Emerging Conclusions Mark Taylor

These Emerging Conclusions offer a preliminary analysis of the findings

of four reports from the Economies of Conflict policy research series,
Emerging Conclusions
which examines the links between private sector activity and armed
conflict. In addition, the four reports are presented here in electronic
March 2002
form on an enclosed compact disc. The occasion is the symposium
Economic Agendas in Armed Conflict: Defining and Developing the
Role of the UN, co-organized by the International Peace Academy and
Programme for International Co-operation and Conflict Resolution, and
sponsored by the Government of Norway, on 25 March 2002 in New
Economies of Conflict:
York.
Private Sector Activity in Armed Conflict
These and additional forthcoming reports from the series are available
from the PICCR web-site at www.fafo.no/piccr

The Economies of Conflict project is supported by the Government of

Norway.

Programme for International Co-operation and Conflict Resolution

Institute for Applied Social Science

P.O.Box 2947 Tyen
N-0608 Oslo
http://www.fafo.no/engelsk/
Mark Taylor

Emerging Conclusions March 2002

Economies of Conflict: Private Sector Activity in Armed Conflict

Programme for International Co-operation and Conflict Resolution

Fafo
 Fafo Institute for Applied Social Science 2002

Cover page: Agneta Kolstad

Printed in Norway by: Centraltrykkeriet AS

2
Contents

Preface ............................................................................................................ 5

1 Introduction ...................................................................................... 7

2 Preliminary Findings ...................................................................... 11

2.1 Anarchic Exploitation ............................................................................ 12
2.2 Criminalized Transactions ...................................................................... 15
2.3 Militarized Production ........................................................................... 17
2.4 Conflict Commodities ............................................................................ 20
2.5 Rogue Companies .................................................................................. 23
2.6 Emerging Conclusions ............................................................................ 25

3 Executive Summaries ..................................................................... 27

Dirty Diamonds ............................................................................................ 28
Fuelling Conflict ........................................................................................... 33
Illicit Finance and Global Conflict ............................................................... 38
The Logs of War ........................................................................................... 47

About the Authors ....................................................................................... 53

Appendix: Contents of the Economies of Conflict CD, Version 1 .............. 54

3
4
Preface

These Emerging Conclusions offer a preliminary analysis of the findings of four re-
ports from the Economies of Conflict policy research series, a project of Fafos Pro-
gramme for International Co-operation and Conflict Resolution (PICCR). These
reports are the first to emerge from the series, which examines the links between
certain private sector activity and armed conflict.
The four reports presented here in electronic form on compact disc are being
released for the first time on the occasion of Economic Agendas in Armed Conflict:
Defining and Developing the Role of the UN, a symposium co-organized by the In-
ternational Peace Academy and PICCR, and sponsored by the Government of
Norway, on 25 March 2002 in New York. These reports will be released in printed
format in the coming months.
The Executive Summaries of the reports are reproduced below, as is a table of
contents for the compact disc itself. We have gathered from the authors a number
of related primary and secondary source documents and included these on the com-
pact disc in order to provide background and context to the studies and to give this
version of the compact disc additional utility. Much of what is included on the
compact disc is also available on the Fafo web site at www.fafo.no/piccr, which will
be updated regularly with additional material. Later in 2002, the Economies of Con-
flict series will release additional reports on regulatory options, the private security
sector, small arms, and brokers.
It should be emphasised that Economies of Conflict is an analytical policy-oriented
project, aimed at a better understanding of processes and behaviour as the basis for
suggesting policy options. The reports issued as part of the Economies of Conflict series
do not seek to accuse or shame particular firms or governments. Rather, the studies
approach the private economic dynamics involved in armed conflict from within
each sector, asking the question, How does certain private sector activity help sus-
tain armed conflict and what can be done about it?
In designing the research programme, PICCR opted for an industry perspec-
tive. The industries identified below have been selected based on their identifica-
tion in the literature and through practice (as evidenced by on-going work of non-
governmental organisations, governments, or multilateral institutions). They are by
no means exhaustive of the economic dimensions of war, but they represent some
of the industries that are, perhaps, most relevant to the challenges to international

5
peace and security posed by contemporary armed conflicts. Although the studies
do address illicit activities within licit industries, the project has yet to commission
studies related to the specifically criminal activities linked to armed conflict (e.g.
narcotics, trafficking in human beings, etc.).
As with past PICCR projects, we have chosen an inductive approach, seeking
to contribute to these arenas through an analysis of experience and lessons-learned.
PICCR commissioned studies from practitioners and researchers engaged in issues
related to the industry and war, or the industry and corporate social responsibility,
and with a keen sense of what has worked and what has not worked - in practice.
The Economies of Conflict project was launched in the spring of 2001 and since
that time we have benefited from the input and support of a growing number of
people. Principal among these has been Ambassador Wegger Strmmen at the
Norwegian Permanent Mission to the United Nations, who has watched the project
grow since its inception. Karen Ballentine, Research Coordinator and Program
Associate on the International Peace Academys project Economic Agendas in Civil
Wars, has been extremely helpful and, along with the excellent staff at IPA, has made
the Fafo-IPA cooperation on these issues both easy and effective. Our team of re-
searchers deserve special thanks, both for their openness to our approach to the
research task and their willingness to share their knowledge with each other across
the seminar table. My thanks also to Leiv Lunde, an advisor on Economies of Con-
flict and the author of an upcoming report from the project, for his help and per-
spective over the past year, and to Christian Ruge, a PICCR colleague, who has made
an invaluable contribution to the project. I am also grateful to the Government of
Norway, which provided financial support for the project, and to those Norwegian
officials who have contributed their perspectives on policy issues. Of course, none
of the above bears responsibility for any inaccuracies or omissions that might occur
in these reports. The views and recommendations expressed in these reports, includ-
ing this summary of emerging conclusions, are those of the authors alone and do
not necessarily reflect the views of Norway, its Government or officials, or Fafo.
These emerging conclusions present a work in progress. Your comments would
be welcome and should be directed to pisk@fafo.no.

Mark Taylor
Programme Director, PICCR
Series Editor, Economies of Conflict

6
1 Introduction

Todays warlords, governments and non-state actors alike, make use of global finan-
cial and commodity markets to transform control over natural resources into war
fighting capacity. Under the cover of secrecy and unaccountability provided by war,
legally or illegally produced commodities are traded on the legitimate, but highly
unregulated, global markets to obtain financial resources, weapons and other ma-
teriel needed to sustain the war.
The economic dimensions of wars are not new. Yet, the horrors of recent wars
seem to have thrown into stark relief the inadequacy of our attempts to end them.
Despite the terrible human cost of the wars of the past decade millions of lives
lost or ruined, societies irrevocably scarred, and economies destroyed it has be-
come increasingly clear that recent wars have far outstripped our ability to bring them
to definitive conclusion1 and that the economies of these conflicts may play a cru-
cial part in sustaining them.
As a priority for international action, the economic dimensions of conflicts have
been catapulted to the top of the international agenda by increasing concerns about
the dark sides of globalization. Since 11 September 2001, the U.S.-led internation-
al effort to target terrorist financing and logistics has underlined the importance of
global financial and criminal networks to national and regional security. Today, a
common, global infrastructure of financial services is used to facilitate transactions
involving drug money, small arms, diamonds, smuggled timber, the proceeds of
corruption, human trafficking and terrorist finance. The apparent ease with which
licit and illicit economic goods and services are able to move between black, grey2
and white markets has forced governments to seek greater financial sector account-
ability. The failures of financial oversight and corporate accountability apparent in
the spectacular bankruptcy of the U.S.-based Corporation Enron have added to a
1
While the number of armed conflicts has dropped since the early 1990s, of those that continue 66
per cent were more than 5 years old in 1999 and 30 per cent were more than twenty years old. In
addition, many conflicts which were suspended in the 1990s not least in Europe, the Middle East,
and Central Asia have not been resolved; see Dan Smith, Trends and Causes of Armed Conflict, Berghof
Handbook for Conflict Transformation (April 2001).

2
The term Grey markets is used here in its more generally legal sense, referring to markets which
bridge legal or white markets and the trade in illegal black market goods.

7
growing sense of uncertainty about the transparency and accountability of firms
operating internationally.
Concerns about the economic dimensions of international peace and security
appear to be converging with an evolving agenda for greater corporate accountabil-
ity. Intense activity is underway in several arenas to better understand and respond
to the economic driving forces of violent conflict and war. Governments and mul-
tilateral organisations, non-governmental organisations, multinational corporations
and industry associations, have all in recent years launched or participated in initi-
atives to study or develop policy options for dealing with economies of armed con-
flict. Campaigning NGOs and industry have moved to address private sector links
to conflict through the increasingly significant lens of corporate social responsibil-
ity (CSR). Multilateral institutions, including the World Bank, the OECD, and the
United Nations, have begun to tackle the issue from their own perspectives (mac-
ro-economic analysis, global policy co-ordination, sanctions). With this convergence
in mind, PICCRs Economies of Conflict project has been structured to build on the
bodies of work that have emerged from these efforts and to provide input to them.3

Summary: Conflict Commodities and Rogue Companies

With the rise to prominence of conflict diamonds, and to a lesser extent conflict
timber, there is a growing sense that goods produced in an economy torn by armed
conflict are, or should be, morally suspect. The tendency to view such goods as con-
flict commodities is a direct result of an increase in consumer sensitivity resulting
from successful campaigns on issues related to corporate social responsibility and
human rights, and the increasing concern that such activities run counter to efforts
to maintain international peace and security. It is arguable that an international moral
and political norm is gradually emerging which views private sector activity that
sustains armed conflict as unacceptable.
The notion of conflict commodities possesses inherent dangers. Countries de-
pendent upon a limited number of exports could face serious economic hardship
should the conflict commodity label taint their product. Companies with legiti-
mate investments in such countries face the potential for significant losses and height-
ened risk to their reputations. These dangers were recognised early on by

3
For a summary of UN oriented initiatives see, e.g., Economic Agendas in Armed Conflict: Defi-
ning and Developing the Role of the UN, Background Paper prepared by The International Peace
Academy and The Fafo Institute for Applied Social Science, on the occasion of a symposium spon-
sored by the Government of Norway, Monday, 25 March 2002, New York. A comprehensive look at
the full spectrum of regulatory options relevant for the private sector is being developed for publica-
tion as part of the Economies of Conflict series in the Spring 2002; see www.fafo.no/piccr.

8
governments, industry and NGOs concerned about conflict diamonds, and they
have guided efforts to define the problem and develop remedies.
Despite the risks, there is as yet no agreed definition of what might constitute a
conflict commodity. By looking at those commodities already linked to the financ-
ing of armed conflict, the Economies of Conflict studies sought to describe the
specific activities involved in the production and marketing of such goods, includ-
ing payments processes and related financial services. What emerges is a picture of
conflict commodities as goods exploited to sustain armed conflict and produced or
brought to market by anarchic exploitation, criminalized transactions, and milita-
rised production.
The policy communities in the international public and private sectors are en-
gaged in trying to identify what mix of private and public policies will be most ef-
fective in addressing the role of private sector activity in sustaining armed conflict.
Defining complicity and developing policy options now will help member states and
companies position themselves in relation to a consensus forming around the issue
of conflict commodities.
Unfortunately, this is unlikely to be enough.
Certain companies, some of a relatively small size but operating international-
ly, continue to use armed conflict as a cover for more or less anarchic exploitation.
These companies profit from the fighting and are often connected with the powers
at the head of repressive rebels or governments. The activities of these companies
are often crucial to the prosperity or survival of these powers, often in direct con-
tradiction to international attempts to make peace.
These are rogue companies, firms that participate in and benefit from the mil-
itarization of production, criminalized transactions and anarchic exploitation. Yet,
the Economies of Conflict studies identify activities carried out by companies with
legitimate business interests that would fit into these categories. As the activities and
consequences associated with conflict commodities begin to be better understood,
and as the consensus around notions of conflict commodities begins to solidify, a
number of companies engaged in otherwise legitimate activities could find them-
selves on the wrong side of international opinion.
The Economies of Conflict studies portray a complex range of licit and illicit ac-
tivities that result directly and indirectly - in a number of intended and unintended
consequences. Judging from the pace of recent policy development, international
companies and their home and host states - will need to adopt clear, verifiable
positions on core issues about their operations in situations of armed conflict. The
elaboration of a clearly defined concept of conflict commodities and rogue compa-
nies would have considerable utility with regard to private sector CSR initiatives. It
would help all sides industry, NGOs, and government by providing some

9
transparency to the negotiation of agreed standards. The analysis and definitions
suggested below are offered as a departure point in the discussion of these issues.

