What the Basel AML Index Reveals About Global Money Laundering Risks

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Today we are very pleased to welcome guest bloggers Gretta Fenner and Dr. Kateryna Boguslavska of the Basel Institute on Governance (“Basel Institute”). The Basel Institute recently issued its Basel AML Index for 2019. As they explain below, this data-rich and fascinating Index, on which we blogged last year, is one of several online tools developed by the Basel Institute to help both public- and private-sector practitioners tackle financial crime.  The Index is a research-based ranking that assesses countries’ risk exposure to money laundering and terrorist financing.

Established in 2003, the Basel Institute is a not-for-profit Swiss foundation dedicated to working with public and private partners around the world to prevent and combat corruption, and is an Associated Institute of the University of Basel. The Basel Institute’s work involves action, advice and research on issues including anti-corruption collective action, asset recovery, corporate governance and compliance, and more.

Gretta Fenner is the Managing Director of the Basel Institute, where she also holds the position of Director of the Institute’s International Centre for Asset Recovery. She is a political scientist by training and holds bachelor’s and master’s degrees from the Otto-Suhr-Institute at the Free University Berlin, Germany, and the Paris Institute for Political Science (Sciences Po), France. She also holds an MBA from the Curtin University Graduate School of Business, Australia.

Dr. Kateryna Boguslavska is Project Manager for the Basel AML Index at the Basel Institute. A political scientist, she holds a PhD in Political Science from the National Academy of Science in Ukraine, a master’s degree in Comparative and International Studies from ETH Zurich as well as a master’s degree in Political Science from the National University of Kyiv-Mohyla Academy in Ukraine. Before joining the Basel Institute, Dr. Boguslavska worked at Chatham House in London as an Academy Fellow for the Russia and Eurasia program.

This blog post takes the form of a Q & A session, in which Ms. Fenner and Dr. Boguslavska respond to several questions posed by Money Laundering Watch about the Basel AML Index 2019. We hope you enjoy this discussion of global money laundering risks — which addresses AML compliance vs. actual effectiveness, kleptocracy, transparency, de-risking, and more. –Peter Hardy

Can you please tell us about the mission of the Basel Institute? What are its goals, and how does it try to attain them?

Our core mission is to help public and private partners to prevent and combat corruption and related financial crimes. Our focuses include strengthening governance structures, enabling a solid law enforcement response and promoting public-private partnerships. We were established in 2003 as an independent, non-profit organization headquartered in Basel, Switzerland, though our 80+ staff members work across the world, with many of them stationed in our partner countries on a long-term basis.

Many of our projects deal with cross-cutting issues in a variety of areas impacting on corruption and governance. These range from assisting governments with asset recovery and public financial management to supporting companies in anti-corruption Collective Action and compliance.

The Basel AML Index is one of a set of online tools developed by the Basel Institute to help both public- and private-sector practitioners tackle financial crime. Other tools include free eLearning courses and a new platform to streamline open-source research for due diligence and investigation, Basel Open Intelligence.

You have just released the Basel AML Index 2019. What was the methodology, and what are the basic findings?

The Basel AML Index is an independent, research-based ranking that assesses countries’ risk exposure to money laundering and terrorist financing (ML/TF).

Published by the Basel Institute since 2012, it provides risk scores based on data from 15 publicly available sources such as the Financial Action Task Force (FATF), Transparency International, the World Bank and the World Economic Forum. These data cover countries’ adherence to anti-money laundering and countering the financing of terrorism (AML/CFT) regulations, levels of corruption, financial standards, political disclosure and the rule of law. They are aggregated into one overall risk score using an expert weighting system.

The final score represents a holistic assessment of the country’s resilience against ML/TF. It is worth remembering, however, that when we speak about risks of ML/TF, we are speaking about a complex set of risk factors and not a single number. Therefore, it is always worth digging deeper into the data to fully understand a country’s final score.

Looking back, one trend stands out in particular: over the eight years since it was first calculated, the Basel AML Index has consistently indicated slow progress among most countries in improving their ML/TF risk scores.

What appear to be the most serious money laundering risks today – and tomorrow?

