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In January 2019, France, Germany, and Britain announced the creation of a new payment-processing system designed to keep alive the Joint Comprehensive Plan of Action (JCPOA), also known as the Iran deal. The Instrument in Support of Trade Exchanges (INSTEX) is a European-government-controlled Special Purpose Vehicle (SPV), a legal entity created specifically to allow companies based in the European Union—and, in the future, potentially elsewhere—to continue to engage in business with Iran without running afoul of U.S. sanctions.
When President Trump withdrew from the JCPOA in May 2018, the United States not only reimposed on Iran the sanctions that existed prior to the agreement but also added new sanctions. As Hilary Hurd noted on Lawfare, “An estimated 700 individuals, entities, and aircraft are now subject to U.S. sanctions, including over 300 targets not previously sanctioned and more than 50 Iranian banks and their foreign subsidiaries.” European countries were incensed and began to openly discuss ways to help companies circumvent U.S. sanctions and thereby preserve the deal. The result was INSTEX.
INSTEX still faces numerous hurdles in its quest to provide Iran sufficient economic benefits to keep the JCPOA alive. But if it is successful, it will create a road map that other countries can use to bypass U.S. sanctions, which could dramatically reduce the effectiveness of U.S. international economic policy.
In their standard form, sanctions prevent entities that are subject to a country’s laws from doing business with a sanctioned entity. But U.S. secondary sanctions go further, prohibiting U.S. companies and banks from doing any business with third-country companies that do business with sanctioned entities. This allows the U.S. to impose sanctions on companies that are not subject to U.S. jurisdiction. This is why Huawei’s Chief Financial Officer Meng Wanzhou was charged with bank fraud: According to the Justice Department, Meng lied to a U.S. bank about Huawei’s business with Iran, putting the bank at risk of violating U.S. law.
This essentially creates a choice for multinational companies: Do business with Iran or do business with the U.S. But the choice is actually more extreme than that due to the importance of the U.S. dollar as the world’s reserve currency. Transactions of all types, all over the world, are conducted in dollars, and many of these transactions—even if they do not have any other connection to the United States—run incidentally through U.S. banks, exposing their makers to U.S. sanctions through fleeting contact.
The extraterritorial impact of U.S. sanctions is magnified by their effect on a private Belgian company called SWIFT. SWIFT provides a messaging system that connects more than 11,000 banks all over the world, allowing for universal money transfers. As a Belgian company, SWIFT is not subject to U.S. jurisdiction or direct U.S. sanctions. But the U.S. has threatened to impose sanctions on SWIFT itself if it does not disconnect sanctioned Iranian banks from its networks. As a result, SWIFT has, reluctantly, agreed to remove sanctioned Iranian banks—including Iran’s central bank—from its systems, cutting them off from one of the core mechanisms of global finance and making it exceedingly difficult technically for them to engage in financial transactions with most of the world’s mid-sized and large financial entities. But SWIFT did so under protest, noting that while in 2012 it complied with EU sanctions on Iran because it is subject to EU jurisdiction, its compliance with the 2018 sanctions was “regrettable” and “taken in the interest of the stability and integrity of the wider global financial system.” And European leaders began to seek an alternative to SWIFT that could facilitate commerce with Iran without falling victim to U.S. pressure.
The International Reaction, Step 1: the EU Blocking Statute
Unilateral, extraterritorial U.S. sanctions have long been controversial (at best). Other countries argue that such sanctions represent an improper extraterritorial imposition of U.S. law; that they violate international law, including World Trade Organization (WTO) law and the U.N. Charter; and that they threaten the international trading system. As a reaction to the reimposition of U.S. sanctions, the EU revived its 1996 blocking statute, which makes it illegal for EU companies to comply with specified extraterritorial U.S. sanctions. The blocking statute requires EU persons and companies to (1) inform the European Commission of any harms the company faces due to other countries’ extraterritorial application of specific sanctions laws, which are identified in the blocking statute’s annex (theoretically this allows the statute to apply to any country’s extraterritorial sanctions, but it currently includes only U.S. laws), and (2) not comply with those laws or with international court decisions stemming from them. The statute creates an extremely broad cause of action for damages for EU persons in the courts of the bloc’s member states to recover any damages, including attorney fees, from any person (presumably, any person over whom the court has jurisdiction), caused by compliance with the specified sanctions laws. It also prohibits EU courts from enforcing judgments stemming from those laws obtained in other jurisdictions. However, it does allow for limited waivers “to the extent that non-compliance would seriously damage their interests or those of the Community,” based on a set of criteria.
