Today we are very pleased to welcome, once again, guest blogger Dr. Kateryna Boguslavska of the Basel Institute on Governance (“Basel Institute”), who will discuss the Basel Institute’s recent release of the Basel AML Index for 2022 (the “Index”). The data-rich annual Index is a research-based ranking that assesses countries’ risk exposure to money laundering and terrorist financing. It is one of several excellent online tools developed by the Basel Institute to help both public- and private-sector practitioners tackle financial crime.  We are excited to continue this annual dialogue between the Basel Institute and Money Laundering Watch.

Established in 2003, the Basel Institute, an Associated Institute of the University of Basel, is a not-for-profit Swiss foundation dedicated to working with public and private partners around the world to prevent and combat corruption. The Institute’s work involves action, advice and research on issues including anti-corruption collective action, asset recovery, corporate governance and compliance, and more.

Dr. Kateryna Boguslavska is Project Manager for the Basel AML Index at the Basel Institute. A political scientist, she holds a PhD in Political Science from the National Academy of Science in Ukraine, a master’s degree in Comparative and International Studies from ETH Zurich as well as a master’s degree in Political Science from the National University of Kyiv-Mohyla Academy in Ukraine. Before joining the Basel Institute, Dr. Boguslavska worked at Chatham House in London as an Academy Fellow for the Russia and Eurasia program.

This blog post again takes the form of a Q & A session, in which Dr. Boguslavska responds to several questions posed by Money Laundering Watch about the Basel AML Index 2022. We hope you enjoy this discussion of global money laundering risks — which addresses enforcement, virtual assets, environmental crime, AML for lawyers, how the U.S. is performing, and more.  –Peter Hardy

The Index asserts that “[w]hen it comes to tackling dirty money, most countries are taking one step forward and four steps back.”  Why?

“One step forward and four steps back” refers to the five domains or categories of money laundering risk indicators that the Basel AML Index uses to calculate the country ranking. On average, we saw slight progress in one domain: the quality of anti-money laundering (AML) and countering the financing of terrorism (CFT) frameworks. In the other four domains – covering corruption, financial transparency, public transparency and legal/political risks, average performance dropped.

It is certainly commendable when governments dedicate resources to fighting ML/TF. But the results call into question whether these resources are being spent effectively on tackling the most significant risks and weaknesses. Could we do better? Probably. It also calls into question whether policies to tackle money laundering (ML) and terrorist financing (TF) need to align better with policies aimed at reducing corruption, improving transparency and fostering legal and political independence.

The Index also suggests that progress in fighting ML/TF has become “paralyzed.”  Let’s assume that’s generally true.  What do you say to the argument that there are inherent limits here to progress – i.e., there is only so much to be done to detect and prevent financial crime, given human nature, limited resources and the ability of criminals to constantly innovate?

This is a good question. Given human nature, limited resources etc. we can never expect to see zero ML/TF geographic risks. Inherent risks like having a large financial center or cash-based economy differ between countries. These types of risk are supposed to be taken into account when developing national AML/CFT risk assessments.

But we are very far from reaching the limits of what can be done. We see major differences in the performance of different regions across the globe, and there is scope for improvement everywhere. Plus, there are critical global issues where we do not see enough progress, namely transparency of beneficial ownership, quality of supervision, application of preventive measures, and capacity to investigate and prosecute ML/TF offenses.

The Index, not for the first time, makes the point that many countries have seemingly good laws and regulations in place, but their practical application is not always effective.  How so, and what should be done?

Indeed, the Basel AML Index has focused on problems of effectiveness for a while. This year the average effectiveness of AML/CFT measures according to data from the Financial Action Task Force (FATF) is at the level of 29%. In contrast, technical compliance is at the level of 66%. Some countries have high technical compliance but zero effectiveness. It is like having a finely tuned racing car that does not start.

Some countries have high technical compliance but zero effectiveness. It is like having a finely tuned racing car that does not start.

There is no universal recipe for ensuring that the application of good laws and regulations is effective in practice. However, analysis of the FATF data shows that key important ingredients are: sufficient financial and human resources, strong institutions, cooperation between authorities, good supervision and proportionate sanctioning of wrongdoing. 

What is the current landscape in regards to international cooperation in fighting ML/TF?

Based on the available FATF data, countries are doing quite well in terms of the effectiveness of international cooperation globally. Of the 11 “immediate outcomes” or effectiveness indicators measured by the FATF, jurisdictions perform best on average in immediate outcome 2: “International cooperation delivers appropriate information, financial intelligence, and evidence, and facilitates action against criminals and their assets”. The average performance across all 135 assessed jurisdictions is at the level of 47% for that immediate outcome, significantly above the 29% average level of effectiveness across all immediate outcomes.

On the other hand, progress remains slow on technical compliance in relation to mutual legal assistance and other forms of international cooperation. In theory, this could be because countries are generally already doing quite well in this area, so there is less scope for improvement. In practice, the Basel Institute’s International Centre for Asset Recovery sees major scope for improving international cooperation policies and practice.

Perhaps not surprisingly, the Index emphasizes that average levels of compliance with international standards on risks from virtual assets are “dropping dramatically.”  Why, and what should be done about this?  Are virtual assets inherently risky from an AML/CFT perspective?

Since June 2019, when FATF strengthened the requirements of its Recommendation 15 on virtual assets and virtual assets service providers, we have been observing a concerning trend of decreased compliance by countries globally. Over a third of jurisdictions have since been degraded in relation to technical compliance with Recommendation 15.

