Wednesday, December 27, 2017

“Wheat doesn’t grow in Dubai.” – How Cikinova sidesteps U.S. Sanctions on Iran

For those working in trade finance, there is a readable case currently pending with the U.S. Southern District Court of New York. Reza Zarrab and his business comrades are accused of having disobeyed U.S. Sanctions Regulations against Iran.

U.S. / Iran Sanctions Regulation

Before spelling out how Reza  how to sidestepped the U.S. sanctions, let’s first start by briefly describing what U.S. authorities aim at:

Since 1979, the U.S. considers that Iran constitutes a threat to its national security, foreign policy, and economy. Opening sanctions were endorsed in 1995. Then, in 2013, the U.S. Government laid out further details and inhibited

  • the exportation, re-exportation, sale, or supply,
  • directly or indirectly, from the United States, or a United States Person,
  • of goods, technology, or services
  • to the Government of Iran, whereby the U.S. Government set a list of entities constituting the Government of Iran,
  • including business affairs with a third country knowing that such goods, technology or services were destined to Iran or the Government of Iran,
  • without a license from the United States Department of the Treasury, Office of Foreign Assets Control (OFAC), bearing in mind that such exceptions could be general (i.e. authorizing some general types of transactions such as food and medical sales and exports for humanitarian purposes) or specific (i.e. authorizing specific businesses only).

Let’s clarify the most important thing right away: The case is actually not about a U.S. company exporting stuff to Iran, in contempt of applicable sanctions. It’s actually about Iranian companies selling stuff (namely oil and gas) to people (not even U.S. citizens) and getting US Dollars in return. This is enough for the U.S. to consider that U.S. financial services have been provided, so triggering a sanctions violation.

Zarrab’s Sanctions Violation – Step 1 – Paying through a web of companies

Let’s assume the National Iranian Oil Company (NIOC) wants to sell crude oil to an international buyer for USD. A simple USD transfer from the Buyer to NIOC cannot work. Indeed, the U.S. Bank processing the USD transfer would block the money transfer right away because NIOC is a sanctioned entity. The solution is palpable: Set up some companies in different countries acting on behalf of NIOC but not declaring NIOC as recipient.

This is what Reza Zarrab and his associates are supposed to have set up. They held companies in Turkey, the United Arab Emirates, Switzerland, Canada, China, and the U.K. and routed payments through these entities.

But here is the catch: How can you track payments if you don’t pay the right beneficiary and don’t refer to the underlying contract while making the payment? Zarrab’s response is a mix of

  • indicating references such as “transfer to MAPNA” [Mapna Group, the Iranian construction and power plant company] in the subject heading of the wire transfer;
  • sending separate Emails defining the purpose of the payments.

The more sophisticated banks’ wire transfer tracking software becomes, the less efficient the first solution gets. This is what happened in the Zarrab case: U.S. banks repeatedly froze payments because they tampered with U.S. Sanctions.

Zarrab’s Sanctions Violation – Step 2 – Stretching Exceptions

As written above, sanctions usually come with exceptions for food, medical exports, humanitarian aid and the like. The Zarrab clan used such exclusions extensively – unfortunately too extensively. Indeed, the defendants are accused of having produced falsified shipping documents. In addition, the U.S. pretends that they have colluded with bank officials who, regularly ask for shipping documents to process the payments. The Turkish Halk Bank is not named as such in court but, due to the name of the defendants involved as well as their functions, easily recognizable.

Here are some illustrations the U.S. Attorneys have produced in court:

On March 16, 2013, Reza Zarrab wrote to Halk Bank’s Mehmet Hakan Attila: “They’re gonna stop the gold in about a month and a half […] do food! Wherever you can provide a document from, do it.”

Another quotation from Zarrab is even more outspoken: “Wherever you can provide a document from, do it […] whichever way you provide it, provide it. Provide it to Cikinova [coded language meaning false documentation] and Cikinova will send it; it is not a problem.”

When fine-tuning customs documents and bills of lading, “inaccuracies” occurred:

I’m thinking it would be slightly difficult to carry [goods] weighing 140-150 thousand tons in things that carry five thousand tons. That’s not physically possible.”

