Blocked funds are capital assets or cash flows generated by a foreign project that cannot be transferred to another country because of restrictions imposed by the host government. Reasons for funds being blocked include political motives, criminal activity, trading violations, or exchange controls on foreign currencies. Some firms specialize in the trading of these securities, but at a sharp discount. Blocked funds are also used in popular media to illustrate any act by a financial institution restricting access to or transfer of funds; this has led to a broader (if somewhat incorrect) use of the term. The use of blocked funds has also led to the emergence of “blocked funds loan scams” on unsuspecting consumers around the world.
Funds are usually blocked for one of four reasons: political motives, criminal activity, trading violations, or exchange controls on foreign currencies. Funds can be blocked for political motives, such as a country being at war or in connection to a national emergency. For example, in 1992, following the Iraqi invasion of Kuwait, Iraqi funds abroad were frozen by the United States to pressure Iraq to stop the invasion as well as for leverage to extract war reparations.
Furthermore, funds can be blocked when the host government suspects the funds are either produced by, or used to generate criminal activities. In those cases, the host government will force the institution to hold the funds until it is satisfied that no illegal activities occurred. If illegal activities are found to have occurred, the host government will demand the funds be turned over to it. One recent example occurred when the U.S. Justice Department requested payment services like Visa and PayPal to block fund transfers to offshore gambling Web sites until which time it could determine the legality of these sites.
Trading violations are a rather uncommon reason for blocking funds; this is usually at the behest of a trading authority, which will ask the financial institution to hold funds because of questionable transactions. Finally, in rare occurrences, currency transfers can be restricted by the host government, forcing financial institutions to block funds until such restrictions are lifted.
Once a host government determines some capital has to be blocked, it will contact the financial institution handling the transaction and will request the institution freeze the funds. The financial institution then places the funds in an interest-bearing account until which time the host government will decide if the funds can be released. During the period when the funds are frozen, the institution makes a reasonable attempt to place the capital in a financial product that generates a commercially acceptable interest rate; interest is returned to the capital holder once funds are unblocked.
It is also possible for funds to be blocked even if they are only transiting in the country hosting the funds. For example, a company in Europe transiting funds through the United States to a country with fund restrictions might have their funds frozen, even if the funds were only in financial transit in the United States. Countries usually reserve the right to verify that funds are not transiting to blocked countries or individuals through its national financial system.
- D. Ellis has suggested different techniques to prevent having funds blocked by host governments. These techniques include receiving contract payments in dollars, purchasing host country dollar bonds, increasing local purchases, making capital investments with the blocked funds in the host country, and establishing counter trades of equivalent value.
There are a number of brokers and banks that specialize in trading blocked funds. By demanding a deep discount on the blocked funds, these firms take on the risk that the funds may never be released in exchange for potential profits. Some firms specialize in blocked funds due to currency transfer issues; they facilitate the exchange from one currency to the next, making profits on the currency conversion rate they request.
Blocked funds transactions are used in less ethical transactions as well. Some organizations use them for money laundering, exchanging illegally obtained capital for “clean” money. Other scams include individuals purchasing blocked funds for deep discount, only to find that the funds did not exist, or that the transaction has been cancelled by the offering party.
- D. Ellis, “Recognizing and Avoiding Currency Exchange Problems in International Project Management,” Proceedings of the Project Management Institute Seminar/Symposium (1988);
- Young Hoon Kwark, “Risk Management in International Development Projects,” Proceedings of the Project Management Institute Annual Seminars & Symposium (2001);
- Zia Ullah, “The Blocking of Funds by OFAC,” Pannone LLP, www.pannone.com (cited March 2009).
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