10
2 Preliminary Findings

The first studies produced under Economies of Conflict reinforce the view that deci-
sion-making about private sector activity in armed conflict is mired in significant
uncertainty. Practitioners in governments, multilateral organisations, firms and
NGOs have few definitive or operational understandings of what might constitute
harmful private sector activity in armed conflict.4 Company officers need to know
the risks involved in certain investment opportunities and, in the context of increas-
ing demands for corporate social responsibility, need a better idea where lie the moral
or political trip-wires. Practitioners charged with managing international peace and
security require operable definitions upon which policy responses can be based.
Governments, those home to multinational corporations or those hoping to attract
investment, need to know about the political and economic implications of certain
company actions, at home and abroad.
The first four reports in the series - covering the oil, diamond, timber and fi-
nancial sectors describe a complex combination of activities spanning production
processes, trade, the provision of services, and touching upon public and private
institutions. What emerges is a tentative categorisation of specific activities that
enable - directly and indirectly rebels or governments to sustain armed conflict.
Three categories of activity are described below, followed by an analysis of poten-
tially useful definitions of conflict commodities and rogue companies. The findings
are preliminary. The analysis presented here is subject to change based on further
research and the conclusions of additional papers to be published as part of the
Economies of Conflict series in the spring and summer of 2002.

4
See, e.g., Private Sector Actors in Zones of Conflict: Research Challenges and Policy Responses, a report
of the Fafos PICCR and the International Peace Academy project on Economic Agendas in Civil
Wars. Thursday, April 19, 2001, International Peace Academy, New York. Rapporteur: Jake Sherman.

11
2.1 Anarchic Exploitation5

Governments and rebels alike make use of global financial and commodity markets
to transform control over natural resources into war fighting capacity. Legally or
illegally produced commodities are traded on the legitimate, but highly unregulat-
ed, global markets to obtain financial resources, weapons and other materiel need-
ed to sustain the war. In all four of the sectors studied to date diamonds, timber,
oil, and financial services private sector activity consists of a series of transactions
which often combine the perfectly legal and legitimate with the thoroughly illegal
or illicit. More often than not, the borders between these categories are ill defined.
One of the principle reasons for the uncertainty of private economic decision-
making in armed conflict is the significant lack of relevant regulatory frameworks.
State sovereignty implies that a government is likely to exploit its natural resources
if it feels the need to mount a military defence, which is usually expensive. But armed
conflict usually results in the destruction or weakening of government institutions,
which lends itself to loss of administrative effectiveness and de facto sovereignty,6
as well as a direct reduction in transparency and accountability of governments. Thus,
while certain activities may be clearly illegal under domestic law, they may not be
enforced; many others are simply unregulated. In other cases, the problem of hav-
ing to enforce or regulate activities that contribute directly to conflict is solved by
having them formally legalized.
There is little in the way of international public or commercial law against which
the legality of private sector activities in armed conflict might be tested or from which
policies might be derived. In fact, all of the studies describe a lack of international
regulation or enforcement related to these activities.7 Together, these domestic and
international regulatory gaps contribute to the blurring of the definitions of licit
and illicit economic activities in armed conflict.
For those involved in armed conflict, the exploitation of resources is made pos-
sible by this relatively unregulated or anarchic state of affairs. In some cases, certain
industries seek out such situations:

5
The term exploitation is used here in its most general and neutral sense of utilising an object for
profitable ends or to obtain potential benefits.

6
States have asserted a permanent right to sovereignty over their natural resources and wealth. The
establishment of this right was a particularly important part of statehood for developing countries
emerging from colonial rule. In addition, most governments justify military action as a form of self-
defence, a right enshrined in international law.

7
An analysis of the debate around regulatory options is forthcoming as part of the Economies of Conflict
series later in 2002.

12
 The tropical timber industry traditionally engages leaders of countries with large
forest resources and weak institutions. Abiding by local business practices, it
negotiates deals to extract raw materials as cheaply as possible. This mode of
doing business suits the warlord economy extremely wellThe state of disor-
der created by conflict suits the perpetuation of these business practices. (The
Logs of War, 2002).
Thus, armed conflict in countries can result in a destructive downward spiral of shady
business practices and poor governance. But armed conflict can also result from these
dynamics. Governments - of developing and industrialised countries alike - are not
always inclined to govern with transparency and accountability. In fact, [h]alf the
worlds [diamond] production or more is mined in countries with unstable or se-
cretive governments, an almost foolproof recipe for expanded and deepened crim-
inality (Dirty Diamonds, 2002).
This relative anarchy in domestic jurisdictions is mirrored by a largely unregu-
lated international financial system. The illicit financial networks imbedded in the
international financial system facilitate the illicit aspects of the trade in conflict
commodities. The absence of an international regulatory framework, or of agree-
ment on universalized domestic regulation, means that at present legitimate banks
would have a hard time trying to avoid handling the proceeds of government cor-
ruption or illicit proceeds gained through the exploitation of armed conflict. The
Illicit Finance study finds that money laundering and international financial arbi-
trage are crucial in undermining the accountability of domestic governments or
private companies:
[f ]inancial transparency is a core structural requirement by which governments,
regulators, law enforcement, judiciaries, civil litigants, and journalists can exercise
oversight and insist on the accountability of both important private sector and public
sector actors. Its absence facilitates impunity, which in turn often leads to conflict.
(Illicit Finance, 2002).
In the case of the oil industry, most companies find the extremes of anarchic ex-
ploitation to be counterproductive. Quite apart from the legal requirements of re-
lating to government, oil production requires the security and legal/administrative
guarantees that only governments can provide. Thus, in situations of armed con-
flict, oil companies are usually allied with governments. Yet, oil companies can con-
tribute to corruption and other governance problems directly related to the growth
of oil revenues. A key problem lies in the lack of transparency of oil company pay-
ments to governments, which can
[O]bscure the direction and volume of oil revenue flows. A large influx of easy
oil revenue into a non-transparent system invites corruption, in turn creating
incentives to further limit transparency and accountability. Under such

13
 conditions, much oil wealth allegedly has disappeared into off-budgetary ac-
counts. (Fuelling Conflict, 2002).
By seeking out weak jurisdictions, or by contributing to the weakening of domes-
tic governance, businesses can help to perpetuate or accelerate the deterioration in
accountability. The downward spiral through corruption towards state failure is
caused in part by - and results in - the loss of domestic control over the resource:
In a developing country with few resources other than vast tracts of forest,
control of this natural capital is control of powerAllocation of timber con-
cessions becomes a mechanism for rewarding supporters and mobilizing wealth
to prop up the existing regime. The result has often been massive corruption and
loss of revenue to the state. It has also contributed to the erosion of democratic
principles as elected politicians and state officials put the rights of companies
before those of the population they are supposed to represent. Protected by
powerful allies, timber companies become the de facto resource owners and state
forestry institutions become the clients of the logging extractors rather than vice
versa. (The Logs of War, 2002).
For governments, the loss of territory through armed conflict, or loss of control to
favoured individuals or private companies, results in the loss of effective control over
the resource. What a government may claim by right and what it can actually ex-
ploit may be very different: de jure state ownership can be rendered meaningless in
practice by de facto control over the resource by individuals, private companies and/
or their political-military allies. If taking or retaining political power in a particular
country requires control and exploitation of the resource, then investment and pro-
duction become the keys to political power and an extension of state sovereignty.
Companies can come to play a central role in the political-economy of a conflict
and may help determine the effective exercise of state sovereignty.
As made clear in the studies, how companies play these roles depends upon a
number of factors, not least the nature of the investment and industrial activity.
Common to all four studies are descriptions of a lack of transparency of transac-
tions, a weakening or loss of government control, and the impunity of firms and
governments, in the proliferation of conflict commodities and the sustainability of
economies of armed conflict in general.
Anarchic exploitation is made possible by a lack of governance mechanisms at
the domestic and international levels, described above as a series of regulatory gaps.
Poor governance may lead to political instability and conflict, but institutional
weakness may also result from armed conflict, making war a good time to for cer-
tain companies to take advantage of poor monitoring and enforcement. These dy-
namics, in the context of regulatory gaps, can significantly blur the lines dividing

14
licit and illicit activity. If the private sector can be assumed to prefer low levels of
government interference, a state of war could be said to represent an ideal regulato-
ry environment for some industries. But exploitation during armed conflict can
promote corruption, impunity, and the incapacitation of government regulation or
control over a countries own natural wealth.

2.2 Criminalized Transactions

Up and down the supply and demand chains - from legal trading in illegally pro-
duced commodities, to illegal transfers of perfectly legal revenues more or less il-
licit transactions involved in financing armed conflict help to criminalize procure-
ment, marketing and payments.
It is estimated that in 1999 approximately 50 per cent of European Union trop-
ical timber imports consisted of illegally logged timber, a figure that is probably
representative of worldwide imports. An estimated 20 per cent of the global dia-
mond trade is illicit. In both cases, logs or rough diamonds that are stolen are then
legally imported to consumer countries. Surprisingly, there is no law that prevents
a European country from importing the products of illegal and conflict timber
operations. Indeed, in the industrialised countries of the West, there is no legisla-
tion that can prevent this from happening Timber is, of course, a legally tradable
commodity. (The Logs of War, 2002). So, too, are rough diamonds.
At a meeting of the inter-governmental Kimberley Process in Moscow in July
2001, the Guinean Delegation unveiled its new certificate of origin, and asked
other countries present not to allow, henceforth, the importation of Guinean
diamonds without the certificate. The EC representative replied that EU coun-
tries could import whatever they want, from wherever they want, and were not
bound by any Guinean document. While this suggested an almost willing ac-
ceptance of criminality, the EC representative was in fact correct: documents such
as Guineas certificate of origin have no standing in international law and no
backing under current trade agreements and regulations. (Dirty Diamonds,
2002).
Central to the problem of the legal importing of illegal commodities are questions
of export and import controls. Both the The Logs of War and Dirty Diamonds re-
ports address in some detail the regulatory options for producer and consumer coun-
tries, inter-governmental co-operation as well as industry. However, the diamond
and timber trades both suffer from the misrepresentation of shipments. In fact, the
re-labelling of timber shipments, or the blending of legal and illegal diamonds

15
during transhipment, are crucial for ensuring the access of illegal diamonds or tim-
ber to consumer markets.
Organized crime has been implicated in the activities of all four of the sectors
covered here. Fuelling Conflict reports allegations of covert illicit arms deals and
logistical support provided by an oil company to rebels in coups detat in Africa (Fuel-
ling Conflict, 2002). For the most part, however, most arms deals involving the oil
industry, while heavily criticized and somewhat murky, appear to have been legal.
The same cannot be said for the diamond and timber trades. The illegal pro-
duction and marketing practices of diamonds and timber have proven attractive to
criminal organisations and networks. The timber trade is characterized by endemic
corruption, links to organized crime and, in numerous instances, to various war-
ring factions(The Logs of War, 2002). Much the same is true for significant parts of
the diamond industry: Conflict diamonds are essentially illicit diamonds that have
gone septic. They have simply been used for a new purpose - to pay for weapons in
rebel wars (Dirty Diamonds, 2002). Indeed, the regulation gap described below
represents an opportunity for dodgy middlemen willing to assume the higher risks
of a environment in which contracts are unenforceable.8
The transactions involved in financing armed conflict are similarly criminalized:
Illicit finance is also a key facilitator of civil warThe laundering of the proceeds
of crime is a necessary means to carry out the trade in diamonds that has fuelled
armed conflict in Liberia, Angola and Sierra Leone, together with their accompa-
nying arms deals and payoffs. (Illicit Finance, 2002). Central to the effectiveness
of illicit financial services, are the licit financial networks across which they oper-
ate. In the global financial system, the transformation of money from black to
white via shades of grey is only marginally more difficult than blending diamonds,
or mislabelling timber:
In recent years, with every substantial national, regional, or global failure of
governance, a financial scandal has been found in close attendance. Accompa-
nying each financial scandal has been the systemic use of banking and financial
secrecy to hide criminal activity. Over the past decade, this pattern has played
out repeatedly in jurisdictions all over the world. Repeatedly, political conflict
and major political destabilizing activity, including grand corruption, narcotics
trafficking, arms smuggling, and civil war have been facilitated and sustained
by illicit finance networks embedded in the worlds licit financial services infra-
structure. (Illicit Finance, 2002).

