90954 FOCUS NOTE AML/CFT and Financial Inclusion: New Opportunities Emerge from Recent FATF Action I ncreasing numbers of countries worldwide are putting in place regulatory regimes that allow more poor people to access and use basic formal This formal recognition coincides with significant FATF actions of relevance to financial inclusion taken in the past two years: financial services they need to improve their lives. The Financial Action Task Force (FATF), which sets • FATF’s Forty Recommendations on AML/CFT4—the international standards for anti-money laundering and body’s highest level normative pronouncements countering the financing of terrorism (AML/CFT), 1 on the subject for countries to follow in crafting has taken significant action over the past two years, their domestic AML/CFT regimes—were revised making it easier for policy makers to pursue financial to introduce the requirement of national and inclusion goals while combating money laundering, sectoral risk assessments, embedding a “risk- terrorist financing, and other financial crimes. based approach” (RBA) to AML/CFT regulation and supervision, and expanding on the concepts Current regulatory trends reflect steadily growing of “lower risk” and “low risk” activities. awareness among FATF members over the past • FATF released updated guidance on Anti-Money decade that country-level implementation of FATF’s Laundering and Terrorist Financing Measures AML/CFT standards and guidance can inadvertently and Financial Inclusion5 produced jointly with prevent poor households and businesses from the World Bank and the Asia/Pacific Group on accessing formal financial services (or discourage Money-Laundering, and new guidance was issued their use even where there is access). The financial on Prepaid Cards, Mobile Payments and Internet exclusion that results can compromise countries’ Based Payment Services.6 ability to track money laundering and terrorist • FATF revised the Assessment Methodology7 used financing by relegating vast numbers of people to assess a country’s compliance with the FATF and transactions to the untraceable world of cash. 2 Recommendations (which are vitally important in This culminated in FATF’s formal recognition of determining which countries get added to or removed financial exclusion as a money laundering and from public lists FATF maintains of noncompliant terrorist financing risk as reflected in the FATF jurisdictions), incorporating for the first time Ministers’ approval of the organization’s 2012– assessment of the effectiveness of a given country’s 2020 mandate.3 Financial inclusion and AML/CFT AML/CFT regime, and explicitly including financial are now recognized as mutually supportive and exclusion and financial inclusion policies as factors complementary objectives: the application of that assessors may consider in their evaluations. measures that enable more citizens to use formal financial services will increase the reach and Collectively, these actions clarify the landscape No. 98 effectiveness of AML/CFT regimes. for country-level policy making, offering new September 2014 Timothy Lyman and 1 FATF’s standards and work focus on preventing the abuse of financial services by criminal and terrorist financiers. This includes a wide range Wameek Noor of topics beyond that directly relevant to financial inclusion. For example, FATF recently added international standards to combat financing related to proliferation of weapons of mass destruction. It has also traditionally provided guidance and published typology reports on topics such as anti-corruption, financial investigations, environmental crime, and stolen asset forfeiture and recovery (to prevent or investigate money laundering or terrorist financing emerging from such underlying crimes). 2 See, e.g., speech by FATF President Paul Vlaanderen (2010). 3 http://www.oecd.org/unitedkingdom/financialinclusionandfinancialintegritycomplementarypolicyobjectives.htm 4 In this Focus Note, “FATF Recommendations” refers to the document “International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation.” 5 In this Focus Note, “FATF Financial Inclusion Guidance” refers to the document “Anti-Money Laundering and Terrorist Financing Measures and Financial Inclusion.” 6 In this Focus Note, “FATF NPPS Guidance” refers to the document “Guidance for a Risk Based Approach: Prepaid Cards, Mobile Payments and Internet-Based Payment Services.” Prepaid cards, mobile payments, and internet-based payment services are recognized as key levers to advance financial inclusion. 7 In this Focus Note, “Assessment Methodology” refers to the document “Methodology for Assessing Compliance with the FATF Recommendations and the Effectiveness of AML/CFT Systems.” 2 opportunities—in some cases, even incentives—for in developing financial inclusion-friendly AML/CFT policy makers to adopt inclusion-friendly AML/CFT regimes as well as some foreseeable challenges regimes. This Focus Note provides an overview countries will face that merit further attention, of the relevant FATF standards and guidance, whether from country-level policy makers, from highlighting the topics that are most relevant for FATF and its affiliates, or from the international financial inclusion policymaking, including the community at large. specific standards and guidance that have changed, and suggesting implications for financial inclusion Part I. The Revised FATF policymaking.8 Requirements and Their Significance for Inclusion The discussion is in three parts: The FATF Framework Part I provides background on FATF and the revised FATF operates as a task-force-style collaboration FATF Recommendations and new guidance, and among 34 member countries and two regional outlines the areas of greatest relevance to financial associations. 10 It collaborates closely with eight inclusion affected by the recent FATF action FATF-Style Regional Bodies (FSRBs). These summarized above. These include financial service autonomous bodies have a collective membership providers’ customer due diligence (CDD) practices, 9 of an additional 177 countries.11 All have committed record-keeping and monitoring, remittances and to implementation of the FATF Recommendations, other money transfer service obligations, and which set standards for national AML/CFT special issues relating to agents playing roles in regulation and supervision, covering a broad range AML/CFT compliance. of financial service providers, as well as certain nonfinancial businesses and professions at risk of Part II discusses changes in AML/CFT compliance exploitation for financial crime. The FATF definition assessment introduced in the new Assessment of “financial institution” is activity-focused rather Methodology and considers potential financial than institutional and covers the full range of inclusion implications. Among these, the new focus products and providers of relevance to financial on the effectiveness of a country’s AML/CFT regime inclusion. (Despite this all-encompassing definition, is the most fundamental, given that assessors may many countries still have AML/CFT regimes that are now consider inadvertent financial exclusion as a institution-focused, rather than activity-focused, contextual factor bearing on effectiveness as well which can be both less effective due to coverage as steps taken to increase financial inclusion. gaps and also less financial-inclusion friendly.)12 The FATF Recommendations also call for countries Part III reflects on the road ahead, including both to adopt a range of criminal law enforcement new opportunities for countries to be proactive measures, to establish Financial Intelligence 8 This Focus Note represents CGAP’s interpretation of these recent FATF actions. Policy makers are advised to refer directly to the relevant FATF documents for the complete and official articulation of issues discussed. Some of the examples and illustrations have not yet been discussed in the context of a mutual evaluation. 9 CDD policies are often colloquially referred to as “know your customer” (KYC) policies. However, in other contexts KYC carries somewhat different connotations. Accordingly, in this Focus Note the FATF term CDD is used throughout. 10 The collaboration works within a periodically renewed and updated mandate approved by the finance ministers of FATF member countries. The current 2012–2020 FATF mandate covers financial crime and integrity-related topics beyond the scope of this Focus Note, such as preventing proliferation of weapons of mass destruction. 