THE BLOG
08/21/2014 05:00 am ET Updated Oct 20, 2014

Real Punishment: Get Rid of Russia's Black Markets in Western Europe

A sanctions scheme designed to target and limit activity among the shadiest comrades within Russia could inadvertently increase their business opportunities in the well-established black markets operating throughout Europe. In order to effectively implement sanctions against Russia as punishment for its destabilizing actions in Ukraine, the West must first address Russian black markets through tougher enforcement of transparency standards within their own borders and beyond. If the U.S. and EU expect current or future sanctions regimes to be effective in Russia, awareness, education, and enforcement of these transparency standards already agreed upon in international bodies must be taken more seriously.

Russian black markets are integrated, global, and effective. Illicit outflows from Russia, mostly into the European market, amount to more than $210 billion since 1994, roughly 46 percent of the country's annual output. Financial flows into shell companies and shadow banks in the UK, Switzerland, and Cyprus make up much of the illicit market supported by Russia's elites. Since the fall of the Soviet Union, black markets in Russia have been big business. Trade mispricing, false labeling on shipments, money laundering from public accounts, capital flight, shadow banking operations, and extortion top the list of illicit operations in and out of Russia. Everything from lumber to rocket launchers to drugs to chemicals to people cross the borders of Russia illegally into the European Union and neighboring countries.

As western sanctions start to clench, the black market flows into shadow companies and offshore accounts can be expected to increase, much like they did in the late 1990s when oligarchs feared collapse of the system in Russia.

In order to make sanctions against Russia less easy to circumvent, one must address the West's inaction against Russian black markets within their borders. Combatting illicit market activity has been raised at the Organization for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF), the World Bank, the G20, the UN, in US Congress, and the European Parliament. Perhaps the most comprehensive report on how developed economies can fight against these illicit market regimes was conducted by the OECD earlier this year. The IMF has been conducting research since 1989 on money laundering, tax evasion, and upholding financial integrity within the world's financial centers.

The EU and the U.S. have the standards in place through the accords of these international institutions to monitor and halt the flow of funds into their financial centers. But in order to be effective, more concerted efforts for coordination among jurisdictions, proper personnel training, and more transparent policing must be implemented. As long as the western countries remain complacent with the status quo, they cannot expect Russia's black market networks to go away. The international community must also start to more closely monitor transactions between Russia and tax havens from Cyprus to the South Pacific nation of Nauru in order to deal with illicit financial flows in and out of Russia. The institutions are in place to put a halt to Russia's illicit operations, but it will take the commitment of the EU, the US, and countries like Switzerland to step up and enforce these policies within their own borders. Otherwise, under tougher sanctions, these networks will get stronger and bigger.

The EU could start by training importers in Cyprus and London to spot misinvoicing, and expose the shadow corporations and financial firms that are well-established within EU jurisdictions. London could also more vigilantly monitor illicit financial flows by cracking down on Russian shadow banks and questionable firms incorporated within its boundaries.

Action against these black markets, paired with sanctions, will send a strong message to Russia that Europe is ready to get rid of Russian corruption within its borders.

CORRECTION: This piece previously stated that illicit outflows from Russia amounted to more than $210 billion annually since 1994. According to Global Financial Integrity, that figure is a sum for the period referenced.