8
More information in this regard will be available in a forthcoming publication on these brokers
to be released as part of the Economies of Conflict series later in 2002.

16
As with the trade in illegal or conflict diamonds or timber, there is no international
regulatory framework that governs the international financial system as a whole.
Regulatory jurisdictions are domestic, and regulators are dependent upon compa-
ny transparency and inter-governmental cooperation to obtain oversight over funds
moved out of their jurisdiction. Offshore banking has made possible the practice
of arbitrage, the practice of structuring international transactions for maximum
profitability and minimum regulatory oversight or risk. While not illegal, arbitrage
makes illicit finance possible, as financial institutions can move their riskiest and
least attractive transactions to jurisdictions that require the least transparency (Il-
licit Finance, 2002).
Rarely are the marketing chains or revenue streams of a conflict commodity or
its producer entirely illegal from start to finish. Nor are the supply lines of combat-
ants necessarily run as criminal networks, or filled with illegal goods. But experi-
ence indicates that to operate effectively, the procurement, marketing and payments
processes related to armed conflict consist of a series of transactions that combine
the perfectly legal and legitimate with the thoroughly illegal or illicit.
The term criminalized transactions is suggested here as a potentially useful
analytical category within which to group some of the illegal, illicit and generally
questionable transactions that help to fuel armed conflict. Transactions involved in
the economies of armed conflict could be said to be criminalized by their facilita-
tion of or profiting from the trade in illegally produced (stolen) commodities; im-
proper or unregulated import-export practices (smuggling); the misrepresentation,
blending or miss-labelling of conflict commodities (fraud); the diversion of legally
obtained revenues (theft); illicit financial dealings (some arbitrage, all money laun-
dering); or the involvement of criminal organizations.

2.3 Militarized Production

The three reports covering extraction industries diamonds, oil and timber all
describe varying degrees of military activity associated with the production of pri-
mary commodities. The spectrum of activity ranges from protection of oil installa-
tions by security companies, to de facto invasion by state or rebel armies in the pur-
suit of natural resources. Although similar patterns emerge across the three sectors,
each affected company or community faces conditions specific to its situation. In
all three sectors, however, the evidence suggests that a key relationship between
production and armed conflict is established once production is militarized.
Militarization of production occurs when a commodity becomes of strategic
significance for a military faction. Rebels in Angola, Sierra Leone and the Democratic

17
Republic of Congo (DRC) have made the control of alluvial diamond mining a
strategic military objective. Similarly, rebels movements and government armies in
Burma, Cambodia, Liberia, and from Zimbabwe have deployed to secure logging
areas and have facilitated the logging of tropical timber, or carried out the logging
themselves.
Opportunity is the determining factor in the transformation of rough diamonds
into a strategic commodity. Diamonds, particularly alluvial diamonds, are a low-
volume, high value commodity[t]hey are highly portable andreadily accessi-
ble (Dirty Diamonds, 2002). Timber is only marginally less so:
Compared to most forms of resource extraction, logging is a relatively easy
activity, requiring low investment for quick return. A few soldiers with chain-
saws and trucks can generate hundreds of thousand of dollars in a relatively short
time; a well-resourced company can generate hundreds of millions. In more
extreme cases military intervention in another country is based around the at-
tempt to control that countrys resources. For a warring faction in control of forest
land, logging is one of the quickest routes to obtain significant funding with
which to continue the conflict. (The Logs of War, 2002).
In the case of conflict diamonds, opportunity exists primarily through access to
alluvial diamonds: since rough diamonds are low-volume, high-value they are more
easily marketed. Similarly, in their study of conflict timber, The Logs of War finds
that access equals opportunity with respect to tropical timber. However, compared
to rough diamonds, the physical size of the logs makes their marketing more de-
pendent upon military control of transportation routes out of the conflict zones, a
sufficient level of corruption at transit points, and the willingness of otherwise le-
gitimate timber companies to launder these logs of war onto the global market.
The military activity associated with oil production does not follow the same
pattern as that of diamond and timber production. The relatively high costs involved
in producing and marketing oil mean that, for rebels and governments alike, access
does not equal opportunity. For an oil field to represent a revenue opportunity it
requires investment, usually by an oil company. Unlike the diamond and timber
sectors, in which production could be profitable to anyone who controls access to
the resource, oil companies national, multinational or both - are a necessary con-
dition for production to take place at all.
In a situation of armed conflict, this places the oil production companies in a
potentially pivotal position. Formally, oil companies typically adopt a position of
political neutrality. Yet, their production is a source of revenue for governments and
ruling elites that depend upon these revenues to finance their war-fighting capaci-
ty. In addition, in a number of cases, oil companies have arranged more or less cov-
ert arms transfers to host governments, often justified by the companies involved

18
on the grounds of improving the capacity of the host government to provide secu-
rity for oil installations.
Oil production in situations of armed conflict usually places investment in harms
way and the company remains at the mercy of the shifting balance of military forc-
es during the conflict.9 Oil production requires the investment and the guarantees
(contracts, security, etc.) that only an alliance between oil companies and govern-
ments can provide. Most companies, dependent upon the host government for
concessions and protection, find governments to be their natural allies:
Common accusations are that companies have allowed militaries to use airstrips,
helicopters, roads and other oil company infrastructure for offensive military
purposes. In some cases host governments even appear to be using oil company
security as a cover for waging military campaigns against political or ethnic en-
emies. Some of the most serious accusations levelled against international oil
companies have involved direct or indirect assistance in procuring weapons for
host country governments, and in some cases even for rebel groups. (Fuelling
Conflict, 2002).
Thus, the militarization of oil production in armed conflict is indirect. Companies
may provide logistical or other support - usually to governments - but rebels or
government troops are unlikely to be involved in the production of oil, or even the
management or oversight of production facilities. However, military activity assures
access to the resource through the control of territory, provides security to the pro-
duction processes and investments, and enables local or regional marketing activi-
ties.
In the diamond and timber industries, the nature of the production process
means that, access to the resource and control of marketing routes are enough to
make them a viable economic activity for rebels and government forces. The extrac-
tion of rough diamonds in armed conflict zones is often an informal affair, run al-
most entirely by the military power in control of the region. In the timber industry,
logging companies play a crucial role, but where they operate they tend to side with
whoever controls forest territoryin many instances insurgent groupspolitical,
military and criminal groups (The Logs of War, 2002). Where it occurs, the milita-
rization of diamond and timber production is direct, in the sense that state or rebel
militaries are more often than not integral to the production process.
For all three commodities, exploitation is in large part determined by the extent
to which the commodity can be said to have become of strategic value to the force
in question. Usually, the opportunity for profitable exploitation defined as access
9
The usual exception being off-shore oil installations which can become targets during intra-state
wars.

19
to a high value resource and to their markets is the deciding factor, but invest-
ment may also be necessary to make access and marketing viable. Still, the central-
ity of military activity to the production of all three of these commodities is hard to
avoid. In some cases, where there is ready access to the resource, the military is the
company and its troops are the labour pool. In others, they operate as sector-wide
protection rackets, determining the production cycles, managing or victimising
labourers and protecting or attacking investments. Over time, and to the extent that
a force exercises continuous control of a territory and roads, they can influence pro-
duction cycles and determine the viability of investments. This is, in a phrase, mil-
itarized production. Production may be considered to have been militarized once
military personnel or military activity become a direct or indirect part of the pro-
duction process.

2.4 Conflict Commodities

With the rise to prominence of conflict diamonds, and to a lesser extent conflict
timber, there is a growing sense that goods produced in an economy torn by armed
conflict are, or should be, morally suspect. Indeed, the activities of companies dealing
in such commodities are increasingly viewed as illegal or a challenge to international
security. The Security Council, through its panels of experts and/or monitoring
mechanisms, has described the sanctions busting activities of a number of compa-
nies. As described in the reports summarised here, the law courts in a number of
countries have heard cases involving allegations of dubious and illegal behaviour by
much larger multinational corporations. The news media in many more countries
have reported similar activities by otherwise legitimate companies operating inter-
nationally, sometimes forcing government action in response.
It is arguable that this activity represents the gradual emergence of an interna-
tional moral and political norm under which private sector activity that sustains
armed conflict is unacceptable. The growing tendency to view certain products as
conflict commodities is a direct result of an increase in consumer sensitivity resulting
from successful campaigns on issues related to corporate social responsibility and
human rights. Yet, there is no agreed definition of what constitutes a conflict com-
modity.
The definitions that have emerged to date have originated as a result of attempts
to grapple with the role of specific commodities in fuelling armed conflict, most
notably diamonds. The term conflict diamonds was an invention of the media, an
attempt to summarize a phenomenon confronting the UN, the industry and NGOs.
Like all media shorthand, it has its drawbacks, but its usefulness as a category has

20
been confirmed by the fact that definitions have been suggested both by the UN
General Assembly and by the inter-governmental series of meetings, known as the
Kimberley Process.
The UN GA defined conflict diamonds as rough diamonds which are used by
rebel movements to finance their military activities, including attempts to under-
mine or overthrow legitimate governments. The Kimberly Process settled on the
following:
Conflict Diamonds means rough diamonds used by rebel movements or their
allies to finance conflict aimed at undermining legitimate governments, as de-
scribed in relevant United Nations Security Council (UNSC) resolutions inso-
far as they remain in effect, or in other similar UNSC resolutions which may be
adopted in the future, and as understood and recognised in United Nations
General Assembly (UNGA) Resolution 55/56, or in other similar UNGA reso-
lutions which may be adopted in future.
Two common aspects of these definitions are immediately apparent. First, both are
concerned with the use of diamonds as a source of finance. This is accurate, as the
financial exploitation is arguably the single most important role that diamonds play
in sustaining armed conflict. However, the definition ignores the impacts of dia-
mond wars (battles for control of diamond territory) or the toll which military con-
trol of a diamondiferous region may have on the population and how that may
contribute to perpetuating the conflict.
Second, both definitions have a clear pro-state bias. This is to be expected as both
definitions have emerged from fora in which states play a dominant role. As already
noted, there is nothing in international law that might prevent states from exploit-
ing natural resources to finance their war fighting capacity. In fact, principles of state
sovereignty entail a responsibility on the part of governments to provide security
and to retain a monopoly on the means violence. Similarly, state sovereignty entails
the right of a government to exploit its natural wealth to this end. But are all states
or government forces in armed conflict necessarily practicing legitimate production
or exploitation of a resource? Would this hold true for a commodity-financed re-
pressive regime, one that put its profits towards maintaining the machinery of re-
pression and war?
The definition for conflict timber offered by The Logs of War takes a more bal-
anced approach. It is based less on the principles of international relations and bet-
ter reflects the economic and logistical processes as work:
For the purposes of this study, conflict timber refers to timber that has been
traded at some point in the chain of custody by armed groups, be they rebel
factions or regular soldiers, or by a civilian administration involved in armed

