```

[Senate Hearing 115-50]
[From the U.S. Government Publishing Office]

                                                         S. Hrg. 115-50

   SECONDARY SANCTIONS AGAINST CHINESE INSTITUTIONS: ASSESSING THEIR 
                  UTILITY FOR CONSTRAINING NORTH KOREA

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
         NATIONAL SECURITY AND INTERNATIONAL TRADE AND FINANCE

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED FIFTEENTH CONGRESS

                             FIRST SESSION

                                   ON

  EXAMINING HOW CHINESE BANKS, BUSINESSES, AND PERSONS PROVIDE NORTH 
    KOREA WITH DIRECT AND INDIRECT ACCESS TO FINANCIAL MARKETS AND 
   RESOURCES, ALLOWING PYONGYANG TO EVADE OR MITIGATE INTERNATIONAL 
                               SANCTIONS
                               __________

                              MAY 10, 2017
                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                 Available at: http: //www.fdsys.gov/

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                          Washington, DC 20402-0001

            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                      MIKE CRAPO, Idaho, Chairman

RICHARD C. SHELBY, Alabama           SHERROD BROWN, Ohio
BOB CORKER, Tennessee                JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada                  JON TESTER, Montana
TIM SCOTT, South Carolina            MARK R. WARNER, Virginia
BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
DAVID PERDUE, Georgia                BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina          CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana              CATHERINE CORTEZ MASTO, Nevada

                     Gregg Richard, Staff Director

                 Mark Powden, Democratic Staff Director

                       Dawn Ratliff, Chief Clerk

                     Cameron Ricker, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

 Subcommittee on National Security and International Trade and Finance

                     BEN SASSE, Nebraska, Chairman

            JOE DONNELLY, Indiana, Ranking Democratic Member

BOB CORKER, Tennessee                MARK R. WARNER, Virginia
TOM COTTON, Arizona                  HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            BRIAN SCHATZ, Hawaii
DAVID PERDUE, Georgia

                Ammon Simon, Subcommittee Staff Director

                Klon Kitchen, National Security Advisor

          Nick Catino, Democratic Subcommittee Staff Director

                                  (ii)

                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, MAY 10, 2017

                                                                   Page

Opening statement of Chairman Sasse..............................     1

Opening statements, comments, or prepared statements of:
    Senator Donnelly.............................................     9

                               WITNESSES

Adam J. Szubin, Distinguished Practitioner-in-Residence, Johns 
  Hopkins University, School of Advanced International Studies; 
  Of Counsel, Sullivan & Cromwell; and Former Acting Secretary of 
  the Treasury and Acting Under Secretary of the Treasury for 
  Terrorism and Financial Crimes.................................     2
    Prepared statement...........................................    27
Juan C. Zarate, Chairman and Cofounder, Financial Integrity 
  Network; Chairman and Senior Counselor, Center on Sanctions and 
  Illicit Finance; Former Deputy Assistant to the President and 
  Deputy National Security Adviser for Combating Terrorism; and 
  Former Assistant Secretary of the Treasury for Terrorist 
  Financing......................................................     3
    Prepared statement...........................................    31

                                 (iii)
 
   SECONDARY SANCTIONS AGAINST CHINESE INSTITUTIONS: ASSESSING THEIR 
                  UTILITY FOR CONSTRAINING NORTH KOREA

                              ----------                              

                        WEDNESDAY, MAY 10, 2017

U.S. Senate, Subcommittee on National Security and 
                   International Trade and Finance,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met, at 10:07 a.m., in room SD-538, 
Dirksen Senate Office Building, Hon. Ben Sasse, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF CHAIRMAN BEN SASSE

    Chairman Sasse. The hearing will come to order.
    I would like to welcome everyone to this meeting of the 
National Security and International Trade and Finance 
Subcommittee of the Banking Committee. I am pleased to be 
joined by my colleague and friend and our Committee's Ranking 
Member, Senator Joe Donnelly, from Indiana, as well as other 
Members of the Subcommittee here today, as we seek greater 
understanding of how so-called secondary sanctions might be 
used to counter North Korean belligerence and Chinese support.
    I am going to offer a more complete opening statement, and 
Senator Donnelly is going to offer a more complete opening 
statement later in the hearing. We are going to be a little bit 
unorthodox in our timing because of some of the things that are 
happening on the Senate floor this morning that may prohibit 
the Committee from meeting at some point in the course of our 
hearing. So even though both of you have excellent opening 
statements that are filled with content that I think we will 
want to unpack--I do not think we want them just for the 
record; we would like to hear longer opening statements from 
you two--would you be willing to confine yourselves to maybe 3 
minutes each just as a kickoff so we can get to some questions 
from some Democratic Members that are going to be called to 
another caucus meeting shortly? So I think we will go a little 
bit out of order in our questioning, if each of you could just 
have maybe 3-minute opening statements.
    Great. I will give very brief biographies of the two of 
you.
    Adam Szubin is currently the senior practitioner-in-
residence at Johns Hopkins University School of Advanced 
International Studies. He is also the former Acting Secretary 
of the U.S. Treasury Department as well as the Acting Under 
Secretary of the Treasury for Terrorism and Financial Crimes. 
Welcome, Mr. Szubin.
    Joining him today is the Honorable Juan Zarate, chairman of 
the Financial Integrity Network, chairman and senior counselor 
of the Center on Sanctions and Illicit Finance, former Deputy 
Assistant to the President and Deputy National Security Adviser 
for Combating Terrorism, and the former Assistant Secretary of 
the Treasury for Terrorist Financing. Welcome, Mr. Zarate.
    Gentlemen, both your written statements will be included in 
the record later, and after Senator Donnelly and I make 
statements, subsequently we will let you make opening 
statements again, but maybe just 2 or 3 minutes from each of 
you.
    Mr. Szubin, welcome and thanks for being here.

  STATEMENT OF ADAM J. SZUBIN, DISTINGUISHED PRACTITIONER-IN-
    RESIDENCE, JOHNS HOPKINS UNIVERSITY, SCHOOL OF ADVANCED 
  INTERNATIONAL STUDIES; OF COUNSEL, SULLIVAN & CROMWELL; AND 
   FORMER ACTING SECRETARY OF THE TREASURY AND ACTING UNDER 
  SECRETARY OF THE TREASURY FOR TERRORISM AND FINANCIAL CRIMES

    Mr. Szubin. Thank you very much. Chairman Sasse, Ranking 
Member Donnelly, Members of this Subcommittee, it is a true 
honor to be here. This is my first time testifying outside of 
the Government. I think it is fitting given our relations over 
the 13 years I had in Treasury, and it really is an honor to be 
back.
    I am often asked a pretty core question at this moment, 
which is whether, as with Iran, the international community 
could generate enough sanctions pressure to force a North 
Korean Government to the table to negotiate a peaceful and 
verifiable end to its nuclear weapons program. It is obviously 
an immensely difficult question, but I do believe the answer is 
a qualified ``yes.''
    Let me just share my top-line assessments, and then I will 
obviously yield in the interest of time.
    First, North Korea is not self-reliant or ``sanctions-
proof.'' Its leadership depends upon access to foreign imports 
and international banking services, and that access can be 
disrupted.
    Second, sanctions leverage over North Korea is concentrated 
in one country: China. If China is prepared to take a 
qualitatively tougher stance on sanctions against North Korea, 
sanctions have a chance to succeed. If not, they do not.
    Third, despite years of high-level international attempts, 
China has thus far resisted more than incremental enhancements 
to its sanctions posture. China does harbor serious concerns 
about Kim Jong-un and their nuclear program, but a collapse of 
the North Korean regime and the chaos that it would unleash on 
China's border poses a far greater threat in China's eyes.
    For that reason, U.S. sanctions alone will not force China 
to adopt a sufficiently aggressive approach no matter how 
draconian and costly those sanctions become. China will not be 
strong-armed into a course of action that it believes imperils 
its own national security.
    For that reason, serious and high-level engagement with 
China will be needed to set out a way forward, to include an 
intensive pressure campaign, and the various scenarios that 
could follow from it, including potential leadership change in 
North Korea.
    China will not roll the dice when it comes to the fate of 
its impoverished nuclear-armed neighbor. Concerns over 
stability will be paramount, but I believe that our interests 
can be reconciled with China's.
    What is needed here is a massive diplomatic investment and 
multilateral engagement to marshal a campaign, including China 
and other countries around the world, both the like-minded and 
the resistant. Having participated in a comparable campaign 
with respect to Iran, I would urge both the Administration and 
Congress to staff key leadership positions at the State 
Department and the Treasury Department quickly, including 
confirming Sigal Mandelker, who has been nominated to serve as 
the next Under Secretary for TFI. I know her to be an 
intelligent, experienced, and strong leader. And I believe that 
it would be counterproductive in the extreme to deplete our 
Foreign Service Corps at a time when we need them so urgently, 
both on this issue and the whole range of national security and 
foreign policy threats we face.
    To conclude, even with a concentrated and strategic 
efforts, we obviously cannot guarantee that a diplomatic effort 
powered by new sanctions pressure will succeed, but I believe 
that it has a real chance to do so, and I am not aware of a 
better alternative. Faced with this ever-growing menace, it is 
our duty to put all of the considerable talents, intelligence, 
and energies of the U.S. Government behind this effort.
    Thank you again for having me to testify.
    Chairman Sasse. Thank you, Mr. Szubin.
    Mr. Zarate.

STATEMENT OF JUAN C. ZARATE, CHAIRMAN AND COFOUNDER, FINANCIAL 
  INTEGRITY NETWORK; CHAIRMAN AND SENIOR COUNSELOR, CENTER ON 
 SANCTIONS AND ILLICIT FINANCE; FORMER DEPUTY ASSISTANT TO THE 
 PRESIDENT AND DEPUTY NATIONAL SECURITY ADVISER FOR COMBATING 
 TERRORISM; AND FORMER ASSISTANT SECRETARY OF THE TREASURY FOR 
                      TERRORIST FINANCING

    Mr. Zarate. Chairman Sasse, Ranking Member Donnelly, and 
distinguished Members of the Subcommittee, it is really an 
honor to be here today. Thank you for the invitation. I will 
tell you it is an honor to be testifying next to my very good 
friend, former colleague, and one of the great professionals in 
this field, Adam Szubin, somebody for whom I have enormous 
respect. And I expect him to take all the hard questions, Mr. 
Chairman.
    [Laughter.]
    Mr. Zarate. Mr. Chairman, as you and I discussed and as we 
know, this is a timely and important hearing. What was once 
seen solely as a threat from North Korea to peace and stability 
on the Korean peninsula and in the region has now become a 
looming, potentially direct threat to the U.S. homeland. All 
the while North Korea tests ballistic missiles and increases 
the pace of its nuclear program, it is also proliferating its 
technology for profit, engaging in illicit finance and 
commercial activity, exploiting forced labor and human rights 
abuses to make money for the regime, and even using cyber tools 
to attack financial infrastructure.
    This is also a moment to challenge the orthodoxies because 
of the urgency of the task at hand, and I agree with Adam that 
this is a moment to think about a renewed financial pressure 
and economic campaign against North Korea that has as its 
centerpiece the change in the Chinese calculus with respect to 
their interests.
    Now, this is not easy. The Chinese have been pressured in 
the past. They have showed glimmers of wanting to cooperate, 
including recent rejections of coal imports from North Korea. 
But the Chinese have a different strategic interest, and our 
interests and theirs have not aligned with respect to the use 
of financial pressure in an existential way against the regime 
in Pyongyang.
    I think this is a moment for China to assume its role as a 
great power, to be able to influence its North Korean ally. 
This Administration and this Congress will have to grapple with 
how best to obtain, to a certain extent coerce, and sustain 
Chinese cooperation in order to maximize pressure on North 
Korea. And, ultimately, we have to change the calculus in 
Pyongyang to either slow or stop the pace of its nuclear 
program.
    But the linchpin here is the Chinese calculus. 
Unfortunately, this has been the third rail of the sanctions 
debate. There has been an uneasiness with a willingness to 
pressure China or to pursue efforts that touch the Chinese 
economy or Chinese interests too directly. I think that 
calculus has to change. In many ways, China becomes the 
linchpin for these efforts, and as we see with all of the 
illicit networks that are exposed, there is inevitably a 
Chinese link, Chinese facilitation, Chinese networks, Chinese 
agents.
    Any effort, whether it is to apply secondary sanctions, 
which would apply to those actors that are not doing business 
directly with the U.S., do not have a U.S. nexus, or other 
financial measures, has to put at risk Chinese interests, or at 
least make clear that Chinese interests are going to directly 
or indirectly be impacted by their relationship with North 
Korea and the illicit activity engaged in. And I would argue, 
as my testimony lays out in greater detail, that secondary 
sanctions are only one part of a panoply of steps that can be 
taken to sensitize the environment, to make the reputational 
risk and the real risk of doing business with North Korea ever 
more dangerous, ever more difficult for the Chinese. The more 
the Chinese realize that their interests are directly impacted 
by what North Korea is doing, be it on the nuclear file, on the 
missile testing program, on the illicit financing activity, the 
more likely it is that the Chinese will change their behavior 
and change their calculus.
    As I said, China has the opportunity to prove its role as a 
great power and to use its influence with Pyongyang. The clock 
is ticking in many ways, and an effective financial pressure 
campaign with China on side is one way of potentially helping 
to slow, if not stop, the clock.
    Thank you, Mr. Chairman.
    Chairman Sasse. Thank you, Mr. Zarate.
    Senator Donnelly has agreed to temporarily defer to 
Senators Heitkamp and then Cortez Masto. Senator Heitkamp.
    Senator Heitkamp. Thank you so much, Mr. Chairman. This is 
a Committee that I had the honor of being the Ranking Member on 
last Congress, and I will tell you it tends to be incredibly 
bipartisan. And I want to pledge to both of you my support and 
anything that I can do as you advance this discussion and this 
agenda, because nothing is more important. Really, it is 
incredible that the Banking Committee has this responsibility, 
and it is a responsibility that is absolutely critical to 
national security.
    I want to turn to Mr. Szubin and Mr. Zarate. I want to say 
just on the record that for some reason the job that you two 
have held attracts absolutely the best and brightest in public 
service in America, people whose intellect and capability could 
be earning riches on Wall Street, but yet you serve our country 
in this very strategic and absolutely essential role of 
monitoring and implementing sanctions. And I want to thank both 
of you from the bottom of my heart for your public service. You 
are true patriots, and your appearance today reinforces that.
    I think there is a lot of cynicism--Mr. Szubin, I am going 
to start with you. There is a lot of cynicism about whether you 
can, in fact, achieve this result without China participating 
and a lot of cynicism about whether China will play the role 
of, yes, we are on board, yes, we are on board, but yet we do 
not see the kind of activity that we need to see given the 
regional threat that North Korea presents.
    North Korea's interest is obviously in preventing regime 
change. You know, that probably is pretty consistent across the 
board in all of world Governments. But this is a very dangerous 
regional development, and I am wondering, how do you assess the 
likelihood of success that China will, in fact, play a critical 
and important role going forward?
    Mr. Szubin. I think that is the question of the hour, 
Senator Heitkamp, and----
    Senator Heitkamp. But I wanted an answer, not a repetition 
of the question, Mr. Szubin.
    [Laughter.]
    Mr. Szubin. I am not going to be repeating the question. I 
would not dare.
    I think we have a chance, and as I put forward in my 
written statement, China does not start with an opposing set of 
interests to our own here. China, I think, is made quite 
nervous by the behavior of this young dictator in Pyongyang. He 
has gone out----
    Senator Heitkamp. Can I ask you, do you think they feel the 
urgency that we feel at this point?
    Mr. Szubin. Probably not quite, and Kim Jong-un has called 
out the U.S. as his leading enemy and has a stockpile of 
nuclear weapons. So, of course, we feel that urgency in a 
different way from China.
    But China, I think, would be very glad to see a solution to 
the nuclear threat to global security. It comes with a lot of 
headaches for China, including the deployment of THAAD in South 
Korea and a lot of military attention from the U.S. right off 
of China's shores. On top of that, I think China would be happy 
to see a more stable leadership posture out of Pyongyang.
    So we have a lot of shared interests, but right now the key 
impediment, I think, to further Chinese cooperation is their 
fear of a regime collapse. And a regime collapse is a much 
greater threat to China given the level of poverty in North 
Korea, the level of chaos that would unleash right on their 
border, than anything else that we are talking about today.
    So this is the key conversation to be had between really 
senior members of our Government and China's Government, is not 
just how do we turn the pressure up, how do we start pushing 
toward nuclear negotiations, but what does that pressure look 
like and what are the next three steps after the pressure gets 
that high, because China is not going to head into this without 
knowing those answers.
    Senator Heitkamp. Do you think secondary sanctions will be 
viable in this situation?
    Mr. Szubin. I think secondary sanctions ought to be 
considered if the need arises, and the reason I put it that way 
is they are just a sanctions tool like any other. We saw in the 
Iran context how powerful they could be, but they were 
marshaled to a broader strategic efforts with diplomacy that 
was really substantial over a period of years, and they 
followed on to a serious of primary sanctions moves that really 
had Iran quite isolated.
    So at the right time, as part of a strategic diplomatic 
campaign, secondary sanctions may be needed in this context. 
But I do not think that time is now.
    Senator Heitkamp. OK.
    Mr. Szubin. I think they need to be--they need to be linked 
to a campaign and not be set out in advance of a campaign.
    Senator Heitkamp. Mr. Chairman, I want to be respectful of 
your great generosity, so I will close there. But I can expect 
that we will be able to file some written questions.
    Chairman Sasse. Absolutely. Thank you.
    Senator Heitkamp. Thank you, Mr. Chairman.
    Chairman Sasse. Senator Cortez Masto.
    Senator Cortez Masto. Thank you, Mr. Chairman and Ranking 
Member. I appreciate that.
