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LONDON — American and British diplomats could hardly believe the reports. Not only was Russian President Vladimir Putin opposing any action to end the deepening bloodbath in Syria: now they had irrefutable proof that Russia was sending a shipment of vital arms to Bashar Assad’s forces.

The MV Alaed was steaming south, from the Russian Baltic port of Kaliningrad, in its hold three refurbished Mi-25 heavy attack helicopters, ammunition, missiles and an air-defense system. Choppers like these have been used to bomb rebel forces and civilians.

The ship passed less than 80 kilometers from the coast of Britain bearing a load that violated European Union sanctions against arm shipments to Syria. Yet the vessel was untouchable.

It may have been flying a flag of Curacao, but its ownership was Russian. Any attempt to board would have led to a major diplomatic row with Moscow, dooming all chances of a joint front with Putin on Iran and Syria.

Yet two weeks ago, on June 19, the Alaed turned back. U.K. Foreign Secretary William Hague said this was due to the EU arms embargo and talks with the Russians. But what had forced the ship to return was the decision by British insurance company Standard Club to notify the vessel’s owners, the Russian cargo carriers Femco, that it was withdrawing insurance from all its ships.

Standard Club said that it had not done so on the government’s instructions, but due to the fact that Femco had “broken internal rules” by contravening an embargo.

Without firing a shot, or using overt threats, the British government succeeded in denying arms that could have been used against civilians and rebels in Syria. It also sent a message to Russia and its allies in the region that Britain still has ways to project power across the globe.

It has been using similar methods for over two years against Iran, in what some diplomats are calling “unprecedented British economic warfare.”

A navy smaller than Brazil’s

At the beginning of last month, when a thousand boats gathered on the Thames to celebrate Queen Elizabeth’s diamond jubilee, nearly all the vessels were civilian – a far cry from Queen Victoria’s diamond jubilee in 1897, when a massive armada of 165 Royal Navy warships saluted the empress.

This time around, Britain’s fabled Senior Service would have been capable of mustering no more than a dozen ships not on operational duty.

A prolonged recession and a drastic change in priorities have led Britain to implement cutbacks to its armed forces. As a result the nation that once ruled the waves today has a smaller navy than India, Turkey and Brazil and its armed forces are smaller than Israel’s.

While the generals and admirals warn that deepening cuts will impair the country’s ability to carry out overseas military operations, Britain is playing a leading role in the economic war on Iran, second only to that of the United States. It is a battle being waged with little fanfare, using non-military measures through independent banks and private insurance companies. It is a battle in which one diplomat says that “Britain has redefined the meaning of soft-power.”

“The level of economic warfare being waged by Britain against Iran in recent years is unprecedented in modern times,” says a legal expert who has represented a number of Iranian companies in recent years.

Despite its eclipse as a military and naval power, Britain, especially the City of London, retains its position as a global financial power, not in terms of GDP or assets but as a hub for international transactions.

In 2010, 20 percent of global cross-border banking business was done through London. In April 2010, 36.7 percent of foreign exchange trading and 45.8 percent of financial derivative trading went through banks based in London. The city is also a major hub for the insurance trade, especially in the field of marine insurance. London is the only city where all 20 of the world’s largest insurers and reinsurers are represented, with Lloyd’s of London, the biggest insurance market in the world, at its center.

In October 2009, the British government announced unilateral sanctions on Iran. The UK Treasury ordered all British financial institutions to cease doing business with two Iranian corporations, The Islamic Republic of Iran Shipping Lines (IRISL) and Bank Mellat. These sanctions followed similar measures taken by the United States the previous year but were not in conjunction with the United Nations Security Council or the European Union. In official statements, British ministers explained that the sanctions were to prevent Iran from procuring and importing materials for its nuclear and ballistic missile programs.

A cat-and-mouse game

The British sanctions were implemented long before similarly sweeping sanctions were agreed upon by the EU and Security Council. According to one diplomat, “it was the way Britain has been pursuing these sanctions, and the power it has through the City of London, that has been increasingly damaging to Iran.” Following the American and British sanctions, what has been described as “a cat-and-mouse” game has developed, with Iran renaming ships, setting up shell corporations and transferring ownership, in an attempt to hide its continuing efforts to import necessary material and components for its nuclear and armament industries and to ship arms to Syria and groups it supports, including Hezbollah, Hamas and Islamic Jihad.

This has led to deepening cooperation on diplomatic, financial and intelligence levels between the UK and Israel, which has often supplied the necessary information for the British government to inform banks and insurance companies of Iranian activities. “Even when we had diplomatic crises and disagreements with the British,” says one former senior Israeli intelligence officer, “we were under strict orders to supply Britain with everything we had on Iran. We gave them the crown jewels of intelligence.”