21
 conflict or its representatives, either to perpetuate conflict or take advantage of
conflict situations for personal gain. (The Logs of War, 2002).
This definition specifically strikes a balance between states and rebels. It seeks to
define conflict timber by virtue of logs having been traded or controlled at some
point by an armed group or parties to a conflict. However, while true to the reality
of conflict timber, this approach to conflict commodities also runs up against state
sovereignty, albeit from a different angle from that of conflict diamonds: in a situ-
ation of armed conflict, military force will almost certainly be required to ensure
the marketing and possibly also the production of timber. Given the acknowledged
right of a state to exploit its natural resources, it must be assumed that a states mil-
itary could at some point be involved in timber transactions in, for example, man-
aging or securing production or marketing of timber (see militarised production
above). Governments are unlikely to accept a definition of a conflict commodity
that may prevent it from exercising its right to exploit.
To get around this, The Logs of War qualifies its definition by seeking to ascribe
intent. Rebels or government soldiers could be considered to be handling conflict
timber if the trade was intended to perpetuate conflict or take advantage of con-
flict situations for personal gain. This, too, is more balanced than the conflict dia-
monds definitions, which describes the overthrow or undermining of govern-
ments as the sole problematic objective. It is useful, too, because it specifically
identifies the criminal dimension of personal gain, which would almost certainly
capture most repressive elites (assuming personal gain includes the use of profits
for patronage to accrue political power, not just enrichment). But this definition
would also fall prey to the principles of states rights, which include the right to self-
defence if attacked and assumes the right to exploit its natural wealth to this end.
Perpetuating and taking advantage of armed conflict may be morally suspect,
but, in a situation of armed conflict, it would difficult to impute this intent to a
government that asserted its right of self-defence.
What emerges from the Economies of Conflict studies completed to date is that a
definition of conflict commodities should probably be based on activities involved
in the production and marketing of such goods, rather than on the actors involved.
The categories outlined above suggest that a definition of a conflict commodity
would include reference to commodities made possible by anarchic exploitation,
criminalized transactions and militarised production.
These categories are only preliminary and require further development. They
appear at first to be far too broad and therefore unlikely to be politically viable.
Certainly, further research into industry activities is needed to provide greater clar-
ity as to definitions, as well as to identify the approximate volume of trade in con-
flict commodities. However, when applied to a particular commodity in the specific

22
context of the armed conflict (e.g. Sierra Leone diamonds, Liberian timber, Suda-
nese oil, etc.), these criteria might offer a more specific understanding of the nature
of the role of the private sector in sustaining conflict. By identifying activities and
transactions that help sustain armed conflict, such definitions help clarify the na-
ture of culpability rather than trying to generalize about the character of parties to
a conflict or their private sector allies.
A focus on activities also makes it easier for concerned citizens, shareholders,
industry associations and others to hold governments and companies accountable
for their actions. This would enable all concerned NGOs, multilateral organisa-
tions, companies and governments - to develop definitions of complicity in armed
conflict that would be relatively transparent and comprehensible across the differ-
ent sectors. In using the categories suggested here, the objective should not be to
cast the analytical net as widely as possible, but to enhance the predictability of
demands for regulation or socially responsible corporate behaviour. These catego-
ries suggest an ability to refine the analysis to enable characterizations to be made
about investments and transactions.

2.5 Rogue Companies

Armed conflicts have created a niche market for companies willing to avoid regula-
tion and assume greater levels of risk. These companies - some relatively small in
size but operating internationally use conflict as a cover for their operations, or
profit from supplying the combatants, or both. The companies operate illegally in
many cases, but many other times they are not technically in violation of any law.
The work of the UN sanctions committees independent panels of experts and/or
monitoring mechanisms has shown that they are often closely connected with the
repressive powers at the head of rebel movements or governments, often in direct
contradiction to UN sanctions, or other efforts to promote security or peace. They
are, in a sense, rogue companies.
Rogue companies are involved in all three categories of activity that define con-
flict commodities: anarchic exploitation, criminalized transactions and militarised
production. Yet, the Economies of Conflict studies identify activities carried out by
companies with legitimate business interests that would fit into these same catego-
ries. As the activities and consequences associated with conflict commodities begin
to be better understood, and as the consensus around notions of conflict commod-
ities begins to solidify, a number of companies engaged in otherwise legitimate ac-
tivities could find themselves on the wrong side of international opinion.

23
The Economies of Conflict studies portray a complex range of licit and illicit activi-
ties resulting directly and indirectly - in a number of intended and unintended
consequences. The elaboration of a clearly defined concept of rogue companies
would have considerable utility with regard to private sector CSR initiatives. It would
help all sides industry, NGOs, and government by providing some transparen-
cy to the negotiation of CSR and armed conflict standards. Judging from the pace
of recent policy developments, it is possible that, sooner rather than later, those
international firms which have taken on CSR initiatives related to human rights or
the environment will have to add the armed conflict lens to their collection of due
diligence perspectives. Eventually, companies will need to adopt clear, verifiable
positions on core issues about their operations in situations of armed conflict or risk
being tarred with the same brush as rogue companies.
As policy and law develop, it is not inconceivable that rogue companies will one
day find themselves named by the Security Council as threats to international peace
and security and treated accordingly. Ultimately, rogue companies could face a range
of targeted sanctions that would affect their management and operations interna-
tionally with a view to influencing their behaviour in relation to one or more armed
conflicts. The utility of such measures for the Council might increase if corporate
sanctions proved effective in targeting specific economic and political interests, could
be shown to have relatively minor consequences for civilian populations.
What companies might qualify as rogue companies? To the extent that compa-
nies have participated in the conflict sustaining activities outlined above, the as yet
simplistic definition of rogue companies offered here would encompass large parts
of the tropical timber industry, a number of international banks, certain compa-
nies dealing in rough diamonds, and certain multinational oil companies. Thus, to
the extent that they have handled finances related to armed conflict, certain banks
operating in problematic jurisdictions identified by the OECDs Financial Action
Task Force (FATF) may qualify as rogue companies. However, a company that looms
large in the trade in rough diamonds may not qualify as a rogue company if it has
participated in attempts to address those aspects of the trade that lend themselves
to the creation of conflict commodities. Similarly, oil companies that have attempted
to deal with aspects of the militarization of oil production for example, through
implementation of the Voluntary Principles on Security and Human Rights may also
be excluded.
As indicated above, the definition of conflict commodities - and its corollary,
rogue companies may be too broad. For example, the categorisation presented
above does not distinguish between activities that are directly or indirectly linked
to sustaining conflict. In addition, it remains unclear as to where responsibility lies
for making a determination as to the status of a commodity or a company.

24
The result is that, in the presently fluid policy context, and in the absence of sharp-
er definitions of the activities that create conflict commodities, simple participation
in the economy of a country in armed conflict could implicate companies involved
in certain industries in the production of conflict commodities as they are defined
above. Clearly, the risk to reputations of companies could present a significant dis-
incentive for investment by some companies.
In fact, the risks will continue to rise for all concerned so long as the actions of
the worst of the rogue companies are not checked and some clarity is not brought
to the debate. For developing countries, where the bulk of some primary commod-
ities are to be found, the danger of a foreign investment freeze - driven by fears over
damaged company reputations or brand profiles - may become an increasingly fright-
ening possibility. Similarly, industrialised countries whether primary commodity
producers or not - will need to pay greater attention to the involvement of their
companies abroad, or risk feeling the political fall-out from actions over which they
have hitherto had little control. Before the agenda can move much further, howev-
er, additional research and dialogue is necessary in order to identify precisely what
activities would cause a good to be classified as a conflict commodity and a compa-
ny to be considered a rogue.

2.6 Emerging Conclusions

The kinds of activities described in the Economies of Conflict studies completed

to date represent significant challenges to the effective exercise of state sovereignty,
corporate social responsibility and international peace and security.
Private sector activity in armed conflict is marked by the convergence of anar-
chic exploitation, criminalized transactions, and militarized production.
Goods exploited to sustain armed conflict and produced or brought to market
by anarchic exploitation, criminalized transactions, and militarized production
could be described as conflict commodities.
Companies involved in the production, marketing or payments related to con-
flict commodities could be described as rogue companies. Company involvement
in the activities related to conflict commodities may be direct or indirect.
The distinction between licit and illicit goods or transactions is misleading. In
the production or marketing of goods from armed conflict situations, there are
perfectly legal actors involved in dubious transactions, and known criminals
involved in legal activity.

25
 While understandable, the moral-political distinction between rebels and states
that appears in most inter-governmental action in this regard is probably un-
helpful for effective policy formulation. The evidence indicates that both state
and non-state actors alike have been engaged conflict sustaining private sector
activity.
The complexity of the subject implies that, in the development of analytical tools,
priority should be placed on the need for transparency of analysis, rather than
on achieving consensus on definitions.
Transparency of analysis is probably best achieved through a focus on the activ-
ities involved in sustaining conflict, rather than on the actors involved.
Definitions of conflict sustaining activity should be deployed as analytical tools
and regulation pursued through the appropriate frameworks.
The complexity of the activities and interests involved indicates that there is no
simple or single regulatory option. The political hurdles, too, suggest govern-
ment and business would oppose a simplistic solution. Therefore, an array of
remedies, voluntary as well as coercive, may be required.
Where regulatory gaps exist, new options will need to be formulated to address
the problematic activities. These should be developed through multi-party dia-
logue.

26
3 Executive Summaries

This section contains the executive summaries of the four reports from the Econo-
mies of Conflict series that are included on the compact disk enclosed. These reports
will be published separately in printed format during the spring of 2002.

27
Dirty Diamonds

Ian Smillie

This study examines the origins of conflict diamonds, suggesting definitions and
surveying ways that the diamond trade is linked to armed conflict. The paper looks
at how aspects of the trade in rough diamonds help sustain armed conflict and de-
scribes attempts to come to grips with the problem by the diamond industry, NGOs,
and governments. The effort to develop an international certification system for
rough diamonds, known as the Kimberley Process, is dealt with in detail. By way
of conclusion, the paper reflects on analytical considerations related to understanding
the links between conflict diamonds and armed conflict, asks if conflict diamonds
are easier to deal with than other commodities, and offers some recommendations
for future action.

Conflict Diamonds
The term conflict diamonds is shorthand to describe a phenomenon researched
and brought to international attention by two NGOs, Global Witness and Partner-
ship Africa Canada, and a UN Security Council Expert Panel dealing with Angola
in 1999 and 2000. The UN General Assembly has subsequently defined conflict
diamonds as rough diamonds which are used by rebel movements to finance their
military activities, including attempts to undermine or overthrow legitimate gov-
ernments. An inter-governmental series of meetings, known as the Kimberley Proc-
ess, settled on something more legalistic and less comprehensive:
Conflict Diamonds means rough diamonds used by rebel movements or their
allies to finance conflict aimed at undermining legitimate governments, as de-
scribed in relevant United Nations Security Council (UNSC) resolutions inso-
far as they remain in effect, or in other similar UNSC resolutions which may be
adopted in the future, and as understood and recognised in United Nations
General Assembly (UNGA) Resolution 55/56, or in other similar UNGA reso-
lutions which may be adopted in future.
Diamonds have an obvious attraction for combatants and the suppliers of their
weapons. Diamonds are a low-volume, high-value commodity. They are highly
portable, they keep their value, and all too often, they are readily accessible. Cus-
toms departments in most countries have no capacity to examine diamonds to
determine origins. There is very little government oversight on the international
trade, and there is a paucity of consistent, reliable trade and production data that

28
might be used for tracking purposes. Even the legitimate diamond industry has been
shrouded in secrecy for generations.
Half the worlds production or more is mined in countries with unstable or se-
cretive governments, an almost foolproof recipe for expanded and deepened crim-
inality. The value of rough diamond production was approximately US$7.5 billion
in 2000. This was converted into $57.6 billion in diamond jewellery sales, of which
the diamond content was approximately $13.7 billion. At least 20 per cent of the
rough diamonds that are sold each year are, in one way or another, illicit, provid-
ing a ready-made cover for the conflict diamonds that are the subject of current
international interest.

Efforts to Curb the Problem

The effort to halt conflict diamonds began in 1998, with a UN Security Council
resolution on Angola. UN Security Council embargoes have been proven an effec-
tive means of alerting importing countries to the problem of conflict diamonds: the
current ban on Liberian diamonds has effectively stopped the laundering conflict
and illicit diamonds via Liberia. It has not, however, stopped the flow of conflict
diamonds from Sierra Leone. Sanctions on Angola have also not stopped the flow
of diamonds.
The diamond industry, NGOs, politicians, individual governments and the
United Nations have become engaged in a large and concerted effort to deal with
the issue. For diamond producing countries, many of them developing countries,
the resource is crucial for economic development.
For the diamond industry the challenge has been twofold. First, it has a moral
obligation to make sure that its product is not tainted. Second, there has been a
public relations problem, fanned by a growing number of churches and NGOs,
which have threatened the reputation of the industry and its product. Diamond
bourses around the world began developing codes of conduct in 2000. However,
while several companies have been named in UN Security Council Reports, little
has been done, in part because the absence of laws in importing countries outlaw-
ing illicit or conflict diamonds means that any industry measures against diamen-
taires could be actionable in a court of law.
The Kimberly Process, which has sought to reach agreement on how to deal with
conflict diamonds, has faced two unspoken obstacles. One is the potential cost and
complexity of putting an effective system in place. The second has to do with sta-
tistics and international inspection. For some countries diamonds are a strategic
mineral and as such could not be subject to international inspection. For NGO
participants, however, self-regulation is a non-starter. By the end of 2001, after ten
meetings, the Kimberly Process had yet to reach an agreement on the precise na-

29
ture of an international certification system. However, the months of negotiation
had resulted in the some consensus on the essential elements of a global certifica-
tion system:
Provisions for a certificate of origin;
Provisions for internal controls in producing, trading and processing countries;
The creation of a common statistical data base on the trade in rough diamonds;
A statement on verification of national compliance.
In addition, the World Diamond Council had spelled out its understanding of what
an industry-managed chain of warranties could look like, and had agreed to ex-
ternal verification of such a system. Key outstanding issues at the time of writing
included credible and effective monitoring and co-ordination, and the creation of
a consistent and reliable data base on rough diamond production and trade. In
addition, there were uncertainties about how and whether the system would con-
form to WTO regulations.

