Japan’s AML Landscape and the Need for Effective Governance

Former regulator and AML subject matter expert Hiroshi Ozaki discusses Japan’s financial crime threat landscape and how firms can mitigate risk through effective governance.

Regulation Asia sat down with Hiroshi Ozaki, Executive Advisor for KPMG AZSA LLC, to discuss the financial crime threat landscape. Ozaki was previously Chief Financial Inspector and Former Director of the AML/CFT Policy Office at Japan’s Financial Services Agency (FSA).

This interview was conducted for the “AML Tech Barometer 2024” report, published by NICE Actimize and Regulation Asia to explore AML and fraud trends based on survey and interview data collected from 144 practitioners in Asia Pacific.

What are the impacts of financial crime and why is it important for Japan and the international community to adopt effective AML measures?

Hiroshi Ozaki: Criminal proceeds obtained by special fraud groups and organised crime groups are used to maintain and expand their criminal organisations, for example, to provide “working capital” for new crimes or to procure weapons.

Therefore, it is essential to detect, investigate, search, freeze, and confiscate the proceeds of crime and then use the proceeds to recover damages to society.

Criminal organisations will often try to evade detection, arrest, prosecution, and confiscation by laundering the proceeds of crime so that the source or actual owner of the proceeds is unknown.

In today’s globalised economy and financial services industry, money laundering is increasingly conducted through countries and financial institutions that are less regulated as well as loopholes in international payments and settlement systems.

In addition, when illegally acquired assets are managed by corporations established in overseas tax havens, assets can be more easily concealed, which makes it difficult to identify the real controlling party.

This is a key reason for why improving the transparency of beneficial controllers in corporations, trusts and other legal arrangements has become an important issue.

The United Nations Office on Drugs and Crime (UNODC) estimates that the amount of money laundered worldwide is between 2% and 5% of the world’s GDP, which may be extremely large. However, the UNODC prefaces its estimate with the statement, “Estimation is challenging”.

If the flow of such funds is left unchecked, illicit funds may be used for future criminal activities or the maintenance and strengthening of criminal organisations.

Furthermore, interference with business activities using such funds may severely affect the economic stability of a country and the broader global financial system through outflows of foreign currency reserves, impacts on asset prices, reduced tax revenues, and competitive distortions.

In addition, AML measures help to combat the financing of terrorism and the proliferation of weapons of mass destruction, which pose a significant threat to Japan and the international community.

There have been several cases where financial institutions with weak AML measures have been subjected to disciplinary actions, including forced management changes and significant fines, not to mention the impact these actions can have on stock prices.

All of these factors make it essential for the international community, including Japan, and specified businesses like financial institutions to continuously improve their AML measures.

What does the fraud and cyber risk landscape look like and how have efforts to combat this been converging with AML measures?

Hiroshi Ozaki: The number of frauds and crimes in the cyberspace has increased in recent years. In Japan, the damages from fraud were estimated at JPY 37.1 billion (USD 2.6 billion) in 2022, the first increase in eight years.

In the 10 months from January to October 2023, the amount of fraud damage was JPY 33.86 billion (USD 2.4 billion), which translates to another overall increase for 2023.

Damages from credit card fraud are also increasing, mostly from phishing attacks and other similar fraud types conducted on the Internet. Ransomware attacks have also been on the rise since 2020.

The proceeds of these types of crimes are often unwittingly processed by financial institutions under the guise of everyday transactions and transferred to criminals.

For this reason, financial institutions must take a wide range of measures to prevent the transfer of criminal proceeds, such as preventing crimes in the first place and cooperating with investigative agencies.

To help combat fraud, AML measures are a key management obligation for every financial institution, for example to detect mule accounts and quickly respond to phishing and other cybercrimes.

When it comes to AML measures, what challenges do financial institutions face and how should these be addressed?

Hiroshi Ozaki: The main challenge for financial institutions is in identifying and assessing the risks they face in their daily operations, and taking measures to mitigate those risks.

The management team should promptly and appropriately assess the financial crime risks they face, cooperate with freezing requests and the exchange of investigation-related information, ensure suspicious transaction reports are filed expediently, and provide leadership on risk reduction measures.

