In the fight against financial crime, the anti-money laundering landscape is ever-changing.
The global battle against financial crime is a challenging one fought by governments, regulatory bodies, and industries. Every financial institution and organisation that provide financial services must better equip themselves against the growing threat of money laundering.
Financial institutions are the most significantly impacted by money laundering and terrorism financing year on year. The United Nations Office on Drugs and Crime estimates that the amount of money laundered globally is between 2 – 5 per cent each year, which in USD is between $800 billion – $2 trillion.
In the ongoing battle to combat money laundering, law enforcement, governments, and regulatory bodies are building stricter anti-money laundering (AML) regulatory frameworks.
Anti-Money Laundering regulations are laws and legal controls aimed at preventing criminals from using financial systems to hide illegally gained funds. As financial institutions are the most impacted, they face the most pressure to be compliant. In accordance, institutions have to create effective processes that detect, report, and ultimately prevent dirty money from entering their financial systems.
Money laundering has many economic, socio-economic, and business consequences if AML regulations are not developed and enforced. This article will discuss the AML regulatory landscape and how financial institutions must comply with AML regulations.
What are the three stages of anti-money laundering?
Money laundering is the process of exchanging illicit funds gained through organised crime into legal currency. To hide the source of such large amounts of money illegally gained, laundered money follows three key stages: placement, layering and integration. Each individual money laundering stage can be extremely complex due to the criminal activity involved.
In the first stage, criminals move their illicit funds into legitimate financial systems.
The second stage is for criminals to hide the illegal source of the funds and make it hard to detect. The illegal source is hidden within a complex network of multiple bank transfers.
Once the illegal source is hidden, this stage involves blending the illicit funds into the financial system through investment into legitimate businesses. Criminal law firm St Pauls Chambers explains, “[t]he ‘dirty’ money is now absorbed into the economy, for instance via real estate. Once the ‘dirty’ money has been placed and layered, the funds will be integrated back into the legitimate financial system as ‘legal’ tender.”
The money is then returned to the criminal as having come from a legal source.
Consequently, financial crimes are becoming ever more sophisticated as technology advances, and the stages are ever more complex as criminals find newer methods to stop their activities from being detected. It is increasingly difficult for regulators and institutions to identify or prevent laundered money from entering financial systems.
The anti-money laundering regulatory landscape
The nature of AML regulations had evolved over the decades since 1970 when the US became one of the first countries to introduce the anti-money laundering legislation, The Bank Secrecy Act (BSA). Since then, numerous AML regulatory bodies worldwide are dedicated to fighting money laundering and terrorism financing. To name a few, AML organisations include the Financial Crimes Enforcement Network (FinCEN) from the US, the Financial Conduct Authority (FCA) in the UK, the French Financial Markets Regulator (AMF), The Financial Consumer Agency of Canada (FCAC) in Canada. Including the development of the Financial Action Task Force on money laundering (FATF), established by the G-7 Summit in Paris in 1989 to develop a coordinated international response.
Changes set out by the FATF set the global AML standards for nations, as seen with the FAFT advising the banking sector to take a risk-based approach to identify money laundering.
Improving the effectiveness of detecting and sharing information on money laundering is a national concern and an international priority. Regulatory bodies are also following guidance from the FATF to set more stringent regulations to combat the risks.
In the US, the new Anti-Money Laundering Act Of 2020 (AMLA) demands institutions take a better risk-based approach to their AML programs. In their AML program effectiveness, Deloitte explains that the AML Act lays the foundation for a more risk-based, innovative and outcomes-oriented approach to combat financial crime and safeguard national security in the US.
In addition, cybercriminals are finding more sophisticated methods to launder money, leaving many more sectors exposed to financial crimes. Recently the UK implemented the fifth AML directive (5MLD), an amendment to the existing Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR 2017). Changes to the regulations now extend to organisations such as letting agents and art market participants, such as galleries, dealers and auctioneers, as well as businesses active in the crypto asset market.
You can read more about tackling money laundering in the art world on our blog.
The pandemic placed immense pressure on financial services, which led to revision at the end of 2020 of EU AML regulations producing the EU sixth anti-money laundering directive (6AMLD).
Bobsguide explains: [s]upercharged by the pandemic, there has been an increasing push for digitalisation in financial services. While an excellent move overall, it does create opportunities for cybercriminals to evolve and expand their financial crime methods. 6AMLD was quickly pushed through to address these growing threats.
Following these shifts in AML regulations and the recommendation of a risk-based approach, financial institutions must comply to ensure they do more to reduce financial crime risk.
The essentials of an AML program
Keeping up with AML regulations has meant that institutions have had to continually shift their priorities and tighten their AML systems to be compliant. They must develop more effective AML programs to record and efficiently report potential risks to their financial systems.
According to guidance from the UK HM Revenue and Customs, an effective AML program must include the following:
- Customer Due Diligence (CDD) procedures
- An appointed AML compliance officer
- Internal operations and ongoing transaction monitoring processes
- Processing policies: record keeping, risk assessments, AML policy
- Detection and Reporting suspicious activities
Carrying out customer due diligence (CDD) is an essential first step in a risk-based AML program. In order to demonstrate CDD has taken place, AML programs must include Know your customer (KYC) procedures. KYC ensures an institution has effectively identified and verified its customers’ identities.
Nice Actimize describes the importance of CDD as “the control procedure that financial services organisations (FSOs) apply to understand and conduct risk assessments of their customers, allowing them to identify and mitigate potential customer risks. CDD is the first line of defence in stopping bad actors from gaining access to global financial services, so there is a lot at stake for getting it wrong.”
Traditionally, financial institutions carried out static reviews of their customers. In the anti-money laundering challenges discussion with FinanicerWorldWide, financial director Shorrock states, “CDD is at the heart of the risk-based approach. Old style KYC measures, where institutions simply established the identity of the customer, are no longer sufficient.”
The second important line of defence is continued monitoring and screening of customer transactions in order to identify any illicit activity. With the new risk-based approach, financial institutions are now challenged to be more proactive in their detection and reporting. A risk-based approach brings with it changes to allow for more real-time monitoring, as the magazine ACAMS Today noted of its importance as ultimately ushering in an era of revolutionary change in the international AML arena.
This presents new challenges for institutions to update their AML programs appropriately and adds to the ongoing difficulties they face to ensure their AML compliance processes are effective and efficient in preventing money laundering.
Tougher regulations mean a more effective AML program
Inevitably, criminals will continuously develop more sophisticated techniques to go undetected in AML programs, as regulators and governments will have to develop countermeasures.
Read more on our article regulatory expectations are evolving: how robust is your AML program, where we discuss the challenges institutions face to update their AML programs.