Finance
Ukraine war and global AML crackdown put financial institutions on the frontline
Published by Jessica Weisman-Pitts
Posted on November 15, 2022
Global Banking and Finance Review
Company
Published by Jessica Weisman-Pitts
Posted on November 15, 2022
The war in Ukraine, with its energy and cost of living fallout, has driven geopolitical conflict back to the top of the global agenda. It has also put financial institutions on the frontline of the battle, writes Shamus O’Donnell, CEO and Founder Deep Pool Financial Solutions
Since Russia began its “special military operation” in February of this year, numerous rounds of sanctions packages have been deployed at unprecedented speed and scale. Multiple individuals and entities have been blacklisted, while State Street research notes that nearly half of the Russian Central Bank’s estimated US$630 billion in FX and gold reserves, representing approximately 35% of Russian GDP, have been frozen.[1]
Sanctions may be a governmental tool to force changes in regime behaviour, yet their success depends on effective enforcement by the different actors in the financial infrastructure. While they did not instigate – and may not even agree with – the sanctions regime, financial institutions have no choice but to comply. Any sanctions breach becomes a crime, bringing the threat of prosecution, hefty financial penalties and reputational damage.
The sanctioned parties are unlikely to sit back and accept their fate. Efforts to evade the restrictions – such as diverting control to family members and associates, or disguising beneficial ownership behind a web of trusts and offshore companies – are inevitable, further complicating the financial community’s task.
Global money laundering crackdown
Sanctions compliance comes on top of a renewed global crackdown on money laundering and counter-terrorism financing (CFT). The United Nations Office on Drugs and Crime estimates that between 2% and 5% of global GDP (up to €1.87 trillion) is laundered each year.[2] Incidents have been rising steadily, with almost 650 cases brought to the European Union Agency for Criminal Justice Cooperation in 2021, more than double the number registered in 2016.[3]
In an attempt to close the loopholes used to launder money in the United States, the bipartisan Establishing New Authorities for Businesses Laundering and Enabling Risks to Security (ENABLERS) Act was introduced to the Senate in October, following earlier approval by the House of Representatives. The Act extends federal due diligence and transparency requirements for financial institutions to key professional service “gatekeepers”, including investment advisors, trust companies, accountants and law firms.
In Europe, legislative proposals were announced last year to strengthen the EU’s anti-money laundering (AML) and CFT regime through more granular customer due diligence measures and tighter beneficial ownership rules. All of this has huge implications for institutions’ AML, Know Your Customer (KYC) and ongoing client due diligence capabilities.
Technology-led AML defences
A multi-jurisdictional AML infrastructure that delivers automated, real-time visibility and control at every stage of the customer lifecycle has become vital. During client onboarding, automated risk profiling allows firms to build a risk-based picture of prospective clients. Identifying the beneficial owner of criminal assets is a particular challenge in many money laundering cases, noted the Eurojust report, making advanced beneficial owner screening able to handle complex, multi-level ownership structures essential. Source of funds/wealth checks add another important layer of screening protection.
Post-onboarding, ongoing client due diligence requires periodic checks of client profiles and documentation, along with continued screening and risk profiling. Real-time suspicious activity monitoring – a cornerstone of an effective AML programme – helps to spot money laundering risks and block suspicious activity/behaviours. Automating the checks frees staff from mundane monitoring activities so they can deal with alerts promptly. And by pinpointing issues early, monitoring tools help users respond quickly to potential issues before they become an actual breach.
Crypto and the weaponization of the dollar
Cryptocurrencies, which are increasingly used by criminals to launder illegal profits, pose a further AML and tax evasion challenge since “they make it difficult to keep track of the assets held by those under investigation,” observed the Eurojust report.
Bitcoin founder Satoshi Nakamoto has stated that the root problem with conventional currencies is all the trust that’s required to make it work. “The central bank must be trusted not to debase the currency,” Nakamoto said, “but the history of fiat currencies is full of breaches of that trust.”[4]
Such philosophical arguments in support of the decentralisation of money are gaining extra impetus with the weaponization of the dollar for sanctions purposes. While the US dollar’s reserve currency dominance has been in slow decline over the past two decades, it will remain the world’s hegemonic currency for the foreseeable future. That dominance is problematic for many outside America.
As the State Street research points out, the sanctions imposed on Russia signal to the world that “each country’s access to their reserves could become contingent on their foreign policy.” The sanctions, it added, “have dramatically raised incentives for United States’ adversaries to reduce their USD exposure.”
Russians reportedly hold at least $214 billion in crypto and the country is the third biggest crypto mining location. North Korea and Iran have in the past used crypto to evade sanctions, with Iran paying bitcoin miners in the cryptocurrency, which can then be used to pay for imports and so circumvent the sanctions on payments through financial institutions.
It is not just US adversaries. Long-time allies including the EU and UK have felt the weight of trade dispute-induced sanctions in recent times. This use/misuse of the dollar further incentivises the drive for alternative reserve currencies and the attractions of cryptocurrencies to allies, adversaries, sanctioned individuals and criminals alike.
