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Why US Sanctions Are So Lethal

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Pacific Money

Why US Sanctions Are So Lethal

The anatomy of a Chinese tech-company disaster.

Why US Sanctions Are So Lethal
Credit: Flickr/ conxa.roda

Most business pundits had never heard of ZTE Corp. (ZTE), the Chinese telecoms manufacturer.

But, in 2017, ZTE was assessed a $1.19 billion penalty for illegal exports to Iran and North Korea, amounting to the largest civil penalty ever assessed for violation of the U.S. Export Administration Regulations (EAR).

Ultimately, ZTE paid $892 million dollars to U.S. enforcement agencies, including the Bureau for Industrial Security (BIS) and the Department of Justice (DOJ). The penalty was especially harsh because ZTE was found to have attempted to obstruct the investigation.

What are the important lessons for multinationals — other than don’t break the law and don’t obstruct justice?

First, U.S. sanctions and export controls have far-reaching jurisdiction and can disrupt global value chains, inflicting collateral damage on a host of innocent parties.

Second, “national security” sensitivities are on the rise, and Washington is gearing up for an aggressive campaign of sanctions and stringent export licensing requirements — with a growing number aimed at Chinese companies. These policy tools fall under the umbrella of “strategic industries and economic security” (“SIES”), and U.S. agencies are rolling out new enforcement programs on a monthly basis.

Third, technology has become both an enabler and a disrupter. U.S. enforcement agencies are deploying new “traceability” tools when it comes to the policing and monitoring of strategic goods. At the same time the geopolitical landscape is becoming increasingly dangerous as nonstate and state actors seek to “weaponize” ubiquitous technologies. This has led to a further expansion of “controlled item” lists — which means more penalties can be expected.

Put all of this together and technology companies are facing a geopolitical landscape fraught with risk and uncertainty.

Collateral Damage  

By any measure, ZTE is a world-class, multinational enterprise. It’s the largest publicly traded telecom company in China, and the fourth largest telecom equipment company in the world. It makes cutting edge devices. With around $15 billion in global revenue, in 2017, and 80,000 employees spread across 160 countries, it operates in a network of complex global value chains.

According to Matt Bell, ZTE Corp’s Chief Export Compliance Officer and Legal Counsel, when the BIS put ZTE on the dreaded “Entity List” and revoked the company’s operating license, its key supply chains instantly ground to a halt.

Bell — who was hired by ZTE to manage the crisis and, going forward, advise the company on how to install a framework of effective export control processes — worked with BIS officials and obtained a temporary general license (TGL). Only then was ZTE allowed to resume business.

What also became clear was the scale of the collateral damage that U.S. sanctions cause within global value chains. Consider the following:

Suppliers: Each year, ZTE purchases $2.5 billion in parts and components from third party suppliers in the United States, including Qualcom, Broadcom, Intel, Oracle, and Google. Many of ZTE’s smaller second and third tier suppliers would have gone out of business had ZTE not obtained a temporary license to continue business. Said Bell, “many small suppliers wouldn’t have lasted 30 days.”

Logistics Companies: An entire ecosystem of logistics companies, warehouse operators, agents, and IT professionals are needed to move thousands of parts, components, and materials through ZTE’s supply chain each day. A shutdown of even one week would have impacted many jobs.

Consumers: In order to keep operating systems updated with critical data and protected from the latest malware and viruses, phone manufacturers provide users with updated “security patches.” An estimated 20-30 million American consumers own ZTE-made smart phones. During the shutdown, ZTE was unable to provide security patches to its U.S customers. Instead, ZTE had to send brand new phones to its users — at considerable cost.

Shareholders: When the ZTE stock price tumbled as news of the U.S. penalty became public, trading of ZTE stock had to be briefly suspended on the Hong Kong and Shenzhen stock exchanges. Markets often react to such headlines irrationally.

The Long Arm of Uncle Sam

U.S. law requires that if any foreign made item — fabricated by any foreign company — uses more than 10 percent (by value) U.S. “controlled items,” the entire product is subject to U.S. laws. That means that a product that is of 90 percent Chinese origin, for example, still needs to be traced all the way to its end user, and can’t be sold to any “denied parties.” There are thousands of denied parties on U.S. lists, and new names are added every day.

It’s a challenge to manage this process. As Bell explained, “telecoms sell multimillion dollar systems that are tailored to specific customers, who often request that a product is shipped in separate components.” So, how do you assess the value of U.S. controlled technology from one part to the next?  Now imagine trying to manage this process for thousands of subcomponents, and partially assembled gadgets.

Why American Sanctions Are So Lethal

The United States still enjoys exorbitant privileges when it comes to exerting its will in the international system. One reason is the dominant role of the U.S. dollar. The U.S. Office of Foreign Assets Control (OFAC) can assert jurisdiction over any U.S. dollar transaction because, eventually, that dollar must clear through the U.S. banking system. And that means a transaction can be traced back to a foreign bank account, to individual parties, and blocked. To borrow a phrase from former U.S. Treasury Secretary John Connally, who said, in 1971 — albeit in a different context — “the dollar is our currency but your problem.”

This rings painfully true to the Russians and the Iranians. Despite having large energy reserves, to exploit them, they are in need of new supply chains and that requires access to technology that belongs primarily to Western firms. That means dollar-denominated transactions, which instantly disqualifies a large number of Russian and Iranian firms that find themselves on U.S. government sanctions lists.

How to Manage Risks

ZTE’s Bell hopes to harness technology, as he leads ZTE in the building of a best-in-class compliance process. That means using system automation, AI, robotics, and data analytics to implement transparency and traceability. That and the daily task of educating and informing those across the organization.

But, when it comes to U.S. sanctions, the road ahead for tech companies will become increasingly challenging.

Alex Capri is a Senior Fellow at the National University of Singapore, where he is a full-time lecturer in the Business School and the Lee Kuan Yew School of Public Policy.