They want to be able to determine that the product is food. […] The wheat’s country of origin is Dubai… I mean, it’s impossible for wheat to be originated from Dubai. […] The man says wheat doesn’t grow in Dubai.”

Zarrab’s Sanctions Violation – Step 3– Getting caught

How do you get caught? You get caught because you are selling your services to Iran and because you exchange with your clients and partners. Supplemental to the above, here are some examples the U.S. prosecutors have presented:

You also get caught because you have to bribe politicians and bank managers. Indeed, the former Turkish Minister of the Economy and the former general manager of Halk Bank are accused as well and supposed to have accepted millions of USD as bribes.

One final word: The above are allegations. You may guess that the defendants dispute the case. Let’s wait and see what will be the final court decision.


  • Indictment dated December 15, 2015
  • Indictment dated March 21, 2016
  • Superseding Indictment dated November 7, 2016
  • Sealed Complaint dated March 17, 2017
  • Superseding Indictment dated September 6, 2017

Sunday, December 3, 2017

Manias, Panics, and Crashes – Financial Crises forever!

Do you remember Occupy Wall Street? The people “fighting back against the corrosive power of major banks and multinational corporations over the democratic process and the role of Wall Street in creating an economic collapse that has caused the greatest recession in generations”?

They would probably be disillusioned upon reading “Manias, Panics, and Crashes”, the reference book on financial crises written by Charles P. Kindleberger and Robert Z. Aliber. Why? Because once you read this book, you will understand that the next crisis is already underway – it’s just a question of time…

The course of a financial crisis

Walking us through the history of many financial crises, the authors outline a typical financial crisis:

Phase 1 – Going up

Asset price increase

The cycle starts with cheap credit – lots of credit.

At the beginning, companies raise funds through hedge financing: Their operating income is more than sufficient to pay both interest and scheduled reduction in indebtedness. At one point in time, speculative financing kicks in: A company’s operating income is sufficient to pay interest but not the indebtedness itself. For the latter, the company must raise new money. The final stage involves so called Ponzi financing, meaning that the anticipated operating income is not enough to pay interest and/or principal. The company must either raise new financing or sell assets to pay back.

On the retail side, households see that others are profiting from speculative purchases and invest as well. Trading volumes increase.

The above trends then spread around – from one country to another, from one sector to another, from one asset class to another, etc. This process is often self-enhancing. Let’s take the example of money flows between countries:

  • The receiving country attracts foreign capital because its economy is booming.
  • The incoming capital leads to higher asset, especially stock, prices. Higher stock prices mean that raising capital for investment becomes less expensive. This further accelerates the economic boom.
  • The economic boom and higher asset prices lead to an increase in household wealth and this, in turn, favors household spending. This then further enhances the economic boom.

The result of the above is higher asset prices. The curve goes up.

At the end of phase 1, an increasing number of investors seek short-term capital gains from increases in prices of real estate and stocks rather than from the investment income based on the productive use of these assets. In other words, people want to earn money not through holding on to the asset but through re-selling it as soon as possible with a profit. This is the moment when the famous bubble builds up. The authors write about a “loss of touch with rationality”.

Can central bankers do something about it?

The short answer is: No. They can perhaps shorten the supply of money as such. However, financial history tells us that there are many close substitutes of money that people can revert to: credit in all possible forms, real estate, commodities such as gold, crypto currencies, etc. Every time the monetary authorities try to control the amount of money, people will circumvent that covert by producing more near-money substitutes.

How to detect a bubble

If we cannot avoid the next financial crisis, can we, at least, detect the bubble before it bursts? For stock markets, the authors give some hints: In the long run,

  • the level of stock prices should reflect the growth rate of GDP;
  • the profit share of GDP (= corporate profits / GDP) should be about 8 %;
  • the price / earnings ratio for stocks (= stock prices / corporate earnings) should be about 18x;
  • excesses in the debt / capital ratio of a large number of firms and individuals lead to financial distress.

