The International Community’s Response to North Korea’s Nuclear Missiles Program: Thinking Outside the Sanction Regime

By Lexi Rubow, Assistant Contributor

On Tuesday, February 12, 2013, the Democratic People’s Republic of Korea (North Korea) launched its third and most powerful nuclear test. The test was executed in response to increased United Nations sanctions, following North Korea’s successful rocket launch in December 2012. The explosion was twice as powerful as the most recent nuclear test in 2009 and was ten times more powerful than the first test in 2006. The explosive power of the test was 10 kilotons and caused a 4.9 magnitude earthquake. In comparison, the bomb the United States dropped on Hiroshima at the end of World War II was 12-20 kilotons. US officials are currently determining whether the explosion used plutonium, or enriched uranium—a signal that North Korea’s technology has advanced. This is significant because North Korea’s plutonium deposits are limited, but its uranium deposits are plentiful, and the uranium enrichment process is easier to conceal. Further, there have been reports that the explosive itself was smaller than that of past tests. The main concern is whether North Korea will be able to manufacture a nuclear explosive that is small enough to fit on the “Unha-3” rocket that was launched in December 2012 and could be used to target the United States.

The test was perceived as an act of aggression and defiance by most of the international community. After the attack, President Obama met with South Korean leader Lee Myung-bak and issued a statement referencing the United States’ “nuclear umbrella” over South Korea, reminding North Korea that an attack on South Korea would be viewed as an attack on the United States. This alliance has been in place since the United States’ participation in the Korean War in the 1950s, but is rarely discussed, much less openly threatened. Further, South Korean and American forces have been carrying outlarge-scale military drills, deploying destroyers and submarines, and demonstrating cruise missiles to show their military readiness. President Obama has also expressed its intent to protect Japan and, together with Japanese Prime Minister Shinzo Abe, has agreed to seek action from the United Nation’s Security Council.

Newly appointed Secretary of State, John Kerry, expressed a willingness to take action: “If you are going to say things, they have to mean something. And to mean something you have to be prepared to follow up, and that’s exactly what we are prepared to do.” Some sources are skeptical, however, speculating that the current international bluster is no different than that following previous tests and will likely not meaningfully advance a solution.

For its part, the United Nations held an emergency session regarding the test and issued a statement condemning the acts and expressing concern for North Korea’s nuclear program’s impact on regional stability. The UN has experienced difficulties in achieving more than strongly worded statements, however, due to a deep divide between China and Russia, who are more friendly towards North Korea, and those countries that want to impose stricter sanctions, such as banning import of specific high-tech items used to create nuclear weapons, limiting banking transactions, and imposing more stringent inspection of ships bound to and from North Korea. There are signs that China’s relationship with North Korea is beginning to sour, particularly after the most recent test, which ignored China’s “appeals not to conduct the country’s third nuclear test.” There is also some speculation that the new Chinese leader, Xi Jinping, will be less patient with North Korea than his predecessor, Hu Jintao. However, despite the Chinese citizens fear of increased radiation exposure and the Chinese government’s realization that North Korea may not return its sentiments of brotherly love, Xi Jinping will have to balance this internal and international pressure with the risk of instability and mayhem that would result if North Korea were to collapse.  Further, even if China does agree to stronger sanctions and thereby ease the UN gridlock, some analysts speculate that North Korea’s economy is so closed that sanctions from China may not have very much leverage or may just enhance the Chinese-North Korean black market trade.

Past sanctions directed at North Korea have not been particularly successful, as North Korea has historically responded by increasing its military development, both in retaliation and as a bargaining chip for economic aid. For example, in 1994, North Korea threatened to withdraw from the Nuclear Non-Proliferation Treaty and produce nuclear weapons. The United States then entered into negotiations with North Korea discussing an Agreed Framework, wherein the international community, led by the United States, was to provide large amounts of capital, as well as enough oil to support the entire nation’s energy needs. Meanwhile, North Korea was supposed to use this capital to transition its energy grid from nuclear to light water reactors. The U.S. stopped shipments of oil in 2002 upon suspicion that North Korea was instead using the capital and other international support to develop a uranium enrichment program. North Korea viewed this as a breach of the Agreed Framework and withdrew from the Nuclear Non-Proliferation Treaty in 2003, and continued to build up its nuclear program. After North Korea’s first successful nuclear test in 2006, the United Nations passed a resolution calling on North Korea to end its nuclear weapons programs, and the United Nations’ member countries agreed to trade and travel sanctions. North Korea used this international attention to enter into six-party talks with China, South Korea, Japan, Russia and the United States, where it promised to shut down its reactors in exchange for foreign aid. In 2009, however, North Korea tested a rocket, which led to harsher UN Sanctions. In response, North Korea performed a second, stronger, nuclear test.