The blocking statute was originally passed in response to extraterritorial U.S. sanctions on Cuba and Iran, specifically the Helms-Burton Act, which codified and expanded the U.S. embargo on Cuba, and the Iran and Libya Sanctions Act. It has seen some use; for example, in 2007 the Austrian government charged an Austrian bank with violating the statute when it canceled bank accounts for Cuban citizens as part of its acquisition by a U.S. hedge fund. (The case was dropped when the hedge fund was able to obtain a special license from the U.S. government to keep the bank accounts open.) However, the statute has not been significantly tested because in 1998 the U.S. agreed to waive the most objectionable sanctions. The new regulation, passed in June 2018, gives the statute new life by extending it to the sanctions the Trump administration brought back when it exited the JCPOA.
But ultimately, despite the blocking statute, EU companies—as well as companies from other countries, including major Chinese state-owned enterprises and Russia’s Lukoil—have largely complied with the reimposed U.S. sanctions, announcing plans to pull out of intended projects in Iran. This includes expected billion-dollar investments from French company Total and German conglomerate Siemens. Although this puts the companies in direct violation of the EU blocking statute, the statute is unlikely to be vigorously enforced, as it would put EU companies in a no-win situation. In a battle between complying with the EU blocking statute and complying with U.S. sanctions, the EU and its companies have largely given way to the U.S.
The International Reaction, Step 2: INSTEX
This is where INSTEX comes in. INSTEX is essentially a barter system that allows companies in the EU, and potentially elsewhere, to completely avoid the U.S. financial system by eliminating cross-border payments. Per the Financial Times:
Under this model, a European fuel trader buying Iranian oil could be matched with a European manufacturer selling machinery to an Iranian company. The European oil buyer would not pay the Iranian seller but would instead send its payment to the European manufacturer. At the same time in Iran, the Iranian machinery buyer would not pay the European seller but would instead send its money to the Iranian oil seller.
INSTEX provides a mechanism to enable transactions with Iran, allowing such transactions to take place in the absence of SWIFT and other typical payment systems. Theoretically, INSTEX will allow any interested companies to continue doing business with Iran without engaging in sanctionable conduct.
It’s unclear whether INSTEX will be successful. The legal and technical details of INSTEX’s functioning remain undefined, and Iran will have to overcome political opposition to set up its own mirror-image version of INSTEX. The EU has been discussing creating an alternative payment system for months, but the process was delayed because no EU country wanted to risk U.S. wrath by hosting the instrument. INSTEX is expected to start small, working with only small- and medium-sized companies that do no business with the U.S. and confined to the realms of food and medicine. And large multinational companies are still extremely hesitant to sign on for fear that U.S. sanctions authorities will find a way to punish them despite technical compliance.
Even if INSTEX fails, it seems certain that the international desire for a dollar-independent payment system will only grow as the U.S. continues to expand its extraterritorial economic policies—a trend that did not begin with Trump but that has accelerated under his administration. Consider Title III of the Helms-Burton Act, which allows U.S. citizens to sue foreign entities over property confiscated in the 1959 Cuban revolution. Every president since the act’s passage in 1996 has waived the provision due to the immense ramifications—in terms of both international reaction and the technical burdens on U.S. courts—of making billions of dollars in foreign-company funds susceptible to confiscation. But in January 2019, Trump suggested that he was considering ending the waiver, and on March 4, Secretary of State Mike Pompeo announced that the administration would be suspending the waiver for Cuban-owned entities. While this suspension does not currently permit suits against non-Cuban companies, administration officials suggested that more significant steps could be forthcoming, potentially including fully terminating the waiver and exposing non-Cuban companies to suit in U.S. courts. This move, should it occur, would cause international interest in alternatives to the U.S.-centered financial system to reach a fever pitch.
Eventually, projects like INSTEX could have a dramatic effect on the United States’ ability to effect change through sanctions. While the effectiveness of sanctions in general is hotly debated, there is no doubt that if other countries are able to create U.S.-independent financial systems, the international influence of U.S. economic policy will decline precipitously. This could eventually even threaten the central role that the United States plays in the global economy—a role that many economists believe has proven essential to the growth and stability of the U.S. economy in recent decades.
At the moment, dollar dominance seems safe; INSTEX is a small, tentative step. Disentangling even a small portion of global commerce from the U.S. would be a major undertaking, and at the moment there are no ready alternatives. But the fact that the EU has actively put into effect a potential path to help companies avoid U.S. sanctions, after decades of complaining about U.S. extraterritoriality, suggests that other countries are ready to do more than talk.
U.S. policymakers may be underestimating the importance of the dollar’s reserve-currency status in keeping U.S. borrowing costs low, magnifying the effects of U.S. economic policy, protecting the U.S. economy, and bolstering U.S. foreign policy. The fact that international distaste is beginning to bubble over into action should be a warning sign.