Phase 2 – Stay high

During phase 2, we remain in the bubble but it stops growing. At the end, buyers become less and the sellers more eager.

Oftentimes, when prices stay high but don’t sprout any more, fraud and swindle spread around: As a matter of fact, when credit becomes scanty, people start using fraud to compensate. This is especially true in case of evergreen finance: This hints to the practice of loans being paid back not through earnings but through cash from new loans.

Phase 3 – Going down

In phase 3, both firms and individuals realize that it’s time to become more liquid, i.e. to reduce holdings of real estate and stocks, and increase holdings of money. Prices start declining and credit is nowhere.

At this point in time, a specific event (failure / bankruptcy of a specific bank or firm, namely one which has previously been thought successful; revelation of a swindle; sharp fall in the price of a specific security or commodity such as oil; an unanticipated devaluation of a currency; a war or other far-reaching political changes; etc.) precipitates the crisis. The bubble bursts. It has to be like this; bubbles always implode because, by definition, they involve a non-sustainable pattern of price changes or cash flows.

The panic is often magnified through international contagion. Indeed, only very few markets are completely separated. This is all the more true in today’s globalized 21st century. Financial crises either affect a number of countries at the same time or, alternatively, spread from the centers where they originate to other countries. The means of transportation can take various forms – commodities, bank deposits, bills of exchange, specie, and last, but not least, pure psychology.

Phase 4 – Going up again

At one point in time, public authorities will feel obliged to intervene to avoid further price decline. Without doubt, such intervention can create moral hazard:

  • Investors first benefit privately on the upside and then avoid losses on the downside through public intervention.
  • Today’s intervention might fuel the next future crisis.

Still, in practice, authorities always arbitrate to stop the panic. Kindleberger and Aliber write – “Today wins over tomorrow.”

Panoply of interventions

How can public authorities react? The book puts together possible measures which have been applied throughout financial history:

  • Formal deposit insurance
  • Informal state guarantee to cover losses if banks fail
  • Lender of last resort
  • Close banks or markets temporarily to take political, military, and other measures
  • Suspend the publication of bank / financial statements: “What you don’t know won’t hurt you.”
  • Set daily limits on the maximum change in commodity and other asset prices
  • Set a time out in financial markets whenever the imbalance between buy and sell orders becomes exceptionally large
  • Issuing clearinghouse certificates (= near-money substitutes which constitute the liability of a group of large banks or other financial institutions) for use by a bank which is under a bank run
  • Other forms of bank collaboration (loan funds, funds for guarantees of liabilities, arranged mergers of weak banks and firms, etc.)
  • Issuance of marketable securities to a firm in financial difficulty against appropriate collateral
  • Tighten financial regulation such as daily mark to market, reserves and write-offs of problematic loans, capital requirements as a percentage of assets or other liabilities

National and international lender of last resort

Who can intervene to stop a financial crisis? There are plenty national lenders of last resort in financial history. By contrast, international lenders of last resort are rather sporadic.

On a national level, the lender of last resort is either the treasury or central bank. The former can be less effective. By definition, a Government’s treasury cannot print money. This, indeed, makes it less flexible to meet any potential demand on the part of sellers. Is simply cannot buy once it has spent all funds and is unable to raise additional liquidity.

Financial crises oftentimes spread across countries, hence the need for an international lender of last resort. But such lender encounters several shortfalls:

  • There isn’t one unique world currency that could be used to face the financial crisis.
  • On an international level, there is no (or, at least, only a very limited) legal framework which could govern the international lender of last resort.

The International Monetary Fund is today the main example for an international lender of last resort, even though his intervention is also pretty much dependent on its member states.

A somewhat similar form of international lender of last resort is the international SWAP network among national central banks.

The book undeniably teaches you to take a step back and accept any financial crisis as what it really is: An unavoidable and recurring pattern of any financial system. In my view, it is a good preparation for the next crisis. On the downside, I found it sometimes a bit repetitive. But this is perhaps due to the fact that financial history itself is iterative.


Charles P. Kindleberger / Robert Z. Aliber – Maniacs, Panics, and Crashes