Thursday, July 17, 2014

BNP Paribas and U.S. sanctions – A story about embargo, satellites, popcorn, and a lot of money

A satellite is an artificial body placed in orbit around the earth or another planet. It collects and/or communicates information.

BNP Paribas (BNPP) used satellites (not the ones in the orbit, but “satellite banks” - That is, at least, how they called them.) to pass money from sanctioned clients through U.S. payment systems. Compared to real satellites, satellite banks had slightly different function: They perhaps collected information but should absolutely not communicate it, at least as regards the origin of payments. It might have been more appropriate to call the banks “popcorn banks”: You fill them with corn and they give you back corn; simply, you cannot recognize it any more...

Let's go back to the hard facts: BNP Paribas has violated U.S. sanctions regulation by serving clients in Cuba, Iran, and Sudan through U.S. payment systems. To settle allegations, the bank will pay a fine of 8.8 BUSD to U.S. authorities.

There are many points you can discuss about this fine – the (high) amount, a possible extra-territorial reach of U.S. authorities, the countries involved, etc. I would like to focus here on the payment scheme that BNPP had implemented and explain how it worked.

Background – How work payment systems?

A payment is the process of transferring money from one person (the payer) to another (the payee). Payments are obviously crucial to any economy: If you can't pay, you can't sell or buy.

Payment is really simple if it is in cash. All you have to do is hand paper money or coins over to your counterpart. Payment, however, becomes more complicated when you don't pay in cash but via your bank account. Such non-cash payments follow three steps:

  • The payer authorizes the payment. To this end, he uses appropriate payment instruments such as credit transfers, credit cards, and cheques.
  • Banks exchange payment instructions. This is called “processing”.
  • The payer’s bank compensates the payee’s bank, either bilaterally or through accounts that the two banks hold with a third-party settlement agent. This is called “settlement”.

In practice and namely due to technological evolution, the limits between the three steps are blurred.

Let's have a closer look at the processing:

It is pretty easy if both payer and payee have accounts with the same bank. In this case, processing is a purely internal process, which depends on whether the bank holds accounts centrally in one location or in different locations.

Processing is a bit more complex if payer and payee don't use the same bank, namely if they are not based in the same country. Here, banks have two options: They can either hold accounts with a same third bank (called the correspondent bank) and pass the payment through that correspondent bank or participate in a common payment system.

Settlement can be done in central bank money or commercial bank money. In the first case, the respective banks of the payer and the payee simply hold accounts with a central bank or the payment system is operated by a central bank. In the second case, they hold accounts with a private commercial bank.

If this in not yet complicated enough, you can carry out the above steps in different countries. Every time this is the case, the respective country might want to regulate if and how funds pass through its jurisdiction. And this is where the BNPP story begins.

How to transfer USD to Sudan?

The normal way

Ibrahim is a Sudanese businessman. He is the CEO of an engineering company that works in the Sudanese oil sector. He needs some equipment that he wants to buy from a U.S. company in USD. Let's assume that he manages to get the equipment and now owes 1 MUSD to his U.S. supplier, a company called “Alaska”. How can Ibrahim pay Alaska, knowing that the U.S. forbids any financial services from or to Sudanese entities?

The normal way for Ibrahim to pay his U.S. supplier would be the following: Ibrahim instructs his Sudanese bank to pay Alaska through a credit transfer. If his account with the Sudanese bank shows sufficient credit, the Sudanese bank will send the funds to its account with a U.S. correspondent bank. This correspondent bank then transfers these funds internally to an account held by Alaska's U.S. bank. Finally, the U.S. bank will advise the correspondent bank to send the funds to a bank account held by Alaska in the U.S. Bank in the United States.

This is where U.S. sanctions regulation kicks in. According to such regulation, it is unlawful to process USD transactions with Sudan through the United States. The problem here is that the U.S. correspondent bank will see that the funds come from Ibrahim and his Sudanese bank. Possibly, they can also see why (“Payment of supply contract […]”) the payment has been made. “Seeing” should not be understood literally here; it's more about the U.S. payment system automatically scanning payment messages for illicit content and blocking those payments if it finds any.

The indirect way

How can you (say the Geneva subsidiary of BNPP) avoid the U.S. correspondent bank finding any critical information about Sudan? The solution is pretty obvious:

First, you change the originator of the payment by sliding one or more banks between the Sudanese bank and the U.S. correspondent bank. This way, the latter cannot see that the payment ultimately comes from Sudan. For example, the client's Sudanese bank holds an account with BNPP Geneva, which holds an account with another non-U.S. Bank, which holds an account at the U.S. correspondent bank, which transfers the funds to the U.S. client's bank's account with the U.S. correspondent bank, which transfers the funds to the account held by the final U.S. client.

Second, you wait some time between the different payments and don't mention the Sudan or Ibrahim in any payment message in the payment chain.

The solution is as if you were minor, want to buy alcohol, and ask your older brother to buy it for you, pretending that he buys for himself. But please don't instruct your brother in front of the store. Give the money a day before, at home...

Why so much money?

BNPP accepted a fine of a bit more than 9x the total market value of both World Cup finalist Argentina and Germany together!

The main reason why U.S. authorities claimed that much money is that BNPP knew that something was wrong. Admittedly so, initial legal advice seemed to have validated the “satellite banking system”. However, later on, there were numerous warning signs both from internal and external compliance counsel, that the scheme violated U.S. sanctions regulation.

What do U.S. Authorities think?

What does BNPP think?

What will change at BNPP?

The bank promises that “all USD flows for the entire BNP Paribas Group will be ultimately processed and controlled via the branch in New York”. It goes without saying that the bank will also enhance its compliance policies and procedures with regard to U.S. sanctions laws and regulations.

And “North America remains a strategic market for the Group where we plan to further develop our retail, investment solutions and corporate & investment banking franchise over the coming years”.


The documentation published by the U.S. Department of Justice publishes the documentaiton here. BNPP's announcement can be found here.