Successful sanctions induce innovations to undo them, and one or more jurisdictions are likely to give such innovations a home. Although democracies might be able to banish sanctions targets from their banking systems, the threat to national security would remain. Is that a risk democracies can afford to take? If national security is at stake, should democracies force critical transactions (such as the payment of interest or the import of essential commodities) through a channel that they control?
The “whole of government” review mandated by Executive Order on Ensuring Responsible Development of Digital Assets issued by the United States on 9 March 2022 could be an opportunity to explore whether and how democracies might do so. The Order explicitly introduces national security as an objective of financial regulation alongside financial stability.
The necessity of spelling out how sanctions should work
To achieve these two objectives simultaneously, it will be necessary to spell out how sanctions should work. As an example, take interest payments. Currently, sanctions prohibit a sanctions target – or any entity controlled by an individual sanctions target, or by sanctions targets collectively – from paying or receiving interest. As a consequence, sanctions will become a factor to consider when assessing the risk of an issuer, borrower or counterparty. What is the likelihood that the entity would become subject to sanctions, and what loss would the investor suffer, if it did?
It cannot be sensible to allow such questions to go unanswered. If sanctions were to cause financial instability, it could harm the jurisdiction imposing the sanction as much or more than it would constrain the sanctions target. But if democracies have to stay their hand against an entity that is “too big to sanction,” what risk will this pose to national security?
Can a digital central bank currency foster sovereign security?
Could a central bank digital currency (CBDC) address such issues? For example, can payment of interest and principal into a CBDC account satisfy the issuer’s obligation to pay, and smart contracts be used to block the transfer of such payments to those subject to sanctions and release payments to those who are not? Conversely, can a CBDC employ mechanisms that induce the sanctions target to change its behavior? For example, should an asset freeze also provide for an “asset thaw,” namely the conditions that the asset owner would have to fulfill, in order to regain control of its assets?
More generally, the review should scrutinize anonymous finance: if an instrument has no identifiable issuer, how can one be sure that it poses no threat to national security? Finally, the review should question the merits of a national approach. Democracies must work together if they are to preserve peace and promote prosperity. But they may need a new forum; existing ones (e.g., the Financial Stability Board and the Basel Committee on Banking Supervision) contain a sanctions target. Should democracies use the review to create an alternative?
Thomas Huertas is a SAFE Senior Fellow, Senior Fellow at the Center for Financial Studies, and adjunct professor at the Institute for Law and Finance in Frankfurt.
This blog post is based on a recent article in the Journal of International Banking and Financial Law.
Blog entries represent the authors‘ personal opinion and do not necessarily reflect the views of the Leibniz Institute for Financial Research SAFE or its staff.