The statements made by the Korean Central News Agency, the North Korea-run news agency, also indicate that sanctions may fan the flames of defiance and retaliation rather than pressure North Korea into compliance. The nation does not show any indication of bowing to pressure, stating that “concession leads to defeat in the face-off. Key to ultimate victory is to steadily increase the military capability in every way.” The UN Security Council’s resolution on sanctions is described as “armed blackmail against the DPRK,” and the most recent nuclear test was characterized as “frustrat[ing] the brigandish campaign of ‘sanctions’ launched by the U.S.” Further, the nation has repeatedly threatened “second and third high-intensity counteractions” if the United Nations and United States continue sanctions. While sanctions are certainly not welcomed by any nation, the vitriol spouting from the Korean Central News Agency indicates that North Korea will likely break before it bends.

In light of the fact that increased sanctions may potentially escalate, rather than diminish, military tension with North Korea, the international community may wish to explore other options, such as those that encourage long-term stability and change from within.  Modern wars are typically fought not against nations, but against leaders. The goal is not necessarily the traditional use of ground force against state militaries to cause one side to capitulate but rather a regime change that must largely come from within a nation. For example during the war in Kosovo, in addition to traditional aerial attacks, NATO also tried to counter Milosevic’s nationalist and ethnocentric propaganda by flying aircraft over Yugoslavia and broadcasting its own propaganda. While some of NATO’s operations were controversial (particularly the bombing of Radio Television Serbia), the idea of stimulating internal regime change by providing outside media may be important to stability in the Korean Peninsula.

An underground market for outside media has already begun to thrive in North Korea. Particularly popular are Korean dramas and American TV dramas, usually smuggled in from China on memory sticks and played on black market computers or televisions rigged to watch foreign broadcasts. These dramas have created a shift in the way that North Koreans evaluate their lives and country, as they compare their living situations with others’ lives in the United States, China and South Korea and find North Korea to be lacking. As stated in the Huffington Post:

“North Korean viewers living in tiny two-room homes and struggling to feed their families can see houses with bedrooms just for children, and dinners with endless food. They see everyday people casually complaining about policemen and politicians. Scenes like that are provocative in a country where defectors say criticizing the ruling family can send entire families to sprawling prison camps, and where bicycles are considered luxury items for many.”

This black market, and the resulting thirst for consumerism, has created an increasingly conspicuous bourgeois class in North Korea. It is questionable whether these black market entrepreneurs are a danger to the government, since they, like bourgeois classes elsewhere, have a stake in preserving the status quo. However, the existence of this market indicates a rare glimpse of resistance to the North Korean regime of enforced austerity and obedience.

The question remains how the international community can encourage this nascent cultural transition. Since North Korea is not currently engaged in any military conflict, the approach NATO took in Kosovo is too heavy handed. An aircraft flying over North Korea would be misinterpreted and would likely spark military conflict. Further, the current political and cultural climate is much more critical of perceived American cultural imperialism. While the level of economic sanctions appear to be a point of contention in the UN, deciding how to expose North Korea to outside culture — and which culture should it be — seems to be even more controversial. Another option may be to increase international protections for those individuals smuggling media into North Korea. However, this is also a dangerous endeavor, since it may be difficult to condone one sector of the black market without inadvertently condoning other criminal behaviors.

Despite the logistical difficulties of these alternatives, as the United States, United Nations and other international entities grapple with how to respond to North Korea’s most recent round of nuclear tests, they should consider alternatives to the typical sanctions routine which has thus far only increased tensions and the probability of forceful retaliation.