    Can I follow up then? Because this was a similar line of 
questioning that I had as well with respect to secondary 
sanctions. I am going to pose this to both of you. What do you 
both understand to be the Trump administration's strategy to 
halt North Korea's missile program and the role that the 
secondary sanctions should play?
    Mr. Szubin. I cannot speak, Senator, to the Trump 
administration's strategy here. Obviously, I am now on the 
outside and am not a part of those discussions. I was a part of 
the last two Administrations' discussions on North Korea, and 
typically there is a focus on how do we turn the pressure up to 
a level where North Korea is forced to the table in a way that 
they have not yet been to date to engage in multilateral 
negotiations over their nuclear program. That is obviously a 
very tall order.
    Senator Cortez Masto. And part of that is making sure we, 
like you said, completely staff up the State Department and 
putting that pressure on through diplomatic channels. Isn't 
that correct?
    Mr. Szubin. That is absolutely right. And it was essential 
in the Iran context. There is a lot of attention that is given 
to the work of our former office, the Treasury Department, the 
intelligence agencies, in terms of getting really effective, 
crippling sanctions in place on Iran. And what is sometimes 
neglected is how much diplomatic outreach was needed to make 
those sanctions work and to make them stick. That was hundreds 
of thousands of hours of visits to different capitals, 
everywhere from Azerbaijan to Singapore, to ensure that 
bankers, traders, and regulators were enforcing the sanctions 
in a tough, meaningful way. And it was a huge effort that 
requires diplomacy.
    Senator Cortez Masto. OK. Mr. Zarate.
    Mr. Zarate. Senator, obviously I am not part of the 
Administration, but I think you can divine two core themes and 
changes in the Trump administration policy in North Korea. The 
first is a sense of urgency with respect to this issue. You 
have heard Director Pompeo from the CIA talk about this. This 
is now an urgent direct problem that is being treated as a 
front-burner national security issue, which is adding 
diplomatic attention and urgency to the issue.
    The second is placing the onus squarely on China to try to 
resolve these issues. Even the President's tweets have been, I 
think, an attempt to do that in perhaps a clever way. But, in 
any event, I think the overarching theme is, Can you persuade 
China in a cooperative way to influence North Korea in a way 
that they have not to date? And I think that is the overarching 
thematic change.
    How they go about doing that, whether or not secondary 
sanctions should be a part of that, I think is yet to be seen. 
I have not seen an articulation of this from the 
Administration.
    Where I would agree with Adam, but then also disagree, is 
there is no question this has to be part of an overarching 
strategy. It has to fit into a strategy. We have to understand 
what we are trying to achieve with the financial and economic 
measures and use the full complement of them and choreograph 
them properly.
    Where I perhaps disagree slightly is I do think this is a 
moment to actually have the secondary sanctions in place, not 
to necessarily apply them, but to have the authority available 
both to signal to the marketplace that this is a potential risk 
of doing business directly or indirectly with North Korean 
entities, and also to begin a signaling mechanism, a financial 
diplomatic message to Beijing that we are upping the ante, that 
this is a more urgent, a more serious dimension of how we are 
going to do this. This is not going to be how we have treated 
the Chinese dimension of North Korea in the past.
    And so I think, at a minimum, as a signaling mechanism, it 
is incredibly powerful, and it begins to open the aperture for 
diplomacy, for discussions with the private sector, for 
targeting of actors, and we see over and over again--the Wall 
Street Journal just this past weekend revealing ties between 
known Chinese entities with a presence in the U.S. and North 
Korean agents and networks. Those are the kinds of things that 
will be accelerated and exposed if you have secondary sanctions 
plus other measures in place.
    Senator Cortez Masto. And following up on that, and I just 
have a minute left, but as we talk about secondary sanctions, 
do you see a difference between applying that pressure on 
smaller Chinese banks versus the larger Chinese financial 
institutions and what implications that means for our financial 
market?
    Mr. Zarate. I think secondary sanctions applied to the 
Chinese banking system, it is very difficult, for three 
reasons, and Adam lays this out very neatly in his testimony. 
But I think the first is the Chinese learned a lesson after 
2005 when we applied Section 311 authorities against Banco 
Delta Asia where the major Chinese banks, to include Bank of 
China, had exposure to North Korea. And so after that lesson, 
they realized it was probably not a good idea for the four 
major banks in particular to have exposure to North Korea.
    And so what you have seen since then has been a 
concentration of the kind of financial and commercial activity 
with North Korea, especially in the northeastern part of the 
country, concentrated with smaller institutions, smaller 
brokers, money service businesses, in a way that has isolated 
that activity from the major banks. That means there is less 
connectivity to the U.S., and secondary sanctions are most 
helpful when there are entities being targeted that want access 
to U.S. markets or facilities.
    The fact that that is the case, though, does not undermine 
the credibility and strength of the potential secondary 
sanctions for two reasons. One is you have unknown connections 
to North Korea still, and even these institutions, these big 
four Chinese banks, may not understand or may not even see the 
exposure that they have to elements of the North Korean 
network. So that is one issue.
    The second is secondary sanctions are going to apply not 
just to banks but to other commercial actors, and at a time 
when China is very much trying to expand the reach of its 
banks--I just got back from the Southern Cone where, you know, 
you see the big towers of the Chinese banks in places like 
Buenos Aires and Santiago, Chile, and they are worried about 
their commercial brands around the world, Huawei and others. 
The reputational risk attached to what North Korea represents 
across the board is quite significant.
    Maybe if I can leave you with this one thought: We have 
consistently underestimated the power of these tools, leveraged 
properly and appropriately with diplomacy and strategy, but I 
think we have to test and probe whether or not these tools can 
be used in a more aggressive form to change the Chinese 
calculus, because I actually think we can. And I think if it is 
done well and smartly, we can change the dynamics.
    Senator Cortez Masto. Thank you. Thank you very much.
    Thank you, Mr. Chair.
    Chairman Sasse. Thank you. Senator Donnelly and I will 
return to opening statements at this time.
    Just very briefly, we are obviously here because of new 
threats from an old foe. Since 1950, North Korea has been an 
aggressive and disruptive player in Asia, and its new leader, 
Kim Jong-un, appears committed to continuing and extending this 
tradition.
    After assuming leadership of the hermit kingdom in 2011, 
Kim Jong-un has oppressed his own people, killed his real or 
perceived opposition both inside and outside North Korea, 
provoked and attacked our South Korean allies, and even 
threatened to strike the United States with a nuclear weapon. 
To the comments that have been made, there is not a more 
critical global national security issue than this. This is 
crazy and cannot be allowed to continue.
    Earlier this week, Pyongyang even referred to our colleague 
Senator Cory Gardner as ``human dirt'' and accused him of 
having lost not only all human judgment but also all body hair. 
I have no idea what that meant.
    Kim Jong-un's patrons in Beijing have him on a very long 
leash. His behavior, at least in part, is enabled by numerous 
Chinese institutions and individuals who allow North Korea to 
bypass the international sanctions regimes that exist by 
providing them with both direct and indirect access to 
international markets via shadow banks, illicit networks, and 
other illegal mechanisms.
    That brings us to the point of today's hearing and I think 
the two central questions before us, and they are: Is it 
possible and is it advisable to employ secondary sanctions 
against these Chinese institutions and individuals in an effort 
to further turn the sanctions screw against North Korea? And as 
the three of us discussed prior to today's hearing, I think we 
will probably toggle across three different topics. One of them 
is that most narrow proximate question of should the U.S. 
Government move toward secondary sanctions, and should the 
Senate and the Congress be moving to give new tools to the 
Administration to advance that agenda, to take action against 
these Chinese institutions that are enabling North Korean 
behavior? Bucket one.
    Bucket two, where does North Korean international money 
come from? What percentage of that is Chinese? And what do we 
know about the decision-making processes inside China, which 
would then further enable the Senate and the Congress and the 
Administration to make calculations about whether or not North 
Korean behavior could be influenced via secondary sanctions 
against these Chinese institutions?
    And then third, and more broadly, a whole range of 
questions that the two of you, given the expert positions you 
have held in the past, might be able to bring to bear and use 
to tutor us on analogous situations in the past about how 
secondary sanctions regimes work in situations that might be 
analogous in some way to this? So I look forward to both of 
your testimony.
    Senator Donnelly.

               STATEMENT OF SENATOR JOE DONNELLY

    Senator Donnelly. Thank you, Chairman.
    I want to start by thanking the Chairman for calling this 
hearing. North Korea poses one of the most dangerous and 
pressing threats to the United States' national security. We 
have to dramatically increase our diplomatic and economic 
pressure on the regime to abandon its nuclear weapons.
    I also want to join the Chairman in welcoming our 
witnesses. You are extraordinary leaders for our country. You 
have done amazing work to keep our citizens safe, and that is 
why we have turned to you today, is because of the faith we 
have in both of you. You have an admirable record of public 
service and formidable expertise on the subject at hand.
    Today's hearing will tackle the critical question of 
whether and how we can reverse decades of failed efforts to 
counter the North Korean threat. There are two key points we 
should emphasize, I think.
    First, the common perception that North Korea is just a 
hermit kingdom, cutoff from the global economy and 
international financial flows. That is deeply misleading. North 
Korea does billions of dollars in international trade, and 
North Korean exports nearly tripled in value in the last 9 
years after the first U.S. sanctions were imposed. As those 
sanctions have escalated, North Korea has responded by 
developing evasion techniques that are increasing in size and 
sophistication.
    Second, China is the linchpin. They are the key to any 
international sanctions efforts. They account for more than 90 
percent of North Korea's trade. While there has been some 
limited progress in China's participation in international 
sanctions, they must do more if we hope to have an impact on 
Kim Jong-un's strategic calculus.
    Secondary sanctions are a logical tool for pressuring China 
to do more, but a tool that must be wielded carefully, and I 
look forward to hearing your views and recommendations on that 
topic.
    I will close by saying that as the Ranking Member of this 
Subcommittee, which deals with U.S. and foreign nuclear forces 
as well, I have studied the situation in North Korea closely 
and been briefed on options for U.S. military action. Those 
have been some of the most sobering briefings of my career, and 
I pray for the sake of our armed forces and, frankly, the world 
that we will never have to put those plans into action.
    I am concerned that we need to focus on this critically, as 
we are trying to do today, and I hope this hearing will help 
lay the groundwork for cooperation between Congress and the 
White House that we tackle this threat together, not as 
Democrats and Republicans but as Americans making sure that 
everyone in our country and all of our friends and allies are 
safe as well.
    Thank you, Mr. Chairman.
    Chairman Sasse. Thank you, Senator Donnelly, and I would 
like to publicly thank you as well for the work that we did in 
preparing for this hearing. There is a long tradition that this 
Subcommittee has been very bipartisan and nonpartisan. One of 
the places that the Senate works much more effectively that is 
not always that visible to the public is when we are in the 
SCIF together getting briefings. There is much less awareness 
of people's partisan labels when they are in there being 
briefed on national security and global security issues. And 
the Ranking Member and I have been briefed on these topics both 
here on the Hill and in a SCIF at the White House on some of 
these topics. And when you are there, they are not really 
Republicans and Democrats. They are American patriots who are 
worried about the future and whether or not we have a clear 
enough strategy.
    So I know that both of you have conducted yourselves that 
way across the last two Administrations, and so we are grateful 
for your time.
    Earlier we gave you truncated opportunities for opening 
statements. I want to give each of you the opportunity to 
expand a little bit if you would like and if you do not have 
anything that you want to pull directly from your statement. 
And, again, thank you for both of them. They were long and 
meaty and helpful tutorials for us.
    I think it would be useful then maybe for you to also give 
us a sense of if you were going to give us--for our colleagues 
who either were here briefly or will not attend today's 
hearing, if you were going to give three or four takeaways of 
what you would like Senators on the Banking Committee to 
understand about the sanctions options before us with regard to 
North Korea, I think we would love to have your takeaway 
insights as well as anything you want to extract from your 
opening statement. Mr. Szubin.
    Mr. Szubin. Well, thank you very much, Chairman Sasse, and 
thank you to both of you for the kind words and, to Ranking 
Member Donnelly, for your support. I was a recipient, a 
beneficiary of the bipartisan support of this Subcommittee and 
the Committee as a whole in my years at Treasury, and that 
bipartisan support unquestionably made for a stronger sanctions 
posture and allowed our sanctions to have a massive impact 
abroad. It was not seen as a wedge issue; it was seen as a 
united front. And I very much hope that continues.
    I do not need to pull more from my written testimony, but I 
do want to come back to, I think, the central issue of the day. 
I think Juan and I are actually extremely close across the 
board on the need, first, to put this issue front and center 
with China. There are so many issues that we deal with when it 
comes to that bilateral relationship, whether they are 
economic, trade, currency, whether they have to do with 
geopolitical issues, the South China Sea. And I think it is 
time, if not past time, to put this issue as our paramount 
priority. China needs to understand that this is not one among 
many. This is first. And an intensified sanctions campaign I 
think has to be part of that. It is not that I think we need to 
be cautious when it comes to sanctioning Chinese entities. The 
caution I was talking about was before deploying a new stage, 
which is secondary sanctions, but there is quite a lot of 
authority and heft to the tools that the U.S. Administration 
has right now thanks to Congress to go after North Korea's 
activity in China and elsewhere, just using the current 
authorities on the books. And I would like to see that stepped 
up, and I would like to see the diplomacy and the high-level 
diplomacy with China stepped up.
    In terms of the when, to my mind, we need to be guided by 
Secretary Tillerson, and when there is a signal from the 
Secretary of State that these tools would be net more helpful 
at this point to unsheathe than damaging, then I think that is 
the right time. And it is going to be very difficult for me as 
an outsider or for any outsider to judge where we are in the 
conversation with China.
    But I do agree that it is not just going to be a carrot 
conversation. There is going to have to be both carrot and 
stick.
    Chairman Sasse. Mr. Zarate.
    Mr. Zarate. Mr. Chairman, thank you, and I want to thank 
the Ranking Member as well for the kind thoughts and echo 
Adam's thanks.
    I do think Adam and I are closely aligned. There may be 
some nuance in opinion here as to how to think about this, but, 
you know, maybe I can provide three insights, pulling a bit 
more from the testimony. And, Senator Donnelly, you pointed to 
this.
    I think one thing this Committee needs to continue to be an 
evangelist for is the idea that the orthodoxy that North Korea 
cannot be impacted by financial and economic measures is just 
not true; in addition to the idea that we have sanctioned 
ourselves out of doing things to North Korea, that is not true 
either.
    And so just the very notion that we should be thinking 
creatively about what those tools and strategies could look 
like is really important. It is the point of this hearing, and 
I commend the Chairman and Ranking Member for calling this.
    At the same time, these measures are not silver bullets, 
and I think one of the follies of some of the literature and 
discussion around these issues and the role of sanctions, 
especially in the wake of the relative success on Iran, which 
credit Adam and Stuart Levey and Danny Glaser and Chip Poncy 
and others, is the fact that when you are dealing with 
fundamental issues that relate to regime survival, which is 
really what we are talking about with Pyongyang, sanctions 
alone and as a stand-alone strategy and campaign will not do 
it. There has to be a collection of tools and influence that 
are brought to bear, including with respect to the Chinese 
calculus. The Chinese calculus is not going to be altered 
simply because one of the Chinese banks is threatened with a 
sanction by the U.S. That is not going to alter fundamentally 
their position. So it has to be a collective set of strategies 
and tools that are brought to bear.
    Where I maybe differ with Adam a bit--and this is where I 
have been somewhat critical with sanctions policy in the past--
is I think we have got to get away from the idea that sanctions 
need to follow neatly from the diplomacy we are engaged in, and 
the financial pressure campaign has to be sort of geared toward 
moments of diplomacy. I think one of the problems of our North 
Korea policy to date has been that we have been in start and 
stop mode. At every moment of a new test, every moment of North 
Korean belligerence, we then impose new sanctions. We then 
think about a new stage of pressure.
    I think we have to think differently about this. I think we 
have to have a constant and consistent pressure campaign that 
in some ways is parallel and complementary to our diplomacy, 
but independent from those stages of diplomatic discourse. And 
part of the reason you want to do that is to make these tools 
effective, you actually have to condition the environment. They 
have to be used consistently. You have to weed the garden at 
all times, and you have to continue to up the pressure. That is 
in part what the success of the Iran campaign demonstrated. It 
was a consistent set of actions that over time constricted the 
Iranian economy. That is what works. In this case, you have 
less time. In this case, the dynamics are different. But, in 
any event, you need a consistent pressure campaign.
    And, finally, I think the one thing that this Committee 
could help drive is creativity and imagination around how you 
change the Chinese calculus. I think one of the orthodoxies we 
have had all along is that the interests are too divided, that 
the Chinese cannot be influenced. I do think there were 
glimmers in the past of Chinese interests changing or their 
calculus being altered by their own self-interest. This is not 
a matter of getting them to want to advance U.S. interests. It 
is a matter of affecting fundamental Chinese interests. And 
when it comes to the health and security of their banking 
system, their economy, this is critical. The Politburo just 
last month held a study group, issued a study group on 
financial security. This matters to the Chinese. They worry 
about human rights and human rights blowback and reflection on 
them. That is a connection to the North Koreans that they do 
not like. They worry about corruption and the taint of 
corruption tied not only internally but also to North Korean 
activity. That is a lever to use.
    And so there is a whole dimension of things that the 
Chinese care about fundamentally that we can then use as 
levers, not to attack the Chinese but to demonstrate we are 
going to pressure the North Koreans. And if it happens to 
affect the Chinese and Chinese interests, so be it. And I think 
this Committee can help, especially with this hearing, to drive 
the opening of that imaginative aperture to think about what 
those tools are.
    Chairman Sasse. Thank you. Very helpful.
    We are going to go to Senator Rounds.
    Senator Rounds. Mr. Chairman, first of all, thank you for 
holding this Subcommittee hearing today, and thank you for the 
courtesy of allowing me to step up in line in the timing.