11 In total, 19 international bodies have observer status at FATF (not including FSRBs, which are referred to as FATF Associate Members), including but not limited to the International Monetary Fund (IMF), the World Bank, the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors, and the Organization for Economic Cooperation and Development. 12 AML/CFT regimes that are institutionally focused may result in an unlevel playing field, as well as gaps in coverage. For example, an electronic wallet for which a nonbank institution serves as the legal issuer of stored value may not be explicitly covered by a given institutionally focused law on AML/CFT, even though an equivalent product offered by a bank would be. While such a coverage gap could result in new entrants offering products that avoid the expense of AML/CFT compliance faced by banks, uncertainty as to their AML/CFT compliance obligations could also discourage nonbank providers that may be better positioned to serve financially excluded and underserved populations. 3 Units (FIUs) to receive, analyze, and disseminate Box 1. Country Risk of Money suspicious transaction reports and to ensure that Laundering and Terrorist Financing Can appropriate regulatory and supervisory bodies Vary Significantly oversee implementation of AML/CFT regulation Money laundering and terrorist financing risks and supervision. vary greatly, from region to region, from country to country, and even subnationally. Pakistan, for FATF, FSRBs, the World Bank, and the International example, which neighbors India, Afghanistan, and Monetary Fund (IMF) use a mutual evaluation Iran, suffered from a number of terrorist attacks in recent years and might have comparatively mechanism to assess the extent to which countries higher terrorist financing risk relative to some have implemented the FATF Recommendations of its more remote South Asian neighbors such (as discussed in Part II). These bodies work as the Maldives and Bhutan. Haiti, a theater in a protracted drug war given its central location cooperatively with countries to undertake country between drug producers to the West and South assessments using the same newly revised and drug consumers to the North, will face different Assessment Methodology.13 money laundering risks relative to countries that lie below the equator and may assess terrorist financing risks comparatively lower. Country-level RBA, Low Risk, and Lower Risk money laundering and terrorist financing risks are Strengthening and clarifying the application of also not static, changing often dramatically over the RBA to AML/CFT regulation and supervision time in accordance with evolving social, political, constituted a central objective of the revisions to and market conditions, subnationally, nationally, regionally, and globally. the FATF Recommendations approved in 2012. The RBA is now a mandatory element of a compliant AML/CFT regime, and the primacy of the RBA is underscored by making identifying, assessing, and of the assessment of risk conducted with respect understanding risks and applying the RBA the first to a given country context. Moreover, the FATF of the revised FATF Recommendations.14 Recommendations call for an assessment of risk to be undertaken both at the country level and at The RBA is fundamental because it recognizes the level of financial service providers operating in the wide variability among countries’ potential that country. FIUs, supervisors, and other relevant exposure to money laundering and terrorist country-level policy makers must therefore be financing, and calls on country-level policy makers knowledgeable, not only about general country- to identify, assess, and understand their own level money laundering and terrorist financing specific risks (see Box 1). The RBA is particularly risks, but also about money laundering and terrorist critical to crafting a financial-inclusion-friendly financing risks that vary according to the nature AML/CFT regime, as it affords the flexibility to and type of the financial service provider, financial tailor risk mitigation policies to the specific nature, service, and customer segment involved. levels, and types of relevant risk of concern in a given market. Financial institutions covered by the The revised FATF Recommendations differentiate AML/CFT regime are required to apply the RBA. between “low risk” and “lower risk” scenarios. In strictly limited circumstances where there is “a The centrality of the RBA in the revised FATF proven low risk of money laundering and terrorist Recommendations puts a premium on the quality financing,”15 countries are permitted to decide not 13 For further explanation of the assessment process, see FATF (2013e, p. 16). 14 Prior to the 2012 revisions, the FATF Recommendations permitted (but did not explicitly require) countries to implement a risk-based approach in relation to some aspects of the AML/CFT regime. This left open the possibility of misinterpretation and inconsistent interpretation in the application of the concept—including among assessors participating in mutual evaluations—undoubtedly contributing to an overly conservative approach, at least in some countries’ AML/CFT regimes. 15 See FATF Recommendations, Interpretive Note to Recommendation 1, p. 31. 4 to apply certain Recommendations to a particular should be read as including other similar business type of provider or activity. FATF has not elaborated relationships between financial institutions and on how a country should “prove” low money their customers.”18 This would imply that the term laundering or terrorist financing risk, leaving this for encompasses some of the types of innovative countries to determine. The concept of lower-risk delivery most relevant to financial inclusion—for scenarios (while also not sufficiently elaborated on, example, a mobile wallet-type stored-value account but does not require countries to “prove” anything), with a mobile network operator or its affiliate. may therefore have greater practical significance for creating AML/CFT regimes that support Similarly, the term “business relationship,” which financial inclusion efforts, at least in the short term appears extensively throughout the revised FATF (see Part III). Where countries identify lower risks, Recommendations, is not defined and is used to they may decide to allow “simplified measures” for refer to a broad range of commercial arrangements some of the FATF Recommendations under certain between parties. Any narrower definition could conditions. 16 The concept of simplified measures risk omitting relevant types of arrangements. In arises importantly with several of the AML/CFT a practical sense, the concept is perhaps best topics of greatest relevance to financial inclusion, understood in counter distinction to “occasional particularly CDD (as discussed in “AML/CFT Topics transactions.” While “occasional transactions” Relevant to Financial Inclusion”). are also not specifically defined in the FATF Recommendations, it is clear from the contexts Accounts and Business Relationships, Occasional in which the concept appears that these are Transactions, and Special Rules for Wire Transfers generally one-off transactions that occur outside and Money and Value Transfer Services an ongoing arrangement between customer and The activity-focused nature of the FATF definition provider (see Box 2). A “business relationship” of “financial institution” 17 calls for a highly flexible could, for example, be a stored-value account in conceptual typology of activities and transactions the customer’s name or loan to a customer. financial service providers might carry out to accommodate widely varying financial systems Special rules for wire transfers and money and and approaches to delivering financial services, value transfer services. Accessible and affordable as well as potentially fast-evolving changes in any means of moving value from one party to given environment. The concepts of “accounts,” another—including electronically and potentially “business relationships,” and “occasional across borders—lie at the heart of innovative transactions” all have special relevance for financial financial inclusion. They are also key to the inclusion—particularly innovative business models massive potential gains in countries’ capacity to for reaching financially excluded customers—as do identify and stop money laundering and terrorist the special rules for “wire transfers” and “money financing that accompany significant progress and value transfer services.” in bringing financially excluded households into the formal financial system. Unfortunately, they Accounts, business relationships, and occasional are also uniquely useful in money laundering, transactions. The term “account” is not defined in terrorist financing, and other types of financial the FATF Recommendations although the General crime because of the speed and frequency with Glossary indicates that “references to ‘accounts’ which value can be moved, potentially over great 16 See FATF Recommendations, Recommendation 1, p. 11. 