Conclusions, Lessons and Recommendations

The study focuses on the connection between one primary export commodity and
conflict. Diamonds did not cause the wars in Angola, Sierra Leone or the DRC.
Diamonds entered the story, in all three cases, after the conflicts had begun. Griev-
ance, however well or badly justified, was the motivator, and power was the goal.
But diamonds became important as a source of financing which helped sustain the
wars, and as a contributing factor to the intensity and scope of the fighting.
There are no internationally agreed mechanisms to monitor the movement of this
highly portable, accessible and valuable commodity. That is what the Kimberley
Process has sought to develop.
The Kimberley Process was initiated on the premise that only a comprehensive
international certification system could be expected to have any serious impact on
the phenomenon. Such a system would include better control in diamond mining
countries, clarity in procedures for shipping diamonds, and controls in trading and
processing countries. These controls would have to be backed by an independent
international monitoring system and an international database on trade and pro-
duction. An effective international certification system would also help to end the
other illicit uses to which diamonds are put, including money laundering.
To be effective, attempts to sever the link between rough diamonds and armed con-
flict will require the following:

30
 The Kimberley Process should result in a strong mechanism for monitoring
national compliance with minimum standards. Consumer confidence cannot
be based on trust or on haphazard, minimal-review mechanisms. Credible mon-
itoring for compliance should be viewed as compulsory and desirable by any
country wanting to demonstrate that its industry is conflict free.
The Kimberley Process should come to grips with the issue of, and the need for,
global production and trade statistics on rough diamonds.
The issue of WTO compatibility should be settled, and it should be settled soon.
Neither the WTO, nor the GATT, condone or permit theft, war, human rights
violations and the other abuses that stem from conflict diamonds.
The certification system should have more authority than can be derived from
a voluntary arrangement or from a UN General Assembly resolution. The rele-
vance of conflict diamonds for international peace and security are now well
understood. Once a system has been finalized and debated by the General As-
sembly, it should be forwarded to the UN Security Council for endorsement and
global application.
The experience of attempting to regulate conflict diamonds via the Kimberly Proc-
ess suggests a number of key lessons for those working to regulate commodities which
fuel armed conflict.
On the supply side, the key element is the accessibility of diamonds a func-
tion of security failures, corruption, and state collapse. UN embargoes, new national
legislation and industry efforts to stop conflict diamonds have had little impact,
except to change the routing and covers under which conflict and illicit diamonds
travel. On the demand side, industry secrecy, an absence of reliable trade and com-
mercial data, and lack of governmental oversight are important factors in generat-
ing and nourishing the opportunity that has sustained armed conflict. The fact that
20 per cent of the diamond industry is essentially crooked means that channels for
the disposal of conflict diamonds had been established by illicit diamonds prior to
the conflicts. Armed conflict and criminality converged, creating a more ready op-
portunity for the emergence of conflict diamonds than might be the case in other
commodities. Effective regulation must address the supply and demand sides of the prob-
lem in tandem, addressing both the accessibility of rough diamonds and lack of trans-
parency and accountability that enable them to be marketed.
The strength of the Kimberley Process was that it was inclusive. NGOs and senior
industry executives attended all meetings, and were encouraged to participate as fully
as government representatives. There was no North-South divide: there were as many
governments from developing countries as there were from the North. And there
was a champion for the issue: the Government of South Africa. Shortcomings in

31
the Kimberley Process may become more obvious with time and distance. Certain-
ly, as this paper was being completed in January 2002, the outcome of the process
remained unclear. Multilateral processes to discuss the regulation of conflict goods should
be as inclusive as possible, integrating the interests of industry, producing and consum-
ing states and NGOs.

32
Fuelling Conflict

Phillip Swanson

This report examines how oil and gas industry activities in developing countries may
contribute to or help perpetuate such conflicts. It emphasises the dynamics that can
occur even when oil companies may be attempting to be good corporate citizens.

Oil, States and Armed Conflict

Some 70% of world oil production currently takes place outside OECD countries,
and over 40% outside either the OECD or the Middle East. Investments by major
oil companies can contribute significantly to the GDP and government revenues
of oil-rich developing countries. However, large investments in natural resource
exploitation and export also tend to give rise to a number of negative dynamics in
the economy, government and society of the host country. Even if unintended, these
dynamics can be very powerful, with consequences for social stability.
Governments typically receive oil wealth via several different routes, including
bonuses, royalty payments and income tax. In many cases, a combination of these
payment methods is used. Together they can be used to obscure the direction and
volume of oil revenue flows. Taxes and other payments related to resource extrac-
tion and export by international oil companies often account for well over half of
government revenues in oil-rich developing countries. Access to large and relative-
ly easy petroleum revenues can give host governments a false sense of economic
security that undermines the need for responsible economic and fiscal management.
A large influx of easy oil revenue into a non-transparent system invites corrup-
tion, in turn creating incentives to further limit transparency and accountability.
Under such conditions, much oil wealth apparently has disappeared into off-budg-
et accounts. Such looting of a countrys natural resources by its governing elites
can provide the incentive and means to remain in power.
Given a regimes dependence upon oil revenues for its power, any threat to such
revenues is likely to be met with significant resistance. In the short term, host gov-
ernments will be concerned about any cut in the flow of oil, which effectively rep-
resents a cut in government revenue. In the longer term, oil-dependent governments
are concerned about the willingness of international oil companies to remain in the
country. In some cases, the desire to maintain security for oil extraction may lead
to the brutal treatment of those opposed to such operations.
Whether or not the dynamics suggested are fully or even partly responsible for gov-
ernment violence towards its population in a particular case, large oil revenues at

33
least provide the means for a government disposed toward violence to carry out such
activities with relative impunity. A governments willingness to resort to the use of
force to protect its continued access to oil revenues is likely to be reinforced by an
increasing estrangement between the government and its citizens. In fact, oil wealth
tends to reduce a governments dependence upon its citizens corporate or indi-
vidual for tax revenues. When a government depends less on its own citizens for
its revenue, it may become less accountable and may depend less upon them for its
legitimacy.
Oil company operations can create or exacerbate tensions between the central
government and oil-producing regions, especially if a disproportionate share of
benefits is seen to accrue to the former and a disproportionate share of costs to the
latter. Tensions can also arise if the region feels that the central governments share
of oil revenue is unfairly large.

Armed Conflict and the Company

Most international oil companies have taken a neutral stance on the nature of host-
country regimes, noting that companies should not get involved in politics. A
number of NGOs have pointed out that large economic investments provide eco-
nomic and political comfort to host countries, including de facto recognition of
rogue regimes.
Violence associated with oil company operations most often results from the use
of force by government security forces against local protesters who opposed oil in-
dustry operations. A number of NGOs, as well as missions by the UN and various
oil company home country governments have reported numerous allegations of
violent human rights abuses committed by government forces in and around oil
producing regions in a number of countries. However, the secrecy surrounding se-
curity arrangements that many international oil companies have concluded with host
governments makes it difficult to assess company complicity in such activity.
There are also documented cases of human rights abuses by oil company secu-
rity forces or by the private forces hired by the oil companies. However, such cases
usually are more clear-cut regarding oil company blame. Hopefully, they will also
be the easiest abuses to avoid in future, since the oil companies presumably have
more control over their own forces.
A number of oil companies have been accused of providing logistical assistance
to government military campaigns against political or ethnic oppositions. Common
accusations are that companies have allowed militaries to use airstrips, helicopters,
roads and other oil company infrastructure for offensive military purposes. In some
cases host governments even appear to be using oil company security as a cover for
waging military campaigns against political or ethnic enemies. Some of the most

34
serious accusations levelled against international oil companies have involved direct
or indirect assistance in procuring weapons for host country governments, and in
some cases even for rebel groups.
For the oil companies, the direct effects of armed conflict are similar to those
on other industries, e.g., threats to personnel, installations and supply lines, with
the related costs of protecting each of these aspects of the business. However, once
conflict erupts in a particular region, it usually will be significantly more expensive
for oil companies to abandon their activities than it will be for most other inves-
tors. This is due to the large and long-term nature of oil company investments, as
well as the location-specific nature of natural resources.
Oil companies may assume that their operations will be relatively shielded from
civil conflict, in some cases by all parties to the conflict. Due to the large potential
revenues that their oil extraction represents, it is not in the parties interest to per-
mit armed conflict to devastate oil company investments. For a company already
heavily invested, a cost-benefit analysis may indicate that the profit from oil extrac-
tion could out-weigh the economic costs of doing business in a conflict zone. For
some companies, armed conflict may be almost a cost of doing business.
One of the most important negative effects of conflict on an oil company now
takes place in the product and capital markets of the developed world. The threat
to company reputation can have negative impacts on profits, share prices and the
ability to raise capital. Oil companies with easily identifiable brand names at the
service station pump are ultimately vulnerable to the sort of boycott campaigns that
already have threatened companies in some other industries. Companies also may
be increasingly susceptible to shareholder activism, especially by large institutional
investors such as pension funds, many of which have adopted codes of conduct.

Policy Options and Instruments

Because oil companies often provide a large portion of host country budgets, they
are among the few entities with potential leverage over such governments. This is
why some observers see oil companies as potential agents for positive change. How-
ever, oil companies face a possible loss of competitive advantage in the event that a
host government decides to punish a company for taking a stand on human rights
issues by rewarding one of its industry competitors. It is conceivable that a coali-
tion of companies could form a united front for policy reform. However, in such
a case these companies still could face non-cooperation from the growing number
of technically proficient oil companies from developing countries that currently are
not under the same Corporate Social Responsibility (CSR) pressures from NGOs,
customers and shareholders.

35
Transparency
One of the main enabling factors for corruption and diversion of funds to off-budget
military expenditures in host countries is lack of financial transparency. A key find-
ing of this study is that a major area for policy focus should be on increasing the
transparency of payments by oil companies to host governments. This would make
it easier for host country citizenry to achieve a better understanding of the amount
of money actually received from the development of their natural resources and to
hold their governments accountable on this basis. Oil companies should be required
to make a full public accounting of their payments to individual host countries.
In many cases of alleged violence by government security troops, the foreign oil
companies involved have either denied knowledge of abuses or insisted that the
actions were not approved by the company. However, it is often impossible to as-
sess company complicity, or to say whether governments have acted outside securi-
ty agreements, since such agreements usually are secret. Companies should commit
themselves to making public their security agreements with host countries.
Given the impact of local violence on the security of oil company staff and op-
erations, it would seem to be in companies best interests to pay more attention to
such issues. It seems highly unlikely that companies are not already performing
various risk assessments and assessments of the political or security situation. Com-
panies should publicly commit themselves to performing systematic risk assessments based
on those suggested in the Voluntary Principles on Security and Human Rights.

