trade goods in US dollars, they purchase raw materials and supplies in US dollars and, because they do, they borrow and raise US dollars to fund those purchases and their operations. The US capital market is undoubtedly the broadest in the world. Markets for many commodities, such as oil, trade virtually exclusively in US dollars. That volume of trade and finance makes the US dollar in the form of US government securities attractive to sovereign nations as the preferred reserve asset. Enforcement actions against banks for US sanctions violations are unlikely to change the US dollar’s inherent liquidity and its prevalence as the global medium of exchange. And, while such actions may spur calls for an alternative global reserve currency, replacing the US dollar would be a long-term effort. The more immediate concern is that monetary and other penalties may cause one or more banks that serve to enable the flow of US dollars to withdraw from the market, which would give rise to a more concentrated payments system, and thereby, one more susceptible to systemic risk.

Large global US and non-US banks perform the important function of processing payments to facilitate the flow of US dollars. From offices in New York City, they process US dollars for multinational corporate clients, sovereigns and as correspondents for other banks too small to do so on their own. Serving as a processor of US-dollar payments is an expensive task. Systems must be maintained and must be reliable. The trillions of dollars that transfer into and out of New York City daily can make US-dollar clearing a profitable venture. It is, however, priced as a commodity business with low profit margins that require volume to justify the capital investment needed. Compliance with US laws and regulations, including those relating to money laundering and sanctions, must and should be a necessary cost of conducting US-dollar clearing for any business in the United States. Violations should not be countenanced. There is a question, however, of whether penalties that not only involve stiff monetary fines but require suspensions and limits on how future business is to be conducted will motivate others in the wholesale US-dollar payments market to retreat from that business. Are the risks getting too high?

Penalties should take into account the potential for resulting systemic risk. A first priority should be to require violating conduct to be ceased and plans implemented to avoid its recurrence. That, historically, has been the consistent approach of US banking authorities in addressing violations of US anti-money laundering laws and US sanctions. Corrective actions have required independent reviews; increased managerial oversight; improved policies, procedures, systems and monitoring; and enhanced supervision by US banking authorities for an extended period. The goal would and should be to have adequate systems and controls in place to ensure that US activities fully comply with US laws.

Required remedial actions may serve to deter future wrongdoing. Care should be taken, however, to limit remedial actions to the offending conduct rather than to alter the market in which the conduct occurred. Remedial actions that prove so troubling as to prompt participants in a market to consider exiting that market would seem a step too far.

Requiring a foreign bank to ring-fence activities subject to host-country law in the host country facilitates supervision by host-country authorities. It may be one thing to impose ring-fencing requirements on foreign banks to maintain competitive equality between home- and host-country banks and pursuant to regulations that have been subject to public comment, but quite another to introduce them in an enforcement context. That seems particularly true where the ring-fencing requires a non-US bank to oversee compliance with US laws by its offices worldwide from the United States. One cannot help but wonder to what extent use of this type of special requirement in enforcement actions may affect the US banking market. Will some foreign banks convert their US branches into subsidiary banks? Will others ‘debank’ – that is, give up deposit-taking in the United States and conduct financial activities through non-bank subsidiaries? Will non-US banks give up participating in US wholesale payments systems?

Punitive consequences may be an effective way to communicate the authorities’ lack of tolerance for violations. Increases in monetary penalties assessed can be used to signal the importance of compliance. That message, however, may be lost if the fines reach levels that hasten others to depart from the market. Penalties that eliminate a global bank’s entire annual profits, require elimination of dividends to shareholders, force asset sales or require significant additional capital to be raised may be at that point. That penalties have reached the point of creating instability in a global market, such as US-dollar clearing, is disconcerting.

It may be that US-dollar clearing is a necessary service that large internationally active banks must be able to offer their clients, and it may be that having to do so through correspondent banks would jeopardise those client relationships. Recent penalties, however, may prompt even seemingly captive banks to explore alternatives. Developing a viable alternative to the US dollar as the global medium of exchange may take some time. But potential is visible on the horizon. Traditional currencies, such as the renminbi and the euro, may be groomed to take on that role, as the former takes on a singular form that facilitates its use, export and repatriation within and outside China, and the latter begins to benefit from consolidated supervision of banks in the community. There is early promise too that the protocols underlying cybercurrencies may one day offer a cost-effective, globally accessible payment system. Those efforts cannot negate the fact that the United States has broad, perhaps unrivalled, capital markets that can easily absorb liquidity. Mirroring that will take much more than the commitment to making it so.

Market participants may begin to consider nearer-term alternatives. One thought may be to establish additional US-dollar payment systems in a major European city or elsewhere outside the United States. Such an alternative host for US-dollar clearing activities would have its own anti-money laundering laws and sanctions against other nations to be complied with. Interestingly, the reaction many years ago to US regulations setting the requirements for compliance with US sanctions, and later with US economic and tax regulations, was one factor that motivated the development of the eurodollar market.

One can envision it not taking all that long for countries and international banks to create a non-US alternative venue to clearing US-dollar payments in the United States. US dollars are widely held outside the United States. US dollars needed by clients to fund activities and operations within and outside the United States could be cleared and transferred as they are now, only the payments would not run through New York City.

Placing a significant deterrent on violations of US sanctions is a worthwhile goal. Compromising US-dollar clearing systems seems less so. Exceedingly punitive penalties may foster the development of payment systems that avoid the US dollar or the United States. It is hard to see how that would be a good thing for New York, the US banking system or even the US government’s effort to use sanctions to prompt countries to cease offending conduct. One would hope that the US authorities recognise that. But should enforcement actions indicate otherwise, it would not be surprising to see non-US banks begin to explore US-dollar clearing alternatives with increased earnest.


Ernest T. Patrikis is a partner at White & Case LLP. He can be contacted on +1 (212) 819 8200 or by email: epatrikis@whitecase.com.

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Ernest T. Patrikis

White & Case LLP

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