17 See FATF NPPS Guidance, p. 11. The FATF Recommendations also apply to “designated non-financial businesses and professions” (DNFBPs), such as legal professionals, accountants, dealers in precious metals and stones, casinos, and real estate agents, who are subject to AML/CFT regulation and supervision because they may be involved in handling large amounts of cash or otherwise are in a position to disguise illicit proceeds (General Glossary, FATF Recommendations, p. 113). DNFBPs are generally not discussed in this Focus Note. 18 FATF Recommendations, General Glossary, p. 110. 5 Box 2. A Challenge for AML/CFT Policy Makers: What Constitutes an “Account Based” vs. an “Occasional” Transaction? Innovation—often spurred by financial inclusion card such as a retail store gift card might generally be objectives—is stimulating the introduction of new assumed to qualify as an “occasional transaction” given retail products and services in countries across the that it was purchased only once. Although multiple globe that don’t divide neatly between “account transactions can occur, it is discarded once the monetary based” and “occasional” transactions.a value stored on it is spent. The user has no “account based”/business relationship with the issuer of the card Over-the-counter transactions because no further transactions can be made with the Over-the-counter (OTC) customers might generally be card once the card's orginal value is spent. (See FATF assumed to include those who do not have an electronic Recommendations, General Glossary, p.110.) However, wallet registered to their name and who visit agents from if this same card can be reloaded with funds and used time to time to have the agents conduct remittance or on a recurring basis, the question arises whether the bill paying transactions on their behalf. Such customers relationship between the card’s holder and its issuer might be assumed to be conducting “occasional should be deemed an “account based” relationship. transactions” rather than having an established “business relationship,” as the latter connotes some type What are countries supposed to do? of contractual or legal arrangement in the customer’s As FATF does not define “account,” “business name through which the transactions are processed. relationship,” or “occasional transactions,” the But what if the same customer visits the same agent responsibility falls to countries to provide reasonable frequently to conduct such transactions? Policy makers meanings for these terms, taking into consideration in at least one country are debating whether these the innovations emerging in their markets and creating customers should be viewed as having an established distinctions in their AML/CFT regimes based on local “business relationship” with the agent in question even circumstances. in the absence of any formal account if they conduct OTC transactions as frequently as every month.b a. See, e.g., CPSS (2012, p. 34). b.  This debate exemplifies the practical challenges of applying the FATF Recommendations in practice, particularly for policy Transactions using prepaid cards makers thinking ahead to future mutual evaluations of their AML/ A similar question arises with prepaid cards. Over the CFT regime. If the decision is reached not to treat such OTC transactions as occasional transactions, what might be inferred years, such instruments have reflected a wide range by assessors regarding this decision? It is understandable of business models and associated functionality, that the policy makers in question have requested not to be presenting unique challenges to AML/CFT regulation identified in this Focus Note pending a final decision. and supervision.c For example, a nonreloadable prepaid c. See FATF NPPS Guidance, p. 5. distances and in potentially significant aggregate (where at least two countries’ AML/CFT regimes volume (even if individual transactions are small). come into play) and domestic wire transfers (where only a single country’s rules are implicated).21 They For this reason, there are FATF Recommendations apply to the entire spectrum of organizations dedicated specifically to “money or value transfer facilitating the transfers, from well-known money services” 19 and “wire transfers,” 20 containing a transfer operators such as Western Union to number of special rules of particular relevance remittance corridor-specific “mom and pop” to financial inclusion (as discussed in “AML/CFT providers of “money or value transfer services”—of Topics Relevant to Financial Inclusion”). The rules particular importance to financial inclusion in many distinguish between cross-border wire transfers contexts.22 19 FATF Recommendations, Recommendation 14, p. 17. 20 FATF Recommendations, Recommendation 16, p. 17. The term “remittance” is not used in the FATF Recommendations. “Wire transfers” should be understood as a subset of domestic and cross-border transfers (i.e., those that are accomplished electronically). 21 A super-national entity may petition FATF to be designated as a single jurisdiction for the purposes of (and limited to) an assessment of Recommendation 16 compliance, as, e.g., the European Union/European Economic Area has done (FATF Recommendations, General Glossary, p. 75). As a result, a transfer between Greece and Germany will be treated as a domestic transfer. 22 According to the Glossary for Recommendation 16, “[m]oney or value transfer services (MVTS) refers to financial services that involve the acceptance of cash, cheques, other monetary instruments or other stores of value and the payment of a corresponding sum in cash or other form to a beneficiary by means of a communication, message, transfer, or through a clearing network to which the MVTS provider belongs.” 6 AML/CFT Topics Relevant with the Recommendation on the RBA, calls for to Financial Inclusion policy makers to fashion CDD requirements that do not inadvertently exclude the “unidentifiable” While most of the subjects covered in the FATF poor, and they provide the flexibility necessary to Recommendations and new guidance have a do so (Basel Committee 2014, p. 7).26 bearing on financial inclusion, four topics are most relevant—particularly to the types of innovation Technical components of CDD. While countries are with the greatest potential to be used by massive encouraged to take advantage of this flexibility, numbers of households that are currently financially rules on CDD have to include some essential excluded or underserved. These are CDD practices, components. First, providers must be required record-keeping and monitoring, remittances and to undertake certain CDD measures ( i ) when other money transfer services, and issues relating establishing a business relationship with a customer; to agents playing roles in AML/CFT compliance.23 (ii) when carrying out occasional transactions above USD/EUR 15,000 (or in the case of certain wire Customer Due Diligence transfers, as discussed in “Remittances and Other CDD and financial inclusion. The revised FATF Money Transfer Services”); (iii) if there is a suspicion Recommendations provide greater clarity on the of money laundering or terrorist financing (as application of the RBA to the implementation of discussed in “Record-Keeping and Monitoring”); a financial service provider’s CDD policies—that or (iv) if the provider has doubts about the veracity is, steps taken to identify and verify the identity or adequacy of previously obtained customer of customers and of the “beneficial owners,”24 identification data. to understand the purpose and nature of their financial transactions and to conduct appropriate CDD measures include four elements: ongoing monitoring of customers to ensure that the transactions are consistent with the 1. Customers have to be “identified” and their customer’s profile. Historically, countries have identity “verified” using reliable, independent often included in their AML/CFT regimes inflexible source documents, data, or information. identification and verification requirements that 2. “Reasonable steps” must be taken to identify many poor households cannot meet. For example, the “beneficial owner”27 involved. (In the case customers are required to provide specific types of of individuals—particularly poor customers identification that poor people often do not have, transacting in small amounts—providers or providers are required to verify a customer’s might reasonably assume that the customer is fixed address, which is impossible for billions transacting on his or her own behalf, but in the of people around the world living in informal case of legal entities, establishing beneficial housing (Isern and de Koker 2009). The revised ownership generally will call for additional Recommendation on CDD, 25 when read together examination and verification.) 