Iran in the Era of Financial War: Reclaiming Sanctions as a Tool of Coercive Diplomacy

The Iranian case suggests that financial sanctions must be reconsidered as a tool of coercive diplomacy. Cutting Iran off from international financial entities has empowered corrupt facilitators, and in effect spread the sanctions to exempted goods and services. The lack of credible sanctions removal processes and the absence of aid to address residual harmful impacts result in sanctions being viewed as a weapon of destruction rather than an incentive to negotiate.

The US administration’s decision to withdraw from the Joint Comprehensive Plan of Action (JCPOA) and to re-impose secondary sanctions on Iran has thrust Washington and Tehran into what US officials have described as a financial war. The remaining parties of the JCPOA are implicated in this new conflict as they strive to sustain the promised economic benefits of the nuclear deal in the face of unilateral and extraterritorial US sanctions. But government officials in Europe, China and Russia—and by extension the international community which remains overwhelmingly supportive of the JCPOA—are already questioning whether extraordinary efforts are warranted on behalf of Iran. After all, while confronting Iran is the principal foreign policy priority for the Trump administration, engaging Iran is not the main priority for Russia, China nor the European powers (setting aside the unique case of the European Union). Aware of this imbalance, Iranian President Hassan Rouhani has sought to cast US policy towards the nuclear deal as a threat to multilateralism and diplomatic engagement generally. He recently declared, “the only way to overcome difficulties is through concerted international efforts based on mutual interests, and not the short-sighted demands of one or a few statesFootnote 64 ”.

With the potential collapse of the nuclear deal looming, and an Iranian dash to build a bomb an increasing possibility, such appeals to multilateralism are a heartening reminder of how far Iran has come as an actor on the international stage and how far it could slide back. This is not, however, the foremost reason why the international community must act to mitigate the re-imposition of US sanctions. The main challenge arising from the US administration’s use of sanctions is not to the nuclear deal, but to the future efficacy of sanctions themselves as a tool of coercive diplomacy. This is not because of the unilateral and extraterritorial nature of the sanctions, but rather because, in this instance, sanctions were re-imposed despite clear evidence that sanctions relief will be near impossible to deliver should Iran partake in a future negotiation. As such, the Trump administration is using sanctions not as a tool of coercion, but of destruction.

From ‘tool’ to ‘weapon’

While the US has accrued sanctions powers over the course of several decades, financial sanctions remain a relatively new tool, first introduced to combat the financing of terrorism initiatives under the administration of George W. Bush. Juan Zarate, who served as Deputy National Security Advisor for Combating Terrorism under President Bush, was among the principal architects of the new sanctions approach. In Treasury’s War, Zarate announced a new era of “financial warfare” in which sanctions would “…increasingly become the national security tools of choice for the hard international security issues facing the United StatesFootnote 65 ”. Zarate explained that while many sanctions powers were first developed in the context of the global war on terror, it was the threat of Iranian nuclear proliferation that gave the US Treasury Department, by then under the authority of President Obama, the test case for financial sanctions as a tool of state conflict.

For the Obama administration, still dealing with the wreckage of the Iraq war, sanctions were an attractive foreign policy tool. The United States’ failure to create a broad coalition for the invasion of Iraq and subsequent quagmire eliminated recourse to military means to deter or halt Iran’s proliferation activities. In a 2008 campaign speech outlining his foreign policy goals, Obama specifically compared John McCain’s desire to seek a military solution to Iranian proliferation, “a failed policy that has seen Iran strengthen its position” to his own progressive desire to pursue “diplomacy backed with strong sanctionsFootnote 66 ”.

President Obama’s misfortune was that his first term coincided with the second term of the Ahmadinejad administration, a period of hardliner dominance in Iran’s domestic politics. Iran sought to resist the economic impact of US sanctions, buoyed by historic oil prices. Ahmadinejad avoided diplomatic negotiations with the Obama administration, in part because sanctions had actually helped concentrate political and economic power in the Islamic Revolutionary Guard Corps (IRGC) which saw engagement with the US as anathema to its interests, especially while military gains were being made in Iraq and Syria. In 2012, the US, working in cooperation with European allies, sought to increase pressure with new “crippling sanctions” that added additional restrictions on the Iranian financial sector and international financial institutions that retained links to designated Iranian banksFootnote 67 . In applying these additional sanctions, the Obama administration misinterpreted the lack of engagement from Iran as an indication that sanctions had not yet had sufficient coercive impact to bring Iran to the table.

