9 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 10 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. 11 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 Fafo’s 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. 12 2.1 Anarchic Exploitation 5 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. 13 “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 well…The 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 world’s [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 14 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 power…Allocation 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 15 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 Guinea’s 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 16 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 d’etat 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 war…The 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 world’s 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. 17 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 18 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 and…readily 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 country’s 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 . 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. discussion of these issues. 11 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. 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