9th July 2020

AML Risk in Foreign Exchange

AML Risks in Foreign Exchange: How to Comply

Foreign currency exchange (FX) is a popular methodology for money launderers, who seek to exploit a range of vulnerabilities associated with the service. The growing volume of FX businesses across the banking and commercial sectors, on Main Streets and online, has also increased the opportunity for criminals to transform illegal funds, while regulators in jurisdictions around the world have failed to keep pace with the emerging threats from the industry. 

FX services are offered by a wide range of entities, including hedge funds, investment firms, traders, brokers and money transfer companies. As an FX service provider, or a financial services firm connected to a provider, it is important to understand the money laundering risks that the industry faces and how to comply with the relevant AML regulations in order to detect and prevent criminal activity. 

AML Risks for Foreign Exchange Service Providers

The key money laundering risks faced by foreign currency exchange service providers include:

Identity verification: Many foreign currency exchange services do not require the same identity verification measures as other types of financial service firms, meaning that criminals can use their services to launder money anonymously. The cash-intensive focus of FX services, and the possibility to obtain cash transfers using associated remittance services, allows criminals to transform money quickly or simply use money mules to carry out transactions on their behalf. Similarly, the proliferation of online FX services makes customer identity verification all the more challenging, and more difficult for the authorities to supervise.  

Regulatory disparity: Because FX transactions often involve different jurisdictions, money launderers may seek to exploit differences or deficiencies in regulatory standards across borders. FATF has warned that many countries, especially those considered higher-risk, do not have adequate AML/CFT regulations or supervisory structures in place to deal with the threat that money launderers pose in the FX industry. That regulatory disparity may see firms use different reporting thresholds for suspicious transactions or see international financial authorities struggling to communicate with each other during investigations, 

Structuring potential: Given the disparity in regulations between jurisdictions and the relative anonymity associated with the service, FX may be vulnerable to structuring, which is when money launderers use a series of transactions to disguise the source of their illegal funds before embedding them within the legitimate financial system. FX transactions are particularly vulnerable to structuring because criminals may move their illegal funds through multiple FX service providers, using multiple currencies, to disguise their origin and embed them within the legitimate financial system. 

Beneficial ownership: The proliferation of FX service providers, both in physical premises and online, has made it easier for money launderers to gain ownership of this type of firm and use that ownership to circumvent AML regulations and protections. Criminals may seek to own FX firms outright (or by using a sub-agent) or may seek to have someone own the firm on their behalf through financial incentive or coercion. Financial authorities may struggle to determine the beneficial ownership of an FX firm, allowing money launderers to conceal their activities.

How to Comply With AML Regulations

FX service providers should be familiar with the AML/CFT regulations that apply in their jurisdiction, including any licensing requirements. In Financial Action Task Force (FATF) member states, firms must take a risk-based approach to the money laundering threats that they face and put commensurate measures in place as part of an internal AML/CFT program. 

In practice, that means that FX firms should:

  • Perform customer due diligence (CDD) checks at onboarding and throughout the customer relationship to verify customer identities accurately. CDD checks should also be used to establish beneficial ownership if dealing with another FX company.
  • Implement transaction monitoring measures in order to spot suspicious FX transactions that might be indicative of suspicious activity. This includes transactions over certain reporting thresholds, unusual transaction patterns or transactions involving high-risk countries.
  • Screen and monitor customers for politically exposed person (PEP) and sanctions status and for their involvement in adverse media stories. 
  • Appoint a compliance officer to oversee the compliance program, liaise with financial authorities and manage audits. 

FX red flags: FX employees should also receive adequate training in order to implement the appropriate AML/CFT measures when customers use their services. With that in mind, firms should be aware of the characteristics, or “red flags,” of money laundering methodologies that target FX services. Those red flags include:

  • Transactions above jurisdictional reporting thresholds.
  • Suspicious transaction patterns, such as customers making an unusually high frequency, or an unusually high volume, of transactions.
  • Customers consistently using non-face-to-face FX services, concealing their identities or sending third parties (money mules) to conduct transactions on their behalf.
  • Multiple exchanges in different currencies that appear to be connected.
  • Multiple exchanges across different service providers.
  • Transactions involving PEPs, sanctioned customers or customers involved in adverse media stories.

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