While the powerful banking and insurance sectors in Britain may have opposed more blatant government intervention, they complied when receiving pinpoint information regarding companies, ships and banks that were to be targeted. “When a bank gets specific details from the government, it will almost always comply with the request,” says a veteran advisor to financial institutions in London. “It is much easier to do that quietly instead of having a row with the government.”

No official figures exist regarding the damage British sanctions have caused the Iranian economy and its nuclear program. Britain has no interest in revealing its hidden hand and the Iranian regime routinely pretends that its economy is strong in the face of sanctions. But Iranian propaganda has for years been singling out Britain, along with the United States and Israel, as nations seeking to undermine Tehran. Western diplomats in London have estimated that “the effect of British insurance companies refusing to cover Iranian ships has made it very hard for Iran to continue importing key components for the nuclear program and send arms to its proxies. It hasn’t made it impossible, but it has often delayed shipments for months.”

There have been many other cases, similar to that of the Alaed, in which ships were forced to turn back when their insurance was suddenly revoked.

London is not only the center for financial organizations, but also the base for two bodies that are central in the coordinated efforts to hamper Iranian operations. Lloyd’s List, the world’s leading shipping daily newsletter, records sales of marine vessels and the UN’s International Maritime Organization tracks shipping and records IMO “hull-numbers,” the vessel’s unique identification number, which remains when the ship changes ownership.

London – a step ahead of the rest in sanctions

Last year, in November, Britain once again imposed sanctions on Iran, this time along with the U.S. and Canada, cutting off all banking ties. The British sanctions were the toughest, it was the first time the UK had ever severed all financial relations with another state and unlike other EU members, it did not wait for the entire Union to vote on the sanctions, as it would do months later, but forged ahead on its own. “In terms of anti-Iran rhetoric, France has been more voluble than Britain,” says one diplomat to the European Union, “but in actions, London is way ahead of Paris and the rest of the EU.”

Some British experts believe their country should not be ahead of the pack on Iran. Sir Richard Dalton, a former ambassador to Iran and today a fellow at the independent policy institute, Chatham House, says that “they (the government) made a mistake in November by adopting certain sanctions unilaterally rather than waiting for others. It was a basic mistake. Iranians use their venomous mistrust of the UK as a cop-out, an excuse for not addressing the problems substantively.”

The Iranians certainly blamed Britain. A week after the sanctions were announced, a thousand Iranians stormed the British embassy in Tehran, ransacked the offices, smashed a portrait of the Queen and burnt the flag. While the Iranian government expressed its “regret” over the attack and tried to salvage diplomatic relations, the Cameron government decided to cut off all diplomatic relations and expel all Iranian diplomats within 48 hours.

Meanwhile, the British efforts have continued. In March, SWIFT, the company that handles international financial transactions cut Iran off its network. Prime Minister Benjamin Netanyahu was quick to praise the decision of the Belgium-based company. His aides leaked that it was the Israeli leader’s urging that had brought about the move. In fact, says one diplomat who was involved, much of SWIFT’s transactions go through the City of London’s banking systems, and it was the Cameron government that played the central role.

This week, on July 1, new EU sanctions came into effect, banning further oil imports by its members but more crucially, forbidding European insurance companies from insuring oil tankers, of any country, carrying Iranian oil.

This sanction has serious implications for countries such as South Korea and Japan, major importers of oil from Iran, since their tankers were underwritten by British insurers. In recent months, senior officials from both countries were in London and Brussels, trying frantically to postpone implementation of the new restriction. The British government firmly opposed their efforts.

While Iran has slashed the price of its oil, countries who continue to purchase it now need to set aside billions of dollars for insurance cover, which will encourage them to find alternative suppliers and further damage Iran’s economy.

The forceful policy of economic warfare against Iran is being directed from the very top. Prime Minister David Cameron dedicated the first foreign policy meeting of his new National Security Council in 2010 to the Iranian issue and his foreign minister William Hague and Chancellor of Exchequer, George Osborne are described by insiders as “extremely hawkish” on Iran, urging their civil servants to enforce the sanctions. Diplomats in London give a number of reasons for this policy.

“It is a way for Britain to prove to the United States that it is its key ally in the world,” says one. “It also gives the British who have lost their military power a chance to act as if they are still a super-power, thanks to their financial position.”

“A lot of the support for the sanctions is for want of a better alternative and sometimes they are in place to keep Israel happy and prevent military action,” says Lord Norman Lamont, who served as Chancellor of Exchequer in the early 1990s and is today the president of the UK-Iran Chamber of Commerce. “It seems also that they have brought the Iranians to negotiating table.”

“The UK and Israel are working extremely closely together on Iran and there is a great measure of cooperation and constant dialogue between the two countries,” says Britain’s ambassador to Israel, Matthew Gould. “We share the sense of threat and we are clear that we need to be pursuing a diplomatic solution, while continuing to ramp up the economic pressure.”