How do you solve a problem like money laundering?
28 Jun 2023
As global money laundering rules continue to tighten, Deep Pool’s Roger Woolman examines how financial institutions can meet their heightened responsibilities
Image: Deep Pool
Are financial institutions around the world doing enough to implement robust anti-money laundering (AML) and know-your-customer (KYC) capabilities? Recent figures suggest not.
Approximately 1 per cent of the European Union’s annual GDP appears to be involved in suspicious financial activity, while the United Nations Office on Drugs and Crime estimates that between 2 and 5 per cent of global GDP is laundered each year. That means that as much as US $5 trillion in illicit cash flows through the global financial system annually. In addition, a 2022 Eurojust report found that money laundering cases have been rising steadily since 2016, with over 600 brought to the agency in 2021 — more than double the number registered in 2016. The report noted that identifying the beneficial owner of criminal assets is a particular challenge. Cryptocurrencies, which are increasingly misused by criminals to launder illegal profits, pose another.
As gatekeepers to the international financial system, banks and other financial organisations have a duty to police actors’ access to it. At present, their efforts are falling short. A litany of AML infractions, KYC system failings and sanction breaches at the world’s financial institutions resulted in fines totalling almost $5 billion last year — more than a 50 per cent jump on 2021. That means that since the global financial crisis, around $55 billion has been meted out in fines. This eye-watering figure raises questions about the efficacy of such penalties to address firms’ behaviour and systems weaknesses. However, a new raft of regulations for money laundering and tax evasion are set to tackle the issue.
Closing money laundering loopholes
One major area of uncertainty is the US bipartisan ENABLERS Act, which aims to close the loopholes used to launder money in the US by establishing new authorities for laundering and risks to security. This proposed legislation comes as Secretary of the Treasury Janet Yellen admitted the US is, at present, “the best place in the world to hide and launder ill-gotten gains.”
The ENABLERS Act also seeks to extend federal due diligence and transparency requirements for financial institutions to key professional service providers, including investment advisors, trust companies, accountants and law firms. The Act received approval from the US House of Representatives last July, but was voted down by the Senate in December. However, the Act or similar legislation could be resubmitted in another form, perhaps as a standalone bill, later down the line.
Beneficial owners in focus
In the meantime, an enhanced US rule for beneficial ownership reporting is set to take effect from 1 January 2024. Put forward by the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) last September, the rule forms part of the Corporate Transparency Act, a component of the 2020 Anti-Money Laundering Act.
In a statement on the new rule’s release, Yellen said the Act will “make it harder for criminals, organised crime rings and other illicit actors to hide their identities and launder their money through financial systems.”
The widespread use of dummy accounts to launder money and evade sanctions is upping the ante on beneficial owner screening. The FinCEN rule will require most corporations, limited liability companies and limited partnerships in the US (including foreign companies registered to do business in the US) to report four key pieces of information about each of its beneficial owners. These will be names, birth dates, addresses and a unique identifying number from an acceptable identification document (from the jurisdiction concerned). Once the initial report has been filed, any change to a beneficial owner’s information must be declared within 30 days.
The information will be maintained by FinCEN in a national beneficial ownership register. Failure to comply with the reporting requirements may result in penalties of up to $250,000.
A third rule under the Corporate Transparency Act will revise FinCEN’s customer due diligence by governing the opening of new accounts by financial institutions. The revision is due to come into force no later than one year after the January 2024 implementation date of the regulations contained in the final rule.
The US changes come as tougher beneficial owner rules have been introduced elsewhere. In August 2022, the UK launched a Register of Overseas Entities rule to tackle the flow of illicit money into the country. The initiative followed an extensive package of AML legislative proposals put forward by the European Commission in 2021. It includes new requirements around nominees and foreign entities and more detailed rules to identify beneficial owners of corporations and other legal entities. At a global level, the Financial Action Task Force has introduced tougher transparency standards around beneficial ownership in an effort to prevent criminals using anonymised corporate structures for money laundering or terrorist financing.
AML weak points
While the rules for key jurisdictions continue to be tightened, curbing the global money laundering threat ultimately depends on financial institutions playing their part.
Capturing and tracking complex, multi-level ownership structures to deliver beneficial owner transparency is an undoubted challenge for the industry. Criminal sophistication certainly complicates institutions’ AML and sanctions enforcement tasks.
However, many of the lapses – and the resulting regulatory fines and censures – stem from simple process weaknesses.
Inadequate onboarding procedures that lack proper investor and multi-level beneficial owner screening, risk-based profiles of prospective clients and source of wealth checks are worryingly common. As are deficiencies in ongoing due diligence throughout the customer relationship.
