The UK parliament to assess AML/CFT, Pakistan stays on the FATF ‘grey list’, and US legal cannabis businesses remain stymied by compliance issues. 

We share our financial regulatory highlights from the week of 26 October 2020.

UK Committee Reviews AML Efforts

The House of Commons Treasury Select Committee, an influential cross-party body within the UK parliament, has announced a new inquiry into the effectiveness of the UK’s AML/CFT regime. 

The inquiry follows a similar review by the committee in March 2019, and has been inspired by the controversy around the leak last month of US Suspicious Activity Reports (SARs) held by the Financial Crimes Enforcement Network (FinCEN), the US Financial Intelligence Unit (FIU). 

The documents, known as ‘the FinCEN Files’, provide details of a range of suspicious transactions worth more than $2 trillion reported by US-based financial institutions between 1999 and 2017. The investigation into the files, led by the International Consortium of Investigative Journalists (ICIJ), highlighted the involvement of some of the UK’s biggest banks and numerous UK registered shell companies. An analysis by the BBC last month showed that a total of 3,282 British companies were named in the leaked FinCEN Files, more than any other country.

The Committee has stated that its primary goal will be to assess how far the UK has progressed in its AML/CFT and sanctions efforts in the last 18 months. Its Chair, Mel Stride MP, commented that “the previous Committee made a series of recommendations on the UK’s effort to combat money laundering and what can be done to prevent consumers from being victims of economic crime. The current Committee will now examine what progress supervisors, law enforcement and the Government has made in these areas.” The Committee has also highlighted several specific strands it wishes to touch upon: 

  • The impact of the ‘FinCEN Files’ and what they indicate about the need for further AML/CFT reform;
  • The work of the Office for Professional Body Anti-Money Laundering Supervision, (OPBAS), set up in January 2018 to oversee professional body AML supervisors in the legal, accountancy and other obligated professions;
  • The appropriateness of current UK laws on corporate liability for economic crime; and 
  • The work of Companies House, the U.K.’s registrar of companies.

The Committee has also said it wishes to understand the impact of economic and financial crimes on consumers, especially as a result of the COVID-19 pandemic. One aspect of this is the performance of the ‘Contingent Reimbursement Model’, a UK payments industry initiative designed to compensate victims of Authorised Push Payment fraud (APP), where fraudsters use social engineering techniques to get individuals or businesses to transfer money to the fraudster. This type of crime has seen notable increases over the last year, as criminals have focused their attention on a largely house-bound domestic population. 

Another COVID-linked aspect of the inquiry will review the abuse of ‘Bounce Back Loans’, a UK-based financial support scheme to help businesses that lose revenue due to the pandemic. Mel Stride remarked that “it’s important that the relevant bodies are held to account and scrutinised effectively to ensure that the UK is a clean place to do business and that consumers are protected from economic crime.”

The previous Treasury Committee report was highly critical, stressing that the UK’s current approach to AML/CFT was fragmented and disproportionately small in the face of the scale of economic crime. The report noted that “the National Strategic Assessment of Serious and Organised Crime 2018 suggested that the scale of money laundering impacting the UK annually could be in the hundreds of billions of pounds,” while the UK government was responding with a Serious Organised Crime Strategy that was being funded “in the tens of billions.”  

It is early days for this new inquiry, but with only a year and a half since its last report, it seems unlikely that it will identify significant progress, especially given the limitations that the pandemic has put on the process of legislation and policy implementation. 

Nonetheless, it is welcome that economic crime is now receiving sustained – if critical – focus in a leading jurisdiction such as the UK, after many years of being treated as a secondary issue. With this and other initiatives and inquiries underway in Canada, Australia and the US, it is a clear responsibility for the financial services industry to take part and make sure its voice is heard. The deadline for submission of evidence to the Committee is 27 November 2020.

Pakistan Still on the Grey List

The Government of Pakistan this week learned that the country will remain on the ‘grey list’ of jurisdictions with strategic AML/CFT deficiencies maintained by the international standard setter, the Financial Action Task Force (FATF). There had been serious concerns in the country that it might be placed into the lower tier of the ‘black list’ at FATF’s recent plenary session. 

FATF, set up by the Group of Seven leading industrialized nations in 1989, is a globally influential body with over 200 jurisdictions seeking to follow its guidelines. Failure to meet those guidelines can lead to ‘black listing’ by the organization, which can have serious economic consequences such as the freezing of international aid, economic sanctions and damage to capital inflows on which developing economies depend. Currently, only North Korea and Iran are on the FATF ‘black list’. The International Monetary Fund (IMF) had warned Pakistan that its $6 billion aid program would be in question if it were downgraded. 

‘Grey listing’, by contrast, suggests that the country has major AML/CFT vulnerabilities, but that governments continue to make efforts to improve the situation. Sixteen countries remain on the ‘grey list’ with Pakistan, including Syria, Yemen and Zimbabwe. Iceland and Mongolia, which had previously been on the list, were removed at the same plenary session. 

FATF noted that Pakistan had made significant progress against 21 of the 27 tasks the group had set them in 2018. This was a significant advance on the 14 that had been accomplished by the summer 2020 plenary. According to the group, Pakistan had taken effective action on illicit money transfer services, implemented controls on cross-border and bearer negotiable instruments, and improved international cooperation on financial crime. However, progress in the final six areas – primarily related to deficiencies in handling terrorist financing – was varied according to the group, and it urged Pakistan to complete all actions by February 2021. This included demonstrating that:

  • Law enforcement agencies are targeting designated terrorists and groups in terrorist financing (TF) investigations; 
  • TF prosecutions are resulting in effective, proportionate and dissuasive sanctions; and 
  • Provincial and federal authorities are cooperating on enforcement cases.