A major risk today comes from the illusions that a technically comprehensive AML/CFT system can protect a country from ML/TF risks. This can lead to complacency. A system is only as strong as those tasked with implementing it. In this context, it is striking that most countries deteriorate in the Basel AML Index ranking after undergoing a fourth-round evaluation by the FATF, which addresses exactly this failure. The fourth-round evaluation assesses not only the technical compliance of a country’s legal and institutional AML/CFT framework with FATF Recommendations, but crucially its effectiveness.

A second serious risk relates to transparency, or rather a lack of it. Countries with relatively strong AML/CFT systems are dragged down the Basel AML Index by poor transparency in relation to their financial sector, public finances and political party/election campaign financing. Transparency is also still largely insufficient when it comes to beneficial ownership, which is widely seen as a critical tool for enforcing AML/CFT laws and regulations. When we look at FATF data we see that on average, countries score only 40% for technical compliance and 23% for effectiveness.

The risks of tomorrow may come from new and unexpected areas, because criminals are adept at finding new methods to launder their illicit money as loopholes are slowly closed. A major risk area for ML/TF will be – in fact, is already starting to be – cryptocurrencies. A lack of reliable data makes it difficult for the Basel AML Index to evaluate ML/TF risks relating to cryptocurrencies, and will make it similarly difficult for regulators to stamp it out. Some of these challenges are covered in a recent working paper by a Basel Institute Financial Investigation Specialist: Regulating cryptocurrencies: challenges and considerations.

We will also be looking at trade-based money laundering ,which has been identified as a significant and still evolving risk.

The AML 2019 Index suggests that “compliance and effectiveness often do not go hand in hand.” Please elaborate. How might this problem be addressed most effectively?

As touched upon in the previous question, as FATF rolls out its fourth-round evaluations across the world, we see disappointingly little correlation between the level of compliance of countries’ AML/CFT systems with the FATF’s 40 Recommendations and their assessed level of effectiveness according to the FATF’s 11 “immediate outcomes.”  Vanuatu is only the most extreme example, scoring highly for the compliance of its AML/CFT system but 0% for effectiveness.

One of the few exceptions that proves the rule is the USA, which is unusual in having a higher level of performance in effectiveness (67%) than in technical compliance (63%) according to the FATF Mutual Evaluation Report of 2016. While we do not want to advocate complacency when it comes to legal and regulatory norms, we often make the point to our partner agencies that rather than waiting for parliaments to adopt perfect laws, we should start by applying the laws that we have.

Indeed, the implications of the discrepancy between compliance and effectiveness are huge, because they touch upon not just AML/CFT but good governance in general. Nominally strong institutions and progressive legislation in a country may be only a façade concealing a lack of political will to combat financial crime.

An important component of addressing this issue that is often overlooked is that laws only tell a part of the story. Informal, unwritten practices often have a significant impact on how these systems and laws play out in practice. We need to understand this in order to find ways of making the formal system work despite sometimes being heavily undermined by the informal. This relation between informal governance mechanisms and financial crime is an important focus of the Basel Institute’s Public Governance research department. Their findings can offer important insights for AML regulators seeking to improve the effectiveness of AML laws in practice.

What is the relationship if any between AML risks and kleptocracy, and the freedom of the press and media – or lack thereof?

Our analysis over the last eight years has consistently shown that countries with a high risk of ML/TF share some or all of the following features: weak public institutions, political rights and rule of law; low levels of financial and political transparency; restrictions on press freedom; lack of resources to control the financial system; and high levels of corruption and bribery.

Whether this relationship is one of causation or correlation is open to debate, but most experts in the field of AML/CFT will agree that kleptocracy and stifled freedom of expression clearly contribute to increased ML/TF risks. Vibrant civil society and a free press can function as watchdogs to expose money laundering offences and demand action against offenders, while financial institutions routinely use media reports to conduct enhanced due diligence on their clients. And if we agree that kleptocracy means a country’s formal institutions are severely undermined by informal structures, we also understand that in a country ruled by kleptocracy, AML/CFT laws and institutions can only be effective up to a point.

Similarly, what is the relationship if any between AML compliance and human rights? AML is often associated in the U.S. with relatively technical and concrete concerns regarding the (mis)use of the financial system. Are there some larger issues at play across the globe?