The problem is not so much that virtual assets are inherently riskier – from an AML perspective – than assets such as cash, real estate or art. More, the issue is that many regulatory, supervisory and law enforcement authorities are yet to catch up with the fast developments. This risks leaving big holes and dark spaces where organized criminals, fraudsters and money launderers can operate without proper scrutiny.

The good news is that investing in capacity building for law enforcement and supervisors can really pay off. The U.S., for example, has made billion-dollar cryptocurrency seizures based on existing AML and asset confiscation laws, thanks to developing high levels of capacity in this area. Other countries are catching up.

The Index makes the interesting point that poor performance in AML/CFT compliance has an economic effect, because poor performance can undermine a country’s business and investment opportunities.  Can you elaborate on that more concretely?

This is true in relation to high-risk jurisdictions or jurisdictions that are “gray-listed” by the FATF as a result of their serious AML/CFT failings.

In general, financial institutions are expected to apply a risk-based approach to their business and perform detailed due diligence on customers from high-risk jurisdictions. Investors may also use the FATF gray list or other lists of high-risk jurisdictions as a restriction for investments and thus choose to reallocate their funds elsewhere.

A 2021 International Monetary Fund working paper demonstrates that gray-listing results in a large and statistically significant reduction in capital inflows:

  • Capital inflows decline on average by 7.6% of GDP when the country is grey-listed.
  • Foreign direct investment inflows decline on average by −3.0% of GDP.
  • Portfolio inflows decline on average by −2.9% of GDP.
  • Other investment inflows decline on average by −3.6% of GDP.

Environmental crime is now a factor considered by the Index.  Why the change?

Yes, indeed, since September 2022, the Basel AML Index includes data on crimes involving flora, fauna and non-renewable resources. The data appears in the category “Quality of AML/CFT framework” with a 5% weighting in the overall score. Environmental crime risks therefore have the same weighting in the Basel AML Index as the current indicators on human trafficking and narcotics trafficking.

The decision to add the new indicator was taken during the annual review meeting in June 2022 for the following reasons:

  • Crimes involving wildlife, minerals, fish, forests and waste not only threaten the health of our planet and sustainable livelihoods but the integrity of financial systems.
  • Such crimes are a highly profitable criminal enterprise, generating around USD 110 to 281 billion in illicit gains each year according to the FATF.
  • The FATF identifies environmental crimes as one of the designated predicate offenses for money laundering and urges both the public and private sectors to do more to detect financial flows from environmental crimes.

As to the United States, the Index finds that its weakest area is the quality of its AML/CFT framework.  Please explain that.  What should the U.S. be doing?

The data on the USA is based on its FATF Mutual Evaluation Report, issued in December 2016, and the latest FATF Follow-Up Report, published in March 2020. The reports provide assessments of both technical compliance with FATF Recommendations and the effectiveness of AML/CFT measures in practice.

The biggest aspect dragging down the U.S.’s scores for the quality of its AML/CFT framework is its beneficial ownership transparency. Based on the FATF evaluation of 11 immediate outcomes or effectiveness criteria, the USA has an effectiveness level of 67%, which is generally higher than the global average level of effectiveness (29%). Only in immediate outcome 5 on beneficial ownership transparency (“Legal persons and arrangements are prevented from misuse for money laundering or terrorist financing, and information on their beneficial ownership is available to competent authorities without impediments”) is the immediate outcome “not achieved or achieved to a negligible extent”. That means that in this area, fundamental improvements are needed.

These poor effectiveness results in immediate outcome 5 are in line with a poor level of technical compliance in FATF Recommendation 24 (non-compliant) and Recommendation 25 (partially compliant), which cover transparency of beneficial ownership of legal persons and legal arrangements.

However, the data does not take into account progress achieved after March 2020, including the recent passing of the Corporate Transparency Act establishing a beneficial ownership information reporting requirement. If implemented effectively in 2024, this law should significantly improve the U.S.’s performance in this area once it is reassessed by the FATF.

The Index references the role of “DNFBPs,” or “designated non-financial businesses and professions,” such as those in the legal and accounting industries.  In the U.S., lawyers and accountants are not subject to direct AML regulations, and their potential inclusion is controversial, to say the least.  What do you see as the proper role of lawyers and accountants?

A significant issue highlighted by the Basel AML Index data analysis is the generally weak application of AML/CFT preventive measures by non-financial entities – so-called designated non-financial businesses and professions (DNFBPs). A related weakness lies in their supervision.

DNFBPs are non-financial entities or individuals with a particular exposure to ML/TF risks due to the nature of their business. According to the FATF definition, DNFBPs include casinos; real estate agents; dealers in precious metals and precious stones; lawyers, notaries and other independent legal professionals; accountants; and trust and company service providers. Traditionally, national AML/CFT policies, standards and financial supervisory bodies have focused more on financial institutions than DNFBPs. However, the latter are important players in financial and economic sectors and have clear exposure to ML/TF risks arising from tax evasion, corruption and bribery, fraud schemes, insider trading or other crimes.

So whether they like it or not, lawyers and accountants are gatekeepers with the potential to prevent financial crimes. They need to apply proper know-your-customer (KYC) procedures based on a risk-based approach, just like other gatekeepers working in banks and money services businesses. Otherwise, money laundering activity will continue to increase in these sectors as financial institutions step up their game. The encouraging news is that some professionals in these sectors are proactively seeking to clarify their role in fighting economic crime even without being subject to mandatory regulations, such as the International Federation of Accountants.

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