“As long as we see a country is progressing in action items, and we have seen progress with Pakistan, we give them a chance to repair the outstanding issues,” said Dr Marcus Pleyer, the current president of FATF. He noted that the government of Prime Minister Imran Khan has changed 15 laws to address FATF’s concerns, and has sought to improve the capacity of the law enforcement agencies to pursue financial crimes. Nonetheless, the six remaining tasks are “serious deficiencies,” Pleyer said, and he noted that Pakistan would need to go through a further on-site inspection to confirm that the actions have been completed. 

Within FATF, Pakistan has received strong diplomatic support from China, Turkey and Malaysia, while its local geopolitical rival, India, has accused it of funding Islamist Extremist networks operating in Pakistani Kashmir. At the plenary session, India is reported to have presented evidence of what it described as Pakistan’s tackle failure to tackle TF, and argued that it should be moved to the ‘black list.’ By retaining its position on the ‘grey list’, therefore, the balance of opinion within the group seems to be in Pakistan’s favour at present, but the patience of FATF is not inexhaustible, and the country has failed to meet four previous deadlines to accomplish the reform program.

The ongoing case of Pakistan highlights again the importance of compliance functions’ retaining a close watch on how the international community defines ‘high risk jurisdictions.’ This is especially the case for those involved in international payments, but should be on the radar of those doing any kind of international business, especially those involving Politically Exposed Persons (PEPs). 

It also emphasizes the importance of taking TF seriously. Often treated as the ‘poor relation’ to AML within financial institutions, terrorism remains a pressing problem across the globe. Current methods of finding terrorist risks – focused primarily on designation lists and key word searches – are increasingly inadequate in the age of lone actor and small cell terrorism. Although terrorists are notoriously difficult to find, it falls to businesses as much as governments to use innovative methods to tackle the threat.

US Cannabis Firms’ Compliance Challenge

According to a recent report by The Wall Street Journal (WSJ), legal cannabis growers and distributors in the U.S. are continuing to struggle with a lack of financial services, due to financial institutions’ wariness about the compliance risks around the industry.

The sale, use and possession of cannabis has been illegal under US federal law since the Controlled Substances Act (CSA) was introduced in 1970; at a federal level, cannabis is deemed a ‘Schedule 1’ narcotic, meaning that it is addictive and open to abuse. The one exception to the rule is hemp, a variety of cannabis used to provide fibres in textiles, which was made legal at a federal level in 2018. 

At the state level, in contrast, there has been a more widespread trend towards the legalization of cannabis for a range of purposes since the 1990s. 11 US states have legalized the recreational use of the drug, and a further 22 allow it to be used for medicinal purposes. This leaves 17 states where cannabis is not legal for any use, even hemp, despite the change in the federal law. 

The increasing tension between the federal and state views has led to recent legislative attempts to ‘square the circle’. In September 2019, the U.S. House of Representatives passed the Secure And Fair Enforcement (SAFE) Banking Act, which would change the law to stop federal regulators from taking direct action to prevent FIs from doing business with cannabis producers, including the removal of the FI’s deposit insurance. Although the act passed the House as part of the provisions of the HEROES Act Covid-19 relief bill in May and October 2020, it has yet to clear the Senate. 

According to the WSJ, the legal cannabis industry’s greatest challenge comes down to financial institutions’ confusions and anxieties about what is required of them in terms of AML/CFT and financial crime risk management. Talking to the paper, Mel Barnes, the chief operations officer at Oklahoma State Bank commented that the reason bankers are so reluctant to get into supporting the legal cannabis industry were the “very intensive compliance requirements, more than any other industry,” he said. 

As a consequence, fewer than 700 of the US’s 4,700 commercial banks and 5,375 credit unions have been willing to service cannabis-related businesses as of June 2020, according to FinCEN. Mike Ford, a cannabis entrepreneur, told the paper that his bank of 30 years had refused to support his industrial hemp-growing firm early last year. “You bring the word cannabis up and they just put their fingers in their ears and say, ‘oh my God, go away,’” he remarked. 

At a federal level, some regulators are beginning to try and provide clarification on how financial institutions should apply a risk-based approach to different aspects of the cannabis industry. In December 2019,  FinCEN noted that financial institutions were no longer required to provide SARs to identify a client that was dealing in hemp, and in July 2020, it issued further guidance to indicate that institutions should take the same risk based, risk specific approach to due diligence of operators in the hemp sector. 

Nonetheless, FinCEN appears to be a rare proactive example, and financial institutions that have expanded their presence in the cannabis-related market have found themselves having to take matters into their own hands, in lieu of clearer state or federal guidelines. Some individual financial institutions have developed their own knowledge base, mapping plant life-cycles and their potential usage, as well as creating their own bespoke controls for distinctive risk profiles of different types of cannabis-related businesses.

As the article notes, there is a painful irony in the situation; a potentially lucrative market is struggling because of the lack of financial access that institutions want to provide, but are afraid to give. For cannabidiol alone – a derivative of cannabis that has become a popular additive in drinks and foods – there is an estimated US market worth $34 billion, according to New Frontier Data, a market research firm. 

There is a clear onus on lawmakers and regulators to help rectify the situation further. However, in the meantime, there are also actions financial institutions can take now to manage their risk when venturing into this area. Although several institutions have chosen to develop a deep understanding of the sector, an obvious first step is the better use of automated adverse media, which can provide insight into those firms and operators that might have a questionable past. Deployed judiciously, such tools can be a more straightforward – and potentially cheaper – way for financial institutions to increase comfort and confidence in this innovative field. 

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