The European Commission is taking decisive action to fight financial crime by reforming its AML rules and enforcement mechanism, writes Refinitiv’s Che Sidanius.
The recent FinCEN Files has exposed what many already know: The global AML regime needs fundamental reform. For practitioners, the following statistic is well-known: Less than 1% of global illicit financial flows is being seized and frozen. Radical action is needed as policymakers now acknowledge that the global and pervasive nature of financial crime is increasingly affecting a wide range of sectors while criminals effectively adopt technologies to target our communities in the pursuit of illicit profits with devastating societal effect.
Over 40 million people are estimated to be victims of modern-day slavery globally today. That should be a shocking number by itself. However, this is not just about today. Financial crime has an insidious impact on future generations. As criminals don’t pay tax, resulting in a loss of revenue to the public funds that pay for vital services. For example, USD 1 billion of missing tax revenues could pay for 150,000 toddlers to have a high-quality education in Spain, or employ 64,000 teachers in Poland.
In other words, these are not just issues that concern policy makers who are committed to more effective means to combat financial crime, but they should be adopted as priorities that affect us all.
Policymakers globally need to make similar reforms as adopted by the European Union’s (EU) 5th Anti-Money Laundering Directive (5AMLD) which rightfully extends the scope of its requirements to other sectors including crypto-assets and custodian wallet providers, estate agents and art dealers, to name a few. It also places greater emphasis on transparency in ultimate beneficial ownership as part of a focused attempt to fight back against criminals who hide behind complex and opaque corporate structures which are otherwise shrouded in secrecy. In addition, 5AMLD requires Member States to create functional Politically Exposed Person (PEP) lists that include titles, roles or functions of individuals deemed to be politically exposed.
Despite these efforts, only five Member States are said to have met the deadlines to transpose 5AMLD into their national legislation. The European Commission now aims for a comprehensive Union policy on preventing money laundering and terrorism financing by converting the provisions of the 5AMLD into a regulation, thereby directly transposing these provisions into law across the EU.
On 7 May, the Commission published an unprecedented “AML Action Plan” to address a number of shortcomings: First, it recognises that the complexity of the Union’s financial system has opened the door to new financial crime risks. Second, the EU rightfully focuses on effectiveness as it delivers better enforcement of existing rules and strengthens its role as a world leader in the fight against financial crime.
While legislative measures globally have aimed to broaden AML regulatory requirements. The central tenant of measuring effectiveness has, historically, been lost. To date, the discussion around AML rules has been unhelpfully transfixed on the choices around a “risk-based” approach (i.e., flexible but tough to manage) versus a “rules-based” approach (i.e., inflexible but easier to manage). This is a false choice and focuses on input frameworks rather than on outputs (i.e., policy effectiveness).
Furthermore, the interaction of other regulatory efforts – such as the implications of how money laundering can trigger the winding-up of a bank under the Recovery and Resolution Directive, and the uncertainty about the application of data protection rules when sharing information between public and private sectors internationally – needs proper attention. The AML Action Plan aims to address these issues. These reforms are welcomed but more is needed to address the fact that only 2.3% of the estimated proceeds of crime are provisionally seized or frozen.
The collective experience of anti-financial crime practitioners suggests that the current model misaligns incentives. The regulatory approach focuses on technical compliance and control failures which lead to overreporting of suspicious activity. The ultimate aim, therefore, is not a reduction of money laundering, but on protecting the obligated entities’ bottom line.
According to a Refinitiv survey, 63% of respondents in the private sector are willing to take regulatory risks “in order to win new business.” Fundamentally there needs to be a change in approach to transform reactive financial crime “compliance” cultures into proactive “risk management.”
To improve efficiency, organisations should increase their agility, deploy new technology, and improve partnerships with other risk-intelligence providers and the public sector. This entails expanding the legal and technical frameworks for fostering intelligence sharing; aligning incentives on the objective of reducing financial crime; and identifying and sharing best practices for integrating financial crime risk into risk management governance structures.
The key policy reforms that need consideration to make the fight against financial crime more effective are the following:
- Harmonise whistleblower protection regimes. The protection of whistleblowers has been at the forefront of the G20 Anti-Corruption Working Group since 2010. Of particular interest is the need to clarify the definition of a whistleblower and to agree on what constitutes protected communications and disclosures, and to encourage reporting by strengthening laws designed to deter retaliation.
- Reform the beneficial ownership registers. This is vital to enhance effective implementation of the rules. Global Witness, in its March 2020 report, reminds us that 63% (17 of 27) of the European Member States do not yet have a centralised register of beneficial owners of companies that is available to the public.
- Renew focus on how data protection rules can support the fight against financial crime. Regulatory AML obligations stem from a multitude of legal, regulatory, industry and international requirements from bodies including the FATF, over 60 sanctions authorities, law enforcement, and regulators, not to mention international commitments such as the UN Global Compact, to name a few. Add in restrictions on international transfers both through privacy and localisation measures, and the reality is that many AML laws still require certain AML data to be held locally, creating unhelpful restrictions that inhibit the ability to address the global threat posed by financial crime to individuals, firms and countries.
- Don’t treat money laundering as a compliance issue. Compliance needs to be recognised as having significant consequences for financial stability and for safeguarding citizen deposits. The possibility of a large financial institution becoming insolvent due to money laundering is real; it has the potential to become one of the most important sources of systemic risk with significant ramifications to the rest of the global financial system.
As the FinCEN Files demonstrate, financial crime is global in nature. What’s urgently needed is an intelligence-led approach to make the fight against crime more effective, and supervisors need to enable it. This is not just about how many SARS are reported, but about empowering law enforcement to take the lead and providing them with sufficient resources and expertise to be the tip-of-the-spear in fighting financial crime.
Che Sidanius is Refinitiv’s Global Head of Financial Crime and Industry Affairs. Refinitiv’s full response to the EU’s AML Action Plan consultation is available here.