23 FATF Financial Inclusion Guidance, p. 6. 24 The General Glossary to the FATF Recommendations defines “beneficial owner” as a “natural person(s) who ultimately owns or controls a customer and/or the natural person on whose behalf a transaction is being conducted.” 25 FATF Recommendations, Recommendation 10, p. 14. 26 The Basel Committee on Banking Supervision has recently issued this AML/CFT guidance for banks, which is called on to include risks relating to money laundering and financing of terrorism within their overall risk management framework. Interpreting FATF Recommendation 10 and Basel Core Principle 29, the guidance provides that banks generally should not establish a business relationship, or even carry out transactions, until the identity of the customer has been satisfactorily established and verified. While the Basel Committee guidance acknowledges the flexibility now incorporated in the FATF Recommendations, it does not tackle the questions of banks’ approach to CDD in lower-risk or low-risk scenarios. 27 The General Glossary to the FATF Recommendations defines “beneficial owner” as a “natural person(s) who ultimately owns or controls a customer and/or the natural person on whose behalf a transaction is being conducted.” 7 3. When CDD measures are being carried out the involvement of intermediaries (such as agents, to establish an ongoing business relationship as discussed in “Agents and AML/CFT”), and the between a provider and a customer such as the sophistication of the technology used are examples opening of an account or the extending of a of factors that should be considered by providers loan (rather than in the context of an occasional and country regulators to evaluate the appropriate transaction) the provider must understand and level of CDD applied.29 Nonface-to-face business obtain information, as appropriate, on the purpose relationships or transactions are identified in the and intended nature of the business relationship. FATF Recommendations as presenting potentially 4. For business relationships, the provider must higher risk situations (triggering enhanced, rather be required to conduct ongoing due diligence than simplified, CDD). 30 These requirements on the business relationship and to scrutinize collectively call for creativity in applying the RBA to transactions throughout the course of that reach financially excluded populations, particularly relationship to ensure that the transactions being those in remote, sparsely populated areas where conducted are consistent with the provider’s conventional, face-to-face approaches to CDD are knowledge of the customer, including his or her prohibitively costly yet where there is lower risk business and risk profile. of money laundering and terrorist financing. The answer could be as simple as the use of camera Simplified CDD for lower-risk scenarios. Perhaps phones or voice recognition software, leveraging the most important clarification regarding CDD is the same low-cost technologies that enable financial that countries should design CDD requirements service delivery also to accomplish low-cost CDD. applying the RBA. This includes explicit authorization to apply simplified CDD measures Record-Keeping and Monitoring in lower-risk scenarios (as identified in the risk AML/CFT record-keeping requirements are assessment of the country in question). In the challenging for all financial service providers, but financial inclusion context, this could allow, for have historically presented particular disincentives example, for the concept of “tiered accounts” 28 to move down market. The reason is simple: the in a country’s AML/CFT regime—where limited costs and practical challenges of record-keeping functionality for the bottom tiers lowers the don’t generally decrease in proportion to the associated money laundering and terrorist financing transaction size, and indeed they may increase risk, and consequently justifies simpler approaches (e.g., in the case of serving remote customers). to CDD (see Boxes 3 and 4). Many countries’ existing AML/CFT regimes only contribute to the problem, such as by requiring CDD and nonface-to-face transactions. For AML/CFT the collection and retention of photocopies of purposes, the specific types of business relationships all customer records collected as part of CDD, and transactions involved, the targeted client groups, regardless of the nature of the provider, the 28 The phrase “tiered accounts” in the AML/CFT context refers to a progression of types of accounts, ranging from a basic, low-value product with limited functionality to a conventional transaction account with greater functionality and higher value limits. See Chatain, et al. (2011, p. 111). Account “tiers” directly link the level of CDD to the extent and range of financial services offered to a customer. For example, a level 1 tier could mean that customers are provided with limited and basic services after undergoing a simplified verification. A level 2 tier could mean the customer accesses an expanded range of financial services with higher transactions ceilings provided that further customer verification has taken place. 29 In addition, a separate, particularized risk assessment of the relevant delivery channels is required in the case of new products and business practices, including new delivery mechanisms, and the use of new or developing technologies for both new and pre-existing products (FATF Recommendations, Recommendation 15, p. 17). 30 FATF Recommendations, Interpretive Note to Recommendation 10, p. 63. For example, the risk of nonface-to-face transactions, such as impersonation fraud, will increase in the absence of adequate risk-mitigating controls. See FATF NPPS Guidance, p. 14. However, as noted in FATF Recommendations and underscored in FATF Financial Inclusion Guidance, these examples are given as general guidance only, and the risks may not be higher in all situations (FATF Recommendations, Interpretive Note to Recommendation 10, para 14, p. 63; Financial Inclusion Guidance, p. 34). 8 Box 3. In the Financial Inclusion Context, What Might “Simplified CDD Measures” Involve?a Allowing flexibility to define what constitutes 1.  to the next tier of account with higher transaction “reliable, independent, source documents, data limits and greater functionality. If the customer never or information” for verifying and monitoring migrates to the next tier of account, verification may customer’s identities. not be necessary. Because the FATF Recommendations provide 3.  Reducing the frequency of customer identification flexibility on the types of information collected for updates borne by the provider. the purpose of CDD, countries may be pragmatic For lower-risk scenarios involving an ongoing and creative regarding the type of credible identity business relationship such as a mobile wallet subject verification documents permitted. For example, to low transaction limits, customer information does a customer unable to provide government-issued not need to be updated as frequently as for other identification documents might be allowed to use a categories of products. Frequency of updates should credible letter from a village chief or references from be determined by taking into account the functionality existing customers.b Countries without comprehensive of and controls that apply to the financial product in national or subnational identification systems might the context of local circumstances as documented in allow a range of alternative source documents, with a a country’s assessment of risk. view to positioning all population groups to provide some form of identity verification. 4.  Reducing the degree of ongoing monitoring and scrutinizing of transactions. Verifying the identity of the customer and the 2.  