Money laundering is not just an abuse of financial systems; it is an abuse of citizens and their basic human rights. Money laundering fuels, and is fueled by, corruption, various forms of illegal trafficking and organized crime. This includes human trafficking and the smuggling of migrants, as the FATF has warned in a 2018 report. In this context, it is interesting that this year’s FATF President has identified wildlife trafficking as a major concern, and our IWT/financial crime project started in 2018 is helping to tackle this issue by working closely with financial institutions, transport companies, Financial Intelligence Units and a wide range of law enforcement partners.

Money laundering is not just an abuse of financial systems; it is an abuse of citizens and their basic human rights.

Another example is the Liechtenstein Initiative for a Financial Sector Commission on Modern Slavery and Human Trafficking, which shows a growing recognition that the financial sector and its AML/CFT systems are key to global efforts to end modern slavery and human trafficking. In the US, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued an advisory in 2014 to guide financial institutions on how to detect and report suspicious financial activity that may be related to human trafficking.

The argument that financial crimes themselves can be considered human rights violations is also growing in strength and volume.

Are there some positive signs on the global fight against money laundering? If so, what are they? What seems to be working?

Indeed, the use of the word “global” is apt: money laundering is a global phenomenon and must be tackled at the international as well as national and institutional levels. The nature of illicit financial flows means that increased ML/TF regulations in one country may simply redirect the flows of illicit money to another country with lower AML/CFT standards. That is one reason why it so important to support efforts to require transparency of beneficial ownership globally.

Positive signs in this respect can be seen in the European Union’s Fifth Anti-Money Laundering Directive (5AMLD). This will require, among other things, EU member states to set up beneficial ownership registers for corporate entities and trusts, and to connect these registers to the European Central Platform. The fact that this initiative applies only at the regional, however, not the global level, is a severe hindrance to its effectiveness for the reason stated above.

Everyone wants to combat money laundering and the underlying misconduct. But AML concerns sometimes have meant that some people or groups across the globe just get shut out of the financial system, through a process called “de-risking.” What is the balance here?

De-risking – avoiding rather than managing ML/TF risks by terminating relationships with entire countries or classes of customers – can have serious consequences for the people and businesses affected as it cuts them off from international financial flows, including legal ones. Arguably and perhaps ironically, those responsible for de-risking an entire jurisdiction or group may also harm themselves through missed business opportunities and reputational damage.

The complexity of factors behind a high ML/TF risk rating, which we touched upon earlier in this interview, has strong implications for those considering doing business in a particular country with high risks. Companies and financial institutions can choose between two options, depending on their risk appetites. In recent years, we have observed a clear trend away from a measured risk-based approach to a no-risk approach. This harms business, and it harms people and entire countries. There is an urgent need for much more enhanced dialogue between law enforcement, policy makers and the financial sector to reverse this trend.

Compiling the AML Index 2019 must have been a daunting task. What goes into this project, and how does the Institute try to maximize “objectivity,” given all of the potential variables? How do you respond to a potential critique – particularly by some developing nations receiving a low rating – that such an exercise is inherently subjective, and therefore also subject to possible cultural bias?

The Basel AML Index does not apply any qualitative assessments to the 15 indicators that make up the final score, so to some extent we are bound by what the data says. Of course, the expert weighting scheme inevitably involves a degree of subjectivity, which we try to minimize through annual review meetings bringing together external experts from a diverse set of AML, compliance and risk assessment backgrounds, as well as from different countries and cultural backgrounds. The review meetings are critical in ensuring that the original weighting decisions continue to be adequate and are not influenced by bias or other undue subjectivity. The methodology is openly described on the Basel AML Index website and we welcome feedback and queries.

One legitimate complaint by governments concerned about their low Basel AML Index scores is that it does not always take into account recent reforms of national AML/CFT systems if these have not yet been reviewed by the FATF. Increasing the frequency of FATF evaluations, and in particular ensuring that all countries undergo fourth-round evaluations, will help to avoid skewed data and time lags due to outdated reports. The impact goes far beyond the Basel AML Index, as the FATF reports themselves also directly impact on the due diligence systems implemented by financial institutions and investors.

Rather than fixate on the overall risk score and superficial comparisons between neighboring countries, we encourage both countries and companies – and the media reporting on this topic – to drill down to the underlining sub-indicators in the Basel AML Index. By doing this, they can identify the exact factors contributing to a high risk score and address them using a targeted and risk-based approach.

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