International Financial Regulation Since 2008: Why Implementation Delays of Basel III are Likely to Persist in the U.S. and EU

By Colby Mangels, Guest Contributor

The Basel III agreements were meant to be the international community’s answer to the lax capital requirements of many financial institutions prior to the 2008-2009 financial crises. These capital requirements stipulate the amount of liquid and non-liquid assets that financial institutions are required to keep on their books. Originating as an addition to the Basel II standards of the Basel Committee on Banking Supervision (BCBS), Basel III was first proposed in December 2010, and revised in June 2011.  The BCBS is made up of close to 30 national finance ministers from across the world. Inter alia, Basel III requires that the capital assessments of banks take into account potential market devaluations and counterparty credit risk. These measures are intended to prevent the typical asset accumulations on bank balance sheets that often lead up to financial crises. The BCBS, in conjunction with its parent institution the Bank for International Settlements, has promoted these standards among its members.

Nevertheless, Basel III implementation efforts have hardly been unified across BCBS members. Basel III implementation has especially run aground in the U.S. and the EU. Last November, a trio of American financial regulators, led by the Federal Reserve Board, indefinitely postponed its implementation, originally planned for January 2013. While the European Parliament continues to debate Basel III implementation, European regulators have already extended key assessment deadlines for the financial sector by at least a year. Additionally, Michel Barnier, European Commissioner for Internal Market and Services, remarked during an interview at the recently held World Economic Forum in Davos, Switzerland, that he would accept a two year timetable for joint implementation with U.S. regulators. So much for speedy resolve.

So, what happened to the push for more unified and precise capital standards among the post-financial crisis global community? American and European regulators each have their own set of reasons for postponement. American regulators, simultaneously dealing with the implementation of the massive Dodd-Frank Act, are afraid of the negative consequence of over-regulation. Specifically, U.S. regulatory agencies are concerned that simultaneous implementation may actually place the financial system in a worse position than it was ex ante.

Europeans, while similarly concerned about imposing heavy burdens on their own financial giants, remain in a process of intense deleveraging following recent volatilities on the European sovereign bond markets. Although recent markets have calmed, European regulators remain sensitive to intensive assessments of bank balance sheets that might reveal under capitalization. Pressured with handling this delicate balance, European regulators want to give banks more time to raise the appropriate types of assets required under Basel III.

But there remains more to this story than meets the eye. In particular, understanding the goals behind Basel III can help to understand upcoming issues in its application to the American and European financial regulatory systems.

Basel III – Why Implementation has Potential to Enhance Financial Market Stability

Basel III is the latest in the Basel Accord series originating from the BCBS. The BCBS was originally formed by the G-10 following the Herstatt banking crisis of 1974. In 1988, BCBS members agreed on the first round of unified credit risk assessments and capital standards to be issued from the Basel Accord.  Later known as Basel I, BCBS signatories to this agreement established unified risk measurements of categories of banking assets, and required banks to hold 8% collateral assets. Basel II expanded on the relatively broad asset categorization techniques under Basel I by further grading the risk categories, allowing qualified financial institutions to develop their own internal (and more sophisticated) risk models, and incorporating value-at-risk-based capital. Basel II was subsequently implemented in many jurisdictions (although implantation in the U.S. was never completed) and was in effect at the outbreak of the 2008 financial crisis. Despite the improvements in terms of asset categorization in comparison to Basel I, Basel II was discredited during the financial crisis for looking too closely at individual bank risk, and failing to look at systemic risks imposed on the financial sector as a whole.

Basel III attempts to improve these problems by (a) requiring stricter definitions of the capital that banks are required to hold, (b) requiring banks to hold greater amounts of capital and (c) creating not only asset, but also liquidity ratios (measuring the assets a bank can expect to sell at any time).

Stricter capital definitions under Basel III improve upon Basel II’s attempts to grade assets and forces financial institutions to disclose to regulators more information about the quality of assets in their balance sheets. Although this approach continues to overlook previous problems of market fluctuations in the price of the valued assets, it does have the potential to provide regulators with better information to carry out their oversight.