    As you know, gentlemen, in 2012, the U.S. Treasury 
sanctioned the Bank of Kunlun, a Chinese bank, which was one of 
two foreign banks subjected to secondary sanctions under the 
Comprehensive Iran Sanctions and Divestment Act, or CISADA, 
which was due to significant transactions with sanctioned 
Iranian banks.
    My question is: Did the U.S. Treasury action adversely 
affect the U.S.-China relationship?
    Mr. Zarate. Senator, based on my knowledge, not at all. 
There were certainly diplomatic objections from the Chinese, 
but at the end of the day, based on what I know from the 
outside, based on what David Cohen, the former Under Secretary 
of the Treasury, has written, the Chinese actually told Kunlun 
Bank to stop its activities. Kunlun Bank remains designated 
under that authority. I do not know what the current status of 
its activities looks like, but the Chinese certainly objected 
diplomatically, but they reacted the way that we would have 
hoped. That also matched the activities and their reaction in 
2005 when the Treasury designated Banco Delta Asia in Macau as 
a primary money-laundering concern, where there was a lot of 
diplomatic objection and tension and arguments that this was an 
infringement on their sovereignty based on a unilateral U.S. 
action. But at the end of the day, they wanted to protect their 
reputation; they wanted to protect the perceived integrity of 
their major banks; and they cleaned up the North Korean 
activity that was at least present obviously in places like 
Bank of China and some of the other major banks.
    Senator Rounds. Mr. Szubin.
    Mr. Szubin. Thank you, Senator. Having been on the inside--
and I do not want to talk about internal diplomatic 
conversations--certainly it was a sensitive issue in the run-up 
to that. It is an issue that we broached with the Chinese 
repeatedly to share our concerns about what was going on with 
Bank of Kunlun, such that when the sanction was actually taken, 
it did not come as a surprise. And I think there were steps 
then taken by China to be able to address the conduct, as Juan 
has said.
    But we also have to distinguish between a bank like Kunlun, 
which is a tiny regional bank that had next to no dealings with 
the U.S. markets and the U.S. dollar, and, you know, one of the 
largest banks in China at the other end of the spectrum. Right 
now, the four largest banks in China are also by assets the 
four largest banks in the world. And their dealings in the U.S. 
dollar, their investments in the U.S. and in the international 
markets are substantially different from what we are talking 
about with Bank of Kunlun. And the evidence for that is Bank of 
Kunlun continues to exist even having been subjected to 
secondary sanctions. It was not a death sentence for Kunlun 
Bank. Kunlun Bank was happy to tailor its services to Iran and 
other secondary or tertiary players.
    I do not think we need to shy away from pressuring Chinese 
banks over conduct with North Korea. To the opposite, I think 
we need to very much hold their feet to the fire. And I think 
we need to hold the feet of the Chinese Government to the fire.
    One of the other differences, though, from the Iran 
campaign to the North Korea situation is Iran conducted and 
still conducts its banking business like a country. It opens 
correspondent accounts for its major banks in other major 
banks, and then it routes its commerce in foreign exchange 
through those correspondent accounts.
    And so you had a pretty easily identifiable set of access 
points that could be turned off and that we were going around 
the world, frankly, urging countries to turn them off. And 
Kunlun did not comply. Kunlun faced secondary sanctions.
    North Korea does not conduct its banking business like a 
country anymore. It conducts its financial business overseas 
like a criminal cartel, frankly. It uses front companies, so 
there is no correspondent account for the second bank of North 
Korea that is open that a Chinese bank could just turn off. 
What is required is sort of a criminal forensic and 
intelligence full-court press to ferret out who those front 
companies and agents are and to shut them down and then to 
continue to turn the screw, because North Korea will not sit 
still to just watch its access points cut. It will find new 
access points.
    For that reason, I am not only describing what will need to 
be a very intensive push by our Government, but also by China 
on the enforcement side, and by Chinese banks. We need to 
somehow enlist their cooperation, and that might involve some 
arm-turning, twisting. It might also and I think necessarily 
will involve discussions about where this is all headed.
    But through a combination of devices, we need to get China 
to care about this issue nearly as much as we do. Otherwise, we 
are not going to succeed in that cat-and-mouse game of forcing 
North Korea's dirty money out of China.
    Senator Rounds. Thank you, gentlemen.
    Thank you, Mr. Chairman.
    Chairman Sasse. Senator Donnelly.
    Senator Donnelly. Thank you, Mr. Chairman, and I want to 
thank both the witnesses.
    You had talked about getting their attention, that this is 
critical to us. And if you had two or three key ideas that you 
said here are the two or three that I would say do most, to 
each of you, what would they be?
    Mr. Szubin. If I were advising the Secretary of State, I 
think the conversation that we are having today, the focus of 
Congress and this Committee on secondary sanctions, could be an 
extremely useful opening to the type of very serious 
conversation that I think they want to have and that we need to 
have.
    Senator Donnelly. And what do you think would be the first 
secondary sanctions that you would say this would be critical 
and this would be critical?
    Mr. Szubin. I am talking here about the threat on the 
horizon that Congress seems to be headed in this direction, 
that we, the Administration, may not be able to stop them, and 
there is always this sort of good cop/bad cop routine that 
plays out with diplomacy. When those secondary sanctions come 
into effect, we want to see major Chinese banks with clean 
hands, not having any North Korean dirty accounts on their 
books, so that this is really going after the small rogue 
actors as opposed to the international-facing, most reputable, 
first-tier banks in China.
    So, to me, that is a conversation that I think could bear 
real fruit right now, and you do not need to enact secondary 
sanctions to have it.
    Senator Donnelly. Mr. Zarate.
    Mr. Zarate. I think Adam is absolutely right. I think the 
mere threat of secondary sanctions and the potential to have a 
conversation with the Chinese to say, ``Look, this is not 
intended to attack your entire banking system, nobody wants 
that.'' What we are trying to do is identify rogue, illicit 
financial behavior, activity that violates international norms 
and principles, to which China subscribes, at a time of 
heightened expectations globally about what the banking world 
is supposed to be doing. We have all seen the billion dollar 
fines of the major global banks around the world. This is a 
time of heightened expectation with respect to transparency and 
accountability and traceability in the international financial 
system. This is a demand of the Chinese system, and to Adam's 
point, I think putting that conversation to them is very 
important. And I would say that could be amplified and 
suggested to them in very material ways.
    So I think in addition to potential secondary sanctions, 
you could use Section 311 of the PATRIOT Act yet again. Section 
311 has been used against the jurisdiction of North Korea and 
financial institutions from North Korea. But as Adam said, it 
is very hard to play Whack-A-Mole with the North Koreans. They 
are changing names, they are changing shipping registries, they 
are changing agents all the time. So that is difficult, and 
that is not the most efficient way.
    Senator Donnelly. A lot of the times in our country, some 
of the smaller banks work with the larger banks as--they are 
kind of like the fortress bank for them. Does that go on in 
China as well? And is that the kind of thing that we can look 
and say, look, you have this bank, this one, this one that are 
all involved in North Korea, and you are the ones that they 
work through? Is that something that would help?
    Mr. Zarate. Absolutely. And, in fact, when I mentioned the 
indirect risk to the major Chinese banks, the four major global 
banks, that is exactly what I was referring to, which is their 
own counterparty and affiliate risk that exists given their 
connectivity within the Chinese system, again, that they may 
not even be aware of. We have seen this with responsible 
Western banks that often do not understand what risk even 
exists within their systems or their account holders. So there 
may be this risk.
    And so the conversation to be a legitimate one, to say, 
look, you need to understand as a responsible international 
player, as a responsible bank, where you have this risk. And 
whereas going with the 311 was exactly this, Senator, which is 
to have a Section 311 action that designates all North Korean 
financial and commercial activity as a class of transactions 
that is a primary money-laundering concern. This is not about a 
particular financial institution. It is about anything that 
touches the North Korean system or any potential transaction.
    What that does is it forces responsible banks to actually 
have to do a lot more due diligence, a lot more investigation 
around what their risk looks like, and that in some ways is 
marshaling then the major Chinese banks which have an interest 
in doing this right, or at least not being affected by the 
reputational taint, to do this.
    Two other quick ideas, though, I think are important. I 
think we should launch an anti-corruption initiative using the 
anti-kleptocracy resources that the prior Administration put in 
place, some of the efforts that the Bush administration put in 
place when I was at the White House, to actually make the issue 
of corruption on the part of the North Korean regime something 
that is somewhat dangerous and potentially revealing on the 
Chinese side. That would get the Chinese attention given 
Chinese internal dynamics on corruption. So having a focus on 
corruption itself in the North Korean context has a potential 
to impact Chinese thinking about their threats.
    The last thing I would say on shipping, I think we can do a 
lot more--and you have seen this from the private sector--to 
map the networks that are used by North Korea to proliferate 
and to engage in activity. The reason that is interesting and 
important is that inevitably reveals the financial networks, 
the conduits that they are using throughout Asia, especially in 
China. It also raises the specter of a more aggressive 
interdiction campaign, perhaps by the U.S., South Korea, Japan, 
Australia, where maritime resources are going to be in places 
that the Chinese are not going to be very comfortable with. And 
so my argument here is let us use elements of international 
norms and principles that the Chinese and Chinese responsible 
entities are going to be sensitive to to actually begin to 
shift Chinese calculus and behavior. And if you did things like 
that--and there are other ideas in my testimony, and I know 
Adam has other ideas, too--I think you could begin to reshape 
the way the Chinese think about this. This is actually more of 
an existential risk to them as a responsible global player than 
ever before.
    Senator Donnelly. OK. Thank you.
    Chairman Sasse. Senator Perdue.
    Senator Perdue. Thank you. And thank you, guys. I think 
this is an extremely critical topic at a really tough time 
right now.
    I have got a question about the validity of the sanctions, 
and I am concerned about that the game has changed. Mr. Zarate, 
you brought up Banco Delta Asia in your testimony, and you talk 
about it being an example of how sanctions work. My question is 
that things have changed since that time. You know, China is 
seeking an alternative to the U.S.-created global system. And 
so with their growth and our debt and our negative current 
account, their trade conversations over there with their 
consortium they are trying to build, do you think that these 
sanctions today would have the same pressure on these financial 
institutions that it did in the past? Or would this begin to 
accelerate their effort to find alternatives to the U.S. model 
and the dollar as a reserve currency? I mean, we have taken 
sanctions for granted for so long that, of course, the U.S. is 
the biggest 800-pound gorilla in the world and sanctions will 
work. Well, I am not so sure that that is going to be forever 
true, and I am really concerned about the intransigence that we 
perpetrated on our financial balance sheet is putting that in 
jeopardy.
    Would you both respond to that quickly?
    Mr. Zarate. Senator, you raise a really important and 
fundamental point. You are right, this is not 2005, and the 
Chinese have adapted to the Banco Delta Asia action. I think 
the Chinese have a dual strategy. One is to play in the 
existing economic and financial order and to become big players 
in that, and they are doing that. In that context, they have to 
play by international norms and rules, and in many ways, we are 
still the largest proponent of that. They are in theory 
cooperative partners in that. And in that realm, that is where 
we can affect them most. If they want to----
    Senator Perdue. Would you agree that that is changing over 
time? It has changed since 2005, as you just said. It is going 
to change over the next decade as well.
    Mr. Zarate. Absolutely. And it is not static, of course. 
And their leverage over us in many ways, their size, not just 
of their banks but of their economy, their ability to dictate 
new rules of the road, leads to the second strategy, which is 
your point: Can they begin to change the rules in a way that 
puts China at the center or at least allows them to dictate 
better what the rules are? You have seen this with intellectual 
property, with our technology companies. You have seen it 
certainly with alternate payment systems, UnionPay. They do not 
rely on Visa and MasterCard. They have got their own.
    And so they are trying to develop a parallel structure, and 
you are right, there is a potential that anything we can do can 
accelerate that. But for now, they are still trying to play in 
the existing structure, and they want to be seen as legitimate 
players. And it is based on those principles and norms that 
they have subscribed to that I think we have the greatest 
strength. And that was the linchpin with BDA.
    Senator Perdue. Right.
    Mr. Zarate. The reason they could not object was they 
realized that what BDA was doing was anathema to international 
norms and principles, their own laws. And if we can continue to 
drive that kind of a theme and that kind of a strategy, I think 
we are likely to be more effective than not.
    Senator Perdue. Mr. Szubin.
    Mr. Szubin. Senator, I think you raise a really important 
point, and it is obviously not a point just about North Korea 
on sanctions in this context, but the broader threat horizon 
and how sanctions are used over the coming decades.
    For now, our leverage is still supreme, and China does not 
have an alternative, no country has an alternative to the 
international financial system as it is set up where the U.S. 
dollar is the primary currency and the U.S. banking system is 
the most pivotal, it is the fulcrum.
    So I do not think our sanctions leverage has today, in 
2017, diminished in a material way from where it would have 
been a decade ago. But I think our use of sanctions over the 
last decade has certainly prodded and prompted a change in 
thinking on the part of countries like China, non-aligned 
movement countries, about, wait a minute, how dependent can we 
afford to be on this Western framework? And the more we use 
secondary sanctions as a tool--and I do see a line between 
secondary sanctions and primary sanctions, and I can explain 
why if there is interest. But the more we use secondary 
sanctions as a tool, where we are in the most blunt way saying 
to countries around the world you do business with X, or you do 
business with us, period. It is not about conduct. It is not 
about hosting missile transactions or terrorist transactions. 
You are going to do business with a bank in that country, you 
are done. The more we are going to be seen as using our 
financial primacy as a weapon and cramming our foreign policy 
down the throats of other countries by force of that weapon.
    So I think we need to be very, very careful in the use of 
that tool. That does not mean we do not ever use it. It just 
means we have to be deliberate.
    Senator Perdue. But the way we use it today is different 
than the way we have used it in the past because of all the 
things you both have said.
    One last question. I am out of time. But the shadow banking 
system really concerns me. I think at the end of last year, the 
public banking system had about $33 trillion directionally. I 
think that is correct. The shadow banking system estimates are 
as high as $9 or $10 trillion, so it is a significant part of 
their overall banking system that I do not think we can get to.
    So the question is: Is North Korea playing in that shadow 
banking area today?
    Mr. Szubin. North Korea, as I mentioned earlier, Senator, 
is going to use any opening it can find to move money.
    Senator Perdue. Are they in it today?
    Mr. Szubin. Yes. I mean, depending on how you want to 
define shadow banking, absolutely. They are using cash 
couriers. They are using ancient ways of moving money that 
predate the banking system. But they are also using and, 
frankly, dependent on modern banks, and the reason I say that 
is they have got billions of dollars of import needs every 
year. In order to pay for that, you are not going to be able to 
have a cash courier or a shadow bank arrange for a payment to a 
reputable exporter. The reputable exporter wants to see a wire 
payment show up from a bank, and they are not going to be paid 
in North Korean currency. I can assure you there is no exporter 
anywhere in the world who wants to be paid in North Korean 
currency.
    So that is a vulnerability for North Korea. It means it has 
to be earning foreign currency, reputable currency, into 
reputable bank accounts, and that is a vulnerability that, as 
Juan was saying earlier, I think we have yet to fully exploit. 
That leverage is there, and so this myth that North Korea is 
somehow isolated, a pariah kingdom, and, therefore, sanctions-
proof is not the case.
    Senator Perdue. Right. Thank you both.
    Thank you.
    Chairman Sasse. Thank you.
    Could we go back and get a little bit of a level set on the 
North Korean economy more generally? Let us talk about GDP and 
about essentially imports and exports. And I understand, I 
think, some of your testimony said that about 90 percent of 
their trade is with China. But help us understand all the ways 
that they are using an international banking system for so that 
we can sort of tailor down our understanding of how targeted 
these secondary sanctions against Chinese financial 
institutions might be. And both of you having a discussion and 
to the degree you differ on anything, that would help flesh out 
stuff for us as well. So I will throw it to both of you.
    Mr. Szubin. Of course, Senator. So the estimates here are 
pretty rough, and I think the best economists who are looking 
at this issue acknowledge that the estimates are going to vary 
pretty wildly. This is not, you know, a country like Mongolia 
or Belgium where you might have regular IMF visits, who are 
doing metrics, and as I said earlier, North Korea's banking 
system and import-export system sometimes looks more like that 
you would see of a criminal organization than that of a 
country.
    But with all of those caveats, the estimates I have seen 
are between $3 and $5 to $6 billion a year in imports and 
something around that level in terms of their exports. That is 
pretty significant. The major imports are petroleum, coking 
coal, and textiles. Their major exports are minerals, with coal 
being No. 1, but a number of other minerals both more high 
value, like rare earth type, and then more basic minerals being 
right behind it. And North Korea, of course, is also selling 
its weapons to a number of countries around the world, and that 
is dangerous both as a source of revenue but, of course, the 
missile technology that they are peddling itself.
    For all of these sales, and anytime you are getting above 
the tens of millions of dollars, you need access to the banking 
system. So that is that reliance that we have been talking 
about, and that presents a vulnerability.
    When you talk about China, I have seen estimates of more 
than 50 percent, estimates of 75, estimates as high as 90 
percent in terms of how much trade. Certainly when you look at 
their largest source of export revenue, coal sales, the portion 
that is derived from China is over 75 percent. And China we 
have seen suspend those purchases temporarily, sometimes for a 
few months, sometimes for a few weeks, or just bring those 
imports down. But that leverage is in China's hands, and China 
is aware of that. I do not think that is a point that is lost 
on China.
    So the truth is not that North Korea is sanctions-proof 
but, in fact, that North Korea has, to its own detriment, put 
all of its eggs in one basket or many of its eggs in one 
basket, and that is China, which makes it very much vulnerable 
to sanctions pressure.
    All of this comes back, though, to the key question we have 
been discussing earlier, which is: How do you get China to 
exert that pressure in a far more meaningful way than they have 
to date? And they have played with the dial. They have turned 
it up. They worked with us on not only drafting but sponsoring 
U.N. Security Council resolutions to sanction North Korea. So 
they have not been immovable on this, but they also have not 
come anywhere close to the level of pressure that it is going 
to take.
    And to my mind--and I am not a foreign policy expert, but 
to my mind, the central hesitation on their point is stability. 
