[co-authors: Gretta Fenner, Kateryna Boguslavska]

AML Standards May Exist in Theory, But Often are Not Enforced in Practice

Today we are very pleased to welcome, once again, guest bloggers Gretta Fenner and Dr. Kateryna Boguslavska of the Basel Institute on Governance (“Basel Institute”). The Basel Institute recently issued its Basel AML Index for 2020. Ms. Fenner and Dr. Boguslavska guest blogged for Money Laundering Watch last year on this data-rich and fascinating annual Index, which is one of several online tools developed by the Basel Institute to help both public- and private-sector practitioners tackle financial crime. The Index is a research-based ranking that assesses countries’ risk exposure to money laundering and terrorist financing.

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

Gretta Fenner is the Managing Director of the Basel Institute, where she also holds the position of Director of the Institute’s International Centre for Asset Recovery. She is a political scientist by training and holds bachelor’s and master’s degrees from the Otto-Suhr-Institute at the Free University Berlin, Germany, and the Paris Institute for Political Science (Sciences Po), France. She also holds an MBA from the Curtin University Graduate School of Business, Australia.

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 Ms. Fenner and Dr. Boguslavska respond to several questions posed by Money Laundering Watch about the Basel AML Index 2020. We hope you enjoy this discussion of global money laundering risks — which addresses AML standards vs. their actual implementation, human trafficking, AML vulnerabilities in the U.S., the effects of covid-19, and more. –Peter Hardy

You have just released the Basel AML Index 2020. What are the basic findings, and how do they compare to the 2019 findings?

In terms of general progress in combating money laundering worldwide, we found disappointingly little movement since last year. The average risk score across all 141 countries included in the Public Edition this year is 5.22 out of a maximum risk rating of 10, compared to 5.39 last year. This is not a statistically significant improvement, especially given the methodological adjustments this year. Looking at individual countries, very few made dramatic progress. In fact, 35 countries received lower scores than last year.

In a nutshell: too many countries remain too badly exposed to money laundering and terrorist financing risks.

This year, we also looked in more detail at regional risk patterns. When the data is visualized on regional maps, it’s easy to see which countries are the “weakest links” and what areas of policy governments particularly need to work on. For example, in North America and Western Europe, the quality of AML/CFT frameworks is the biggest deficiency. In the rest of Europe and Central Asia, as well as in Latin America, high levels of corruption and bribery are significant factors dragging countries down. The regional infographics are all freely downloadable and shareable from the Basel AML Index website.

The Index stresses that many countries have robust AML standards, but those standards are not often being implemented. Please elaborate, and what are some possible solutions?

Data from the Financial Action Task Force (FATF) makes up 35 percent of a country’s score in the Basel AML Index. Since 2013, the FATF has been evaluating countries’ AML/CFT systems in line with two criteria: first, technical compliance with the 40 FATF Recommendations, and secondly, the effectiveness of these measures according to 11 “Immediate Outcomes.” Previously, only technical compliance was evaluated. Just over 100 countries around the world now have undergone fourth-round evaluations.

First, the vast majority of countries evaluated using this “fourth-round” methodology obtain dramatically lower scores for effectiveness than for technical compliance. What does this mean? Many countries have AML/CFT systems that tick the right boxes in theory. But in practice they don’t work. For example, look at Vanuatu: it has one of the highest scores in technical compliance yet scores zero percent for effectiveness.

[L]ook at Vanuatu: it has one of the highest scores in technical compliance yet scores zero percent for effectiveness.

Second, levels of effectiveness are really low across the board. The “best” average performance across all countries is relation to IO2 on international cooperation and facilitation – but that’s still only at 48 percent. The most problematic issues facing most countries relate to supervision, preventive measures, beneficial ownership information, and prosecution of money laundering.

Of course, the most immediate and obvious solution is for countries that receive poor scores for effectiveness to implement targeted measures to fix their specific weaknesses. But many of these issues are difficult to resolve only at the country level. Greater efforts and co-operation at the international level are needed to close the gaps that are, frankly, widely known and just waiting to be taken seriously.