The debate over higher capital requirements remains a heated issue surrounding Basel III implementation. While financial institutions have stressed the inherent costs associated with requiring more capital, regulators reiterate that both quality and quantity of assets is critical. However, Basel III sets minimum capital levels between 8-9.2% (for systemically important banks). It is true that these rates are potentially lower than the rates that some banks often self-impose, or rates that domestic legislation in certain jurisdictions already imposes. Nevertheless, by establishing an international minimum requirement, across the broadest number of relevant financial systems, Basel III would minimize the impacts of future crises where capital rates typically drop much lower.

Finally, liquidity ratios would require banks to hold enough liquid capital to get through periods of contracting credit markets (i.e. 30 day periods). This is the first imposition of global liquidity standards and it has the potential to reduce future dangers in short-term market liquidity freezes of the kind that took place in September-October 2008.

U.S. Implementation of Basel III: Second to Dodd-Frank

In early January 2010, the U.S. Congress approved H. R. 4173, the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 171 of the Act establishes new capital requirements for financial institutions. Supervising regulatory agencies will articulate these requirements. The Dodd-Frank implementation process has taken significant time, with regulatory agencies failing to meet repeated deadlines.

Due to the broad nature of both Dodd-Frank and Basel III legislations, implementation of Basel III in the U.S. would require concerted efforts by the American authorities currently implementing Dodd-Frank to ensure that neither piece of legislation interferes with the other. The Federal Deposit Insurance Corporation, a main overseer of Dodd-Frank implementation, announced last June that it would incorporate Basel III into Dodd-Frank-related regulations during future drafting. However, last November, the Federal Reserve Board announced that it would delay Basel III implementation passed the proposed date of January 1, 2013. Recently, the Federal Reserve Bank announced that implementation could be finished “in the coming months.” Meanwhile, chief EU regulator Mr. Barnier recently agreed to coordinate European implementation with the U.S. over a two-year time frame and continues to press for U.S. cooperation. This comes at a time when implementation of Dodd-Frank is, itself, considered a challenge.

Why the slow-up on implementation in the U.S.? Simply put, regulators are concerned that enforcing simultaneous implementation of Basel III and Dodd-Frank will cause onerous compliance commitments for financial institutions. Simultaneous implementation would require the in-house compliance teams of financial institutions to juggle compliance issues between both pieces of legislation, potentially reducing the ability for effective compliance with either. Additionally, an international component is also relevant. Given the delayed implementation of Basel III in Europe, American authorities face little pressure from their European counterparts when postponing the Basel III framework.

Implementation in Europe: Stalled by the Euro-Crisis.

Basel III implementation has taken a different route in Europe. In 2009, the European Commission began work on the new European Capital Requirements Directive IV (CRD IV). The CRD IV, which preceded the Basel III proposal, has become the European Union’s template for new capital standards. Any implementation of Basel III into the CRD IV will first require approval from the Council of the European Union and the European Parliament. The European Council approved a compromise draft of the CRD IV last spring, incorporating the main aspects of Basel III, while reducing some of Basel III’s more burdensome capital requirements. The European Parliament continues to debate the Council’s proposal.

Slow European implementation reflects continuing stresses faced by the financial system. One of the most significant departures of the Council’s proposal from the original Basel III legislation concerns how each piece of legislation defines bank capital. Specifically, the Council proposes less stringent capital measures. This request by the French and German governments reflects the on-going uncertainties these governments face as they attempt to manage the financial sector’s deleveraging of sovereign bond markets.

The European sovereign debt crisis created intense volatility within a number of Eurozone bond markets, rendering financing difficult for those member-states affected. The financing market for these members has calmed since the European Central Bank’s (ECB) President, Mario Draghi, announced last year that the ECB would purchase Eurozone members’ sovereign bonds in order to relieve financing pressures. However, Eurozone national governments currently find themselves in a precarious situation, as many of their own banks that invested heavily in the sovereign debt markets in past years are currently attempting to “deleverage” or sell-off their assets without sending the market into a downward spiral.

Within this context, the governments of the two largest Eurozone economies, France and Germany, remain cautious towards any new capital requirements or capital inspections of their financial sector. Although the recently established European Banking Authority has carried out a number of “stress tests”, these have been readily discredited by financial analysts as being too vague to provide a meaningful assessment of the banks’ assets in the European financial sector. Similarly, during the European Council debate concerning Basel III implementation, Germany and France negotiated to have the strictest requirements of Basel III capital removed. The European Parliament is facing similar trade-offs between protecting national banking sectors and enforcing more stringent definitions of banking capital.