beneficial owner after the establishment of the Relatedly, for such lower-risk scenarios as the business relationship and until the account reaches mobile wallet subject to low transaction limits, the next tier level. it is also permissible to reduce the degree of ongoing monitoring and scrutinizing of transactions When a product presents a lower risk of money (as discussed in “Record Keeping and Monitoring”).e laundering or terrorist financing (e.g., a simplified account with low maximum transaction and balance Not collecting additional information or carrying 5.  limits), the verification of customers’ identity could be out specific measures to understand the purpose postponed, rather than conducting verification before and intended nature of the business relationship. allowing the customer to transact.c This allows, for While collecting information to understand the example, for a customer to open a deposit account purpose and intended nature of the business pending identity verification.d More importantly relationship is an important component of CDD, from a financial inclusion perspective, it allows for the FATF Recommendations allow this information a tiered approach whereby customers may open a to be inferred in lower-risk cases. For example, if very basic account such as a mobile wallet subject to the product is a basic savings account, it may be low transaction limits with minimal upfront identity inferred that the customer opens the account to verification, but the provider must undertake more save money. extensive verification before the customer migrates Italicized text in the five subheadings is paraphrased from the FATF Recommendations, Interpretive Note to Recommendation 10, a.  p. 66, and FATF Financial Inclusion Guidance. In some cases, such an approach may be the only one practicable. However, regulators should always be mindful of potential b.  unintended ancillary consequences. For example, where regulations were amended to allow those who do not have formal proof of their personal particulars to present letters of affirmation drafted by their employers, it was found to increase the power and hold of employers over vulnerable employees, and in some cases where village chiefs were allowed to draft such letters, the chiefs started to demand money for these “verification services.” See de Koker (2011). c. The postponement of verification is permitted in other contexts as well, not just in situations of low risk. Although this provision facilitates the opening of deposit accounts by lower-income clients, it also raises questions at a practical level d.  in case clients are not able to reach the verification threshold. For example, do their monies remain frozen while they try to reach the verification threshold? Will the bank return the funds when it lacks assurance, including assurance that the person in front of them is the person who opened the account? These are just a few illustrative questions that will need to be addressed through the development of appropriate business practices and regulation at the country level. In determining an appropriate approach to CDD, the degree of ongoing monitoring required should also be considered together with e.  the approach taken to upfront identification and verification: relaxed requirements at the identification and verification stages could hamper certain aspects of monitoring the business relationship over time. 9 technical components—of the record-keeping and Box 4. Are Anonymous Accounts monitoring requirements under the revised FATF Allowed? Recommendations and new guidance. With respect to The FATF Recommendations clearly prohibit “anonymous accounts,” as customers must be record-keeping, these are straightforward: providers identified and their identity verified in establishing must maintain records on transactions for at least five the business relationship.a Yet the concept of years; CDD records (e.g., identification documents anonymity is not defined. Poor customers transacting such as passports) must be held for at least five years in their community using only cash are clearly transacting anonymously for AML/CFT purposes in after the business relationship is ended, or after the the sense that the transactions cannot be tracked date of an occasional transaction.31 With respect to through the formal financial system. When these monitoring and suspicious transaction reporting, customers accomplish the same transactions using a mobile wallet with strict limits on the amounts and providers of all types are called on continually to frequency involved and number of other parties monitor money laundering and terrorist financing with whom they can transact, the money laundering risks emerging from their business, including and terrorist financing risk may remain low while outsourced relationships, such as agent networks, minutely specific “financial identities” emerge, associated with the SIM cards used. Moreover, and to report suspicious and unusual transactions to these SIM-based identities, coupled with the their country’s FIU.32 feasibility of mapping transaction flows down to the level of specific cell phone towers and agent Clarifications on record-keeping. For purposes of locations, offer both providers and law enforcement new means of discerning suspicious transactions fashioning a financial-inclusion-friendly AML/CFT and finding perpetrators of financial crime. The regime, the important clarification about record- phenomena also trigger strong reactions from some keeping to be gleaned from the revised FATF privacy advocates across the country income level spectrum. An alternative policy approach permitted Recommendations and new guidance lies in the under the revised FATF Recommendations and new flexibility now explicitly permitted regarding the guidance would involve targeted exemptions from manner in which records are gathered and kept. CDD requirements for such specially designed and For example, the provider may scan documents limited basic accounts, based on a finding of proven low risk.b and store electronic copies or hold physical photocopies, or staff may simply record details a FATF Recommendations, Recommendation 10, p. 14. bAs observed above, and as noted in “Foreseeable Challenges manually. 33 This explicitly permitted flexibility Meriting Further Attention,” FATF has not yet offered positions regulators to accommodate record- insights into how a country or provider “proves” low risk. keeping that is practical and inexpensive for the smallest microfinance institution or the most vast and diverse network of mobile wallet cash-in/cash- customer, or the transaction. Similarly, monitoring out agents. transactions can be prohibitively expensive for providers trying to serve excluded customers unless Clarifications on monitoring transactions. Given the they are risk-adjusted (something not provided for adverse commercial and regulatory consequences in many existing AML/CFT regimes). that may emerge from illicit financial transactions flowing through their systems, mainstream financial Technical components of record-keeping, monitoring, service providers have an incentive to invest heavily and suspicious transaction reporting. Such country- in automated transaction monitoring and pattern level rigidity in record-keeping and monitoring detection systems and related human resources. requirements run counter to the spirit—and the Under the revised FATF Recommendations and 31 FATF Recommendations, Recommendation 11, p. 15. 32 FATF Recommendations, Recommendation 20, p. 19. 33 Financial Inclusion Guidance Paper, para. 111, p. 39. 10 new guidance, the level and form for ongoing financial services that poor customers want and monitoring of customers and transactions should need (CGAP 2013).36 be risk-based. The degree of monitoring should therefore be determined with reference to the Technical components of remittances and other risks associated with customer segments and the money and value transfer services. As observed, products or services these customers use. This the FATF Recommendations distinguish between means that cost-effective monitoring could be domestic remittances (where only a single country’s done manually in the case of a small microfinance AML/CFT regime comes into play) and cross- institution where personal knowledge of staff border remittances (where at least two countries’ position them to identify suspicious transactions, AML/CFT regimes—the sending country and the but via sophisticated electronic transaction receiving country—need to be considered).37 Also, monitoring and pattern-detection systems in the because of the speed and frequency with which case of a mobile network operator offering mobile value can be moved electronically, potentially wallets through a vast network of agents. 