Policy Instruments
Companies would seem to have a significant market incentive to respond to or avoid
NGO criticism, because negative publicity can damage their image with consum-
ers and shareholders. A major drawback with NGO pressure, however, is that it does
not seem to be applied evenly to all companies. NGOs have targeted those compa-
nies they perceive to be most likely to respond to their criticism. The absences or
ineffectiveness of pressure by NGOs is especially evident when it comes to the large,
technically proficient non-OECD oil companies that are offering increasingly cred-
ible competition to the majors in developing countries. Many of these currently face
comparatively little pressure from their customers and shareholders to address CSR
issues, thus giving NGOs little leverage to affect them commercially.
Voluntary codes of conduct have become an important tool for companies to
demonstrate support for particular social principles. However, experience from other
industries indicates that codes developed by companies or industry associations in
isolation often lack legitimacy vis--vis outside observers. Governments could play
a role in bringing together industry actors and NGOs to work out codes that various

36
parties find acceptable (e.g. the negotiations to establish the Voluntary Principles
on Security and Human Rights).
Collective action by oil companies may also benefit from the sponsorship of a
respected international body, such as the UN or the World Bank. Governments and
the oil industry should recognise the value of multilateral institutions such as the
United Nations or the World Bank in helping to manage collective action problems
and reputational risk. Government and private sector partnerships with multilater-
al institutions must reflect the international norms and law that these institutions
embody.
One approach to stimulate companies to provide more information or to im-
plement other desired policies would be to make these provisions or policies a re-
quirement for receiving certain services provided by or regulated by government.
There has been discussion in some countries about expanding criteria for environ-
mental conditionality, already in place in some OECD countries, to include strict-
er requirements regarding transparency and accountability of payments. There has
already been some work to co-ordinate action in this area among OECD govern-
ments. As an issue for multilateral negotiation, the transparency of payments by
international oil companies to foreign governments may lend itself to the existing
negotiating framework, along the lines of the OECD anti-bribery convention. Sim-
ilarly, stock market listings are in many cases regulated by states, giving governments
scope for imposing conditions in this area. A major criticism of conditions on stock
market listings is that they could inadvertently punish the financial centres that
impose them. However, this collective action problem could be solved by co-ordi-
nated action to introduce harmonised legislation in the worlds major financial
centres. Governments should consider the development of mechanisms of positive
conditionality in support of stricter requirements regarding transparency and ac-
countability of payments.

37
Illicit Finance and Global Conflict

Jonathan Winer

In recent years, with every substantial national, regional, or global failure of gov-
ernance, a financial scandal has been found in close attendance. Accompanying each
financial scandal has been the systemic use of banking and financial secrecy to hide
criminal activity. Over the past decade, this pattern has played out repeatedly in
jurisdictions all over the world. Repeatedly, political conflict and major political
destabilizing activity, including grand corruption, narcotics trafficking, arms smug-
gling, and civil war have been facilitated and sustained by illicit finance networks
embedded in the worlds licit financial services infrastructure.

Structural Consequences of the Globalization of Money

In Latin America, Mexico lost a quarter century of economic growth when the peso
collapsed in 1994, amid evidence of drug money laundering and massive high-lev-
el corruption. Similar financial catastrophes in which billions went missing attend-
ed the collapse of governments in Ecuador, Peru, and most recently, in late 2001
and early 2002, Argentina10. Fraudulent pyramid schemes decapitalized nations in
transition in Albania, Bulgaria, and Latvia. Kleptocrats stole and then sequestered
the national wealth of the Congo/Zaire, Indonesia, Nigeria, and Russia using the
same infrastructure of globalized financial services to hide their money. The use of
the offshore sector to mask large financial losses facilitated the industrial-corporate-
governmental corruption that has burdened the economies of Japan, South Korea
and Taiwan. The same global financial infrastructure and major global banks han-
dled political slush funds laundered for former German Chancellor Helmut Kohl
and similar monies for illicit arms trafficking by the son of the late French Presi-
dent Francois Mitterand11. Major international banks in Europe, the Americas and
the Middle East processed the funds moved from the Persian Gulf by Al Qaeda and
10
See e.g. The Guardian, "In Argentina Today, the police raid foreign banks, January 18, 2002. "Police
in Buenos Aires made dawn raids on foreign banks yesterday as part of an investigation into allega-
tions that billions of dollars was smuggled out of Argentina in the days before its financial collapse
last month. The investigation into reports that the regime of the former president, Fernando de la
Rua, allowed $10bn to disappear offshore came as the slide into economic chaos continued with the
resignation of the central bank governor, a sharp drop in the stock market and a further decline in
the value of the peso."

11
See e.g. Newsweek, July, 2000, online international edition, "The Kohl Case: Oh, What a Tangled
Web: The tale of how Germany's CDU nurtured a system of corrupt finance."

38
Osama bin Laden to terrorist cells around the world, transmitting them by electronic
transfers until they became cash delivered by automatic teller machines. Even na-
tions with strong anti-money laundering, financial transparency and disclosure laws
continue to find themselves victimized by regulatory failures, as the recent case in-
volving Enron - the seventh largest company in the U.S. prior to its bankruptcy -
has vividly demonstrated.
In each case, the common infrastructure of global banking and financial servic-
es has been abused by criminals to accomplish serious crimes. Repeatedly, govern-
ments, regulators, law enforcement agencies, and the most important and prestig-
ious international organizations have found themselves unable to trace illicit
transactions after something has gone radically wrong.

Structural Consequences of the Globalisation of Money

Affluent countries like the members of the G-7 or the European Union may be able
to tolerate and ultimately to shrug off abuse of their financial institutions by crim-
inals, fraudsters, corrupt officials, and terrorists who launder hundreds of billions
of dollars per year in illicit funds. For countries in transition and for less developed
economies, the theft of natural resources or development assistance, capital losses
from public funds gone missing, or the perversion of government institutions
through bribery, create burdens that are not so easily managed.
Recently, this problem has begun to be recognized within a macroeconomic
context. In January 1999, International Monetary Fund (IMF) staff issued a report
concluding that offshore banking centers had played a sometimes catalytic role
in recent Asian and Latin American financial crises. The IMF found that global
offshore assets and liabilities whose ownership has often been impossible to trace
- had grown by over 6 percent annually during the mid-1990s to about $4.8 tril-
lion.
The IMF staff working paper found that services provided by such centers, and
the banks, lawyers, accountants, and company formation agents working with them,
had contributed to global financial crises by hiding risk and loss in ways that pro-
fessional home country supervisors and auditors were unable to penetrate.
In Argentina, some $3 billion to $4 billion were lost or hidden offshore by April
1995;
In Venezuela, billions in problem loans were moved offshore in 1994;
In South Korea, insider dealings off-shore circumvented regulatory limits on bank
lending from 1993 through 1996;

39
 In Thailand, poor lending decisions were rolled over offshore from 1993
through 1996;
In Malaysia, some $10 billions in losses were hidden offshore in 1997.
In each case, the IMF found that the offshore sector had created a problem of inad-
equate transparency and fragmented regulation, which increases the potential for
dubious activities and contributes to weakening good governance in banks and
corporations. 12

Impact of Globalization on Political Stability and on

Areas of Conflict
There is increasing recognition that globalization has facilitated the growth of local
financial problems into international ones. Indeed, Robert Litan, an economist at
the Brookings Institution in Washington, describes regional and international
financial contagions as a direct consequence of a process of globalization [that] has
also facilitated the transmission of financial crises across national borders. 13
At least as significant is the role that globalization has played as a process that
has facilitated the transmission of crises of governance across national borders. There
is also a growing body of academic work analyzing the impact of globalization on
different forms of conflict within jurisdictions, including economic conflict, social
conflict, and political conflict, as well as military conflict. For example, a 1999 study
undertaken by Norwegian sociologists Ranveig Gissinger and Nils Petter Gleditsch
on globalization and conflict used econometric modeling to research the relation-
ship between high levels of trade and political stability world-wide between 1965
and 1993. The Norwegian researchers found that exports of manufactured goods
create high levels of welfare and equality, while exports of agricultural products pro-
mote poverty and inequality, which in turn become among the factors that lead to
political instability.14
Separately, an econometric study undertaken for the World Bank by Paul Col-
lier and Anke Hoeffler found that an important predictive factor for civil war be-
tween 1960 and 1999 is the availability of finance, with primary commodity exports
12
Lucia Errico and Alberto Musalem, Offshore Banking: An Analysis of Macro-and Micro Pruden-
tial Issues, IMF Working Paper (WP/99/5), January 1999.

13
Economics: Global Finance, Robert E. Litan, in Managing Global Issues, Carnegie Endowment
for International Peace, 2001.

14
Globalization and Fonclit: Welfare, Distribution and Political Unrest, Ranveig Gissinger and Nils
Petter Gleditsch, Journal of World-Systems Research, Vol 5, 2, 1999, 327-365.

40
substantially increasing the risk of conflict due to making rebellion economically
viable.15
Economist Dani Rodrik, a professor at the Kennedy School of Government at
Harvard University, has also reviewed the relationship between globalization and
conflict. His study found that where governance was weak, the economic changes
brought by globalization increased internal conflicts. Professor Rodrik found that
the world market is a source of disruption and upheaval as much as it is an oppor-
tunity for profit and economic growth. Without the complementary institutions
at home - in the areas of governance, judiciary, civil and political liberties, social
insurance, and of course education the result is too much of the former and too
little of the latter. 16
Financial transparency is a core structural requirement by which governments, reg-
ulators, law enforcement, judiciaries, civil litigants, and journalists can exercise over-
sight and insist on the accountability of both important private sector and public
sector actors. Its absence facilitates impunity, which in turn often leads to conflict.
Jurisdictions that do not have financial transparency, and which do have natural
resources that can be readily exported with minimal accountability, are often those
where direct foreign investment and agricultural exports have led to impoverishment
and conflict, rather than development and democracy, as found in the Gissinger/
Gleditsch study.
Lack of financial transparency plays a substantial facilitating role when mem-
bers of a countrys ruling class steal national wealth, or grand corruption. The
corruption of the Suharto family and crony capitalists in Indonesia, of the Nigeri-
an military under Sani Abacha, and of the oligarchs in Russia were all made possi-
ble by international bankers. Funds stolen at home were transmitted to offshore
havens in the Channel Islands, the South Pacific and the Caribbean, before com-
ing to rest for investment in places like London, Zurich, and New York.
Less recognized, perhaps, has been the role that transnational movements of dirty
money have played in harming the global environment. For example illegal trading
in ozone-depleting chloroflorocarbons (CFCs) requires the smuggling of not only
the CFCs but also the money generated by smuggled CFCs. Similarly, when illegal
logging takes place in Cambodia, or toxic wastes are dumped in Guyana, the funds
generated from those criminal activities are not limited to cash payments in the local
economy. Smuggling large quantities of illegal timber or toxic wastes across
15
Greed and Grievance in Civil War, Paul Collier and Anke Hoeffler, October 21, 2001, Develop-
ment Research Group, World Bank.

16
Rodrik, Dani (1997b), Has Globalization Gone Too Far?, Institute for International Economics,
Washington, DC., see also Professor Rodriks speech, Globalization, Social Conflict and Economic
Growth, presented to UNCTAD in Geneva on October 24, 1997.

41
international borders requires both falsified shipping documents and payments for
the goods offshore. These payments are in turn moved through the global financial
system so that criminals can enjoy or reinvest the fruits of their crime.
Human rights, too, have been undermined by the ease with which internation-
al criminal organizations have been able to launder their funds across borders. Crim-
inal organizations smuggling people across borders need to move funds across bor-
ders as well, to bribe officials, to pay off other elements of their infrastructure, and
to send remittances back home for further recruitment of their human cargo. The
same phenomenon is present as an element in the trafficking of women. The wom-
ens economic value is sharply greater at a distance from their original home. Funds
they generate as sexual slaves have been reinvested in the transborder infrastructure
that enslaved them, laundered across many national borders.
Illicit finance is also a key facilitator of civil war and civic instability. The laun-
dering of the proceeds of crime is a necessary means to carry out the trade in dia-
monds that has fuelled armed conflict in Liberia, Angola and Sierra Leone, togeth-
er with their accompanying arms deals and payoffs. The narcotics trade has long
been understood as a massive generator of illicit money to be laundered, as well as
a generator of corruption and weakened governance. Drug trafficking is also close-
ly associated with conflict, and one of the enduring factors in such conflict is the
fact that drug funds sustain combatants in civil wars. It is no accident that each of
the three countries which produce most of the worlds opium and coca crops
Afghanistan, Burma, and Colombia have ongoing insurrections fuelled by drug
money.
In short, illicit finance has played and continues to play a role in undermining
many of the goals of the United Nations and international security policy. Dirty
money laundered through the worlds major financial institutions simultaneously
threatens democracy, human rights, free markets, the environment, sustainable
development, governance, political stability, and civil society. Contrary to the posi-
tion of many banks and bankers, moving money from country to country, disguis-
ing its origin, and enabling its use for criminal purposes, is not a morally neutral
activity.

