FATF and the Global Financial System

February 20, 2020 5 minute read

Members of the Financial Action Task Force (FATF), as well as representatives from the FATF-style regional bodies, are in Paris this week for the intergovernmental body’s first plenary session of 2020 — and the second plenary session chaired by President Xiangmin Liu of the People’s Republic of China. On the agenda are virtual assets, digital identities, the illegal wildlife trade and countering terrorist financing. In addition, several countries that were identified as risks to the global financial system, including Iran and Pakistan, will be evaluated on the progress they’ve made to implement FATF guidance.

To say that the agenda is ambitious is an understatement, but so too is FATF’s mission: to set standards and help implement measures to combat financial crime on a global scale. As FATF wraps up its week of meetings, we take a look at its significance on the world stage and how that changes (or doesn’t) year to year.

FATF on the World Stage

Underpinning FATF’s raison d’être is the idea that, while there may be regional nuances, there is a single global financial system in which all countries participate. For it to function properly and to minimize exploitation by bad actors, countries must adopt a standardized approach to regulating that system.

But as the adage goes, you’re only as strong as your weakest link. It is, therefore, crucial that countries struggling to implement measures that support a robust financial system have the guidance and, at times, the political motivation to close gaps. This is where FATF shines: it sets a universal standard and then works to help (and sometimes pressure) governments to develop policies that live up to it.

It’s worth noting that while there are other regional intergovernmental bodies that work similarly, FATF is, by far, the largest. Further, because it counts many of those regional organizations as associate and observer members, its influence is felt, whether directly or indirectly, to varying degrees by all nations. At the same time, this structure means FATF is heavily dependent on those associated organizations to carry out its work. FATF’s mutual evaluations, for example, whose purpose is to measure the effectiveness of regulators’ enforcement mechanisms, are often conducted by regional organizations.

A Question of Influence

With the presidency, and therefore the perception of power, changing hands each year, it’s easy to assume that the president has an outsized role in setting the organization’s agenda — an assumption that prompted speculation when it was announced that the presidency would be moving from the US to China last year. Indeed, the president may exert some influence: the US-driven agenda focused on virtual currencies, other crypto assets and terrorist financing, whereas the Chinese agenda has placed more emphasis on illegal wildlife trade. Yet these are small shifts in priorities, where slightly greater weight might be given to one priority over another; given the short-term nature of the president’s term, the organization’s overall agenda stays relatively constant.

As a result, while governments can attempt to elevate their overall global profile by being an active participant in (or donor to) FATF, from a policy-making perspective, much of the organization’s initiatives likely originate in other tangentially associated organizations. These could include national and international NGOs, think tanks, world banks, and so on. With illicit activity sharing an inextricable link to the financial system, these bodies have a vested interest in forging partnerships that share in and pursue their own objectives.

The Power of the Blacklist

Given that FATF’s objectives align more closely with those of other international organizations and policy-making bodies, those organizations are more incentivized to follow FATF’s guidance, including severing business ties when FATF places a country on its blacklist. Individual countries, on the other hand, may or may not follow suit. Their cooperation is driven by national interests, and each must weigh the costs versus benefits for themselves.

Pakistan, for example, was placed on FATF’s “grey list” in June 2018. If it is unable to show significant progress on steps to control financial crime, it risks joining North Korea and Iran on the blacklist — a move currently being debated in this week’s plenary session. While Pakistan will likely avoid this fate, it’s worth considering the ramifications: Would this endanger the $6 billion loan the IMF approved for Pakistan last July? Would China halt work on its ambitious Belt and Road Initiative, of which the China-Pakistan Economic Corridor is a significant part? The former is conceivable; the latter is not.

This doesn’t necessarily mean FATF’s blacklist isn’t significant or influential, however. It represents a huge red flag for any organization or country that may be considering doing business with those on it, which would inevitably result in at least some hurdles to economic investments. But the fact that only two countries thus far have been deemed both to have insufficient controls in place to prevent financial crime and to have been unable or unwilling to implement best practices suggests FATF’s main purpose is rehabilitative rather than punitive. Pakistan’s lobbying attempts to avoid the blacklist are illustrative that, in this, FATF’s influence is considerable.

FATF in 2020 and Beyond

As we move into 2020, however, we are continuing to see signs of significant regulatory divergence. Responses to changes in the financial system are likely to become even more heterogeneous in the years to come. This, in addition to new technologies that are transforming how the world does business, will inevitably complicate FATF’s mission to create a standardized approach to regulating the global financial system.

If FATF fails to adjust course and account for these developments, it risks a loss of relevancy and authority and provides an opportunity for other regional organizations to step in and become formidable standard-bearers in their own right. Nevertheless, while this question of relevancy is one that merits additional exploration, it will likely take several years to answer.