34 over great distances and in potentially significant aggregate volume (even if individual transactions Remittances and Other Money Transfer Services are small), a separate Recommendation is Remittances, other money transfer services, and dedicated to the subject of “wire transfers” 38 (both financial inclusion. Remittances—money sent from domestic and cross-border), which under FATF’s earners in one location to a distant household or definition is any electronic transfer. 39 The wire community—have been recognized as a lifeline for transfer rules apply to any kind of money or value poor families (Dilip 2005). Cross-border remittances transfer service, from huge bulk fund transfers are critical components of the economy in many via SWIFT to person-to-person (P2P) transactions lower-income countries; therefore it is a worrying through the smallest money transfer operators;40 trend that the accounts of many remitters are however, the rules vary between account-based currently under threat of closure (see Box 5).35 transfers and occasional transactions (to the extent More broadly, the capacity to move money or value CDD requirements with respect to the party electronically—inexpensively and conveniently— sending or receiving the transfer have already from one place to another (referred to as “money been met).41 or value transfer services” [MVTS] in the FATF Recommendations) is critical to the goal of financial Under the FATF Recommendations and new inclusion, given the potential to build on other guidance, for both account-based transfers 34 Even sophisticated transaction monitoring and pattern detection systems will not obviate the need to involve employees or agents, because they can observe facts about customers that are not captured as data in the systems. 35 The World Bank estimates that in some areas of Somalia, remittances accounted for more than 70 percent of GDP in 2006. See, also, Dilip (2012). In countries such as Tajikistan, it is estimated at 47 percent of GDP (April 2013). See http://siteresources.worldbank.org/ INTPROSPECTS/Resources/334934-1288990760745/MigrationDevelopmentBrief20.pdf 36 See, also, Todoroki, Noor, Celik, and Kulathunga (2014). 37 More than two countries’ AML/CFT regimes could be involved in the case of rules governing obligations of intermediaries; e.g., a remittance transfer between Canada and Jamaica may involve a U.S. bank as an intermediary, thus triggering the AML/CFT regimes of all three countries. The distinction between domestic and cross-border remittances is drawn in FATF Recommendation 16 (Wire Transfers). 38 The FATF Glossary of Specific Terms used in the Interpretive Note to Recommendation 16 defines a wire transfer as “any transaction carried out on behalf of an originator through a financial institution by electronic means with a view to making an amount of funds available to a beneficiary person at a beneficiary financial institution, irrespective of whether the originator and the beneficiary are the same person” (p. 76). 39 FATF Recommendations, Recommendation 16, p. 17. 40 Recommendation 16 aims to ensure that basic information on the originator and beneficiary of wire transfers is immediately available to relevant authorities and financial institutions. The Recommendation does not cover debit, credit, or prepaid cards if they are used for the purchase of goods or services and an accompanying identification number is able to track the full payment transaction. However, it does apply when these payment instruments are used to conduct person-to-person remittances. 41 FATF Financial Inclusion Guidance, p. 25. 11 Box 5. The Challenge of Cross-Border Remittances to Conflict Hotspots: The Case of Somalia In post-conflict and fragile states such as Somalia, sufficient comfort to providers and regulators that money transfer businesses operating from diaspora integrity risks are adequately mitigated. It will develop communities abroad are essential to the very survival its guidance through the following: of large segments of the population. Moreover, given Identifying associated financial crime risks (led by 1.  the country’s underdeveloped financial infrastructure, the National Crime Agency). This includes providing AML/CFT-related obligations at the receiving end more detailed and specific risk assessments and are inherently challenging to discharge. Recently a alerts about the sector to banks and money transfer number of U.K. banks, including most notably HSBC businesses, to help differentiate the risks involved and Barclays, have moved to terminate hosting in dealing with different money transmitters. relationships with hundreds of such money transfer businesses operating in Somalia and other countries 2.  Improving supervisory guidelines (led by Her purportedly due to concerns regarding questionable Majesty’s Revenue and Customs). This will entail AML/CFT compliance policies.a The actions by the U.K. increasing “days of action” with law enforcement as banks are increasingly mirrored by those of banks in well as the number of risk-targeted supervisory visits other remittance-sending countries such as the United Her Majesty’s Revenue and Customs undertakes States.b Indeed, this is not a new phenomenon; large to provide further confidence that noncompliant banks in the United States and Canada took similar money transmitters are being required to improve actions over the past decade, although the recent or are removed from business. Her Majesty’s U.K. and U.S. actions have attracted additional media Revenue and Customs will also provide further outcry given the severe humanitarian implications in training to money transmitters to help them achieve Somalia.c an effective level of compliance. The U.K. government is attempting to better Creating and testing the possibility of a “safer 3.  understand and address the situation by establishing corridor” pilot between the United Kingdom a national-level “Action Group on Cross Border and Somalia (led by DFID). The pilot will create Remittances.” Comprising of relevant domestic and test alternative mechanisms in which certain agencies in the United Kingdom, including the National money transfer operators could continue operating Crime Agency, Her Majesty’s Revenue and Customs in Somalia in an environment that provides (the national tax authority in the United Kingdom), and sufficient comfort to bank partners and regulators. the U.K. Department for International Development It is expected that this work will lead to certain (DFID), the Action Group has a 12-month mandate and regulatory, operational, and commercial models will focus on identifying policy recommendations that that could be replicated globally, with application would ensure continuation of vital formal remittance to remittance corridors facing comparable market flows to fragile states such as Somalia while providing environments and dynamics.d a. In May 2013 in the United Kingdom, e.g., Barclays Bank, which at the time was estimated to hold more than 200 money transfer accounts of businesses in the United Kingdom, gave 60 days’ notice of its intention to close money transfer business accounts that did not meet its new eligibility criteria. See http://www.bankingtech.com/154562/barclays-under-fire-for-outrageous-remittance- closures/. Barclays and some other banks have expressed their rationale in public press releases. See, e.g., https://www.newsroom. barclays.com/Press-releases/Barclays-statement-on-Money-Service-Businesses-aa8.aspx. While the U.K. government is looking at alternatives, the concern is real for the dramatic impact this would have on the lives of millions. http://www.theguardian.com/ global-development/2013/jun/24/somalis-barclays-remittance and http://www.theguardian.com/global-development/2013/oct/16/ barclays-somalia-remittances-court-ruling, https://theconversation.com/banks-move-on-money-remitters-but-will-it-really-combat- crime-16969 b. Large banks such as JPMorgan Chase (Rapid Cash product), Bank of America (SafeSend product), and Citigroup’s BANAMEX USA unit (prompted by a federal criminal investigation related to money laundering) have eliminated low-cost money transfer options catering to some low-income immigrant populations, in particular Mexican immigrants sending remittances to their families back home. Regulators acknowledge that banks must now invest significantly more to monitor the money moving through their systems or risk