Nonetheless, the financialisation of the sanctions meant that Iran was no longer being targeted with a coercive tool, but an out-and-out weapon. Targeting financial networks makes sanctions risks systemic in a way that focusing on individual industrial sectors does not. Moreover, for banks, the facilitation of business with Iran does not necessarily require a deliberate commercial action. Routine transactions could implicate a bank because of the clients or other stake-holders involved, even without the bank’s active knowledge. Bank compliance officers quickly understood the implications of the new sanctions, whose risks were amplified by the unrelated but concurrent introduction of new laws intended to tackle the lax oversight that contributed to the global financial crisis. These laws introduced personal criminal liability for compliance failures. Almost overnight, Iranian banks were isolated from the global financial system. As intended, Iran began to feel the economic pain of the sanctions more acutely.

However, shortly after their imposition, warning signs emerged that the financial sanctions were also having various unintended consequences. Shortages of foodstuffs and medicine in Iran became more common as US and European exporters struggled to find financial channels for the trade that was technically sanctions-exempt. In the face of such challenges, trade was increasingly funnelled through opaque intermediaries in Turkey and the United Arab Emirates, suggesting that financial sanctions could actually lead to less transparency in Iran’s financial dealings. The politicisation of global finance spurred by sanctions was in evidence as the US and Europe disagreed as to whether the international payment messaging system SWIFT should disconnect Iranian banks, which it eventually and unwillingly did under US pressure. Even the bank accounts of members of the Iranian diaspora living in Europe were affected, demonstrating ‘over-compliance’ from banks that had come to see any link to Iran as a liability.

The failures of sanctions relief

These early instances of humanitarian consequences, harmful evasion, political disagreements and stubborn over-compliance were a harbinger of the much more profound policy failure that would later haunt the Obama administration in its implementation of the JCPOA. Despite the historic achievement of the nuclear deal and the broad international consensus that Iran had earned sanctions relief through its embrace of diplomatic engagement and verifiable non-proliferation commitments, the US failed to deliver timely sanctions relief in the aftermath of implementation, leaving the deal vulnerable to its eventual repudiation by the United States.

For Iran, the experience of implementation has been a bitter one. The Islamic Republic has continued to fulfil its obligations under the JCPOA. The US had only managed to lift sanctions in principle, while in practice the lingering effects of financial sanctions stymied the rebound of trade and investment until President Trump’s withdrawal from the deal brought sanctions back into force. In a January 2018 survey of multinational executives active in Iran, 79 per cent of respondents reported that their company had delayed market entry plans in the preceding two yearsFootnote 68 . While Iran’s complex business environment certainly posed hurdles for foreign companies seeking post-JCPOA opportunities, the lingering effects of sanctions remained the largest impediment.

The superficiality of sanctions relief has tainted Iranian public opinion. Whereas in December 2016 most Iranians believed that the US “had lifted the sanctions it agreed to lift in the JCPOA” but was “finding other ways to keep the negative effects of those sanctions” by January 2018 nationally representative polling showed that the majority of Iranians believed that the US had “not lifted all of the sanctions it agreed to lift in the JCPOAFootnote 69 ”. Such a turn in public opinion speaks to the worrying ways in which a failure to deliver sanctions relief in the present will prejudice a political system against constructive responses to sanctions pressures in the future. Can countries placed under sanctions really count on the prospect of sanctions relief as a reason to modify behaviour?

The US has spent the last decade converting sanctions from a tool of coercive diplomacy into a powerful weapon of financial war. But no commensurate effort has been made to evaluate the damage financial wars inflict on target countries, nor to devise the policy instruments that can help ‘reconstruction’ efforts when a financial war is brought to a negotiated end.

In a speech on the evolution of sanctions, then Treasury Secretary Jack Lew observed that “Since the goal of sanctions is to pressure bad actors to change their policy, we must be prepared to provide relief from sanctions when we succeed. If we fail to follow through, we undermine our own credibility and damage our ability to use sanctions to drive policy change”. He was perhaps alluding to his own sobering failure to convince financial institutions to engage with Iran in the aftermath of sanctions-lifting. According to Lew, the Treasury Department relied on nothing more than “global outreach to help governments and businesses understand the sanctions relief provided” to implement its side of the JCPOAFootnote 70 . This outreach was ineffective, not least because the same officials, who had just months previously been warning against commercial engagement with Iran, now were tasked with encouraging it.