Existing Initiatives
As Brookings Institution economist Robert Litan has recently stated, successful
international efforts to regulate cross-border finance generally only emerge in re-
sponse to crises.17 The sheer scope of the present anti-money laundering initiatives

17
Litan, id, p. 197.

42
provide some indication that a lack of global financial transparency has created just
such a crisis, requiring a comprehensive global response.
In the late 1990s, money laundering became recognized as a global problem
requiring a global response. This response now includes new international instru-
ments, such as the 2000 United Nations Convention to Combat Transnational
Organized Crime and the Second Money Laundering Directive, issued by the
European Union in late 2001. It is also includes the rapid development of name
and shame sanctions programs. The most important has been that initiated by the
member states of the Financial Action Task Force (FATF) against non-cooperative
countries and territories. In the first two years that the FATF threatened to limit
market access to jurisdictions not meeting international standards, most of the nearly
twenty targeted jurisdictions enacted new anti-money laundering laws. The Organ-
ization for Economic Cooperation and Development (OECD)s similar exercise
against unfair tax competition is having a similar impact on ring-fencing, the strat-
egy by which jurisdictions offer unregulated financial services to non-residents that
they deny to their own citizens. Most recently, the new consensus was demonstrat-
ed after September 11 2001. After the United Nations Security Council passed UN
Resolution 1373, most nations took actions to freeze the assets of a wide range of
terrorists and terrorist organizations, while taking other steps to make themselves
less vulnerable to terrorist finance.
Principle self-regulatory organizations, such as the Basel Committee for Bank-
ing Supervision (BGBS), the International Organization of Securities Commissions
(IOSCO), and the International Association of Insurance Supervisors (IAIS) have
focused on extending standards for international regulation to cover transparency
issues.18 The new standards have been designed to respond to the major failures of
existing financial regulation to provide protection against illegal activities. These
failures have included:
Fragmented supervision, within countries by sector, and among countries by
national jurisdiction.

18
See e.g. Statement of the G-7, June 18, 1999; Strengthening the International Financial Architec-
ture, Report of the G7 Finance Ministers, June 1820, 1999; Financial Havens, Banking Secrecy
and Money-Laundering, UN ODCCP, New York, May, 1998; and numerous recent analytic docu-
ments of the Basel Committee available on the website of the Bureau of International Settlements
(BIS).

43
 Exploitation of differences among national laws to use regulatory arbitrage19 to
circumvent more stringent national laws and international standards.
Secrecy laws that impede the sharing of information among countries and be-
tween regulators and law enforcement.
Inadequate attention to electronic payments in existing anti-money laundering
supervision and enforcement, including know your customer rules, which
focus on currency, even as the worlds financial services businesses rapidly con-
tinue their move into E-money.
The lack of international standards governing key mechanisms used in transna-
tional financial transactions, such as international business companies (IBC), off-
shore trusts, off-shore insurance and reinsurance companies, and off-shore fund
vehicles, including but not limited to hedge funds.
Minimal due diligence by company formation agents, attorneys, and financial
institutions in the process of incorporating and licensing of new financial insti-
tutions and shell companies and trusts owned by their affiliates.
Over time, the existing international initiatives to respond to these problems are
creating a new global code articulating new international standards for transparen-
cy. Each of these initiatives is based on the promise that national financial service
regulators have the capacity to determine whether their own local institutions meet
the standards or not. Under the principle of consolidated supervision, the home
country regulator of any international financial institution is solely responsible for
exercising oversight over the global operations of that institution. Although far from
infallible, over the past ten years the principle of consolidated supervision has proven
helpful by requiring multi-jurisdictional financial institutions to take their home
regulators seriously. In turn, these home regulators are increasingly subject to a com-
mon set of standards, such as those established by the Basel Group of Bank Super-
visors (Basel Group). Over time, these standards have come to promote global
financial stability by promoting good practices for banks in their lending and
investment practices. However, the same system has to date demonstrably failed to
do much to protect the world from money laundering.

19
Regulatory and enforcement arbitrage are mechanisms by which private sector entities structure
transactions to avoid the laws of a jurisdiction with stricter standards in favour of a jurisdiction that
is more lax. In the borderless world of global finance, the ability to engage in regulatory arbitrage
has grown exponentially. As a result, there has been a corresponding reduction in the ability of do-
mestic regulators and law enforcement agencies effectively to enforce local laws on businesses based
in that jurisdiction.

44
There is mounting evidence to justify questioning whether global banks, operating
transnationally to move money instantaneously across national borders, can be read-
ily regulated or supervised by any one country. While these financial institutions
may have their headquarters nominally based in a single country typically one
of the G-7 countries, the EU, or Switzerland they generate profits and carry out
activities on a global basis involving dozens of UN member states. As a result, they
are for many purposes beyond the capacity of any single state to police. The cur-
rent name and shame exercises have had the salutary effect of forcing some of the
worlds least-adequately regulated jurisdictions to abandon traditional notions of
bank secrecy, and to begin insisting that their financial institutions carry out due
diligence and know their customers. But these exercises have not and cannot create
capacity at a national level to assess the meaning and integrity of cross-border
financial transactions. It is not reasonable to expect a small jurisdiction that houses
a subsidiary of a major international financial institution to fully understand the
cross-border transactions engaged in by the subsidiary, let alone by its affiliates or
far-away parent. In practice, even the most sophisticated and best regulated financial
centers, including those of the G-7, European Union, and Switzerland, are similar-
ly incapable of exercising adequate oversight over the global enterprises they license.

Developing and Implementing Global Standards:

A White-list for Global Finance
In recent years, the proposed solution has been a mixture of public sector regula-
tion and private sector self-regulation. Self-regulation has been advocated as a means
by which private institutions subject to market forces will, as a matter of good
business, avoid transactions that could lead to transactional, institutional, or repu-
tational risk. However, it is not clear that this approach has been effective. Indeed,
the combination of both government regulation and self-regulation has not to date
effectively discouraged abuse of financial institutions operating globally by drug traf-
fickers, terrorists, major financial criminals, corrupt officials, arms smugglers, or
sanctioned regimes, let alone those engaged in local armed conflict, timber theft,
or other criminal activity.
Today, there is no list that evaluates whether international financial institutions
have complied with basic rules of transparency or integrity. On the name and
shame side, there is no compilation ranking major international institutions for
the greatest or least laundering of proceeds of drug trafficking, corruption, terrorist
finance, illegal logging, toxic waste, human trafficking, or corporate fraud, although
such a ranking might be compiled from court documents, public investigations and
press reports. Nor has there been a list involving a seal or certificate system by

45
which an institution can be endorsed as having put into place a series of best prac-
tices to promote transparency.
Every year, many billions of dollars flow from international organizations and
international financial institutions through the worlds major international banks.
These public funds are deposited and held in these private-sector institutions with-
out consideration as to whether these institutions have put into place excellent trans-
parency policies and procedures, or minimal ones. Indeed, such funds are deposit-
ed and held in private sector institutions that have had no due diligence or know
your customer principles, if they happen to be located in jurisdictions where such
principles are either not required, or are minimally enforced. The value of such
deposits to the private sector financial institutions is substantial, generating not only
substantial fees but the ability to engage in further lending activities of their own,
due to the multiplier effect of bank deposits.
To date, the only limitations placed on those holding or benefiting from such
international funds has been the obligation of the institutions to adequately account
for the uses of those funds. Broader obligations, such as requiring a particular bank
to have in place strong measures for financial transparency or protection against
money laundering, have not been expected of private sector banks by the interna-
tional organizations and international financial institutions that deposit their funds
in such institutions. Rewarding private sector institutions who agree to meet high
standards of transparency for the funds they process on a global basis could create a
significant incentive for banks, providing a further weight to existing national efforts.

46
The Logs of War

Global Witness

Timber is an easily exploitable, valuable and readily marketable commodity, and has
been the resource of choice in several recent civil and international armed conflicts.
For the purposes of this study, conflict timber refers to timber that has been trad-
ed at some point in the chain of custody by armed groups, be they rebel factions or
regular soldiers, or by a civilian administration involved in armed conflict or its
representatives, either to perpetuate conflict or take advantage of conflict situations
for personal gain. Illegal logging is the felling of trees or the export of timber in con-
travention of domestic regulations or laws.
Conflict timber is closely linked to the increasingly important issue of illegal
logging. Conflict timber is not necessarily illegal, as the legality (or otherwise) of
timber is a product of national laws. However, in practice, conflict timber is usual-
ly illegal timber. The nature and the practices of the trades are the same, as are many
of their stakeholders.

The Political-Economy of the Timber Trade

In a developing country with few resources other than vast tracts of forest, control
of this natural capital is control of power. Political circumstances including the
innate instability of non-democratic political regimes favour the rapid transfor-
mation of this natural capital into more tangible assets. Allocation of timber con-
cessions becomes a mechanism for rewarding supporters and mobilising wealth to
prop up the existing regime.
The result has often been massive corruption and loss of revenue to the state. It
has also contributed to the erosion of democratic principles as elected politicians
and state officials put the rights of companies before those of the population they
are supposed to represent. Protected by powerful allies, timber companies become
the de facto resource owners and state forestry institutions become the clients of the
logging extractors rather than vice versa.
The tropical timber industry traditionally engages leaders of countries with large
forest resources and weak institutions. Abiding by local business practices, it ne-
gotiates deals to extract raw materials as cheaply as possible. This mode of doing
business suits the warlord economy extremely well. As timber revenues are separat-
ed from state control, and the resource is exploited in an unsustainable manner,
poverty is exacerbated. The seeds of dissent, and of conflict, are sown and overall

47
stability is affected. The state of disorder created by conflict suits the perpetuation
of these business practices.
Compared to most forms of resource extraction, logging is a relatively easy ac-
tivity, requiring low investment for quick return. A few soldiers with chainsaws and
trucks can generate hundreds of thousand of dollars in a relatively short time; a well-
resourced company can generate hundreds of millions. As a result, senior command-
ers and politicians begin to bypass such national laws as may be in place to control
forest exploitation. In more extreme cases military intervention in another country
is based around the attempt to control that countrys resources. For a warring fac-
tion in control of forest land, logging is one of the quickest routes to obtain signif-
icant funding with which to continue the conflict.
Illegal timber operations need to protect themselves, even in peacetime. This
involves the hiring of armed militias and the acquisition of arms. In turn, this mil-
itary capability can lead to skirmishes between the company and the local commu-
nity, or between the militias of different companies. Logging companies side with
whoever controls forest territory; in many instances this means insurgent groups.
High-risk areas, where there is a significant risk of loss of investment, also tend to
attract the proponents of organised crime who, it seems, are prepared to accept higher
levels of risk. Revenues generated by natural resources exploited and made possible
by armed conflict fuel the power bases of these political, military and criminal groups,
and are a disincentive to bringing about an end to conflict.

Policy Recommendations
The timber trade is characterised by endemic corruption, links to organised crime
and, in numerous instances, to various warring factions. Despite this, consuming
countries and multilateral agencies, such as the World Bank, display an amazing
tolerance for the illegal activities of logging companies.
Timber is, of course, a legally tradable commodity. However, it has been esti-
mated by Friends of the Earth UK that, based on 1999 figures, approximately 50%
of tropical timber imports into the European Union are illegal. There is no reason
to suppose that worldwide imports are much better. Surprisingly, there is no law
that prevents a European country from importing the products of illegal, and con-
flict timber operations. Indeed, in the industrialised countries in the West, there is
no legislation that can prevent this from happening.
There are three major impediments to producer and exporter countries address-
ing the issues of conflict timber. First, a sovereign government is likely to exploit its
natural resources if it needs to defend itself. Second, in the case of corrupt govern-
ments, the allocation of resultant revenues will almost certainly be opaque, with a
large percentage diverted off-budget for non-state purposes. Third, logging opera-

48
tions, by their very nature, take place in peripheral, frontier regions where estab-
lished infrastructure is minimal to non-existent. In peacetime, forest management
bureaucracies often do not act. In times of war, such action is all the more difficult.