They like the status quo, as bad as it is, as unpleasant as it 
is, more than they are willing to deal with these very ugly 
scenarios of regime collapse. And that is a conversation that 
we need to have with China. What is our end game here? What is 
our, the U.S. Government's, end game? Yes, we know we want to 
put pressure on North Korea to bring Kim Jong-un to the table. 
But let us say we turn the heat up very, very high and he 
refuses to come to the table. Let us say he is committed to 
this to his death. What does the pressure campaign look like 
then? And how are we ensuring that we are not looking at a 
total regime collapse? If we are looking at leadership change, 
which is different from regime collapse, how are we navigating 
those waters? And how are we going to work with China to ensure 
that their nightmare scenario is not realized?
    I think we have overlapping interests here, or at least 
reconcilable interests. I think there is room for that 
conversation to be fruitful. But that is going to be a sine qua 
non of any successful campaign involving real China cooperation 
on turning these screws up.
    Chairman Sasse. Very helpful.
    Mr. Zarate.
    Mr. Zarate. Mr. Chairman, I think one way of thinking about 
the North Korean economy is in three buckets. One is their sort 
of what would be called ``normal trade'' with China; that is to 
say, trade in coal, largely, but as Adam said, more and more 
with other minerals being extracted. I gave the estimate in the 
testimony based on one expert that 90 percent of trade with 
North Korea is China-dependent. As Adam says, that is an 
approximation, and I do not think we have an exact number. But 
there is a form of formal elements of the economy that are 
functioning. In fact, if you look at the first quarter numbers 
for this year, it appears that you have an increase in trade 
with China, according to some of the experts, by over 35 
percent. And so that trade is real. It uses agents and 
companies and financial institutions to actually do the trade, 
as you would imagine normal trade. And so there is kind of an 
ecosystem around that.
    There is the ecosystem around the illicit financing and the 
sanctions evasion and the smuggling, which we all know about. 
As Adam said, North Korea is known as the ``Mafia State,'' you 
know, the ``Sopranos State,'' and very much acts in that way. 
And so they change front companies, they change agents, they 
change ship registries. The recent U.N. Panel of Experts report 
indicates that they are growing more sophisticated in terms of 
how they are engaging in these network operations and moving 
money, materiel, and arms around the world, to include in 
Africa now. And so there is an entire illicit economy that 
feeds the regime and gives it sustenance.
    And then there is a third element that is important, 
especially from a human rights perspective, which is their use 
of slave labor or forced labor, both within the country and 
then outside of the country. And most people who do not 
concentrate on North Korea would not realize that there are 
estimates of maybe over 50,000 forced laborers working around 
the world, being paid but where the pay is actually going 
straight back to the North Korean regime. Some of the estimates 
is that this goes up to $2 billion per annum, per year, worth 
of income. These are laborers of all sorts in places that you 
would not anticipate, places like China, of course, but also 
Qatar, Poland, other places where these are forced laborers, 
and their pay is going right to the regime.
    And so there are these ecosystems of an economy in which 
the North Korean regime uses all elements of the financial 
system, to Adam's point, formal and informal, as a way of 
moving money in and out of the country as needed and largely 
trying to pull capital in so that the regime can strengthen 
itself, strengthen its own economy, and ensconce the regime.
    A final point that is important and interesting is recent 
articles about sort of the flourishing of more of a private 
sector in North Korea. There is a bit more of what we could 
call a private sector economy in North Korea. That is 
interesting to watch because I think a lot of that is being 
amplified and affected by some of this cross-border trade with 
China. And so China maybe could impact some of those 
developments as well if they understand how that is evolving. 
But as Adam indicated, it is a difficult question as to how you 
think about Chinese touch points in each of those ecosystems. 
But that is one way of thinking about it.
    Chairman Sasse. Thank you. Very helpful. In a subsequent 
round, I want to come back to this. It was in your testimony as 
well as the slave and forced labor. But one more thing before 
we go to Senator Donnelly. You said maybe we have not had a 
level set at any point in this hearing on the extant primary 
sanctions regime that exist. And so when you distinguish among 
the three buckets of trade that they have, first of all, the $3 
to $6 billion estimate--and I know that we do not really have 
great numbers on this, but what share of GDP would we think 
their import-export number is? How large is the total North 
Korean economy?
    Mr. Szubin. I am not sure. I believe the estimates are $20 
to $30 billion.
    Chairman Sasse. OK, so a significant share of their economy 
is import-export. And given the current sanctions regime--and I 
understand all the caveats that both of you have given, and I 
think you have tried to be delicate, and I think we are not 
trying to beat anybody up here that a new Administration does 
not have clarity of a long-term strategy vis-a-vis North Korea 
and that you could try to bring the Chinese along at this 
stage, but it is perplexing to think that the Chinese are 
worried about these same set of problems, and yet your point 
about the four large banks and the way that you would insulate 
them from potential exposure to a sanctions regime by allowing 
the smaller banks to do this and that not necessarily being 
something that we could target in a way that could affect 
larger decision making, is any of the extant trade that is 
cross-border something that is potentially violative of the 
primary sanctions regime? So besides the financial institutions 
question that are the subject of this hearing, at the level of 
primary sanctions, is there already cross-border Chinese-North 
Korean trade issues that should also be on our docket for 
discussion here?
    Mr. Szubin. Yes, absolutely. And that is what I was 
alluding to, perhaps too indirectly, in my testimony, talking 
about existing authorities providing a lot of leverage right 
now. And it is not just U.S. sanctions, U.S. primary sanctions. 
Interestingly, the U.N. Security Council resolutions provide a 
lot of leverage. If those were being implemented as they are 
written, you would see massive impacts, massive pressure on 
North Korea.
    So, you know, sometimes it is not a question of what new 
tool do we need, but how do we use the existing tools which are 
binding on countries? And China is not just a member State of 
the U.N. They are a co-drafter of these resolutions. How do we 
get better implementation? And the resolutions target each one 
of North Korea's major sources of export revenue, which you 
have been asking about today. They target their coal sales. 
They target forced labor, as Juan was talking about. They 
target banking access. And, of course, as with any resolution, 
there is room to interpret it more expansively and room to 
interpret it more narrowly. So when a U.N. Security Council 
resolution says there is a prohibition on offering 
correspondent banking services to North Korea, you could 
interpret that in a very narrow way and say, well, North Korea 
does not use correspondent banking, and so there is nothing 
here. Or you could interpret it in a robust and meaningful way 
and say, What are the de facto access points that North Korea 
is using as its correspondent banking beachheads in China, and 
how do we cut them off? And there is a lot of room to enlist 
China's help, forgetting about any U.S. sanctions, just under 
the U.N. Security Council umbrella.
    Mr. Zarate. It is a really important point that Adam just 
made. The interpretation of existing sanctions is really a 
critical question, and the Chinese have traditionally viewed 
these Chapter 7 obligations in the context of the U.N. 
sanctions in a very limited way.
    The other good example is in the shipping context where 
suspect cargo and shipping moving in and out of North Korea, 
especially that tied to weapons of mass destruction programs, 
are subject to interdiction. The Chinese read that very 
narrowly. What is suspicion? How do you define it? How do you 
evidence it? That is an area where a more robust 
interpretation, as I was indicating to Senator Donnelly, in 
terms of shipping interdiction could be incredibly powerful and 
based on international existing sanctions that the Chinese have 
agreed to.
    There is also the role--and we have seen this with some of 
the revealed networks that have touch points with China. There 
is also a role for greater just investigation and analysis 
around what these corporate structures and networks look like. 
There is a lot of work being done in the private sector. Sayari 
Analytics has been cited in the press. C4ADS has put out 
important reports.
    Just looking at ownership and control interests, that alone 
has been very revelatory, and that is based on existing 
sanctions. And as Adam indicated, the last Executive order 
signed--he probably fashioned it himself when he was at the 
Treasury--in 2016 was sort of a potpourri of delicts that North 
Korea was being targeted for: human rights, cyber, other 
activities. And so we do have authority. The question is: How 
amply and aggressively do we apply it? And can we draw that to 
the international obligations and then, frankly, compel the 
Chinese to come along with us?
    Chairman Sasse. Yes, thank you, and how we rank order 
those, back to Senator Donnelly's great opening questions about 
if you were doing two or three things, how would you rank order 
the narrow or broader interpretations of extant primary 
sanctions and this new secondary sanctions bucket we are 
considering today.
    Senator Donnelly.
    Senator Donnelly. Thank you, Mr. Chairman.
    One of the things you hear about North Korea is that they 
would rather have their people eat grass than give up any part 
of their nuclear program, any part of their weapons program. So 
when you look at this, how do you change their calculus? If 
China cooperates more with us, that they look and they go--is 
there a push point for North Korea where they say, you know, 
now we probably have to come to the table a little bit more? Or 
do they look and go we just do not care? And basically the only 
way you stop them is having them run out of resources. Mr. 
Szubin.
    Mr. Szubin. You know, to an intelligence analyst, I think 
that is often the $64,000 question, the leadership decision-
making calculus. And I personally suspect that Kim Jong-un may 
be immovable on this, by which I mean, yes, he would rather see 
his people eat grass, starve, see widespread famine before he 
relinquishes his nuclear weapons. And it is not entirely 
irrational if you put yourself in his shoes. He believes that 
they are the guarantor of his survival, and that if he gives up 
the program, he will be done away with.
    The truth, though, is because of the vulnerabilities, the 
reliance that he has on international export earnings--and one 
of the best examples of this is the patronage system--that 
keeps him in power. His ability to buy off other North Korean 
elites in the military and the intelligence services, just the 
sort of aristocrats or oligarchs, as you will, of North Korea, 
he needs access to foreign export earnings for that and foreign 
luxury goods for that.
    But what if that dries up? How dedicated are those people 
to their beloved leader? I do not think very. And so he faces a 
real vulnerability, a real risk of losing his control over the 
leadership. That may be what is required before a North Korean 
Government comes to the table.
    But I do believe that a North Korean Government, not 
necessarily this North Korean leader but a North Korean 
Government, a person who might succeed him, would see the 
tradeoff as not only necessary but compelling, the tradeoff 
being your question: giving up their nuclear weapons, coming 
into compliance with international resolutions when it comes to 
their nuclear program, in exchange for allowing them some form 
of access to international trade and international currency 
and, therefore, survival.
    Senator Donnelly. Mr. Zarate.
    Mr. Zarate. Senator, you ask the fundamental question with 
respect to what is the strategic purpose of a financial 
pressure campaign, and I think there are several answers here 
that do test the proposition that this can be an effective tool 
to change Pyongyang's decision making. And I think ultimately 
this is a regime, as Adam said, that is focused on its own 
survival; it is focused on the development of a nuclear and 
missile program that ensconces its internal power as well as 
its deterrent capability externally; and it is not going to 
give that up unless there is a sense of existential threat to 
the regime itself.
    But I think sanctions, and effective sanctions, and a 
financial pressure campaign can do several things. There is a 
material dimension. You can make it harder for them to actually 
acquire the things that they need to advance in their programs. 
Very hard to do, but if done effectively, you can at least slow 
the progress and clock. And we have seen that with other 
sanctions programs.
    Second is you can affect the decision making. These leaders 
have budgets to deal with. If they have less income coming in 
because the sanctions are proving more effective, they are 
going to have to make a decision, whether it is feeding their 
people or developing the next version of the nuclear program. 
And so forcing them to actually make these hard decisions and 
to stress them internally is part of the goal.
    Affecting their sense of regime stability, to Adam's point, 
the patronage system regime stability, it is part of the reason 
one of the recommendations I have is we should announce that we 
are going to engage in a leadership asset hunt from the get-go. 
It may not be that there is much we can actually find, but just 
signaling that we are willing to do that, to use the elements 
of the international system that we have built over time, that 
we usually reserve for when a bad regime collapses or when 
there is a failed State or something, let us use that ex ante, 
let us use it before the fact to say we are going to try to 
find where the leadership is stealing assets from its people, 
we are going to try to capture it and preserve it as a way of 
dealing psychologically with this issue, and perhaps even 
affecting the Chinese, and then having the Chinese actually 
change their behavior. That could have an impact in Pyongyang. 
The Chinese are the lifeline, the backstop for North Korea, 
diplomatically, economically. If that begins to change in more 
dramatic, fundamental ways, that could impact what happens in 
Pyongyang. We just do not know. And I think Adam's caution 
about being careful about where we go is right. I also think we 
have to explore what we can potentially do, because if we 
continue to wait, I think we know where we are going to end up. 
We are going to end up with a North Korean regime that has a 
nuclear capability, has potentially intercontinental ballistic 
missiles, has multiple missile platforms by which they can 
potentially threaten and attack U.S. interests, not just in 
Guam and Hawaii but in San Francisco and New York. And that is 
an unacceptable position to be in.
    And so I think we have got to be a little bit of risk 
takers here and a bit more aggressive than we have been in the 
past in terms of what we try to do influence their decision 
making.
    Senator Donnelly. Thank you.
    Chairman Sasse. Could we go back to this question of slave 
or forced labor, both inside and outside the regime? Tell us a 
little bit more on how it works inside the regime for sure, but 
also abroad, how do they have certainty that they will get 
these assets back? What is the command-and-control structure of 
those remittances?
    Mr. Zarate. Mr. Chairman, the internal dynamics I do not 
pretend to know well. The reality is the North Korean regime 
uses different types of forced labor internally--prison labor, 
forced labor, for generating billions of dollars of product, 
commerce, revenue internally to the North Korean economy. I do 
not have details as to how they actually run that from a 
security perspective, but it is not a pleasant regime in that 
regard, and certainly it is a command economy in all the senses 
that that means.
    I have a bit more familiarity with what is happening on the 
outside, which is that the North Koreans have purposefully in 
essence sold their labor into foreign markets cheaply to serve 
across the board in terms of a variety of labor and service 
sectors, everything from working in shipyards to construction 
to even a little bit higher-end kind of labor in pockets around 
the world. Part of that is to not only sort of gain revenue, 
but also gives them some influence and allows them to operate 
in countries around the world where they otherwise would not 
have a presence.
    And so there has been recent news reports, for example, of 
the North Korean workers' presence in Poland, workers that are 
working in the shipyards. Vice News did a big report on this. 
And, in essence, what is done is these are forced laborers; 
they work in what are considered to be inhumane conditions. 
They are paid for their labor. That pay does not go straight to 
them, straight to their bank account, straight to their family 
members. It is not part of some remittance scheme where they 
send it back to their wife or grandmother or whomever. The 
payment actually goes back into a North Korean account, back 
into North Korea. And in some cases, based on what I have read, 
there are additional commissions paid for purposes of payment 
to the Government. So it is not just the pay for the labor. It 
is a commission for the State itself that then goes back into 
the coffers.
    Mr. Chairman, in fairness, I do not pretend to know how 
some of that is financed, but I imagine, as Adam indicated, 
there are elements of the financial system that are used as a 
way to facilitate the movement of the money back into North 
Korea. And, again, as I indicated earlier, this is to the tune 
of $1 billion, some estimates over $2 billion worth of revenue, 
and it is why I think we should have a concerted effort--we 
have had sanctions on the books to date on this, but a 
concerted effort to tie the forced labor and human rights 
abuses to their financing as a way of understanding what the 
financial networks are and as a way of adding to the 
international taint of doing any business with the North 
Koreans. It is almost unimaginable that you would have this 
scheme operating in legitimate countries around the world. 
There should be an end to it. The labor should not be 
exploited, obviously. And certainly there should not be 
payments and commissions being paid back to the North Korean 
regime. That is an area of focus that I think not just people 
like us who care about sanctions would focus on. This is 
something the human rights community around the world should be 
heavily focused on as well.
    Chairman Sasse. Mr. Szubin.
    Mr. Szubin. The only thing I would add is my understanding 
is they typically are sending one member of a family only in 
situations where family members stay behind so that there is 
leverage to ensure that that person does not defect or run 
away, and it is that leverage that incents the enforcement 
mechanism to keep the forced labor in place and to keep them 
earning.
    I think that the more knowledgeable, sophisticated human 
rights people who have looked into this have come away with the 
conclusion that it is, as Juan says, an appalling practice. It 
is not a situation where you can really argue both sides, that 
this is a financial lifeline for these families. Far from it.
    The other thing I would note is North Korea does not need 
to repatriate these funds. It actually needs money located in 
third countries for its imports. And so oftentimes it can just 
accumulate money, whether in the Gulf, whether in Eastern 
Europe, whether in China, whether in Southeast Asia, and then 
use that to finance its imports. But as Juan says, those are 
funds, those are accounts, those are front companies that we 
and our allies should be targeting.
    Chairman Sasse. Really helpful. We are under constraints 
because of some Senate objections on the floor that we have to 
conclude the hearing at this time. But I think there are a 
number of us on this Committee who would like to return to you 
and ask those targeted questions about what you would rank 
order, if Secretaries Mnuchin and Tillerson came together and 
asked your counsel, and how nuanced the new Under Secretary's 
team will be as they are getting stood up. I think there are a 
number of people in both the Article I and Article II branches 
that are grateful for your past work, but would also benefit 
from your present and future counsel.
    So thank you both for being here today. This hearing is 
concluded.
    Mr. Szubin. Thank you, Chairman.
    Mr. Zarate. Thank you, Mr. Chairman.
    [Whereupon, at 11:27 a.m., the hearing was adjourned.]
    [Prepared statements supplied for the record follow:]
                  PREPARED STATEMENT OF ADAM J. SZUBIN
  Distinguished Practitioner-in-Residence, Johns Hopkins University, 
   School of Advanced International Studies; Of Counsel, Sullivan & 
Cromwell; and Former Acting Secretary of the Treasury and Acting Under 
      Secretary of the Treasury for Terrorism and Financial Crimes
                              May 10, 2017
    Chairman Sasse, Ranking Member Donnelly, and Members of this 
Subcommittee. In my years at Treasury, I testified before Members of 
this Committee more than any other, and I am honored to present my 
first testimony as a private citizen before you today. Thank you for 
convening this hearing on such an important and timely topic and for 
inviting me to testify today. More broadly, thank you for your 
longstanding bipartisan support to my former office, Treasury's Office 
of Terrorism and Financial Intelligence (TFI). On that note, I would 
respectfully urge that you move deliberately but quickly to confirm 
Sigal Mandelker, who has been nominated to serve as under secretary 
overseeing this office, including Treasury's intelligence, sanctions, 
and money laundering authorities. It is critical that TFI have a 
confirmed under secretary in place, and I know Sigal to be an 
exceptionally intelligent, experienced, and strong leader.
