A Guide to Anti-Money Laundering for Crypto Firms

North Korea and Sanctions, FATF and Virtual Assets, US and Cryptocurrencies

Sanctions Knowledge & Training

The UN Panel of Experts on North Korean sanctions is renewed; FATF issues new draft guidance on Virtual Assets; and the US crypto sector fears a government ‘crackdown’ despite growing signs of mainstreaming. 

We share our financial crime regulatory highlights from the week of April 12, 2021.

UN Maintains North Korean Sanctions Panel

Following the publication in early March of the latest report from the UN’s Panel of Experts on the Democratic People’s Republic of Korea (DPRK, commonly known as North Korea), the UN Security Council (UNSC) has recently voted to extend the panel’s mandate for a further year. 

The Panel of Experts was set up in 2009 to monitor and evaluate the effectiveness of the implementation of UN sanctions on North Korea and produces biannual reports into the logistics of North Korea’s ballistic missile and Weapons of Mass Destruction (WMD) programs, sanctions evasion attempts, and the effectiveness of the international community’s efforts to limit North Korea’s activities. 

The Panel of Experts’ report notes that over the last year, North Korea has continued to violate UNSC resolutions by developing nuclear weapons and an array of short, medium, and long-range ballistic missiles, capable of delivering nuclear warheads against the country’s immediate neighbors and US military assets in northeast Asia – and potentially further afield, against the US itself. These efforts have included the ongoing domestic production of fissile materials and physical missile infrastructure, but the report stresses that the country has also “continued to seek material and technology for these programs from overseas.” 

As a result of the COVID-19 pandemic, North Korea has faced severe limitations on these efforts, some of which have been self-imposed through even tighter national border controls, and others by the actions of other governments increasing restrictions on the movements of goods and people. However, the Panel found that the country continued to use a wide number of ways to work around physical constraints to a source not only materials for its weapons programs, but other sanctioned assets, such as oil. The Panel highlighted the illicit import of around 500,000 barrels of refined petroleum via “elaborate subterfuge” between January 1 and September 30 in 2020, as well as the illegal acquisition of fishing rights and the ongoing export of coal. 

The Panel further noted the many methods by which North Korea has sought to evade and subvert the financial aspects of the sanctions regime. Operating through the mainstream fiat currency-based international financial system, the country has used its own bank representatives, carefully camouflaged joint ventures, shell companies, and offshore assets, and North Korean nationals living overseas, to meet its needs. In addition, the experts found that North Korea was increasingly seeking to exploit the potential of cryptocurrencies and other Virtual Assets (VAs), both as a means of transferring and laundering funds, but also to receive payments from frauds, scams, and malicious cyber attacks against companies and individuals. 

Taken together, the report suggests that even in the face of the practical difficulties of the last year, North Korea remains as determined as ever to pursue its nuclear ambitions, however difficult this might be. The point has been further underlined by the North Koreans themselves, with the test of tactical missiles off the country’s coast on March 25.  

Nonetheless, the renewal of the Panel by the UNSC, the recent extension of sanctions by significant North Korean neighbors such as Japan, and tough rhetoric from the Biden administration, suggest that the international community remains equally determined to tackle the North Korean challenge. 

Indeed, recent US actions, such as the unprecedented extradition of a North Korean national from Malaysia to the US for involvement in sanctions evasion, indicates that although the door to negotiations remains open, the US is again looking to apply coercive pressure, following the failure of the previous administration’s diplomatic initiatives to generate dividends. 

For businesses within the region, it will therefore be important to keep a close watch on the forthcoming developments, especially as the US takes a more robust position. Given the creativity of North Korea’s approach to sanctions evasion, firms will both need access to the most up-to-date and wide-ranging risk data and screening tools to ensure that they mitigate the risks of exposure, and have platforms that can respond quickly to a changing environment. 

FATF Issues Draft Guidance on Virtual Assets

The Financial Action Task Force (FATF), the Paris-based international standard setter for Anti-Money Laundering and Countering the Financing of Terrorism (AML/CFT), has recently issued new draft guidance on Virtual Assets (VAs) and Virtual Asset Service Providers (VASPs). The group has asked for public comments on the guidance by April 20 2021 and hopes to finalize the proposals later in the year. 

The published draft document follows FATF’s original VA and VASP guidance of June 2019, which set out the need for VASPs such as cryptocurrency exchanges to undertake a full range of AML/CFT obligations, including the collection of Customer Due Diligence (CDD) and Know Your Customer (KYC) information, maintaining originator and beneficiary data from all transactions (the so-called ‘Travel Rule’), and ongoing monitoring and suspicious activity reporting.

At its core, the proposed guidance seeks to resolve definitional problems that have emerged over the last two years on what – and what might not – be deemed a VA or VASP. The new guidance reasserts that ‘stablecoins’ – VAs linked to an underlying asset such as a fiat currency – are subject to AML/CFT rules, and further suggests that both the terms ‘VA’ and ‘VASP’ should be “interpreted broadly,” to allow an expansive approach “that can accommodate technological advancements and innovative business models.” 

