By Michael Barron and Tim Law
The standards that attempt to keep the global financial system honest are nearly ten years old and pre-date the Pandora, Panama, Paradise, Lux and FinCen leaks. While these leaks have not always revealed illegal transactions, they have highlighted weaknesses in those standards and shone a light on methods that criminals can use for money laundering and other illicit purposes.
British finance minister Rishi Sunak pointed at the Financial Action Task Force (FATF)’s evaluation of the UK’s anti-money laundering (AML) measures in response to questions about London’s role in the efforts by prominent politicians to hide their wealth as revealed in the Pandora papers. He claimed that FATF, which is the international standard setter on this subject, ranked the UK as among the best for AML measures. This defence is as leaky as some financial service providers appear to have become. He pointed to a set of standards that may no longer be fit for purpose. As well as being dated, many countries have not been evaluated against the standards and many of those who have, are only partially compliant at best.
FATF does evaluate jurisdictions but does not compare one with another. It published its current set of standards, which it terms “Recommendations”, in 2012. While there have been updates of some of the Recommendations in the past ten years, some remain out of step with international best practice. For example, Recommendation 24 on beneficial ownership disclosure does not mandate public registers of the ultimate owners of companies and other legal persons. The EU has legislated for public registers in its member states and such registers are increasingly seen as representing best practice. Perhaps in reflection of this, FATF earlier this year held a public consultation on reforms to Recommendation 24 that included questions on public registers.
There are 208 jurisdictions that are subject to evaluation by FATF or its regional affiliated bodies. This includes most independent countries as well as territories such as so called “tax havens” in the Caribbean and elsewhere. However not all of these jurisdictions have been evaluated under the 2012 Recommendations, this includes some of the countries that have featured in the recent Pandora Papers. Current data suggests that 92 of those 208 jurisdictions have yet to undergo a FATF evaluation. This means that their AML measures have not been benchmarked against international standards for more than 10 years and in some cases not since the early years of this century.
One of the FATF Recommendations specifically deals with “politically-exposed persons” (PEPs); that is people who hold an influential political office, whether it is head of state, cabinet minister or senior civil servant, judge or military officer. This is Recommendation 12. It also applies to close family and associates of PEPs. Recommendation 12 obliges governments to put in place measures to ensure that financial institutions conduct additional due diligence enquiries when dealing with PEPs, undertake extra risk assessment, conduct enquiries into the source of wealth, have additional approval processes in place and undertake enhanced monitoring of the business relationship.
As part of the FATF evaluation process, a country’s compliance with Recommendation 12 is tested. Of the 116 countries evaluated under the 2012 standards, 39 are deemed fully compliant, another 50 are deemed “largely compliant” and 23 “partially compliant” (including the US). As well as checking technical compliance with Recommendation 12, FATF also evaluates the effectiveness of the measures in place, under 11 “immediate outcomes”, rated “satisfactory”, “moderate” or “low”. Recommendation 12 falls under immediate outcome 4 on preventative measures. Being fully or even largely compliant does not mean that measures are effective. There are only four jurisdictions rated “satisfactory” for immediate outcome 4. The bulk of jurisdictions (77) are rated “moderate”, this includes the UK, US, Russia, Ukraine and Turkey. The remainder of the 116 evaluated countries are rated “low” for effectiveness. This includes China, the Cayman Islands and the Turks and Caicos Islands.
With only a minority of jurisdictions fully compliant with Recommendation 12 and even fewer demonstrating satisfactory effectiveness, the revelations in the Pandora Papers and earlier leaks should come as no surprise. Until, international AML standards are strengthened and match the real risks and threats, further examples of dubious practice by politicians, business leaders and others will continue to come to light. While many of the activities revealed by the Pandora Papers are not illegal, many leave a bad smell and will tarnish the reputations of those involved for many years to come.
The gap between FATF’s current Recommendations and international best practice will take many years to bridge. However, FATF is unlikely to react quickly to bring its standards in line with the cutting edge of efforts to counter money laundering and other illicit financial flows. The organisation moves slowly and can take eight years or more to agree changes to any of its Recommendations. Meanwhile, those who want to avoid paying taxes or engage in illegal activities to hide their wealth will find plenty of gaps to exploit. The Pandora revelations have renewed calls for the ending of anonymous companies, but governments need to fix the rules that allow such companies to operate.
Michael Barron and Tim Law are independent consultants that have advised governments on four continents on implementing effective beneficial ownership reporting systems.