substantial penalties (Corkery 2014). c. Somali money transfer businesses in the United States are facing similar challenges. See, e.g., National Public Radio (2014). d. Written Ministerial Statement, Money Service Businesses, HM Treasury (10 October 2013). See http://www.parliament.uk/documents/ commons-vote-office/October%202013/10%20October/2.CHANCELLOR-money-service-businesses.pdf 12 and occasional transactions, 42 countries may services. The revised FATF Recommendations and significantly reduce information requirements for new guidance reflect a growing recognition that cross-border wire transfers below USD/EUR 1000.43 overly strict CDD requirements disproportionate For these transactions, the minimum information to the risks observed regarding remittances and required is ( a ) name of the originator of the other money transfer services threaten financial wire transfer (the remittance sender), ( b) name inclusion goals and risk relegating poor customers of the beneficiary (the remittance recipient), to informal means of moving funds, and that this, and (c) account number of both the sender and in turn, compromises a country’s capacity to trace recipient (if the transfer is account to account) transactions and identify suspicious patterns. The or, alternatively, a unique transaction reference interpretive note to the Recommendation on wire number for the transaction. Importantly, this transfers states that to accomplish the objectives customer information does not need to be verified, of the Recommendation “countries should have the unless the transaction is viewed as suspicious or ability to trace all wire transfers” but should also unusual by the provider. take into account “the risk of driving transactions underground and the importance of financial For domestic wire transfers (including domestic inclusion. It is not the intention of the FATF to remittances) below USD/EUR 1000, and applicable impose rigid standards or to mandate a single to account-based and occasional transactions, operating process that would negatively affect the the requirements are even fewer: only the name payment system.”46 of the remittance sender is required, and this does not need to be asked for upfront if it can Agents and AML/CFT be made available to the recipient financial Agents and financial inclusion. In increasing institution and relevant authorities through other numbers of countries worldwide, agents47 are being means, such as an account number or unique used by banks and other financial institutions as a transaction reference number that can trace the way to reduce cost and increase outreach to low- transaction back to either the remittance sender or income customers—often these are customers who recipient.44 Further, for domestic and international could not be reached profitably with traditional remittances, where remittances and other money branch-based financial service delivery. The models transfers are made specifically from existing vary widely from country to country and even within accounts, there is no need to perform CDD each some countries. The common feature of agents time a remittance transfer is made following the (as the term is used in this Focus Note) is that a initial account opening. 45 party other than the legal provider of the financial service—typically a local retail establishment— New recognition of financial exclusion risks in interacts with retail customers, often serving as the the area of remittances and other money transfer cash-in/cash-out point and potentially performing 42 FATF Financial Inclusion Guidance, p. 38, and FATF Recommendations, FATF Recommendation 10, p. 14. 43 Countries may elect to set a lower threshold in their AML/CFT regime. For cross-border wire transfers over USD/EUR 1000 (or the applicable lower threshold), the required information includes (a) the name of the originator; (b) the originator account number where such an account is used to process the transaction; (c) the originator’s address, or national identity number, or customer identification number, or date and place of birth; (d ) the name of the beneficiary; and (e) the beneficiary account number where such an account is used to process the transaction. The information about the originator needs to be verified for accuracy. And this information needs to be sent through the payment chain. See Interpretative Note to Recommendation 16 (Cross-Border Qualifying Wire Transfers), para 6. 44 FATF Recommendations, Interpretive Note to Recommendation 16, p. 72. 45 As mentioned in Box 4, “account” based remittance transfers could enable reductions in frequency of customer identification updates. This would suggest that CDD would not need to be done every time a remittance transaction is made by a specified account that is used by the specified account holder (after the initial transaction). 46 FATF Recommendations, Interpretive Note to Recommendation 16, p. 71. 47 In this Focus Note, an agent is considered any third party acting on behalf of a bank (or other principal), whether pursuant to an agency agreement, service agreement, or other similar arrangement. 13 other functions as well on the financial service of the providers of the money or value transfer provider’s behalf. 48 services (see “Accounts and Business Relationships, Occasional Transactions, and Special Rules for Wire FATF’s approach to agents. FATF considers agents Transfers and Money and Value Transfer Services”). an extension of the financial service provider, which remains responsible for the agents’ actions Implications of the revised FATF Recommendations and for ensuring agents’ compliance with FATF and new guidance for the use of agents. The norms. 49 This includes the requirements outlined previous version of the FATF Recommendations above on CDD, record-keeping, monitoring, and preceded widespread use of agents as they reporting suspicious transactions, as well as wire are used today around the world to advance transfers and money and value transfer services. financial inclusion. Among the challenges to the Agents’ roles in record-keeping, monitoring, use of agents historically was the country-level and reporting suspicious transactions vary based interpretation given to the requirement that on the model in question, 50 and there are often third parties to which a provider outsourced CDD opportunities to use the same communications responsibilities be “licensed or registered” by the infrastructure by which transaction details are competent national authority.52 The revised FATF transmitted between providers and agents Recommendations still require that money or value (such as mobile phones) also to facilitate remote transfer service providers be licensed or registered compliance, though at a minimum agents must be by the country’s competent authority. However, involved in identifying and reporting suspicious Recommendation 14 explicitly permits such transactions, as they are the ones dealing directly providers to satisfy the licensing or registration with customers. (See Box 6.) requirement with respect to their agents53 simply by maintaining an updated list of them and making Cash-in/cash-out functions relating to wire the list accessible to relevant competent authorities transfer services51 fall within FATF’s definition of if and when requested.54 This is crucial as it applies, money and value transfer services; therefore, the not just to the agents of banks and other traditional Recommendations applicable to wire transfers suppliers of money or value transfer services, but and money and value transfer services apply to also to agents of the entire range of stored-value agents that perform such functions on behalf issuers that satisfy FATF’s definition of money 48 FATF defines the term “agent” as follows for the purposes of Recommendations 14 and 16: “agent means any natural or legal person providing MVTS on behalf of an MVTS provider, whether by contract with or under the direction of the MVTS provider” (FATF Recommendations, General Glossary, p. 110). It should be emphasized that FATF contrasts “reliance on third parties” (Recommendation 17) with an outsourcing or agency relationship, stating that the “third party will usually have an existing business relationship with the customer, which is independent from the relationship to be formed by the customer with the relying institution, and would apply its own procedures to perform the CDD measures. This can be contrasted with an outsourcing/agency scenario, in which the outsourced entity applies the CDD measures on behalf of the delegating financial institution, in accordance with its procedures, and is subject to the delegating financial institution’s control of the effective implementation of those procedures by the outsourced entity” (Interpretive Note to Recommendation 17, p. 77). 