Insufficient market liquidity means extensive sanctions evasion using crypto remains some way off. Nevertheless, given the potential regulatory penalties and reputational harm, financial institutions and any company dealing with crypto must do what they can to protect themselves from inadvertently conducting business with sanctioned entities.
Rigorous KYC and customer due diligence are increasingly crucial both at the outset and throughout the course of any client relationship. Source of funds checks, plus automatic monitoring of sanctions lists and customers from high-risk countries become all the more important. Institutions will also have to be vigilant to guard against use of concealment techniques such as VPNs, proxies, mixers or tumblers. Any suspicious activity will need to be reported diligently and quickly.
Crypto reporting proposals fuel transparency drive
The OECD’s proposed Crypto Assets Reporting Framework (CARF) and the EU’s eighth Directive on Administrative Cooperation (known as DAC8) add to the transparency onus.
Government officials and tax authorities around the world are concerned that because crypto assets can be transferred and held without a traditional financial intermediary and with no central administrator visibility, global tax transparency advances achieved through the Common Reporting Standard (CRS) and US Foreign Account Tax Compliance Act (FATCA) will be undermined.
Crypto has not been a focus of the Automatic Exchange of Information regimes to date, but that is now changing. “Banks and other financial market participants that are classified as reporting financial institutions under CRS likely would be heavily impacted by this new framework and should take steps to prepare for its implementation,” warns PwC.[5]
The CARF proposals will require service providers involved in crypto-to-crypto exchanges and/or crypto-to-fiat currency transactions to identify and screen their customers. They will then need to report the aggregate values of customers’ exchanges and transfers to their respective tax administration. DAC8 will introduce similar obligations.
Digital onboarding processes and ongoing client due diligence – to ensure all the necessary client information has been properly captured and stored, and stringent AML/KYC checks and transaction monitoring carried out – will be fundamental to compliance. Automated tracking of indicia such as place of birth, citizenship, address and phone number will allow crypto service providers to accurately determine clients’ tax residency status. Reports will then need to be submitted using the appropriate format and in the correct schema.
The power of a single investor record
Faced with so many overlapping regulatory responsibilities, having a single, accurate, up-to-date global investor record that can be used across multiple compliance obligations offers financial institutions significant cost and time benefits.
Consolidating AML and regulatory reporting processes on an end-to-end, multifunctional, multi-jurisdictional compliance platform strips out the layers of technology and support cost that weigh down so many compliance departments. By shifting to a unified system that allows firms to create a single, golden-source investor record that can be easily enriched, maintained and updated, multiple downstream benefits ensue.
Onboarding becomes a one-time exercise, making for a smoother, more client-friendly experience. Storing static data and documents in a centralised repository enables key compliance information to be shared across regulations and jurisdictions – whether to meet multiple authorities’ AML rules, or as part of firms’ tax reporting duties. Eliminating requests for duplicate information eases internal teams’ workloads, cuts error rates and minimises the client aggravation from having to contact them multiple times.
Initial and ongoing client screening are streamlined. Reporting accuracy is improved. Rule changes are easier to manage – and regulatory risk reduced. With rising regulatory and sanctions-enforcement burdens piling more pressure on already stretched compliance departments, an automated, consolidated framework offers a much-needed solution.
Shamus O’Donnell is CEO and Co-founder of Deep Pool Financial Solutions, an investor servicing and compliance solutions supplier, providing software and consulting services to fund administrators and asset managers. To learn more, please visit www.deep-pool.com.
About Deep Pool
Deep Pool Financial Solutions is a provider of world-class software and financial consultancy services to the world’s most prestigious fund administrators and asset managers. Founded in Ireland in 2006, the company provides high-quality solutions for its clients to enable them to achieve the penultimate goals of their business. Deep Pool has an international team of 125 specialists across the investment and software sectors and serves clients in over 30 countries. For more information please visit https://www.deep-pool.com/.
[1] What Does the Weaponization of Global Finance Mean for US Dollar Dominance, State Street, June 2022, https://www.statestreet.com/content/dam/statestreet/documents/Articles/weaponization-of-global-finance-mean-for-us-dollar-dominance.pdf
[2] Money Laundering, United Nations Office on Drugs and Crime, https://www.unodc.org/unodc/en/money-laundering/overview.html
[3] Eurojust Report on Money Laundering, European Union Agency for Criminal Justice Cooperation, 20 October 2022, https://www.eurojust.europa.eu/publication/eurojust-report-money-laundering
[4] The Bitcoin Ideology, by Alan Feuer, The New York Times, 14 December 2013, https://www.nytimes.com/2013/12/15/sunday-review/the-bitcoin-ideology.html
[5] OECD releases cryptoasset reporting framework and CRS amendments, PwC, May 2022, https://www.pwc.com/us/en/services/tax/library/oecd-releases-cryptoasset-reporting-framework-and-crs-amendments.html
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