    I am often asked whether--as with Iran--the international community 
could generate enough sanctions pressure to force the North Korean 
Government to the table to negotiate a peaceful and verifiable end to 
its nuclear weapons program. It is of course an intensely difficult 
question, as it requires assessments of notoriously opaque issues, such 
as the internal thinking of North Korea's leadership, its internal 
power dynamics, and possible succession scenarios. That said, I believe 
the answer is a qualified ``yes.'' Whether new secondary sanctions 
legislation is needed or advisable at this stage is a related but 
separate question that I will take up in turn.
    My topline assessments are as follows:

  1.  North Korea is not self-reliant or ``sanctions proof.'' Its 
        leadership depends upon access to foreign goods and 
        international banking services, the denial of which would 
        quickly build substantial pressure on its leadership.

  2.  Unlike in Iran's case, which enjoyed diverse access to the 
        international marketplace, sanctions leverage over North Korea 
        is concentrated in one country--China. If China is prepared to 
        take a qualitatively tougher stance on sanctions against North 
        Korea, sanctions have a real chance to succeed. If not, they 
        have none.

  3.  Despite years of high-level international attempts, China has 
        resisted more than incremental enhancements to its sanctions 
        posture. China is risk averse when it comes to North Korea, and 
        for understandable reasons.

  4.  U.S. sanctions alone will not force China to adopt a 
        qualitatively tougher approach, no matter how draconian and 
        costly those sanctions become. China is exponentially more 
        concerned about the fate of North Korea than it is about Iran, 
        and China will not be strong-armed into a course of action that 
        it believes imperils its national security.

  5.  Serious and high-level engagement will therefore be needed to 
        assure China that (1) this issue is paramount for the United 
        States, above other commercial and geopolitical priorities; (2) 
        the proposed sanctions campaign against North Korea is aimed at 
        enabling nuclear diplomacy not regime collapse; (3) our 
        interests in this diplomatic effort overlap with and are 
        reconcilable with China's national security interests, 
        including maintaining stability on the Korean peninsula.

  6.  As part of a stepped up sanctions effort around targeting North 
        Korea's activities around the world, the U.S. will almost 
        certainly need to sanction complicit Chinese entities, both to 
        combat sanctions abuse and to demonstrate our seriousness of 
        purpose. The Administration has ample authorities to do so 
        already. If new legislative authorities become necessary down 
        the road, it is important to introduce them only once the 
        strategic and diplomatic groundwork has been laid.

    To begin, all experts agree that the threshold of pressure that 
will be needed to even bring North Korea to the negotiating table is 
extraordinarily high. Kim Jong-Un doesn't just see his nuclear weapons 
program as one pillar of his country's national security. He sees it as 
the primary guarantor of his regime and his personal survival. The only 
conceivable scenario in which Kim Jong-Un would consider negotiating 
over his nuclear weapons program is if he believes that--unless he does 
so--he is at risk of a near-term loss of power. This means that the 
required threshold of sanctions pressure will be high and cannot be 
expressed as an incremental add-on to the status quo. I will return 
below to what the requisite level of pressure would look like in 
practice.
    Some experts believe, however, that even if the sanctions pressure 
reaches the point where Kim Jong-Un fears for his hold on power, he 
would persevere and risk being deposed rather than give up his nuclear 
weapons and, in his mind, guarantee his demise. That assessment may 
well be correct. If so, the global community needs to see a different 
leader in Pyongyang, one who is willing to address the security 
concerns of the international community. Either way, it will be 
necessary to build international pressure to the point where it 
threatens leadership change.
    Because I am unable to predict Kim Jong-Un's internal calculus, I 
framed my central question not around his personal decision making, but 
rather whether international pressure could force a North Korean 
Government to the table to negotiate a verifiable end to its nuclear 
weapons program. Faced with suffocating international pressure, I do 
believe that a North Korean leader would be willing to negotiate the 
disposition of the country's nuclear weapons in exchange for survival 
and some form of diplomatic and economic re-integration.
    It is vital to remember here, as elsewhere, that toughened 
sanctions in and of themselves are not a strategy. Massive diplomatic 
investment and multilateral engagement will be needed to marshal a 
successful effort, and it will require enlisting likeminded and 
resistant countries. Having participated in a comparable campaign with 
respect to Iran, I would urge the Administration and Congress to staff 
leadership positions at the Treasury and State Departments quickly. And 
I believe that it would be counterproductive in the extreme to deplete 
our foreign service corps at a time when we need them so urgently--both 
on this issue and the whole range of national security and foreign 
policy threats we face.
    What would a sufficiently tough sanctions program look like and how 
would it be obtained? The good news here is that--contrary to some 
observers--North Korea is not somehow ``sanctions proof.'' It is highly 
isolated but it is not self-reliant. In fact, in many ways, its 
isolation renders it more vulnerable to sanctions pressure than Iran 
was in the mid-2000s when we commenced our pressure campaign.
    North Korea's anemic economy requires imports of petroleum, coking 
coal, and textiles. Its antiquated industrial and communications 
sectors require significant imports of machinery, equipment, and 
expertise. On top of the general economic needs of the country, Kim 
Jong-Un depends upon a system of patronage to purchase the loyalty of 
senior political and military officials, for which he needs to import 
foreign luxury goods such as cars, technology, and high-end 
consumables. In the aggregate, these imports and purchases are 
estimated at approximately $5 billion a year. None of them can be 
bought using North Korean currency; no exporter outside of North Korea 
will accept payment in North Korean won. All of this means that the 
leadership of North Korea must (a) continuously generate new foreign 
currency earnings through the sales of minerals, weapons, counterfeit 
goods, etc.; (b) receive payment for those exports in foreign bank 
accounts via the international banking system; and (c) pay for and 
arrange for the delivery of needed imports.
    A North Korean leader depends on all three of these elements, both 
to stave off a broader economic collapse and to maintain the loyalty of 
his inner circle. The first two elements are the most exposed to 
sanction pressure. I assess, then, that a stepped up sanctions campaign 
would need to target North Korea's foreign currency earnings--for 
example by dramatically reducing North Korea's sales of coal and other 
minerals--and would need to disrupt North Korea's access to the foreign 
bank accounts it currently enjoys.
    Multiple U.N. Security Council resolutions, binding on all U.N. 
member States, have already targeted North Korean exports, imports, as 
well as its financial activity and now prohibit the purchase of North 
Korean coal and minerals and the maintenance of correspondent accounts 
for North Korean entities.
    In terms of implementation, the key question is and has always been 
China. To bring the pressure up to the threshold required, we must find 
a way to enlist the cooperation of the Chinese Government and the 
compliance of Chinese private actors. This is not a hopeless task. 
China is not comfortable with either Kim Jong-Un or with North Korea's 
burgeoning nuclear and ballistic missile capabilities. Indeed, the 
North Korean leader has at times gone out of his way to provoke China's 
leaders, snubbing Chinese diplomats, timing provocative missile 
launches to the Chinese New Year celebration, and murdering senior 
North Korean officials who had good relations with China. China would 
also strongly prefer that North Korea not have a nuclear weapons 
program, both because of the instability it engenders in the region and 
because it has justified a robust U.S. military presence just off 
China's shores, including the recent deployment of the THAAD anti-
missile system in South Korea. I believe that China would breathe a 
huge sigh of relief if it could successfully resolve the world's 
concerns over North Korea's nuclear weapons program.
    We have seen China act on those concerns, including in the realm of 
sanctions. China has not just acquiesced in the last two U.N. Security 
Council resolutions targeting North Korea, it has co-sponsored them 
with the United States. The resolutions have had real teeth, including 
new mandatory sanctions against North Korea's exports of coal, its 
import of luxury goods, and its ability to bank. And China has 
periodically acted against individual agents and entities in China, 
when pressed firmly by the United States. This includes Ma Xiaohong and 
the Dandong Hongxiang Industrial Development Company, an important 
North Korean facilitation network that was targeted by the U.S. Justice 
Department, sanctioned by the Treasury Department, and ultimately 
investigated by Chinese authorities for ``serious economic crimes.''
    That said, China's implementation of the U.N. sanctions has been 
spotty and decidedly incomplete. Time and time again, we have seen 
China pull back from implementing the toughest measures, whether at the 
level of broad economic measures or targeting specific sanctions 
evaders in China.
    The problem is that, as much as China may dislike Kim Jong-Un and 
his nuclear program, there is an alternative that is far worse from 
China's perspective, which is North Korean regime collapse. Even an 
erratic Kin Jong-Un is preferable to a regime implosion, which could 
immediately trigger an outpouring of millions of indigent refugees 
across China's border, a struggle for control over North Korea's 
military and nuclear programs, and the potential prospect of 
reunification of the Korean peninsula under a South Korean Government, 
bringing a close U.S. military ally to China's borders.
    It is important to recognize, then, that China will not ratchet up 
the pressure on North Korea to anything close to a leadership-
threatening level unless it understands what comes next and views the 
scenario/s as acceptable. China will not ``roll the dice'' when it 
comes to the fate of its impoverished, nuclear-armed neighbor, and 
concerns over stability will be paramount.
    Threatening and/or imposing U.S. secondary sanctions against 
Chinese targets may change the conduct of individual Chinese entities 
or banks from afar, then, but it will not bring about the kind of 
comprehensive and sustained crackdown by Chinese authorities, traders, 
bankers, and businesspeople that is required to bring North Korea to 
the table. That type of sanctions pressure will only be obtained when 
the Chinese Government agrees to apply it.
    I want to pause here to address two counter-arguments that I hear. 
First, we forced China to cut its oil imports from Iran using secondary 
sanctions, so secondary sanctions should work in this context as well. 
Second, even if the Chinese Government doesn't agree, Chinese 
businesses and banks will comply with secondary sanctions because, 
given a choice between doing business with the United States or North 
Korea, all banks and businesses will choose the United States.
    The arguments are flawed for a few reasons. First, the stakes for 
China were dramatically lower in the Iran case. If the sanctions 
pressure worked and an international solution to Iran's nuclear program 
was reached, that would be good for China. If the sanctions fell short, 
China had played a responsible role in the international community. If 
sanctions over-achieved and provoked instability in Iran, China was not 
a primary or even secondary stakeholder. Put simply, Iran plays a 
minimal role in China's geopolitical outlook compared to North Korea.
    Second, while it is true that we won grudging Chinese acquiescence 
to curtail imports of Iranian crude oil, months of painstaking 
diplomacy were needed and what China did was easier and more limited 
than what we will need them to do here. China reduced its crude oil 
imports from Iran by a certain percentage every 6 months as it lined up 
alternate sources for its crude oil. And it escrowed Iran's oil 
earnings for use in bilateral Iran-China trade only--notably, a 
restriction that hurt Iran but benefited Chinese exporters. We will 
need far more extensive and proactive cooperation here. Iran was 
conducting its business with China largely in the ordinary way. Iran's 
correspondent accounts were easily identifiable and oil tankers cannot 
be smuggled across a border. North Korea conducts its banking activity 
and trade more like a criminal organization than a country--through 
cut-outs and agents, such as front companies posing as ordinary Chinese 
trading or business enterprises. This means that a large bank in China 
may be hosting millions of dollars of North Korean financial activity 
without any direct relationship with a North Korean person and, 
potentially, without knowing it. The type of rigorous investigative and 
enforcement effort that will be required to police North Korean covert 
banking activities and smuggling far outstrips what China did in the 
Iran context.
    Third, secondary sanctions are a blunt and unpredictable instrument 
and their application carries broad risks for the U.S. and our allies. 
To focus on the banking arena, as noted above, North Korea generally 
conducts its financial activities surreptitiously through cut-outs. As 
such, the Chinese banks involved fall along a spectrum of awareness. In 
some cases, they may indeed be complicit, and looking to facilitate 
North Korean activity for a profit. In many cases, they may be hosting 
North Korean transactions without knowing it, but where we would assess 
that they could be doing more to detect and prevent this activity. 
Finally, there are instances where Chinese institutions are practicing 
all due care and are nevertheless still being abused, as large and 
careful U.S. and European banks will have criminal proceeds moving 
through their institutions under the names of agents and front 
companies. Secondary sanctions are an extremely blunt instrument to 
respond to such a spectrum of conduct. In practice, their use means 
that a target is completely severed from the U.S. financial system, a 
condition that--for an internationally active bank--is generally 
tantamount to a death sentence. That power and lack of adjustability is 
both a strength and a limitation.
    In this context, we should note the types of entities we are 
discussing. The four largest banks in China are the four largest banks 
in the world, each larger than JPMorgan Chase by assets. Yes, they are 
inextricably dependent on access to the U.S. financial system but the 
dependencies run both ways. They hold several trillion dollars of 
assets in our markets and at our largest institutions. By comparison, 
Lehman Brothers before its collapse was only one-seventh as large. The 
implosion of one of the world's largest financial institutions is not 
something to be trifled with. It would send shock waves through the 
international financial system and trigger large and unpredictable 
fall-out. And none of this is to consider the inevitable response and 
counter-sanctions from China.
    The fourth error made in assessing the viability of secondary 
sanctions is that, with some targets, they may have little to no 
impact. A trading firm or coal importer in Dandong province that does 
tens of millions of dollars of business with North Korea may do no 
business with the U.S. or Europe. Forcing a choice between doing 
business with North Korea or the United States may be an easy one for 
that firm, and not in the direction that we would like.
    For all of these reasons--and other longer-term costs and risks 
that time does not allow me to address here--we need to be 
exceptionally judicious in our use of secondary sanctions. And creating 
the authority just to have it available carries risks as well. As a 
sanctions practitioner, I believe that we do ourselves and our 
credibility major harm if we unsheathe this powerful weapon without 
understanding if and how we are prepared to use it. America has had 
major successes in its use of sanctions in the last decade, but one of 
the reasons for those successes is that we do not bluff. Were we to 
depart from this practice, we would see our sanctions credibility 
undercut, not just in this context, but across a whole range of vital 
national security and foreign policy portfolios.
    A comparison with the use of secondary sanctions vis-a-vis Iran is 
instructive. In that context, the Bush and Obama administrations had 
aggressively deployed primary sanctions for years to target those 
entities colluding with Iran, and brought costly enforcement actions 
against global banks that were evading our sanctions. The 
Administrations coupled these actions with an extensive outreach 
campaign, approaching Governments, banks, and businesses to ensure that 
they understood the gravity of Iran's conduct, the primacy of this 
issue for the United States, and the risks of a lax approach to Iran. 
In response, the world's first-tier banks exited their Iran business 
and every relevant jurisdiction began to subject its Iranian trade to 
careful scrutiny and diligence.
    Congress then turned the heat up considerably in 2010, with a 
series of secondary sanctions bills. The Administration worked with 
Congress to refine those bills, ensuring that they included aggressive 
but attainable thresholds and sufficient discretion and waivers to 
allow the Administration to use them effectively across a range of 
countries and circumstances. And the Administration was staffed and 
ready to immediately deploy senior officials to every corner of the 
world upon passage. The result was the most effective sanctions 
campaign the world had ever seen, as Congress's secondary sanctions 
dramatically amplified the work that the Administration had underway. 
Second- and third-tier banks that had picked up the Iran business as it 
was shed by their larger competitors suddenly exited. Iran's crude oil 
exports dropped by 40 percent. And Iran's leadership saw only one way 
out--through negotiations over its nuclear program. The outcome is 
remembered clearly, but we also need to remember the preparation and 
work that allowed it to succeed. That groundwork has not yet been laid 
in the case of North Korea.
    My conclusion then, is that we cannot unilaterally sanction China 
into imposing the type of sanctions pressure necessary to change North 
Korea's course. We will need to win China's cooperation. This will 
require serious diplomacy, and both carrot and stick. As part of that 
effort, I suspect that we will need to sanction Chinese entities that 
are knowingly doing business with North Korea, both to show China that 
we are serious and to combat sanctions evasion. The Administration has 
the authorities to do that already. But the key to success will be 
high-level diplomacy to take up and work through China's interests and 
reconcile them with our own.
    There is enough overlap between China's interests vis-a-vis North 
Korea and our own concerns with North Korea's nuclear program to allow 
for a mutually acceptable approach. And there are many incentives and 
irritants in our bilateral relationship with China that could be used 
to facilitate this diplomacy. But China must know that we have thought 
through the steps that follow after crippling pressure is applied, and 
that China's core national security interests will be protected. From 
China's side, it would be helpful if China identified one or two senior 
officials who could speak for President Xi on addressing the North 
Korean nuclear threat, across the range of diplomatic, strategic, and 
financial facets involved.
    Against such a diplomatic backdrop, a range of sanctions approaches 
could be drawn up. As noted earlier, I see the primary targets as North 
Korea's access points to the international financial system and its 
export earnings, primarily from the sale of coal, minerals, and 
weapons. A campaign plan could be structured and staged in various ways 
to dramatically increase the pressure against North Korea. If the 
international community were to fully cut off North Korea's coal 
exports alone, it would drop the country's foreign revenue earnings by 
more than one-third immediately.
    The U.S. Administration is already well-armed with sanctions 
authorities to play a leading role in such a global sanctions effort. 
The Treasury Department has broad and flexible authorities to sanction 
businesses, trading firms, and banks anywhere in the world that are 
facilitating North Korea's activities or providing North Korea's banks 
with surreptitious access to the global financial system. What the 
effort will require, though, is senior leadership in the Administration 
to lead the charge and the resources and bodies to sustain it. Those 
resources will be needed at State, at Treasury, and in the intelligence 
community--an effort of this scale and sophistication will necessarily 
require a full-court, sustained interagency press. As such a campaign 
progresses, the Administration may need additional authorities from 
Congress--including potentially secondary sanctions--but such 
authorities should be deployed to advance a strategy not in advance of 
one.