In that regard, the document points specifically towards what is known as ‘Decentralized Finance’ (DeFi) platforms, which support varieties of Peer-2-Peer (P2P) financial transactions using blockchain, without the need for a traditional financial intermediary such as a bank. Although FATF suggests that the underlying software or technology which drives the platform does not have to be designed to meet AML/CFT requirements, it does say that the owners and operators of such platforms should be required to meet those obligations. 

The guidance also alludes to the growth of ‘Non-Fungible Tokens’ (NFTs), unique digital assets that are stored on blockchain ledgers. Previous FATF wording had said that the standards only covered VAs that were “fungible” – ie not unique and immediately replaceable – but the new guidance suggests that this be changed to “convertible and interchangeable,” potentially bringing into scope NFTs that, although unique, can be bought and sold in secondary markets for fiat or cryptocurrencies, like any other asset.

Both of these developments, if realized, will create challenges for the fast-evolving VASP sector, especially for those decentralized platforms where no one firm or individual can be seen as the owner or operator. In these situations, the questions of who collates CDD/KYC data, and where it is stored will be critical, and not easy to answer immediately. Talking to the online media outlet Coindesk, Kristin Smith, the Executive Director of the Blockchain Association, suggested that if enacted, the new rules might require the developers of platforms to remain “accountable for implementing AML/CFT,” even after they are no longer an active part of its ongoing operation.

FATF has shown a willingness to listen to the concerns of the industry about how easily conventional AML/CFT frameworks can be applied to new technologies. However, even though the organization is sympathetic to the practical difficulties firms face, it seems likely to continue with an expansive approach to the definition of VAs and VASPs, in order to ‘future proof’ regulations for new technological developments. FATF has made it clear that it does not wish to see anyone area of the VASP sector take advantage of gaps in regulation. As stated in the press release that opened the public consultation on the new proposals, the changes are intended “to maintain a level playing field…as well as minimizing the opportunity for regulatory arbitrage between sectors and countries.” 

This attitude suggests that for VASPs of all varieties, it will be prudent to assume that AML/CFT obligations will be as relevant to them as all other forms of financial institutions. VASPs will therefore need to take into account how best to undertake core compliance responsibilities in harmony with the creative nature of the sector, and the need to maintain efficiency. Unsurprisingly for an industry that prides itself on innovation, the most natural place to look for answers will probably be through the application of new technologies to these regulatory challenges. 

Crypto Leader Predicts Tough US Government Stance

In a recent interview with US media outlet CNBC, Jesse Powell, Chief Executive Officer (CEO) of Kraken, a US-based cryptocurrency exchange, has warned of an increasingly tough approach to the regulation of VAs and VASPs by the US government. Powell, who heads the world’s fourth-largest crypto exchange by trading volume, said that “there could be some crackdown,” coming from the US authorities, despite the surging value of Bitcoin and other major cryptocurrencies. 

Powell noted that US officials such as Treasury Secretary and former chair of the Federal Reserve, Janet Yellen, had raised concerns about the potential abuse of VAs as a vehicle for money laundering or terrorist financing. In February, Yellen had told US news media that she did not think cryptocurrency was “widely used as a transaction mechanism,” and that “to the extent, it is used…it’s often for illicit finance.” 

However, Powell commented that the emerging US government view was “shortsighted,” and influenced by a legacy banking industry that feared losing business to more agile competitors. He suggested that the US government should avoid a “narrow view” and recall that the basic use-case behind the development of VAs, “ was to just make financial services accessible to everyone.”

Powell further noted that current evidence suggested that despite the fears of officials, actual levels of crypto abuse were very small, both relative to the fiat economy and as a proportion of crypto use overall. According to a report by Chainanalysis, a blockchain analytics firm, less than half a percent of crypto-transaction volumes last year were likely to be related to criminality. 

Powell’s comments came as the conventional financial and economic system showed further signs of embracing VAs and VASPs as part of the ‘mainstream.’ On Wednesday 15 April, another major cryptocurrency exchange, Coinbase, was publicly listed on the US stock market after it achieved record trading volumes in the first quarter of 2021. According to the CNBC report, Kraken is also considering a direct public listing in the US. 

Despite the market’s increasing enthusiasm for VAs, however, the ongoing concerns about the risks around cryptocurrencies from US officials such as Yellen – shared also by international regulators such as Christine Lagarde, the President of the European Central Bank (ECB) – need to be taken seriously by the industry. 

Even if the current scale of financial crime risks is overstated, unregulated financial sectors remain highly vulnerable to abuse, and as players in the financial system, VASPs need to accept their responsibilities to prevent and detect potential financial crimes. At the same time, firms that accept the scrutiny which comes with a public listing also need to factor in the potential reputational damage and effects on stock valuation which might result from regulatory censures over AML/CFT violations. 

Either way, it is in a VASP’s interest – legally, ethically, and commercially – to take its compliance and financial crime risk responsibilities seriously, and the most forward-thinking firms in the sector such as Gemini, another leading US crypto exchange, are embracing regulatory technology solutions to do so. As the push towards wider societal acceptance of cryptocurrencies continues, a prudent decision to work with the system – and not against it – is likely to be the most effective way of reassuring the skeptics. 

Originally published April 15, 2021, updated November 19, 2021

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