To summarize: the European Union, especially the Eurozone, faces serious short- to mid-term challenges in reducing the exposure of its financial sector to sovereign bonds. These challenges have motivated Eurozone governments to oppose more stringent capital definitions and targets, as found in Basel III. While the European Parliament continues to debate the CRD IV/Basel III implementation, these concerns will likely shape the compromise that emerges.

Where will Basel III Implementation Go from Here?

Both the U.S. and the EU have differing reasons for opposing a swift adoption of Basel III. Given the apathetic nature of European and American regulators towards its adoption, what is likely to happen to Basel III in the coming years? For one, financial institutions are likely to continue arguing that the capital requirements imposed by Basel III will be too costly.

In December 2011, the BCBS published its assessment of how much capital banks would need to raise in order to comply with the common equity Tier 1 capital ratio in Basel III. The BCBS reported that large, internationally active banks would need to raise €386 billion ($516 billion) in order to comply with a 7.0% capital level. For comparison, these same banks earned a combined profit of €356 billion ($476 billion) in 2011.

Last month, the heads of those national central banks, who are members of the BIS, entered into a compromise with the BCBS to postpone one of the key provisions of Basel III: liquidity requirements. Banks across Europe and America now have at least four years to implement the liquidity requirements of Basel III, meant to supply banks with enough capital to get through short-term financing periods. Additionally, the BCBS agreed to allow a wider range of assets to be included on the list of liquidity resources, raising questions as to how liquid these products will be in a potential crisis situation.

The long-term postponement of Basel III liquidity requirements reflects enduring concerns within both financial institutions and regulatory agencies that if the capital requirements of Basel III are actually imposed, their costs will be too great a burden for the financial system. Given the ongoing economic challenges in Europe, and the delayed Dodd-Frank implementation in the U.S., it seems likely that governments on both sides of the Atlantic will continue to push back the implementation of Basel III. If nothing else, postponement provides time for these governments to curry favor with their respective financial sectors and prioritize the implementation of national legislation.

Response from the BCBS and the BIS has been conciliatory. BIS head Stefan Ingves claims that the delays do not reflect a lost interest among regulators, but merely attempts to lay the groundwork for correct implementation. Mr. Barnier, chief EU financial regulator, has similarly stated that he expects the U.S. to respect Basel III in the coming years. However, Mr. Barnier’s comments may simply reflect the fact that Europe remembers how it implemented Basel II, while the U.S. never completed its implementation. And despite the rosy sentiment of Mr. Ingves, it seems only far too likely that despite recent calls for action, it appears that the incentives remain for regulators to continue “kicking the can” until the next crisis.

The Record: This Week in Review

New EU Law- The “Two Pack”

EU lawmakers have introduced a new law to strengthen the euro zone budget discipline and prevent another sovereign crisis debt. The EU commission will now have new levels of insight over member countries’ budgets.

Urgent Action Necessary to Protect the Arctic:

The UN Environment Program has stated that more effective measures need to be put in place to avoid damage to the Arctic. The most important recommendation to help the Arctic is the reduction of greenhouse gases emissions

UN Conference on Disarmament: North Korea v South Korea

North Korean diplomat, Jon Yong Ryong has received much criticism after he stated that South Koreas erratic behavior would result in its own destruction. Such a statement has been viewed as offensive by UN member states.

European Parliament Urges Stricter Reforms As Part of Basel III, But Talks Stall

The European Commission is considering stricter disclosure requirements for European banks as well as limits on the sizes of bonuses as part of the laws that will implement the international Basel III accords on banking regulations. There had been hopes of a deal being reached this week, but talks broke down Tuesday. They are expected to resume next week.

European Parliament Moves Towards Boosting Carbon Market

In 2008, a European carbon allowance cost €30 per ton.  Last year that price had dropped to €9 per ton.  Last month it reached a low of €2.80 per ton.  To support the carbon trading market—and the entire emissions trading scheme—the European Parliament’s environmental committee voted to allow the European Commission to reduce the number of allowances to be auctioned over the next three years.