    Of course, even with a concentrated and strategic effort, we cannot 
guarantee that a diplomatic effort powered by new sanctions pressure 
will succeed. But it has a chance to do so. And, faced with this ever-
growing threat and absent a better alternative, I believe that it is 
our duty to put all of our energies into this effort.
    Thank you again for inviting me to testify.
                                 ______
                                 
                  PREPARED STATEMENT OF JUAN C. ZARATE
   Chairman and Cofounder, Financial Integrity Network; Chairman and 
   Senior Counselor, Center on Sanctions and Illicit Finance; Former 
Deputy Assistant to the President and Deputy National Security Adviser 
for Combating Terrorism; And Former Assistant Secretary of the Treasury 
                        for Terrorist Financing
                              May 10, 2017
    Chairman Sasse, Ranking Member Donnelly, and distinguished Members 
of the Senate Banking, Housing, and Urban Affairs Subcommittee on 
National Security and International Trade and Finance, I am honored to 
be with you today to discuss the urgent need to pressure North Korea 
and the utility of secondary sanctions against Chinese institutions in 
such a strategy.
    This is a timely and important hearing. The international security 
challenge from North Korea has grown more dangerous and direct for the 
United States. The regime in Pyongyang remains intent on developing 
ballistic missile and nuclear capabilities that will allow it to reach 
and threaten the United States directly. In defiance of international 
sanctions and pressure, North Korea has quickened the pace of missile 
and nuclear tests, demonstrating ever-expanding capabilities and 
claiming to have the ability to place a nuclear warhead on the tip of 
an intercontinental ballistic missile. Despite recent missile launch 
failures, the regime continues its march toward these capabilities.
    What was once seen solely as a threat to peace and stability on the 
Korean Peninsula and our regional allies has now become a looming, 
direct threat to the U.S. homeland.
    All the while, North Korea proliferates its technology for profit, 
engages in illicit financial and commercial activity, exploits forced 
labor to make money for the regime, and has deployed cyber tools to 
attack adversaries and the private sector, including U.S. companies and 
the banking system. North Korea remains a threat to international 
security and to the integrity and stability of the financial system.
    The threats from North Korea require a sober, more comprehensive, 
and urgent response, including the use of financial and economic tools 
and pressure. This in turn requires a more aggressive and imaginative 
approach leveraging new tools and mechanisms, including secondary 
sanctions against Chinese and other businesses, entities, and networks 
still doing business with North Korea.
    China is North Korea's economic and diplomatic lifeline, and its 
principal interest is ensuring the stability of the North Korean 
Government and avoiding regime collapse. As a result, China has 
maintained ties with North Korea and been unwilling to bring 
overbearing pressure on its ally in Pyongyang. Over the years, North 
Korea has found outlets and connectivity to the financial and 
commercial system through Chinese banks, companies, and agents--to 
circumvent sanctions, serve their economy, and enrich the regime.
    Because China remains the regime's backstop, the United States 
needs Chinese cooperation and support to slow and stop North Korea's 
missile and nuclear programs. The Chinese calculus has not changed in 
the past and will not change unless its own interests are fundamentally 
threatened or affected. Chinese and American interests do not yet align 
with respect to North Korea.
    This is a moment for China to assume its role as a great power and 
to influence its North Korean ally to stop its nuclear and missile 
programs and contain the threats from proliferation. This 
Administration and Congress will need to grapple with how best to 
obtain, coerce, and sustain Chinese cooperation in order to maximize 
pressure on North Korea. Ultimately, the United States must find a way 
to change Pyongyang's calculus and the trajectory of their nuclear 
program. This testimony addresses how to leverage financial and 
economic pressure, including secondary sanctions, to increase the 
chances of changing the calculus in North Korea and China and avoiding 
conflict.
    My testimony has benefited directly from the ongoing work and 
contributions of Anthony Ruggiero at the Foundation for Defense of 
Democracies, along with the scholarship of Victor Cha and Bonnie Glaser 
at the Center for Strategic and International Studies, John Park at the 
Harvard Kennedy School of Government, and the Council on Foreign 
Relations' Task Force on North Korea led by Chairman Mike Mullen and 
Senator Sam Nunn, on which I served.
Core Principles for a Financial and Economic Pressure Campaign
    There are fundamental principles that should drive any serious 
financial or economic pressure campaign. These principles should inform 
the design, choreography, and strategy deployed before launching any 
type of sanction or form of economic coercion.
    Strategy Matters. To be effective, an attempt to use sanctions or 
financial measures of any sort must nest within a coherent strategy and 
cannot stand alone. Too often, sanctions have been seen as either the 
only retreat for action to address a thorny national security issue or 
as a silver bullet that can bend behavior and alter a threat landscape 
on its own. For any financial pressure campaign to work, it must be in 
service of an understood strategy and complemented by other tools of 
statecraft, power, and coercion. In this case, the strategic objective 
must be to slow, stop, and ultimately reverse the North Korean nuclear 
program and ensure that the regime never has the ability to threaten 
U.S. territory with nuclear weapons. The financial strategy must then 
follow and be crafted to achieve this core goal, in aid of diplomacy, 
coercion, and material disruption of the targeted programs.
    Coercive Tools in Concert. The sanctions and economic toolkit must 
be seen as part of a broader set of coercive tools that are more 
effective when deployed in concert to shape the environment. 
Interdiction of suspect North Korean shipping, arrests of those 
involved in North Korean illicit financial activity, broad-based 
information campaigns to weaken the regime's control of the information 
environment, and an aggressive focus on the regime's human rights 
abuses are all complementary and functional parts of any campaign to 
isolate the North Korean economy. These are also tools that should 
target, impact, and deter those who do business or finance the regime's 
activities. Sanctions must be seen as part of a broader effort to 
disrupt the regime's ability to resource its nuclear and missile 
ambitions and access the key elements of the financial and commercial 
system.
    Constant, Consistent Pressure. For a financial pressure campaign to 
work, it must be applied constantly to identify and isolate North 
Korea's rogue behavior. U.S. and international sanctions and pressure 
in the past have suffered from applying an escalatory model based on 
reactions to North Korea's provocations, tests, and violations of 
existing sanctions. Such sanctions have been perceived as important 
simply in aid of diplomacy. Although that is a critical use of these 
tools, in order to be effective, they must be seen as their own form of 
pressure, coercion, and disruption that complements our diplomacy. As a 
result, the sanctions approaches of the past have been dictated more by 
what the regime in Pyongyang does as opposed to what an effective 
financial and economic pressure campaign looks like. Any use of 
sanctions must be part of a broader campaign to sensitize the 
international community and markets to exclude rogue actors involved 
with North Korea from the legitimate financial and commercial system. 
Like weeding a garden, such work has to be consistent and constant, to 
shape market and Governments' behavior.
    Conduct-Based Focus. A successful campaign against North Korea that 
enlists China and our allies would focus intently on conduct-based 
sanctions and measures that target the illicit, dangerous, and 
suspicious activities that violate international norms and principles 
and put the financial system at risk. A fundamental vulnerability for 
North Korea is that it is not only developing nuclear weapons 
capabilities in violation of international sanctions, but it is a 
criminal State. It is engaged in proliferation, massive human rights 
abuses, money laundering, corruption, sanctions evasion, 
counterfeiting, smuggling, drug trafficking, and other nefarious and 
suspect activities.
    These activities are interwoven in how North Korea does business 
and should be isolated by the international community--Governments and 
the private sector alike--regardless of the state of diplomacy. Such 
activities are the subject of sanctions, criminal laws, and financial 
regulations. At a time of heightened concern over transparency and 
accountability in the financial system, there should be no objection to 
doing so, especially in major economies like China, Japan, and South 
Korea. As long as the efforts to target North Korean networks and their 
financial and commercial infrastructure remain focused on the 
activities that violate accepted international norms and principles, 
they will prove more effective and be amplified by the actions of the 
private sector and actors concerned about real and reputational risk.
    Altering the Chinese Calculus. China must play a central role in 
pressuring North Korea, but its interests do not align with those of 
the United States and it has not been willing to exert existential 
pressure against the regime to force it to stop its nuclear program. 
For the United States, for too long, trying to coerce China to exert 
more pressure on North Korea has appeared as the third-rail of the 
sanctions debate. But we have reached a moment where we need to align 
U.S. and Chinese interests with respect to pressuring North Korea. We 
cannot ignore the role that Chinese actors are playing to evade 
sanctions, enrich the leadership, and enable the regime to develop its 
dangerous capabilities across the board.
    If this is an urgent international security issue, the Chinese 
dimension cannot be spared attention, and the Chinese calculus must be 
altered. Chinese interests and standing will have to be put at risk 
directly and indirectly. Of course, this needs to be a balanced 
approach, understanding direct financial and economic confrontation 
with China through sanctions will likely prove counterproductive. This 
balance can be drawn if China sees itself as a partner in these efforts 
and if the campaign is geared toward targeting and isolating rogue 
financial and commercial activity and those flouting legitimate 
authorities and international norms. Getting the Chinese to realize 
that the continued, current path with North Korea is itself creating 
regime and regional instability--and putting its own reputation and 
economy at risk--will be a difficult but essential element of any 
campaign.
    U.S. sanctions against North Korea have lacked both a comprehensive 
approach of this nature and a willingness to put China's interests on 
the table. The U.S. Government's recent strategy of strategic patience 
and a prior pattern of lessening financial pressure or rewarding the 
regime in Pyongyang in the face of provocation have not forced the 
Chinese to make hard choices. The idea of pressuring China to alter its 
calculus is difficult, but if the problem of a nuclear armed and 
threatening North Korea is growing acute, then we need to apply a more 
aggressive approach.
    It is in this context that the question of whether and how to use 
secondary sanctions and other types of financial tools and measures 
arises. Before treating the issue of secondary sanctions, it is 
important to understand the nature of North Korean financial activity 
and its dependence on the Chinese economic and financial system.
North Korean Financial Activity and Chinese Connectivity
    For years, the North Korean regime has found creative and often 
devious ways to run its economy. They have raised and moved capital 
into the Hermit Kingdom in order to prop up the regime and develop an 
expensive nuclear and missile program. It has adapted to sanctions and 
attempts to isolate the regime financially and commercially--relying on 
the Chinese economy, including Chinese banks, networks, and brokers, 
for most of its trade and connectivity to the commercial and financial 
world. The North Korean regime has consistently leveraged commercial 
relationships to its advantage and worked around existing sanctions and 
restrictions. Much of this has involved illicit financial activity and 
schemes to raise money for the Government.
    The North Korean schemes outside their borders rely heavily on 
front companies, layered transactions, opaque ownership structures, and 
trusted or corrupt relationships, making it difficult for legitimate 
banks and compliance systems to detect and stop its nefarious 
activities. The United Nations has issued annual reports that detail 
North Korea's aggressive efforts to evade financial sanctions. \1\ In 
2011, the Financial Action Task Force called for its members to impose 
countermeasures on the Kim regime due to its significant lack of anti-
money laundering and counter-terrorism finance controls. \2\ Last year, 
the United States Treasury labeled North Korea a jurisdiction of 
``primary money laundering concern,'' ordering that the country be cut 
off from the U.S. financial system and prohibiting foreign banks from 
providing indirect access. \3\ In the designation, the Treasury 
Department described North Korea's financial activities as a ``threat 
to the integrity of the U.S. financial system.'' \4\
---------------------------------------------------------------------------
     \1\ United Nations Security Council, ``Reports of the Panel of 
Experts Established Pursuant to Resolution 1874 (2009)''. (https://
www.un.org/sc/suborg/en/sanctions/1718/panel_experts/reports)
     \2\ Financial Action Task Force, ``Public Statement--24 February 
2017'', February 24, 2017. (http://www.fatf-gafi.org/publications/high-
riskandnon-cooperativejurisdictions/documents/public-statement-
february-2017.html)
     \3\ U.S. Department of the Treasury, Financial Crimes Enforcement 
Network, ``Finding That the Democratic People's Republic of Korea Is a 
Jurisdiction of Primary Money Laundering Concern'', 81 FR 35441, June 
2, 2016. (https://www.fincen.gov/sites/default/files/shared/2016-
13038(DPRK_Finding).pdf)
     \4\ U.S. Department of the Treasury, Financial Crimes Enforcement 
Network, ``Finding That the Democratic People's Republic of Korea Is a 
Jurisdiction of Primary Money Laundering Concern'', 81 FR 35441, June 
2, 2016. (https://www.fincen.gov/sites/default/files/shared/2016-
13038(DPRK_Finding).pdf)
---------------------------------------------------------------------------
    The U.N. Panel of Experts has investigated Pyongyang's financial 
activities, noting that ``circumvention techniques and inadequate 
compliance by Member States are combining to significantly negate the 
impact of the resolutions.'' \5\ The Panel reported that North Korea 
generates ``significant revenue'' from its financial networks with most 
denominated in U.S. dollars, euros, and renminbi. \6\
---------------------------------------------------------------------------
     \5\ United Nations Security Council, ``Report of the Panel of 
Experts Established Pursuant to Resolution 1874 (2009)'', S/2017/150, 
February 27, 2017. (http://undocs.org/S/2017/150)
     \6\ Ibid.
---------------------------------------------------------------------------
    The regime generates profits from all forms of illicit activity--
from counterfeit cigarette smuggling to proliferation. The U.N. Panel 
of Experts noted that North Korean proliferation networks are expanding 
and blending to include arms trafficking in Africa and the manufacture 
and trade of military technologies. Such networks rely on trusted and 
sophisticated agents able to move people, goods, and money undetected 
across borders. Those networks and agents are growing more 
sophisticated in masking and layering corporate identities and records 
and play within the seams of the international system.
    The North Koreans are profiting from their human rights abuses. 
Within the country, unpaid labor earns around $975 million for the 
Government each year, according to Seoul-based NGO Open North Korea. 
\7\ The report estimates that 400,000 people make up the lowest class 
of forced laborers, or dolgyeokdae, who are put to work on construction 
projects throughout the country.
---------------------------------------------------------------------------
     \7\ Steven Borowiee, ``North Koreans Perform $975 Million Worth of 
Forced Labor Each Year'', Los Angeles Times, October 6, 2016. (http://
www.latimes.com/world/asia/la-fg-north-korea-forced-labor-20161006-
snap-story.html)
---------------------------------------------------------------------------
    The regime also profits handsomely from forced labor outside its 
borders. U.N. Special Rapporteur on Human Rights in North Korea Marzuki 
Darusman estimated that there are approximately 50,000 North Koreans 
abroad, earning between $1.2 billion to $2.3 billion per year for the 
DPRK. \8\ Countries like China, Poland, Qatar, and others allow their 
companies to use such labor and to make arrangements to pay North 
Korea. \9\
---------------------------------------------------------------------------
     \8\ Christian Vonscheidt and Miriam Wells, ``Cash for Kim: How 
North Koreans Are Working Themselves to Death in Europe'', VICE News, 
May 23, 2016 (https://news.vice.com/article/cash-for-kim-how-north-
koreans-are-working-themselves-to-death-in-europe); Edith M. Lederer, 
``U.N. Investigator: North Koreans Doing Forced Labor Abroad To Earn 
Foreign Currency for Country'', AP, October 28, 2015. (https://
www.usnews.com/news/world/articles/2015/10/28/un-investigator-north-
koreans-doing-forced-labor-abroad)
     \9\ VICE News discovered that 14 Polish companies have used North 
Korean workers between 2010 and 2016. The workers were supplied to 
Polish companies Armex and Alxon by the Korea Rungrado General Trading 
Corporation. Working conditions in these shipyards meet the definition 
for forced labor, as laid out in the European Convention on Human 
Rights and the International Labor Organization. (Christian Vonscheidt 
and Miriam Wells, ``Cash for Kim: How North Koreans Are Working 
Themselves to Death in Europe'', VICE News, May 23, 2016. (https://
news.vice.com/article/cash-for-kim-how-north-koreans-are-working-
themselves-to-death-in-europe))
---------------------------------------------------------------------------
    The workers are used in industries like shipyards, surface 
construction, furniture production, agriculture, metalworking, 
medicine, and finance. Wages are paid in foreign currency directly to 
the DPRK as a method of bypassing U.N. sanctions. \10\ Workers are paid 
between $120 and $150 per month, but the employers ``pay significantly 
higher amounts'' directly to the North Korean Government. \11\
---------------------------------------------------------------------------
     \10\ Christian Vonscheidt and Miriam Wells, ``Cash for Kim: How 
North Koreans Are Working Themselves to Death in Europe'', VICE News, 
May 23, 2016. (https://news.vice.com/article/cash-for-kim-how-north-
koreans-are-working-themselves-to-death-in-europe)
     \11\ Jethro Mullen, ``North Korea Believed To Earn a Fortune From 
Forced Labor Overseas, U.N. Says'', CNN, October 29, 2015 (http://
www.cnn.com/2015/10/29/asia/north-korea-un-forced-labor-overseas/); 
Edith M. Lederer, ``U.N. Investigator: North Koreans Doing Forced Labor 
Abroad To Earn Foreign Currency for Country'', AP, October 28, 2015. 
(https://www.usnews.com/news/world/articles/2015/10/28/un-investigator-
north-koreans-doing-forced-labor-abroad). The Leiden Asia Center 
estimates that between 70-100 percent of the earnings go directly to 
the DPRK.
---------------------------------------------------------------------------
    With all this, China remains North Korea's most important economic 
and trading partner. China accounts for approximately 90 percent of 
North Korea's total trade volume, and Chinese-North Korean trade was up 
37.4 percent in the 1st Q of 2017 when compared to 2016. \12\ China has 
benefited from access to North Korean coal and minerals while North 
Korea has used Chinese networks and its economic system, in particular 
broker relationships and access to financial institutions, as a way of 
accessing hard capital and driving its economy.