AML and KYC responsibilities don’t stop once a client is through the door. Post-onboarding, firms need to undertake periodic client profile and documentation checks and continued screenings.
Monitoring and analysing the millions of customer transactions that flow across institutions’ books is vital to spot money laundering risks and to block suspicious activity or behaviours.
This task has been made more difficult by changes to suspicious activity definitions over time and across jurisdictions.
Staff need solutions
Effective employee training can go a long way to strengthen firms’ AML defences. Staff need to be aware of what warning signs to watch out for, and know that sensible, robust procedures are in place for them to follow. However, highly-trained employees can’t do it alone.
Effective compliance demands real-time visibility and control at every stage of the client and transaction lifecycle.
The volumes of customers and documentation are too great, the criminal networks are too sophisticated, and the cross-jurisdictional regulations that financial institutions must meet are too diverse and exacting to rely solely on manual effort.
In addition, compliance staff costs are soaring. This factor has been exacerbated by a shortage of skilled professionals. Therefore, a growing headcount to tackle problems is not always a viable option. Instead, the future of the compliance function will be data- and technology-driven, according to the most recent Thomson Reuters annual Cost of Compliance report.
This means adopting an automated, systematic, multi-jurisdictional approach that ensures firms can report on any suspicious activity to the appropriate authorities may be a significant trend of the future.
With today’s breed of customisable, risk-based AML/KYC technology capabilities, firms can digitalise the onboarding journey and create efficient, accurate, robust and scalable client due diligence processes based on rigorous customer screening, risk profiling, beneficial owner tracking and source of wealth checks.
Automated account reviews and ongoing screening — to monitor any change in status throughout the client lifecycle — can help firms identify, mitigate and manage fraud risk. Real-time suspicious transaction and behaviour identification (and reporting) can spot money laundering risks as they arise, trigger automated alerts for follow-up, and block accounts or transactions when suspicious events occur.
Automating repetitive and mundane activities wherever possible will leave teams free to focus on the red flags that require some degree of human judgement, while helping to prevent potential issues from becoming actual breaches.
The rising price of AML failures
The financial crime landscape is becoming ever more complex, while the obligations and expectations placed on financial institutions to combat the threats are growing inexorably.
Firms that don’t have the AML capabilities to cope will pay a hefty price – not just in headline-worthy penalties but, more importantly, through the reputational damage they suffer. The latter will no doubt lessen their competition edge.
Creating a fit-for-purpose AML/KYC environment entails a certain amount of investment and reengineering of existing practices.
The price of inaction, though, is far greater.
Approximately 1 per cent of the European Union’s annual GDP appears to be involved in suspicious financial activity, while the United Nations Office on Drugs and Crime estimates that between 2 and 5 per cent of global GDP is laundered each year. That means that as much as US $5 trillion in illicit cash flows through the global financial system annually. In addition, a 2022 Eurojust report found that money laundering cases have been rising steadily since 2016, with over 600 brought to the agency in 2021 — more than double the number registered in 2016. The report noted that identifying the beneficial owner of criminal assets is a particular challenge. Cryptocurrencies, which are increasingly misused by criminals to launder illegal profits, pose another.
As gatekeepers to the international financial system, banks and other financial organisations have a duty to police actors’ access to it. At present, their efforts are falling short. A litany of AML infractions, KYC system failings and sanction breaches at the world’s financial institutions resulted in fines totalling almost $5 billion last year — more than a 50 per cent jump on 2021. That means that since the global financial crisis, around $55 billion has been meted out in fines. This eye-watering figure raises questions about the efficacy of such penalties to address firms’ behaviour and systems weaknesses. However, a new raft of regulations for money laundering and tax evasion are set to tackle the issue.
Closing money laundering loopholes
One major area of uncertainty is the US bipartisan ENABLERS Act, which aims to close the loopholes used to launder money in the US by establishing new authorities for laundering and risks to security. This proposed legislation comes as Secretary of the Treasury Janet Yellen admitted the US is, at present, “the best place in the world to hide and launder ill-gotten gains.”
The ENABLERS Act also seeks to extend federal due diligence and transparency requirements for financial institutions to key professional service providers, including investment advisors, trust companies, accountants and law firms. The Act received approval from the US House of Representatives last July, but was voted down by the Senate in December. However, the Act or similar legislation could be resubmitted in another form, perhaps as a standalone bill, later down the line.
Beneficial owners in focus
In the meantime, an enhanced US rule for beneficial ownership reporting is set to take effect from 1 January 2024. Put forward by the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) last September, the rule forms part of the Corporate Transparency Act, a component of the 2020 Anti-Money Laundering Act.