Then we need more effective mechanisms to enforce implementation of international standards in national legislation and practice. Take the 5th European Union AML Directive, which requires EU Member States to ensure that national registers of beneficial ownership are publicly accessible and accurate. The deadline to enact all necessary legislation was January 2020, but at least eight countries missed that deadline. And that is only the first step of enacting legislation, never mind implementing it. Without stronger enforcement mechanisms, it seems unlikely that Member States that are already so far behind international standards will comply with the 6th EU AML Directive, which comes into effect in December 2020.

The Index specifically references the ongoing scandal involving Wirecard. How does Wirecard fit into the overall findings of the Index?

The Wirecard scandal, involving a German-based fintech company accused of massive accounting fraud, raises questions about how it is possible for these irregularities to have persisted for so long without the supervisory authorities getting wind of it. Although the details of the case are still not clear, it does chime with the findings of a comparative analysis of FATF data relating to AML supervision in this year’s Basel AML Index report. Our analysis of 100 countries that have undergone fourth-round FATF evaluations reveals systemic weaknesses in AML supervision even in countries generally considered to be low-risk for money laundering and other financial crimes.

According to the data on these 100 countries, technical compliance with FATF Recommendations on supervision is low: 57 percent on average for financial institutions, and 42 percent for designated non-financial businesses and professions (DNFBPs). But the real issue appears to be with the effectiveness of supervisory authorities and measures. Here, the average score across all 100 countries is only 26 percent. 32 of the 100 countries score zero.

Germany has not yet undergone a fourth-round evaluation so we have no data on the effectiveness of its AML supervision. But media reports do point to some of the common weaknesses we have identified in other countries. These are:

• Limited sanctioning powers
• Limited resources
• Lack of a risk-based approach to supervision
• Poor coordination between supervisory authorities
• Supervisory authorities do not provide sufficient guidance on ML/TF risks to reporting entities
• Beyond supervision, the Wirecard scandal points to other widespread problems that stand in the way of implementation of AML/CFT systems, including lack of transparency in matters of beneficial ownership and the abuse of complex corporate structures.

The Index describes its methodology, which relies in part on the below graphic. Please explain the methodology, and respond to a potential critique that it is very hard to quantify something as complicated and potentially subjective as global money laundering risk.

The Basel AML Index uses a composite methodology based on 16 indicators relevant to evaluating ML/TF country risk. These are categorized into five domains in line with the five key factors considered to contribute to a high risk of ML/TF, as shown in the diagram. The indicators receive different weights in the final score according to their relevance in assessing money laundering risk. The indicators and weighting system are reviewed each year by an international committee of experts to ensure their relevance and accuracy.

It is of course not possible to quantify exact levels of either money laundering or money laundering risk in a country or globally. Thus, the Basel AML Index examines countries’ exposure to ML/TF.

We also emphasize some important limitations of the methodology related to the usage of perception-based indicators, lack of data for all 16 indicators, and incomplete coverage of FATF fourth-round evaluations. These factors make comparability between countries problematic.

What did you find in regards to the issue of human trafficking?

This year, our independent expert committee decided to include a new indicator on human trafficking: the Trafficking in Persons (TIP) report of the US Department of State. This report ranks around 160 governments according to their perceived efforts to acknowledge and combat human trafficking.

Why did we include this? Firstly, because according to the FATF, human trafficking is one of the fastest-growing and most profitable forms of international crime in the world. It affects practically every country and generates an estimated USD 150 billion in profit each year. This money is laundered through international financial systems, so human trafficking is fast becoming an important predicate offence for money laundering.

The Index observes that the U.S. poses one of the highest financial security risks globally. Why, and what can the U.S. do better?

One of the indicators used in the Basel AML Index is the “financial secrecy” score calculated by the Financial Secrecy Index (FSI). The U.S. ranks second on the 2020 FSI, just after the Cayman Islands.