---------------------------------------------------------------------------
     \12\ Eleanor Albert, ``The China-North Korea Relationship'', 
Council on Foreign Relations, April 26, 2017. (http://www.cfr.org/
china/chinanorth-korea-relationship/p11097)
---------------------------------------------------------------------------
    Unfortunately, China has allowed its economy to be used by North 
Korea to evade sanctions and engage in illicit activity. In most cases 
when a new North Korean sanctions evasion network is revealed, 
inevitably it has a nexus to or in China. Given Beijing's robust 
security services and sensitivities to exposure to North Korean 
activity, it is hard to believe the Chinese leadership is not aware of 
such exposure to North Korea and the Kim regime's activities.
    Recent examples of how North Korea's financial and commercial 
activities are intertwined with the Chinese economy and financial 
system are illustrative:

    Limac-Ryonbong Joint Venture: This past weekend, the Wall 
        Street Journal reported that Limac Corp, a Chinese State-owned 
        company, has maintained a joint venture since 2008, with a 
        North Korea's Ryonbong General Corp, which has been under U.S. 
        sanctions since 2005, for its involvement with weapons of mass 
        destruction. \13\ The North Korean firm has reportedly ``tried 
        to procure chemicals for solid-fuel for rockets'' in the past, 
        and several of its employees were sanctioned as recently as 6 
        weeks ago by the Treasury Department. \14\ Meanwhile, the 
        Chinese firm maintains a U.S. affiliate, and records show that 
        in 2013, it shipped Canadian nuclear-power equipment to China 
        via the U.S. \15\ This represents just one node of the China-
        North Korea nexus. Sayari Analytics (which discovered the link) 
        ``says it has identified more than 600 Chinese companies that 
        trade with North Korea.'' \16\
---------------------------------------------------------------------------
     \13\ Jeremy Page and Jay Solomon, ``Chinese-North Korean Venture 
Shows How Much Sanctions Can Miss'', Wall Street Journal, May 7, 2017. 
(https://www.wsj.com/articles/chinese-north-korean-venture-shows-how-
much-sanctions-can-miss-1494191212)
     \14\ Ibid.
     \15\ Ibid.
     \16\ Jeremy Page and Jay Solomon, ``Chinese-North Korean Venture 
Shows How Much Sanctions Can Miss'', Wall Street Journal, May 7, 2017. 
(https://www.wsj.com/articles/chinese-north-korean-venture-shows-how-
much-sanctions-can-miss-1494191212)

    The Dandong Hongxiang Network: Dandong Hongxiang Industrial 
        Development Co., Ltd and four Chinese individuals created a 
        mechanism to help North Korea evade financial sanctions. \17\ 
        The network was exposed in August 2016, in a ground-breaking 
        study, In China's Shadow, published by the Center for Advanced 
        Defense Studies (C4ADS) and the Asan Institute for Policy 
        Studies. \18\ The Justice Department filed an indictment 
        against the company and four individuals shortly after the 
        publication of the C4ADS-Asan study. \19\ From 2009 to 2015, 
        the network allegedly routed at least $75 million through the 
        U.S. financial system, and from June to August 2016, the 
        network routed $8 million through the U.S. financial system. 
        The Treasury Department also designated the four Chinese 
        nationals and Chinese companies in September 2016, in 
        coordination with the public unsealing of the indictment. \20\
---------------------------------------------------------------------------
     \17\ The four individuals are: Ma Xiaohong, a Chinese national who 
resides in Dandong, China, and was the majority owner (80 percent) of 
DHID; Zhou Jianshu, a Chinese national who also resides in Dandong and 
was the general manager of DHID working directly for Ma; Luo Chuanxu, a 
Chinese national who is the financial manager of DHID and an assistant 
to Ma and Zhou; and Hong Jinhua is a Chinese national who also resides 
in Dandong and was the deputy general manager of DHID working for Ma. 
U.S. Department of Justice, Press Release, ``Four Chinese Nationals and 
China-Based Company Charged with Using Front Companies To Evade U.S. 
Sanctions Targeting North Korea's Nuclear Weapons and Ballistic Missile 
Programs'', September 26, 2016. (https://www.justice.gov/opa/pr/four-
chinese-nationals-and-china-based-company-charged-using-front-
companies-evade-us)
     \18\ ``In China's Shadow'', The Asan Institute for Policy Studies 
and C4ADS, August 2016. (https://static1.squarespace.com/static/
566ef8b4d8af107232d5358a/t/57dfe74acd0f68d629357306/1474291539480/
In+Chinas+Shadow.pdf) U.S. Department of Justice, Press Release, ``Four 
Chinese Nationals and China-Based Company Charged With Using Front 
Companies To Evade U.S. Sanctions Targeting North Korea's Nuclear 
Weapons and Ballistic Missile Programs'', September 26, 2016. (https://
www.justice.gov/opa/pr/four-chinese-nationals-and-china-based-company-
charged-using-front-companies-evade-us)
     \19\ U.S. Department of Justice, Press Release, ``Four Chinese 
Nationals and China-Based Company Charged With Using Front Companies To 
Evade U.S. Sanctions Targeting North Korea's Nuclear Weapons and 
Ballistic Missile Programs'', September 26, 2016. (https://
www.justice.gov/opa/pr/four-chinese-nationals-and-china-based-company-
charged-using-front-companies-evade-us)
     \20\ U.S. Department of the Treasury, ``Press Release: Treasury 
Imposes Sanctions on Supporters of North Korea's Weapons of Mass 
Destruction Proliferation'', September 26, 2016. (https://
www.treasury.gov/press-center/press-releases/Pages/jl5059.aspx)

    Global Communications Co (Glocom): Pan Systems Pyongyang, a 
        North Korean branch of a Singapore-based company, created 
        Glocom claiming it was a Malaysia-based company to sell 
        prohibited military equipment. The U.N. Panel of Experts 
        reported that the company used bank accounts in China to 
        transfer funds to suppliers located in mainland China and Hong 
        Kong. \21\ The Panel noted that a ``series of transactions by 
        Glocom initiated by companies registered in Hong Kong, China, 
        and cleared through several United States correspondent banks 
        in New York.'' \22\ The U.N. noted that Pan Systems Pyongyang 
        is controlled by the U.S.-designated Reconnaissance General 
        Bureau (RGB), North Korea's intelligence agency, and also 
        received funds from U.S. and U.N.-designated Korea Mining 
        Development Trading Corporation, a key proliferation entity. 
        \23\
---------------------------------------------------------------------------
     \21\ United Nations Security Council, ``Report of the Panel of 
Experts Established Pursuant To Resolution 1874 (2009)'', S/2017/150, 
February 27, 2017. (http://undocs.org/S/2017/150)
     \22\ United Nations Security Council, ``Report of the Panel of 
Experts Established Pursuant To Resolution 1874 (2009)'', S/2017/150, 
February 27, 2017. (http://undocs.org/S/2017/150)
     \23\ Ibid.

    March 31, 2017 U.S. Designations: The Trump 
        administration's actions against North Korea's financial 
        facilitators provided insight into the workings of Pyongyang's 
        financial network. The designations included the following: Han 
        Jan Su, the Moscow-based representative of U.S.-designated 
        Foreign Trade Bank; Jo Chol Song, the Dandong, China deputy 
        representative of U.S. and U.N.-designated Korea Kwangson 
        Banking Corporation; Kim Tong Ho, the Vietnam-based 
        representative of U.S. and U.N.-designated Tanchon Commercial 
        Bank; Kim Mun Chol, the Dandong-based representative of U.S. 
        and U.N.-designated Korea United Development Bank; and Kim Nam 
        Ung and Choe Chun Yong, the Moscow-based representatives for 
        Ilsim International Bank. \24\ These representatives were 
        engaged in a variety of conduct including working with RGB on 
        financial transfers, working with Moscow-based Tempbank that 
        was designated by the U.S. for its activities with the Syrian 
        regime, and weapons and missile-related sales. \25\
---------------------------------------------------------------------------
     \24\ U.S. Department of the Treasury, ``Press Release: Treasury 
Sanctions Agents Linked to North Korea's Weapons of Mass Destruction 
Proliferation and Financial Networks'', March 31, 2017. (https://
www.treasury.gov/press-center/press-releases/Pages/sm0039.aspx)
     \25\ U.S. Department of the Treasury, ``Press Release: Treasury 
Sanctions Syrian Regime Officials and Supporters'', May 8, 2014. 
(https://www.treasury.gov/press-center/press-releases/Pages/
jl2391.aspx) U.S. Department of the Treasury, ``Press Release: Treasury 
Sanctions Agents Linked to North Korea's Weapons of Mass Destruction 
Proliferation and Financial Networks'', March 31, 2017. (https://
www.treasury.gov/press-center/press-releases/Pages/sm0039.aspx)

    North Korean Banks in China: The U.N. Panel of Experts 
        reported that U.S.-designated Daedong Credit Bank (DCB) and 
        U.S.-designated Korea Daesong Bank (KDB) are operating in China 
        using representative offices in Dalian, Dandong, and Shenyang. 
        \26\ The U.N. reported that U.S.-designated Kim Chol Sam 
        operated a financial network inside China, including millions 
        of U.S. dollar transactions, without apparent repercussions 
        from Beijing. \27\
---------------------------------------------------------------------------
     \26\ United Nations Security Council, ``Report of the Panel of 
Experts Established Pursuant to Resolution 1874 (2009)'', S/2017/150, 
February 27, 2017. (http://undocs.org/S/2017/150)
     \27\ Ibid.

    These are some examples of how the North Koreans continue to engage 
in illicit commerce and financing by leveraging their ties, facilities, 
and agents in China. More research attention and disclosures of these 
kinds of networks will continue from the media and scholars like 
Anthony Ruggiero at the Foundation for Defense of Democracies and our 
Center on Sanctions and Illicit Finance and analytic firms like C4ADS 
and Sayari. The dependency of the North Korean economy on the Chinese 
system raises the difficult question of what more can be done to 
pressure China to crack down effectively on the regime in Pyongyang.
Killing the Chicken To Scare the Monkey: Secondary Sanctions and Beyond
    This Subcommittee has asked to focus on the potential use of 
secondary sanctions to impact those entities in China that continue to 
do business with North Korea. Secondary sanctions are not a common tool 
in the various U.S. sanctions regimes, but they have been employed or 
implicated recently in sanctions programs against Iran, Hizballah, and 
in the Russia/Ukraine context.
    Secondary sanctions entail imposing sanctions or restrictions 
against third-country parties for transactions with no U.S. touch 
points or traditional nexus. The goal of secondary sanctions with 
jurisdictions or regimes is to force a foreign third-party to choose 
between doing business in the United States or doing business in the 
targeted jurisdiction. Such sanctions apply to all persons (natural and 
legal) on a global basis, regardless of the person's connection with 
the United States. Those sanctioned are then subject to various 
potential penalties that restrict their ability to access the U.S. 
market.
    In the Iran context, U.S. secondary sanctions primarily targeted 
certain sectors and exports directly relevant to the Iranian economy 
and prohibited foreign financial institutions from conducting any 
significant transactions in Iranian currency. The United States used 
these sanctions to restrict Iran's activities and squeeze their 
economy. Their greatest effect may have been in the potential 
application of such sanctions and the resulting chilling effect on 
market and commercial activity--even absent designations.
    Secondary sanctions are not without problems or controversy. Other 
countries and foreign parties see them as the most aggressive extra-
jurisdictional application of American economic power and influence--
leveraging access to U.S. markets as a tool of coercive economic 
statecraft. They are also effective only if they can be credibly 
threatened and applied. This is not the case when those engaged in the 
activity of concern have no desire to deal with the United States and 
no potential exposure making them subject to sanction or financial or 
economic isolation. These can also appear to be toothless sanctions if 
the categories of potential institutions or sectors targeted are ``too 
big to sanction.''
    To the Chinese, the potential application of primary or secondary 
sanctions to their citizens, companies, or interests will be seen as a 
challenge to their sovereignty. Consistently, the Chinese have objected 
to any form of unilateral sanctions that fall outside of the auspices 
of the United Nations, and any financial or commercial measure that has 
the effect of sanctioning a Chinese party will engender a negative 
reaction. In addition, China has tended to defend against more 
aggressive application of Chapter 7 U.N. sanctions, and it has often 
been lax in enforcing sanctions regimes when Chinese interests are at 
play, as in the case of North Korea.
    In the current context, North Korea appears to rely less on major 
Chinese global banks and financial institutions directly for access to 
financing and banking services. North Korean financial and commercial 
activity has tended to concentrate in recent years with smaller Chinese 
banks and entities to facilitate financial and commercial activity and 
with many entities with little to no connectivity to the United States. 
Even so, more research and analysis is uncovering deeper and more 
entangled commercial, transport, and financial ties between the Chinese 
and North Korean economies. The direct and indirect exposure by major 
Chinese companies and banks to North Korea may not be fully known or 
appreciated, perhaps not even to those institutions.
    Though Chinese sensitivities have to be kept squarely in mind to 
ensure greater cooperation, there needs to be a more comprehensive set 
of tools that attempt to squeeze the Kim regime's access to financing 
and commercial outlets, sensitizes the markets to the risks of doing 
business with North Korea, and begins to demonstrate a willingness to 
expose and target key nodes and conduits of North Korean financial and 
commercial activity.
    In that context, it is appropriate to consider creating secondary 
sanction authorities that target those entities--of whatever country of 
origin that continue to do business with North Korea in certain sectors 
of concern. The mere threat of secondary sanctions--regardless of 
sectors identified--would condition Governments and the private sector 
to engage in deeper due diligence to understand better where North 
Korean agents, networks, and entities are accessing capital and 
resources. It would result in North Korean accounts being shut down, 
activity locked out of the financial system, and agents attempting to 
recast their businesses and identities to avoid scrutiny.
    The risk from direct or indirect exposure to North Korea would be a 
serious concern for the major Chinese banks--the Industrial and 
Commercial Bank of China, Bank of China, China Construction Bank, and 
Agriculture Bank of China--trying to establish legitimate and 
sustainable footholds in the United States and other Western markets. 
Even if these banks did not have direct business ties with North Korea, 
they would have to ensure that their counterparties, correspondents, 
and clients did not expose them to the threat of secondary sanctions or 
enforcement actions in the United States. The risk of being cut off 
from U.S. markets would be too great a risk to ignore for legitimate 
actors in the banking, shipping, and commercial worlds.
    The mere existence of the authority does not mean it has to be used 
in each instance of a violation. The authority would open up economic 
and diplomatic dialogue with concerned actors that could result in 
changed behavior, more information, and the cut off of commercial 
relations with North Korea--even without designating any entities. The 
use of such authority may ultimately be shaped or constrained by 
diplomatic considerations, but this tool could provide diplomatic 
leverage that does not currently exist with North Korea and China.
    Secondary sanctions authority, though important, would not be the 
only step the United States could take unilaterally and in concert with 
international partners and the private sector to pressure North Korea, 
including in and through China. As with any effective sanctions 
program, there needs to be a commitment of analysis, investigations, 
targeting, and follow-up--constantly undertaken to counteract the 
evasion and masking techniques used by nefarious actors. And such 
efforts cannot be left to the United States alone, though it will need 
to lead any such effort.
    The following are other steps that should be taken to address the 
risks from North Korea and catalyze Chinese and other actors to do more 
to prevent North Korea from accessing the financial and commercial 
system.

    North Korean ``Class of Transaction'' 311 Designation. On 
        November 9, 2016, the U.S. Treasury designated North Korea a 
        ``primary money laundering concern'' and prohibited any 
        correspondent accounts with North Korean financial institutions 
        or the facilitation of any transaction from a North Korean 
        financial institution. This was a very important step and a 
        signal to the financial community of the seriousness of the 
        risks to the integrity of the financial system and 
        international community posed by North Korea. This step should 
        be amplified by designating any North Korea financial and 
        commercial transaction or activity as a class of transaction of 
        ``primary money laundering concern'' and requiring specific 
        enhanced due diligence, information collection, and reporting 
        tied to any transactions touching North Korean activity--inside 
        or outside of the country. This would put the onus on financial 
        institutions, in particular Chinese banks with exposure to the 
        United States and Western banking systems, to determine if they 
        have direct or indirect exposure to anything that touches North 
        Korea. This scrutiny goes beyond designated North Korean banks 
        or entities--whose names and affiliations may change--and more 
        broadly to the suspect nature of any transaction that touches 
        North Korea.

    Dynamic Financial Information Sharing With Private Sector. 
        The U.S. Government, in concert with Japan, South Korea, 
        Australia, and other allies in Asia, should establish a dynamic 
        information sharing mechanism with key private sector actors to 
        explain and share where potential exposure to suspect North 
        Korean activity lies. Financial intelligence units could be 
        tasked with compiling data and reports that could be 
        disseminated, with a goal of targeting and exposing more North 
        Korean financial and commercial activity more quickly. Banks, 
        shipping companies, and the insurance sector would welcome more 
        information that would allow them to comply with relevant 
        sanctions and understand where risk lies within their 
        businesses. This could follow other models and platforms being 
        created in the banking industry to share more specific 
        information about specific risks and threats.

    Regulatory and Enforcement Attention to Chinese Banks. 
        Authorities in the United States, Western, and Asian countries 
        have begun to devote more regulatory and enforcement attention 
        to Chinese banks operating abroad for failure to have adequate 
        financial crimes and sanctions compliance risk management. This 
        is an important shift in attention, as Chinese banks seek to 
        meet international global standards for transparency, sanctions 
        compliance, and financial crimes risk management. Billions of 
        dollars of fines against European, American, and other Western 
        banks have focused the attention of banks to improve their 
        sanctions compliance. Scrutiny over Chinese banks' lack of 
        adequate financial controls and a culture of compliance--as has 
        happened with other global banks--would further sensitize 
        Chinese institutions to the risks presented by exposure to 
        North Korea. \28\
---------------------------------------------------------------------------
     \28\ Anthony Ruggiero, ``Severing China-North Korea Financial 
Links'', Center for Strategic and International Studies, April 3, 2017. 