In a statement on the new rule’s release, Yellen said the Act will “make it harder for criminals, organised crime rings and other illicit actors to hide their identities and launder their money through financial systems.”
The widespread use of dummy accounts to launder money and evade sanctions is upping the ante on beneficial owner screening. The FinCEN rule will require most corporations, limited liability companies and limited partnerships in the US (including foreign companies registered to do business in the US) to report four key pieces of information about each of its beneficial owners. These will be names, birth dates, addresses and a unique identifying number from an acceptable identification document (from the jurisdiction concerned). Once the initial report has been filed, any change to a beneficial owner’s information must be declared within 30 days.
The information will be maintained by FinCEN in a national beneficial ownership register. Failure to comply with the reporting requirements may result in penalties of up to $250,000.
A third rule under the Corporate Transparency Act will revise FinCEN’s customer due diligence by governing the opening of new accounts by financial institutions. The revision is due to come into force no later than one year after the January 2024 implementation date of the regulations contained in the final rule.
The US changes come as tougher beneficial owner rules have been introduced elsewhere. In August 2022, the UK launched a Register of Overseas Entities rule to tackle the flow of illicit money into the country. The initiative followed an extensive package of AML legislative proposals put forward by the European Commission in 2021. It includes new requirements around nominees and foreign entities and more detailed rules to identify beneficial owners of corporations and other legal entities. At a global level, the Financial Action Task Force has introduced tougher transparency standards around beneficial ownership in an effort to prevent criminals using anonymised corporate structures for money laundering or terrorist financing.
AML weak points
While the rules for key jurisdictions continue to be tightened, curbing the global money laundering threat ultimately depends on financial institutions playing their part.
Capturing and tracking complex, multi-level ownership structures to deliver beneficial owner transparency is an undoubted challenge for the industry. Criminal sophistication certainly complicates institutions’ AML and sanctions enforcement tasks.
However, many of the lapses – and the resulting regulatory fines and censures – stem from simple process weaknesses.
Inadequate onboarding procedures that lack proper investor and multi-level beneficial owner screening, risk-based profiles of prospective clients and source of wealth checks are worryingly common. As are deficiencies in ongoing due diligence throughout the customer relationship.
AML and KYC responsibilities don’t stop once a client is through the door. Post-onboarding, firms need to undertake periodic client profile and documentation checks and continued screenings.
Monitoring and analysing the millions of customer transactions that flow across institutions’ books is vital to spot money laundering risks and to block suspicious activity or behaviours.
This task has been made more difficult by changes to suspicious activity definitions over time and across jurisdictions.
Staff need solutions
Effective employee training can go a long way to strengthen firms’ AML defences. Staff need to be aware of what warning signs to watch out for, and know that sensible, robust procedures are in place for them to follow. However, highly-trained employees can’t do it alone.
Effective compliance demands real-time visibility and control at every stage of the client and transaction lifecycle.
The volumes of customers and documentation are too great, the criminal networks are too sophisticated, and the cross-jurisdictional regulations that financial institutions must meet are too diverse and exacting to rely solely on manual effort.
In addition, compliance staff costs are soaring. This factor has been exacerbated by a shortage of skilled professionals. Therefore, a growing headcount to tackle problems is not always a viable option. Instead, the future of the compliance function will be data- and technology-driven, according to the most recent Thomson Reuters annual Cost of Compliance report.
This means adopting an automated, systematic, multi-jurisdictional approach that ensures firms can report on any suspicious activity to the appropriate authorities may be a significant trend of the future.
With today’s breed of customisable, risk-based AML/KYC technology capabilities, firms can digitalise the onboarding journey and create efficient, accurate, robust and scalable client due diligence processes based on rigorous customer screening, risk profiling, beneficial owner tracking and source of wealth checks.
Automated account reviews and ongoing screening — to monitor any change in status throughout the client lifecycle — can help firms identify, mitigate and manage fraud risk. Real-time suspicious transaction and behaviour identification (and reporting) can spot money laundering risks as they arise, trigger automated alerts for follow-up, and block accounts or transactions when suspicious events occur.
Automating repetitive and mundane activities wherever possible will leave teams free to focus on the red flags that require some degree of human judgement, while helping to prevent potential issues from becoming actual breaches.
The rising price of AML failures
The financial crime landscape is becoming ever more complex, while the obligations and expectations placed on financial institutions to combat the threats are growing inexorably.
Firms that don’t have the AML capabilities to cope will pay a hefty price – not just in headline-worthy penalties but, more importantly, through the reputational damage they suffer. The latter will no doubt lessen their competition edge.
Creating a fit-for-purpose AML/KYC environment entails a certain amount of investment and reengineering of existing practices.
The price of inaction, though, is far greater.
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