According to the FSI assessment, the U.S.’s high risk score is partly explained by its high secrecy score (63) plus huge scale weighting due to the fact that the U.S. accounts for 21.37 percent of the global market in offshore financial services. Additionally, according to the FSI, the U.S. provides a wide range of secrecy and tax-free facilities for non-residents at both the state and federal level.

The FSI report comments: “While the United States has pioneered powerful ways to defend itself against foreign tax havens, it has not seriously addressed its own role in attracting illicit financial flows and supporting tax evasion.”

Certain Nordic countries rate relatively well in the 2020 Index. How is that possible, given major AML scandals enveloping northern Europe such as the Danske Bank scandal?

First, it is unrealistic to expect that any country has – or ever will have – zero risk of money laundering. All countries have to stay on their guard and evolve their AML/CFT systems as criminals find new ways to launder the proceeds of their crimes. The Nordic countries are not immune from systemic issues and weaknesses when it comes to money laundering.

Second, scandals are not a good way to evaluate a country’s money laundering risk. If a country has effective AML/CFT legislation and high levels of media freedom and public transparency – i.e. can be expected to be low-risk for money laundering – it is more likely that money laundering offences will be brought to light. This doesn’t mean there are more offences than in countries with weak AML/CFT frameworks and low levels of transparency and media freedom. It is just that in those other countries they are better hidden. What’s more, many of these scandals date back several years, such as the Danske Bank scandal. The scandal may not accurately reflect the country’s contemporary risks.

Third, as mentioned above, a country’s vulnerability to ML/TF is a complex issue. Scores in the Basel AML Index do not reflect factors such as a country’s geographical proximity to high-risk countries, although our regional infographics this year are an attempt to make these risks more visually apparent. The scores also don’t take into account other types of ML/TF risks related to clients and businesses.

We asked this question last year: Are there some positive signs on the global fight against money laundering? If so, what are they? What seems to be working?

We mentioned above that greater international co-operation and coordination are needed to tackle money laundering risks across the world. In that sense, we can see some hope in the fact that the FATF evaluates countries’ effectiveness in international cooperation and facilitation as relatively effective (48 percent), at least compared to other measures. This means that countries take international co-operation fairly seriously: they deliver appropriate information, financial intelligence and evidence, and facilitate action against criminals and their assets.

What trends do you see going into 2021, and what role if any do you see the COVID-19 pandemic playing in regards to global threats of money laundering and terrorist financing?

The outbreak of the covid-19 pandemic and related roll-out of emergency relief and economic recovery packages have had a significant impact on financial crime risks. The FATF reported a significant increase in covid-related crimes, including “fraud, cybercrime, misdirection or exploitation of government funds or international financial assistance, which is creating new sources of proceeds for illicit actors”.

While none of these are new typologies of financial crimes, they certainly expose and exacerbate existing vulnerabilities of countries and result in new variations of old risks. Criminals typically use opportunistic moments such as these to test the strength and vulnerabilities of AML/CFT frameworks, mostly in the areas of procurement fraud, benefit fraud, digital identity fraud and virtual know-your-customer procedures.

Our Basel Open Intelligence open-source intelligence tool is one way that companies, financial institutions and law enforcement can fight back against this. The tool searches open-source information in multiple languages and assists compliance officers and financial investigators with identifying potential links between individuals, organizations and financial crimes.

COVID-related lockdowns and travel restrictions will exacerbate the shortage of data on countries’ money laundering risks. The FATF is currently unable to conduct onsite missions to countries and since April has not published any new Mutual Evaluation Reports.

The financial crime risks arising from the pandemic also remind us of the need to constantly reinforce the risk-based approach and take a proactive approach to combating financial crimes. Plus, they clearly illustrate the urgent need for cooperation within the public sector (between regulators, law enforcement bodies and supervisors) as well as further public-private cooperation in particular in improving data quality and sharing.