(https://www.csis.org/analysis/severing-china-north-korea-financial-
links)

    Anti-Corruption Initiative. The United States should launch 
        an anti-corruption initiative to investigate and build public 
        cases against corrupt North Korean actors and those who are 
        colluding with them, perhaps using a new executive order to 
        focus targeted sanctions on North Korean kleptocracy. Such 
        sanctions and any related cases exposed would focus attention 
        on the amount of wealth and corruption within the regime 
        leadership and the ties that they have with others outside of 
        North Korea. The Chinese would be concerned about North Korean 
        corruption bleeding into their system and implicating Chinese 
        actors. This would likely prompt greater attention to North 
        Korean ties and lead to more Chinese actions to shut down 
---------------------------------------------------------------------------
        illicit or corrupt networks of concern.

    Leadership Asset Hunt. In conjunction with this, the United 
        States should declare that it is launching a leadership asset 
        hunt for assets stolen and held by the Kim leadership, using 
        the tools and resources of the intelligence community, law 
        enforcement, and regulators and working with international 
        institutions like the World Bank's Stolen Asset Recovery 
        Initiative. The goal would be to determine how the senior 
        leadership of the regime in Pyongyang holds and stores its 
        money outside of North Korea and with whom it is dealing and 
        operating. This could have direct implications for China and 
        could expose where North Korea and China maintain existing 
        financial relationships. This would further shine a spotlight 
        on suspect ``Politically Exposed Persons'' requiring additional 
        due diligence and attention by the Chinese and other banking 
        systems.

    Human Rights and Sanctions. The United States should expand 
        the list of companies and entities subject to sanctions under 
        Executive Order 13722 (March 15, 2016), including considering 
        designating those companies employing North Korean workers and 
        paying their fees directly to the North Korean regime. It 
        should call on countries currently allowing this practice to 
        shut it down and push for human rights designations at the U.N. 
        and a prohibition on paying North Korea for overseas laborers. 
        \29\ This should be matched with a Treasury advisory to 
        financial institutions warning against facilitating or engaging 
        in any transaction related to this forced labor.
---------------------------------------------------------------------------
     \29\ Anthony Ruggiero, ``Don't Let North Korea's Nukes Overshadow 
Human Rights Abuses'', The Hill, April 28, 2017. (http://thehill.com/
blogs/pundits-blog/foreign-policy/331061-dont-let-north-koreas-nukes-
overshadow-human-rights-abuses)

    Shipping: Mapping and Interdictions. The United States in 
        concert with Japan, South Korea, Australia, and other allies 
        should coordinate the sharing of North Korean shipping and 
        transport data--along with private sector actors to track and 
        map shipping interests doing business with or in North Korean 
        ports or waters. The mapping and investigation of shipping tied 
        to North Korea would allow for more robust information sharing 
        and understanding where the proliferation and trafficking risks 
        lie and would expose networks and business interests of 
        concern. This would also enable more robust maritime 
        interdiction strategies, which would put pressure on those 
        countries or entities that continue to do business with North 
---------------------------------------------------------------------------
        Korea.

    North Korean Illicit Activities Enforcement Initiative. The 
        law enforcement and intelligence communities--in concert with 
        the U.N. Panel of Experts and the private sector--should 
        concentrate on understanding and exposing North Korea's 
        continuing illicit commercial and financial activity. 
        Smuggling, money laundering, arms trafficking, and sanctions 
        evasion should all be subject to intense investigation and 
        exposure and should be a priority for law enforcement in Asia 
        and wherever North Korea engages in commercial activity. An 
        illicit activity initiative would allow for more disruptions, 
        designations, and identification where illicit networks are 
        operating with impunity. This could be done in concert with the 
        Chinese to underscore the need to attack illicit financing 
        networks.

    Cyber Litigation--Private Rights of Action. To match 
        existing sanctions targeting those involved in undermining 
        cybersecurity, Congress should consider providing victims of 
        North Korean cyberattacks the right to sue and seek damages 
        from entities and actors that have facilitated or knowingly 
        benefited from North Korean cyber activity. This is important 
        as North Korea expands its cyber footprint and attacks. Though 
        this may not reach into Pyongyang, this right of action would 
        put private sector actors that deal with North Korean or other 
        cyber belligerents on notice that they could be subject to 
        private litigation and suits.

    These are just some of the ideas that can be woven into a strategy 
that includes secondary sanctions. These tools--if leveraged and 
choreographed wisely and in concert--would not only squeeze the North 
Korean regime but also compel the Chinese to consider its own ties and 
the risks of exposure to North Korea.
Changing the Chinese Calculus
    There is reason to believe that the Chinese calculus and behavior 
can be affected if North Korean actions and taint threaten the 
fundamental interests and reputation of the Chinese economy, 
leadership, and system. There are hopeful signs in recent months and 
past episodes that provide a window into Chinese thinking and can be 
guideposts for any pressure campaign.
    China has been willing to exert pressure and crack down on its 
trade with North Korea when it has faced public scrutiny over such 
ties, or when it wishes to express selective disapproval over North 
Korean actions. In September 2016, it was reported that China had 
opened an investigation into the Chinese citizen, Ma Xiaohong, who was 
indicted by the United States. She ran the Dandong Hongxiang Network, 
which had allegedly undertaken half a billion dollars in trade with 
North Korea between 2011 and 2015, \30\ some of which ``included 
materials that can be used in the production of nuclear weapons.'' \31\ 
China has reportedly frozen her assets.
---------------------------------------------------------------------------
     \30\ James Pearson, ``China Probes North Korea Bank Suspected of 
Nuclear Link--South Korea Paper'', Reuters, September 26, 2016. (http:/
/www.reuters.com/article/us-northkorea-nuclear-bank-idUSKCN11W049)
     \31\ Jane Perlez and Chris Buckley, ``China Announces Inquiry Into 
Company Trading With North Korea'', New York Times, September 20, 2016. 
(https://www.nytimes.com/2016/09/21/world/asia/north-korea-china-
inquiry-hongxiang.html?_r=0)
---------------------------------------------------------------------------
    In February and April of this year, China curbed its imports of 
coal from North Korea, likely in response to recent multiple missile 
tests Pyongyang carried out and in the wake of the assassination of Kim 
Jong-Un's half-brother in Malaysia via a VX nerve agent. \32\ 
Furthermore, in May 2013, the Bank of China closed the account 
belonging to Foreign Trade Bank, ``North Korea's most important 
financial institution'', which had been sanctioned by the U.S. in March 
of that year. \33\ These actions do not necessarily signal a 
fundamental shift in Chinese policy, but it reflects a willingness to 
take actions against North Korean interests and connections in China.
---------------------------------------------------------------------------
     \32\ John Ruwitch and Meng Meng, ``North Korean Ships Head Home 
After China Orders Coal Returned'', Reuters, April 11, 2017. (http://
www.reuters.com/article/us-china-northkorea-coal-exclusive-
idUSKBN17D0D8)
     \33\ Jane Perlez, ``U.S. Sanctions Expected To Hit Small Banks' 
Business With North Korea'', New York Times, June 3, 2016. (https://
www.nytimes.com/2016/06/04/world/asia/us-sanctions-expected-to-hit-
small-banks-business-with-north-korea.html)
---------------------------------------------------------------------------
    In addition, the Chinese Politburo held a study group last month 
focusing on ``financial security,'' signaling that the Chinese 
leadership is attaching a high priority to this topic. The United 
States could work with the Chinese to focus on protecting the Chinese, 
U.S., and broader financial system from the collective threats of 
illicit activity, cyberfinancial attacks, and corruption that North 
Korea represents, especially to Chinese banks.
    In the past, there have been key episodes that demonstrate the 
Chinese system's sensitivity to the risks North Korea represents to its 
own economy and reputation--and a willingness to cooperate and change 
their risk calculus as a result of a changed landscape.
    Banco Delta Asia (BDA). In September 2005, as part of a strategic 
pressure campaign, the Treasury Department ordered U.S. financial 
institutions to close correspondent accounts for a private bank in 
Macau--Banco Delta Asia (BDA)--pursuant to Section 311 of the Patriot 
Act. This bank--designated as a ``primary money laundering concern''--
was facilitating money laundering, proliferation, and counterfeiting on 
behalf of the North Korean regime.
    The regulation cut the bank off from the U.S. financial system. 
More important, the unilateral regulation unleashed a wave of financial 
isolation against North Korea. Banks in China, Asia, and Europe stopped 
doing business with North Korea, denying it access to the international 
financial system. North Korean bank accounts were closed, its 
transnational commercial transactions were canceled, and officials' 
financial activities were carefully scrutinized.
    This hurt Pyongyang. The North Korean regime scrambled to regain 
access to money and accounts around the world while trying to undo the 
official damage done to its reputation in the international financial 
community. Key State actors, including China, had no incentive to block 
the full effect of the market reaction. On the contrary, they did not 
want their banks or financial reputations caught up in the taint of 
North Korea's illicit financial activity.
    This pressure became the primary leverage for the United States to 
press for North Korea's return to the six-party negotiating table. Once 
the six-party talks reassembled, the financial pressure campaign 
against North Korea ended, resulting in a loosening of the financial 
squeeze.
    Unlike traditional State-based sanctions, this kind of financial 
leverage relies more on the risk-based calculus of global financial 
institutions than the policy decisions of Governments. For legitimate 
financial institutions, there are no benefits to the risk of 
facilitating illicit transactions that could bring high regulatory 
costs and damage to their reputations if uncovered. If financial 
institutions act according to their own interests, targeted actors and 
their suspected fronts will be denied access to the facilities of the 
international financial system. In this case, the Chinese financial 
institutions defended their own interests and reputations, not putting 
themselves at risk on behalf of the North Koreans.
    Kunlun Bank. On January 31, 2012, the U.S. Department of the 
Treasury sanctioned Bank of Kunlun Co. Ltd., a Chinese bank under the 
Comprehensive Iran Sanctions, Accountability, and Divestment Act of 
2010 (CISADA) for providing ``significant financial services'' to at 
least six Iranian banks designated by the Treasury. \34\ Bank of Kunlun 
transferred nearly $100 million from accounts it held for Bank Tejarat 
and made at least one payment for an affiliate of the Iranian 
Revolutionary Guard Corps. \35\ At the time, Chinese Foreign Ministry 
Spokesman Qin Gang urged the U.S. to lift sanctions against the Bank of 
Kunlun, stating that the imposition of U.S. sanctions ``violates the 
norms of international relations and damages China's interests.'' \36\ 
\37\ Despite the protestations and fears of Chinese backlash, the 
Chinese quietly dealt with Kunlun Bank and directed it to stop such 
activities.
---------------------------------------------------------------------------
     \34\ ``Treasury Sanctions Kunlun Bank in China and Elaf Bank in 
Iraq for Business With Designated Iranian Banks'', Department of the 
Treasury Press Release, July 31, 2012. (https://www.treasury.gov/press-
center/press-releases/Pages/tg1661.aspx)
     \35\ ``Exclusive: Iran Uses China Bank To Transfer Funds to Quds-
Linked Companies--Report'', Reuters, November 18, 2014. (http://
www.reuters.com/article/us-iran-sanctions-china-exclusive-
idUSKCN0J20CE20141119)
     \36\ ``China Hits Back at New U.S. Sanctions Over Iran'', Kelly 
Olsen, AFP, August 1, 2012. (https://www.yahoo.com/news/china-hits-
back-us-sanctions-over-iran-063058172.html)
     \37\ Wayne Ma, ``China Scolds U.S. Over Iran-Related Bank 
Sanctions'', Wall Street Journal, August 1, 2012. (https://www.wsj.com/
articles/SB10000872396390444320704577
562330527832056)
---------------------------------------------------------------------------
    Chinese Position Shift on Sudan ICC Indictment. At a recent Harvard 
Law School panel discussion, the first Chief Prosecutor of the 
International Criminal Court (ICC), Jose Luis Moreno Ocampo, provided 
an instructive example of a Chinese policy shift during his tenure. 
Ocampo noted that the Chinese position regarding the ICC's 
investigation of the Bashir regime in Sudan had always been to support 
and defend it because President Bashir guaranteed the stability of 
Sudan. The Chinese position changed in the face of the Bush 
administration's forceful support of the ICC's indictment of President 
Bashir of Sudan, leading the Chinese to conclude that Bashir no longer 
represented stability and began to explore other options. According to 
Ocampo, the Obama administration's consolidation of Bashir's stability 
led to the consolidation again of China's support to the regime in 
Sudan.
    Indeed, the Chinese will not want to react directly to pressure, 
but they will understand when their interests are directly affected by 
the taint, attention, and illicit activity of the North Koreans. We 
have seen this already with the discomfort China has felt and expressed 
with the deployment of the THAAD missile defense system in South Korea 
and the increased U.S. maritime presence in Asian waters. If the 
Chinese see that their interests and credibility will be undermined 
fundamentally by connectivity and support to North Korea, the less 
likely they are to allow those financial and commercial ties to exist. 
If they understand that exposure to North Korea will bring greater 
scrutiny to issues like corruption, human rights abuses, and financial 
crimes in China and Chinese institutions, then the Chinese calculus 
will have to change.
    This is a moment of growth and expansion for the Chinese banks and 
commercial brands, with many establishing footholds in Western 
economies. If protecting the North Korean economy or regime represents 
a real threat--direct or indirect--to the credibility and strength of 
the Chinese banking sector and the future stability and growth of the 
Chinese economy, the Chinese may not elect to maintain suspect 
commercial and financial ties with North Korea. The potential 
application of secondary sanctions could affect this calculus and move 
the Chinese to place more serious pressure on Pyongyang.
Caution and Caveats
    When considering secondary or other types of sanctions with respect 
to China, policymakers and national security strategists have to take 
into account the size and significance of the Chinese economy. The 
second largest economy in the world, growing to become the leading 
economy in this century, with its deep trading and investment ties in 
the United States and the West cannot be isolated or treated as a 
target of a maximalist financial and commercial pressure campaign. In 
addition, our need to cooperate and compete with--as well as confront--
China in many other arenas, including in the South China Sea and 
cyberspace, limits how far we may go with our financial and economic 
toolkit.
    There are too many costs to U.S. interests if a maximalist approach 
were attempted, with boomerang effects on the U.S. economy, trade, and 
U.S. and allied interests in China and Asia. China could always 
retaliate with sanctions of its own against U.S. interests, as they 
have threatened recently after the announced sale of U.S. high-end 
military equipment to Taiwan. And China can use its own resources and 
economic power to express its diplomatic displeasure, as it has done in 
the recent past with Japan by restricting the export of rare-earth 
minerals in 2010, allowing bananas from the Philippines to rot in port 
in 2012, and placing sanctions on South Korean companies for allowing 
the deployment of the THAAD missile defense system in early 2017. \38\ 
The Chinese dragon knows how to bite and to use financial and economic 
tools--in the physical and virtual worlds.
---------------------------------------------------------------------------
     \38\ Tom Miles and Krista Hughes, ``China Loses Trade Dispute Over 
Rare Earth Exports'', Reuters, March 26, 2014 (http://www.reuters.com/
article/us-china-wto-rareearths-idUSBREA2P0ZK20140326); Andrew Higgins, 
``In Philippines, Banana Growers Feel Effect of South China Sea 
Dispute'', Washington Post, June 10, 2012 (https://
www.washingtonpost.com/world/asia_pacific/in-philippines-banana-
growers-feel-effect-of-south-china-sea-dispute/2012/06/10/
gJQA47WVTV_story.html?utm_term=.493ab5719154); Elizabeth Shim, ``China 
Sanctions, Hacking Threats Eclipse South Korea THAAD Deployment'', UPI, 
March 7, 2017. (http://www.upi.com/Top_News/World-News/2017/03/07/
China-sanctions-hacking-threats-eclipse-South-Korea-THAAD-deployment/
9311488902166/)
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    In addition, any new pressure campaign has to consider the 
potential for asymmetric attacks from North Korea, especially attacks 
on the financial system. North Korea has increased its capabilities and 
increased the pace of its probing cyberattacks. The North Korean 
hacking group Lazarus has reportedly targeted organizations in 31 
countries, including the November 2014 Sony hack in the United States, 
the $81 million heist from the Bangladesh Central Bank, \39\ and banks 
and broadcasting companies in South Korea. \40\ North Korean hacking 
activity has increased this year, with reports that banks in the United 
States, Poland's biggest bank lobbying group ZBP, and banks throughout 
the world have been targeted by North Korean entities.
---------------------------------------------------------------------------
     \39\ Jim Finkle, ``Cyber Security Firm: More Evidence North Korea 
Linked to Bangladesh Heist'', Reuters, April 3, 2017. (http://
www.reuters.com/article/us-cyber-heist-bangladesh-northkorea-
idUSKBN1752I4)
     \40\ Jim Finkle, ``North Korean Hacking Group Behind Recent 
Attacks on Banks: Symantec'', Reuters, Mar 15, 2017. (http://
www.reuters.com/article/us-cyber-northkorea-symantec-idUSKBN16M37J)
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    This is not an attempt to give credence to a heckler's veto. 
Instead, this is a cautionary note that any effective action taken in 
the financial and economic domain may result in reactions by those 
targeted or affected by U.S. actions. The United States--and the 
private sector--must be prepared for such a reaction. In addition, 
there will be limits to what can be done in this domain, but the United 
States should always try to use the most effective and appropriate 
means to pressure the North Korean regime. The United States and her 
allies should not pull punches just because the effects of those 
actions may implicate China. If secondary sanctions can help squeeze 
the North Korean regime and help shift the Chinese calculus, then they 
should be authorized and used, in concert with other tools.
Conclusion
    It is time to test if China and the United States together can 
influence the North Korean regime--and stop its march toward nuclear 
weapons capabilities that threaten the U.S. homeland. China has the 
opportunity to prove its role as a great power and to use its influence 
with Pyongyang. The clock is ticking, and an effective financial 
pressure campaign with China on side is one way of helping to slow, if 
not stop, the clock.
```