Transparency
Transparency is essential to the prevention of illegal logging and the supply of con-
flict timber, and should be applied to every stage of a logging operation. Allocation
of concessions should be by competitive and technical tender, with the results widely
publicised. Concession boundaries, the allocation of cutting licenses and forest rev-
enues accrued to the state should all be publicly available.
If local people had a share of the profits deriving from a logging operation, they
would be inclined to protect their forest from outsiders, insist that it be managed
sustainably and, in short, would be the best monitors of the operation. Local com-
munities should be included in the decision-making process related to the use of forests.

Enhanced Enforcement
In some examples the logging industry acts as a law unto itself. Forest management
authorities may need external capacity building to fulfil their mandates. External
monitoring, for example in Cambodia and Cameroon, can enable national enforce-
ment units to tackle situations which would ordinarily be too sensitive for that coun-
trys nationals. Donor countries need to work with governments to improve and sup-
port capacities for detecting and suppressing forest crime.

Legislative Reform
Legislation governing forestry practices is often inadequate, at times an outdated
relict from colonial times unsuited for controlling modern industrial timber extrac-
tion. Legislation is only effective in the context of a skilled and independent judici-
ary that can impose meaningful (i.e. expensive) penalties on illegal loggers. Experi-
ence dictates that the producer country must have ownership of the development
of the legislation or it is unlikely to take action based on the new law. However,
without external pressure experience has shown that producer governments are
unlikely to bother to change existing legislation, which more often than not it does
not adhere to. Donor countries need to work with governments to improve and domes-
tic legislation and to ensure judicial capacities for the prosecution of forest crime.

49
Certificates of Legality
The current lack of international legislation suitable to tackling illegal logging means
that as soon as illegally obtained timber leaves the borders of the producer country,
it is de facto immediately laundered into the legal timber trade. A certificate of le-
gality could be awarded by the appropriate authority in the producer country, and
be subject to independent verification. In turn, the certificate would be recognised
in the legislation of signatory consumer countries. All timber imports would need
to be accompanied by this certificate, with other imports being impounded. Like
all systems this would be vulnerable to forgeries etc, but monitoring and enforce-
ment should minimise this problem. Producer and consumer countries should begin
to develop a certificate of legality for timber shipments, in order to distinguish between
legal and illegal timber.

Chain of Custody
Tagging of timber, bar-coding and transponder technologies need to be used to
establish chains of custody and prevent the admixing of legal and illegal material.
Accurate systems of accounting and inventory control are imperative and will re-
sult in enhanced revenue collection. Simple computer packages should be developed to
permit governments and enforcement agencies to track products from the forest to the
marketplace, and overseas.

Consumer and Importer Countries

There is an overarching need for international legislation governing illegal and con-
flict timber. Given that an international agreement of this nature could take many
years, an interim alternative solution is essential.
A crucial first step would be bilateral cooperation between producer and consumer
countries to enforce domestic legislation in both countries. If not already in existence,
legislation should be passed in producing countries to outlaw illegal logging. Con-
sumer countries should recognise this legislation and a bilateral agreement between
the two countries should ban the trade in illegal timber. These bilateral agreements
would form a body of international law that could form the basis of a future mul-
tilateral international agreement.

Customs Collaboration how co-operative enforcement could work

If customs officials were directed to look for illegal logs or timber, or required im-
porters to declare the legality of its source, the question would arise as to upon whom
would fall the onus to vouch for the legality of the timber. Importers may be unaware

50
of the preceding processes and authorisations required to export the timber. Ship-
ping companies may unknowingly be transporting illegal timber or products. The
exporting country would also be involved in the process since an export certificate
may legitimise the shipment. Consumer country customs controls might follow a
red amber green approach to investigating illegal timber shipments. For ex-
ample, exports from countries with known illegal logging problems could be flagged
for further inspection; information on the shipment could then be exchanged with
national authorities in the producer country. For the purpose of ensuring an efficient
customs management process, a standard certificate would be desirable.
Also, producer countries should be able to request information concerning the
volume of imported material being declared to a consumer countrys authorities for
taxation purposes. Systems can be developed to promote reciprocal recognition of
trade restrictions, ensuring consuming countries aid compliance with producer
country measures. More effective networks of cooperation should be developed between
producer and consumer countries.

Regulating Domestic Markets

A legal requirement could be established in consumer countries that all timber, forest
products and derivatives that are sold must be produced legally. This would impose
a burden on sellers and manufacturers. In addition, there would be internal market
implications in relation to the European Union since such regulations could place
UK retailers at a competitive disadvantage to retailers in other countries not required
to prove that their timber had been produced legally. Governments should take meas-
ures to ensure that they do not procure any illegal/conflict timber, in the same way that
some governments have moved to green procurement systems.

International Action
Currently, the international community has no legislative power, other than UN
sanctions, to place an embargo on a producers timber exports. The UN Security
Council has taken this action only once. In 1992 it was recognised that the Khmer
Rouge guerrillas in Cambodia were obtaining funding essential to their war effort
by trading timber with Thailand. The UN passed resolution 792 which banned
exports of round logs from Cambodia, effective from 1st January 1993. As described
below, the ban was effective in undermining the financial basis of the Khmer Rouge,
but had several unintended consequences that need to be considered in future bans.
The G8 has taken a strong stance on illegal logging, particularly the five-point
Okinawa statement. The G8 could provide direction to international action. Given
the pace at which the forests are being destroyed, and the fact that armed conflict

51
and criminality are both driving this destruction and resulting from it, member states
of the G8 and United Nations should consider more immediate and direct measures.
The architects of illegal logging and the conflict timber trade are comprised of
relatively few very large logging companies. These same companies the Malaysian
Samling and Rimbunan Hijau companies to name but two crop up again and again
in different countries. Their record of illegal logging, dealing with combatants, en-
gaging in corrupt practices and human rights abuses is damning. Yet these same
companies are engaged by the World Bank at the highest level and are selected as
the company to practice the establishment of model concession programmes, with
World Bank funding. It is high time that these companies are regarded and treated
as international pariahs. The presence of companies engaged in illegal logging anywhere
in there areas of operations should not be tolerated in countries undergoing internation-
ally funded forestry reform programmes.
There is no specific treaty that could take on the issue of illegal logging or con-
flict in any concrete way. The various fora for discussing forestry issues, such as the
UN Forum on Forests (UNFF) do not appear to have any specific mandate to take
comprehensive action to combat illegal logging. The UNFF is supposed to consid-
er the prospects for a legal framework on all types of forests within five years. This
would provide an obvious forum for global discussion of the issues raised by illegal
logging and conflict timber. However, the participants at the UNFF remain divid-
ed over whether a forestry convention is needed, let alone any forestry sector spe-
cific measures. Any discussion of a forestry convention should include on its agenda the
issues of illegal logging and conflict timber.
Other instruments discussed in this report include:
Convention on International Trade in Endangered Species
The OECD Anti-Bribery Convention
The World Trade Organisation
The International Tropical Timber Organisation
The World Bank and Positive Aid Conditionality

52
About the Authors

Ian Smillie is a development consultant and Research Coordinator for Partnership

Africa Canada, an organization that has worked on the issue of conflict diamonds
since 1999. He served as a member of the UN Security Council Expert Panel on
Sierra Leone in 2000. He is the author of several books, including Patronage orPart-
nership: Local Capacity Building in Humanitarian Crises (Kumarian 2001). He is
an Associate of the Humanitarianism and War Project at Tufts University and an
Adjunct Professor at Tulane University in New Orleans.

Philip Swanson is a senior economist in the Paris office of ECON Centre for Eco-
nomic Analysis, Norway. A specialist on energy sector policy and regulatory mat-
ters, his current focus is on corporate social responsibility issues in the oil sector.
Philip joined ECON in 1999 from the International Energy Agency, and prior to
that worked in the energy practice of Price Waterhouse in London. Philip has a
Masters degree in economics from the Johns Hopkins School of Advanced Inter-
national Studies.

Mark B. Taylor is the Programme Director of PICCR at the Fafo Institute. Since
1997, he has worked primarily on issues related to international responses to con-
flict and the reform of UN peace operations. He was Executive Officer - Research
and Special Projects for the UN Special Co-ordinator in the West Bank and Gaza
Strip (1994 - 95) and has carried out human rights and security analysis in the
Middle East for the UN and non-governmental organisations.

Jonathan M. Winer was U.S. Deputy Assistant Secretary of State for International
Law Enforcement from 1994 through 1999. He currently practices international
financial regulatory law at the firm of Alston & Bird LLP in Washington, D.C.

Global Witness is a London-based non-governmental organisation that focuses on

the links between environmental and human rights abuses, especially the impacts
of natural resource exploitation upon countries and their people. Using pioneering
investigative techniques, Global Witness compiles information and evidence to be
used in lobbying and to raise awareness. Global Witness information is used to brief
governments, inter-governmental organisations, NGOs and the media. Global
Witness has no political affiliation.

53
Appendix: Contents of the Economies of Conflict
CD, Version 1

The compact disc enclosed with these Emerging Conclusions contains the electronic
versions of four Fafo reports commissioned as part of the Economies of Conflict pol-
icy research into private sector activity and armed conflict.

Full Reports from the Economies of Conflict project

Dirty Diamonds: Armed Conflict and the Trade in Rough Diamonds

Ian Smillie
Fuelling Conflict: The Oil Industry and Armed Conflict
Philip Swanson
Illicit Finance and Global Conflict
Jonathan M. Winer
The Logs of War: The Timber Trade and Armed Conflict
Global Witness
About the authors
About Fafo Programme for International Cooperation and Conflict Resolution
Web Links to project partners and more on the political economy of armed
conflict.

Appendix. Documents relevant for the topics covered in

Economies of Conflict.

Private Sector Actors in Zones of Conflict: Research Challenges and Policy

Responses, Fafo and IPA 2001
Economic Driving Forces of Violent Conflict and War, Econ Centre for Eco-
nomic Analysis 2001, commissioned by Norwegian Ministry of Foreign Affairs

Reports from UN Independent Panels of Experts

Report of the Panel of Experts appointed pursuant to Security Council resolu-

tion 1306(2000), in relation to Sierra Leone

54
Interim report of the United Nations Expert Panel on the Illegal Exploitation
of Natural Resources and Other Forms of Wealth of the Democratic Republic
of the Congo
Report of the Panel of Experts on the Illegal Exploitation of Natural Resources
and Other Forms of Wealth of the Democratic Republic of the Congo
Report of the Panel of Experts on Violations of Security Council Sanctions
against UNITA, March 10, 2000
Final Report of the Monitoring Mechanism on Angola Sanctions, December
21, 2000

Reports from Global Witness

Can Controls Work? A Review of the Angolan Diamond Control System, Dec
2001
Conflict Diamonds: Possibilities for the identification, certification and
control of Diamonds, May 2000
A Rough Trade; the role of Companies and Governments in the Angolan
Conflict, December 1998
Chainsaws speaks louder than words, May 2000
The Credibility Gap and the Need to Bridge it; Increasing the pace of the
forestry reform, May 2001
A Crude Awakening The role of Oil and Banking Industry in Angolas Civil
War, December 1999
Branching Out Zimbabwes Resource Colonialism in Democratic Republic of
Congo
Photos from Global Witness

55
Emerging Conclusions Mark Taylor

These Emerging Conclusions offer a preliminary analysis of the findings

of four reports from the Economies of Conflict policy research series,
Emerging Conclusions
which examines the links between private sector activity and armed
conflict. In addition, the four reports are presented here in electronic
March 2002
form on an enclosed compact disc. The occasion is the symposium
Economic Agendas in Armed Conflict: Defining and Developing the
Role of the UN, co-organized by the International Peace Academy and
Programme for International Co-operation and Conflict Resolution, and
sponsored by the Government of Norway, on 25 March 2002 in New
Economies of Conflict:
York.
Private Sector Activity in Armed Conflict
These and additional forthcoming reports from the series are available
from the PICCR web-site at www.fafo.no/piccr

The Economies of Conflict project is supported by the Government of

Norway.

Programme for International Co-operation and Conflict Resolution

Institute for Applied Social Science

P.O.Box 2947 Tyen
N-0608 Oslo
http://www.fafo.no/engelsk/