To enable risk mitigation measures, continuous customer due diligence and sophisticated transaction monitoring systems should be implemented, leveraging advanced technology. These systems should be constructed to enable risk-based implementation of AML measures.

In Japan, financial institutions have a March 2024 deadline for complying with the FSA AML Guidelines and need to prioritise action in this area.

Specifically, it is important to consider management issues within financial institutions, including securing and training of personnel, collaboration, and streamlining the use technology including artificial intelligence (AI) to enable a medium- to long-term response.

In addition, ongoing customer due diligence (ongoing CDD), including to conduct reviews of customer risk and identify ownership and control of entities, should be conducted continuously to lower the compliance burden.

Such measures are needed to better understand customers’ financial flows and beneficial ownership, including to improve detection of and prevent transactions with sanctioned countries like North Korea and Russia.

Financial institutions are required to identify and assess the risks of money laundering and terrorist financing based on a company-wide basis, considering the products and services they offer, the types of transactions they handle, the countries and regions they deal with, and the attributes of their customers.

They must also take mitigation measures that are appropriate to the business environment as it evolves, changing international conditions, business management strategies, and risk tolerance.

Such organisation-wide efforts can only be implemented with support, understanding, involvement, and leadership from the management team.

Can you elaborate on the role of governance and the management team in mitigating money laundering and other financial crime risks?

Hiroshi Ozaki: Effective AML measures necessarily involve resource allocation by the management of a financial institution. They must take the initiative when it comes to establishing governance and controls rather than leaving it to related departments, given that money laundering risk is among the most severe risks facing the management team.

The management team must make policy decisions, allocate resources, and monitor implementation of AML measures. They must also demonstrate leadership, a positive attitude and appropriate messaging regarding AML to promote an appropriate culture of accountability to all officers and employees.

While the details of AML measures may often be left to officers in charge of day-to-day operations, it is important to ensure status updates are continuously provided to the top management, management committees, and the board to ensure they are aware of the risks the organisation faces.

Such reporting should cover information concerning trends in suspicious transaction reports, gap analysis between the FSA AML Guidelines and implementation progress, findings from regulatory inspections and related responses, among other information.

There should be active engagement from the board and senior management, which should ensure that the internal audit department provides an independent view of AML measures. Based on the audit findings, the management must provide input not only to the front-line, but also the second-line AML and compliance departments to continuously enhance these functions.

How has Japan progressed in its FATF evaluations and what are the next steps for enhancing AML measures?

Hiroshi Ozaki: The FATF released its fourth mutual assessment report on Japan in August 2021. While the report was overall positive about Japan’s AML efforts, it said priority should be given to several areas, such as strengthening supervision of financial institutions and specified non-financial businesses.

Based on the report’s findings, both the public and private sectors are working to upgrade AML and other measures in the country.

In October 2023, the second follow-up report was released, re-rating Japan’s compliance with four recommendations from partially compliant to largely compliant. Following this, there are only 6 recommendations rated below partially compliant, compared to 11 in the 2021 mutual evaluation report.

The fifth round of mutual evaluation to Japan by the FATF is expected to begin sometime in 2027 and discussed at the plenary meeting in February 2029, so Japan still has a lot of work to do to improve compliance with the recommendations. The fifth mutual evaluation will place additional emphasis on verifying effectiveness, making the evaluation more results oriented.

For example, the effectiveness of risk controls will be checked for specified business operators and it will be essential to reduce the number of recommendations with a low rating as much as possible.

The Designated Non-Financial Businesses and Professions (DNFBP) sector is expected to become one of the ‘immediate outcomes’, which is a significant change. This will require much stronger public and private sector efforts not only in the financial sector but also in the nonfinancial sector.

Japan also needs to step up its crackdown on cyber-enable crime and fraud, and enhance confiscation, and asset recovery of illicit funds.  We must show to the organised crime groups that financial crime does not pay off.

This work will require cooperation from various government ministries and agencies as well as financial institutions.

This interview was conducted for the “AML Tech Barometer 2024” report, published by NICE Actimize and Regulation Asia to explore AML and fraud trends based on survey and interview data collected from 144 practitioners in Asia Pacific. Download the report here. 

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