US Business Groups Renew Push for Legislative Reform to the Foreign Corrupt Practices Act

Last November, the US Justice Department and the Securities and Exchange Commission released new guidance on how they would enforce the FCPA, which business groups have criticized for being too ambiguous.  While several lobbying groups, including the Chamber of Commerce, the American Bankers Association, and the National Association of Manufacturers, offered some praise for the guidance, they released a letter to federal regulators this week calling for legislative reforms to bring greater clarity to the act and provide for additional legal defenses.

Chinese Military May Be Tied to International Cyber Attacks

Mandiant, an American computer security firm, released a report this week that implicates the Chinese Army in a number of cyber attacks against American infrastructure and businesses.

G-20 Finance Ministers and Central Bankers Pledge Not to Manipulate Exchange Rates

Two-day talks by G-20 finance ministers and central bankers ended on Sunday with the group strengthening its stance against exchange rate manipulation.  This is seen as an effort to lower fears of a global currency war and put pressure on Japan to stop publicly providing guidance on its currency’s value.

Bangladesh’s International Crimes Tribunal Introduces Retroactive Legislation to Allow for Death Sentence

Bangladesh’s parliament has amended its laws so as to allow the state to appeal against the life sentence of an Islamist party leader. Jamaat chief Abdul Kader Mullah was given life for his alleged role in crimes in the 1971 war which resulted in independence from Pakistan. The amendment appears to be a reaction to violent protests that called for his execution. Human Rights Watch says the law is worrisome.

Moscow Unwilling to Back ICC Referral of Alleged Syrian War Criminals

Deputy Foreign Minister Gennady Gatilov indicated that Russia would not immediately back calls to refer the civil war in Syria to the International Criminal Court for the investigation and possible prosecution of alleged war criminals. Investigators recently urged the UN Security Council to act.

Afghanistan: “Human Cost of the Conflict Remains Unacceptable”

While the number of civilian casualties in Afghanistan has decreased for the first time in six years, targeted killings by insurgents – particularly of women, girls and government employees – increased dramatically according to a UN report.

Tunisia Prime Minister Resigns in Shaky Post-Arab Spring Democracy

Tunisian Prime Minister Hamadi Jebali has resigned after failing to reach agreement on forming a new government. He had been trying to form a new coalition in response to the political crisis sparked by the killing of opposition leader, Chokri Belaid.

Former Head of State on Trial in Front of ICC

Ivorian ex-President Laurent Gbagbo has appeared at the International Criminal Court. He faces four charges, including murder and rape, in the wake of Ivory Coast’s disputed presidential poll in 2010. Defense lawyers argued that he was already under investigation in his own country and that the authorities there must be the ones to try him under the ICC’s principle of complementarity.

Protest in West Bank for Palestinian hunger Strikers in Israeli Jails

Protesters in the West Bank are marching in solidarity with hunger strikers in Israeli jails. One, Samer Issawi, has been on protest for 200 days and is said to be in critical condition. Many of the hunger strikers are under administrative detention, held without trial or charge by the military because it fears an immediate risk to security or to protect informants. UN as well as European governments have recently called on Israel to respect the human rights of Palestinian detainees.

UN Security Council Warns Yemeni Ex-Leaders Not to Interfere in Democratic Transition

The UN Security Council has warned Yemen’s former president, Ali Abdullah Saleh, and vice president that they could face sanctions if they continue to interfere in the country’s democratic transition. The statement also expressed concern about money and weapons being brought into Yemen. Mr. Saleh had stepped down in exchange for immunity in a deal arranged by the Council and elections are to be held in 2014.

Intellectually Disabled Prisoner’s Stay of Execution Sparks Legal Uncertainty

Warren Hill, Georgia prisoner who has been found by nine medical specialists to be mentally disabled, came within half an hour of being put to death on Tuesday night. The case has led to reactions from European leaders who called on the U.S. to strengthen its laws prohibiting the death penalty against intellectually disabled prisoners. The postponement is temporary and the Supreme Court has declined to hear his case, which leaves him in a state of legal uncertainty.