by Mark Ford

L/Cs and politics are a potent mix. In fact, political considerations have shaped aspects of the letter of credit market for decades.

At the geopolitical level, the United Nations used L/Cs to regulate the oil-for-food program that marginalized Iraq under Saddam Hussein from 1995 to 2003. In 2009, the G20 leaders mobilized multilateral development banks and national export credit agencies to make L/Cs more available in a world where trade finance was drying up. In Africa, obtaining L/Cs without having to resort to western banks has been a strategic objective for the Common Market for Eastern and Southern Africa (COMESA) for several years.

Bilateral trade can be boosted by L/C agreements as well. In recent years, Thailand has entered into bilateral trade agreements with India and separately with Malaysia to improve L/C flows. In 2009, high-level talks between Bangladesh and Myanmar - where L/Cs have been hard to come by for the better part of a decade due to international sanctions - contemplated the use of direct L/Cs to boost trade between the two countries.

Country-specific policies can also affect the L/C market. Pakistan and India have used legislation to increase or decrease the cost or even to ban L/Cs in order to shape trade flows of specific commodities between their countries. Algeria passed controversial legislation in 2009 insisting on the use of L/Cs to curb imports, only to ease this requirement in September 2010. The Philippines legislated to make L/Cs available at a wider range of financial institutions.

Geopolitical contexts

More uses of L/Cs in a geopolitical context can be expected soon. On 18 July 2010, responding to substantial US pressure, Pakistan and Afghanistan announced a landmark trade partnership that aims to boost the regional economy and undermine the efforts of insurgents to destabilize the two countries' governments. The deal, which was announced shortly after US Secretary of State Hillary Rodham Clinton visited Islamabad, would give landlocked Afghanistan sea access and provide Pakistan with direct road links to other Central Asian economies. As of this writing, the deal has yet to be ratified by both countries; however, it has been in the offing for years, and L/Cs may be called upon to make it work.

The forerunner of the deal is the Transit Trade Agreement signed last year by the two countries. Under that scheme, Islamabad grew concerned about goods supposedly passing through the country on a duty-free basis and being smuggled into Pakistan. This led for calls for L/Cs to be used in this transit trade to curb the smuggling.

Iran's nuclear ambitions

Probably the most noticeable current use of L/Cs in a geopolitical way is driven by international concerns over Iran's nuclear ambitions. Sanctions applied to Iran - particularly those imposed by Washington - have made L/Cs very scarce, not only for businesses in Iran, but also those in Dubai where a sizeable Iranian trading community operates. Traders there are reportedly moving operations further afield to countries like Malaysia and Turkey, where there are fewer difficulties.

According to local sources, rather than spending time and money trying to work out whether their clients' activities fall within the scope of transactions allowed under various sanctions regimes, Dubai's banks are dropping some Iranian customers.

Indeed, more sanctions on Iran are emerging. On 9 June 2010, the UN Security Council imposed its latest set of sanctions on Iran. These call for member states to prohibit financial institutions within their territories or under their jurisdiction from opening representative offices, subsidiaries or bank accounts in Iran if these outlets could contribute to Iran's nuclear program.

The UN measures came within days of US President Barack Obama's approving legislation imposing new unilateral sanctions that will affect companies and banks dealing with Iran and block sales of petrol and other petroleum products to the country.

New EU measures introduced in July also target the oil and gas sector and bar new European investments in major sectors of the Iranian economy. Tighter scrutiny of Iranian banks operating in the EU means money transfers of more than EUR 10,000 must be declared, while transfers of amounts exceeding EUR 40,000 will require authorization.

Lifting sanctions

Sanctions imposed by Washington on countries it considers bad actors - including Syria, Zimbabwe, Cuba, Somalia and Myanmar - can have a severe impact on a country's economy, and some have been around for years. Washington first imposed sanctions on North Korea in 1950.

But sooner or later, sanctions are lifted, and sometimes unexpectedly. Following nuclear testing programs by both India and Pakistan in May 1998, former US President Clinton's administration imposed trade and economic sanctions on both countries. The sanctions restricted credit, guarantees and financial assistance, including L/C-based trade transactions.

However, in September 2001, less than a fortnight after the 9/11 terrorist attacks on New York and Washington, former President George W Bush waived these sanctions. Analysts saw the waiver as a clear example of how the rest of US foreign policy - in this case, fears of nuclear proliferation - was being subordinated to the campaign against terrorism.

Now there are signs that Washington is considering lifting sanctions on Cuba that require agricultural exports to the island to be paid for through L/Cs from a third-party financial institution in another country or by cash in advance. In 2009, the Obama administration eased travel restrictions to Cuba, and US farmers are lobbying hard for Washington to lift sanctions that apply to L/C usage. "If we could establish L/Cs here, it would help tremendously," one US apple grower told local media. "I don't think we are going to eliminate the [trade] embargo right away, but we can certainly take small steps toward that."

Sanctions and penalties

The willingness of the US to crack down hard on violators of sanctions was highlighted in May 2010 when the Royal Bank of Scotland (RBS) said it would pay a fine of USD 500 million for breaches of the Bank Secrecy Act and sanctions violations committed by the now-defunct ABN Amro. Investigators found that between 1995 and 2005, the bank removed or changed interbank transaction data on entities blacklisted by the US. ABN Amro's New York branch was accused of "wilfully" ignoring Bank Secrecy Act requirements and for having processed over USD 3.2 billion of business with banks in Iran, Cuba, the Sudan and Libya.

The fine followed a penalty imposed in 2006 on ABN Amro - which is now part of RBS - when it was ordered by US officials to pay fines totalling USD 80 million for transactions that US banking regulators say violated money laundering laws and sanctions imposed on Iran and Libya.

The largest penalty to date emerged in December 2009 when Credit Suisse agreed to pay US authorities USD 536 million for stripping documents showing Iranian involvement. The bank processed USD 700 million for blacklisted Iranian entities between the mid-1990s and 2006.

In another case, in 2009 a USD 350 million deferred prosecution agreement was made against Lloyds TSB Bank over charges that its London and Dubai branches falsified and omitted data in wire transfers for Iranian banks.

Individuals may also be liable for failing to comply with sanctions from the US Treasury's Office of Foreign Asset Control (OFAC). According to Deloitte, private banks having transactions involving US currency, checks, wire transfers and L/Cs may have significant exposure to sanctions imposed by the US via OFAC. Violations could lead to criminal prosecution with penalties ranging up to ten years in prison.

Politics and L/Cs may make strange bedfellows, but the links between the two are clearly here to stay.

Mark Ford's e-mail is