The contradiction between the message and the messenger was notably pilloried by Stuart Levey, who served as Under-Secretary for Terrorism and Financial Intelligence under Bush fils, and later became chief legal officer for HSBC, the global bank. Reacting to a meeting between Secretary of State John Kerry and bank compliance officers in London in 2016, Levey noted that US officials were encouraging “non-US banks to do business with Iran without a US repudiation of its prior statements about the associated financial-crime risks. Moreover, there were “no assurances” provided “as to how such activity would subsequently be viewed by US regulatory and law-enforcement authoritiesFootnote 71 ”. Levey made it abundantly clear that HSBC would not be conducting business with Iran, reflecting a sentiment widely held among compliance officers within the financial sector.

In 2018, a chorus of former State and Treasury Department officials has warned that the Trump administration was misusing sanctions. The prevailing concern is maintaining the efficacy of the tool by ensuring that sanctions are not used in ways that undermine multilateral campaigns and thereby accelerate efforts to create alternative structures and instructions in the international financial system to reduce US primacy. But far less attention has been paid to the issue of sanctions relief, which in many respects seems to be the more urgent problem. While the capacities for multilateralism and US primacy in global financial system are supported by other factors which will ensure a certain baseline ability for sanctions to inflict economic pain, their efficacy in supporting positive policy outcomes is overwhelmingly related to the question of their effective lifting in response to a change in behaviour in the target country. To this end, the current instruments available to the international community for the lifting of sanctions are totally insufficient.

New instruments for reconstruction

As the international community deals with the fall-out from the US withdrawal from the JCPOA, most attention has been focused on the European effort to establish a Special Purpose Vehicle (SPV), now known as INSTEX, that would help enable Europe-Iran trade in the face of secondary sanctions, particularly by reducing the reliance of trade on direct financial transactions between European and Iranian banks. In this sense, the SPV is a hopeful solution to the problem of Iran’s unrealised economic recovery under the nuclear deal. But seen another way, the SPV represents the first concerted attempt by governments to devise instruments that would help ensure sanctions relief can be delivered despite issues such as over-compliance among banks and possible cleavages in the sanctions policies of former partners in multilateral sanctions campaigns. Whether or not the SPV succeeds, it would behoove the international community to find new instruments for the more effective lifting of sanctions prior to seeking a new deal with Iran and before embarking on any new sanctions campaigns against other countries. For sanctions to remain a valuable tool for multilateral, non-military coercion, new instruments must be developed to address dilemmas of sanctions relief in two important areas.

First, the international community must make available resources to help targeted countries overcome the institutional impact of sanctions, namely the diminished capacities for trade and investment facilitation following years of economic isolation. These diminished capacities stem from changes in the target country’s political economy, such as the concentration of assets among politically-connected elites, and its institutional frameworks, such as an increase in corruption among civil servants. While the negative effects of sanctions are well documented, no clear effort has been made to ensure that sanctions relief includes technical assistance to help remediate these negative impacts. Iran’s experience in trying to satisfy the action plan set forth by the Financial Action Task Force (FATF) is indicative of the problem. The US government refused to provide direct technical support to help Tehran achieve FATF compliance, for example by helping train Iran’s financial intelligence teams, due to likely congressional resistance. European efforts to provide technical assistance were meanwhile hampered by the lack of US guidance on the permissibility of such assistance. The provision of such assistance is also central to addressing the stigma that is attached to countries and entities formerly placed under sanctions.

Second, like military conflict, financial wars can create societal path dependencies. In the case of Iran, the middle class has proven remarkably resilient to sanctions, able to rebound quickly when macroeconomic fortunes improve. But sanctions stunt the prospects of Iran’s poor who are vulnerable to relatively low levels of economic growth and are dependent on welfare programs. Because the effects of sanctions are inherently intangible, such harms remain largely overlooked and are not remediated with development aid as would be expected in the aftermath of a military conflict. Responsible sanctions policy would require more direct assistance for the poor. Such aid would be relatively uncontroversial and broadly consistent with the existing humanitarian considerations in sanctions policy.


There is a growing risk that the US administration’s success in applying unilateral sanctions on Iran will embolden its use in the event of further escalation in disputes with Russia, Turkey and others. Depending on the circumstances of the political disagreements, Europe, Canada and other traditional US allies may face a choice as to whether to join or not in the proposed sanctions campaigns. But so long as the financial war between Washington and Tehran is unresolved, states should exercise caution in the application of sanctions on new targets while also moderating expectations when it comes to the ability of sanctions to push targets towards the negotiating table. Solving the Iran crisis, especially its sanctions dimension, is therefore about reclaiming sanctions as a tool of coercive diplomacy. This is a goal that warrants extraordinary effort.

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