49 Indeed, the revised FATF Recommendations and new guidance make it clear that even when a third party dealing with customers on a provider’s behalf is itself a financial institution “adequately subject to AML/CFT regulation and supervision by a competent authority,” the provider retains ultimate responsibility for customer identification and verification (FATF Financial Inclusion Guidance, p. 35). 50 “AML/CFT functions of the principal financial institution and its agents should be seen as complementary and inclusive, keeping in mind that the principal financial institution bears ultimate responsibility for compliance with all applicable AML/CFT requirements” (FATF Financial Inclusion Guidance, p. 143). 51 An example of cash-in/cash-out transactions relating to wire transfers is a person-to-person remittance transfer of any form. Such functions would not include cash-in/cash-out transactions for bill payments, merchant payments, and other such services currently offered by agents of financial service providers in an increasing number of developing countries. 52 FATF Special Recommendations (2001, p. 14, Rec. SRVI [alternative remittance]). 53 FATF has a special definition for agents of money and value transfer service providers, which the General Glossary defines as “any natural or legal person providing money or value transfer service on behalf of an MVTS provider, by contract with or under the direction of the MVTS provider” (FATF Recommendations, p. 110). 54 FATF Recommendations, Recommendation 14, p. 17. 14 Box 6. Using Agents in AML/CFT Compliance: Illustrative Examples from Three e-Money Issuers Table B6-A illustrates which entities are operationally AML/CFT compliance management among e-money involved on behalf of e-money issuers in managing issuers can vary significantly across the diversity of AML/CFT compliance for particular stages of a typical business models that now exist around the world. P2P transaction. The comparisons have been made Therefore, the practices of the three highlighted assuming that customers have registered electronic e-money issuers—M-PESA in Kenya, G-Cash in the wallets (e-wallets) with the e-money issuer in question, Philippines, and Easypaisa in Pakistan—might not be and thus are treated as account-based, rather than applicable to other business models. occasional, transactions. Table B6-A. Using Agents in AML/CFT Compliance M-PESA G-Cash Easypaisa Initial e-Wallet Opening A, CM CM A, CB Entities Operationally Involved in Cash-In/ A, ATM A, ATM A, ATM, B Cash-Out Transactions Identification for Cash-In/Cash-Out Transactions A A A Verification for Cash-In/ Cash-Out Transactions A, CM A, CM CB Transaction Monitoring for P2P Transactions CM CM CB Nonface-to-Face Account Opening* A, C, CM A, C, CM A, B, CB Record Keeping A, CM, O A, CM, O A, CB, O Reporting Suspicious Transactions** A, C, CM A, CM C, CB Blocking Suspicious Transactions A, CM A, CM CB * For purposes of this table, “face to face” account opening takes place at a branch or other physical premises staffed by the financial institution’s employees, not using agents and not allowing the customer to automatically register for the e-wallet himself/herself. ** For purposes of this table, reporting suspicious transactions refers to the entities that may be operationally involved in some form to report suspicious transactions, not the entity legally authorized to report suspicious transactions. A 5 agent; ATM 5 automated teller machine; B 5 branch personnel; C 5 customers; CB 5 Central Bank; CM 5 central compliance; NA 5 not applicable (nonexistent practice); O 5 other outsourced entity on behalf of central compliance Source: M-PESA, G-Cash, Easypaisa, 2014. or value-transfer service providers and whose value transfer services. Many agents, for example, business models potentially depend on vast agent facilitate merchant payments, which are excluded networks that may be impossible to license or from the FATF definition of money or value transfer register individually.55 services. These agents may, for example, also facilitate delivery of microinsurance, savings, and The cost-reducing implications of this FATF credit products. In the case of M-Shwari in Kenya, provision are significant and translate into potential for example, agents facilitate access to a savings for increased outreach to financially excluded and credit product; the agents are managed by customers. It should be noted, however, that the a mobile network operator, although the legal service offerings available through agents of banks provider of the loans and savings accounts remains and other similar financial institutions in many a bank.56 For such agents, a country’s AML/CFT countries are not always confined to money or regime should calibrate the degree of oversight 55 For all agents falling within FATF’s definition, the MVTS provider is required to include them in its AML/CFT programs and monitor them for compliance with these programs (FATF Recommendations, Recommendation 14, p. 17). 56 See, e.g., https://www.safaricom.co.ke/personal/m-pesa/m-pesa-services-tariffs/m-shwari. Because the FATF Recommendations are activity based, rather than based on institutional type, if nonbank agents and bank agents in a given country offer identical financial services, the country’s AML/CFT regime should accord them identical treatment. 15 (by both the providers hiring them and the relevant collectively comprise nearly all the countries authorities) to the specific services the agents offer in the world—participate, with FATF and the and the risks they represent. separate FSRBs each conducting evaluation of its members.59 The new FATF guidance also takes stock of the importance of agents to an inclusion-friendly AML/ Mutual evaluations are either conducted by teams CFT regime in additional respects. The nature of composed of AML/CFT experts from FATF and the typical retail establishments serving as agents FSRB member countries or by teams led by the to reach financially excluded populations is now World Bank or the IMF. The evaluations are a understood, as is the fact that they see only part cooperative activity between the evaluating of the transactional picture with respect to a given teams and the evaluated country. The result is a customer. 57 Mutual Evaluation Report, which is submitted for adoption by the FATF Plenary (including for mutual Part II. Enforcement—The New evaluations conducted by the IMF or the World FATF Assessment Methodology Bank) or the relevant FSRB. This report becomes publicly available, and countries found to be FATF is unique among the global standard-setting insufficiently compliant are called on to improve bodies in that it has a comprehensive mechanism their AML/CFT regimes based on the report’s for assessing compliance with all its standards and recommendations. A follow-up process with a peer pressure mechanism to address compliance countries’ reporting on progress made to address deficiencies.58 The new Assessment Methodology the deficiencies identified is organized after the carries significant potential ramifications for publication of the report. financial inclusion. Among these, the new focus on the effectiveness of a country’s AML/CFT regime The FATF Lists and Their Ramifications is the most fundamental, given that assessors may A Mutual Evaluation Report, which identifies a now consider both inadvertent financial exclusion number of deficiencies, holds potential adverse and steps taken to increase financial inclusion as economic implications for a country. 60 This factors that may affect how effective the systems negative potential increases when a country is are at reaching their objectives. placed on one of FATF’s public lists of high-risk jurisdictions presenting major deficiencies and not Background making sufficient progress in addressing them. The listing process is overseen by FATF’s International FATF Mutual Evaluations Cooperation Review Group (ICRG). 61 Countries FATF’s Mutual Evaluations Reports, now entering are referred to ICRG if they hold a specified their fourth round, are the means by which threshold of key deficiencies based on their latest compliance with FATF standards is assessed. Mutual Evaluation Report, do not participate All FATF and FSRB member countries—which in the global network as a member of FATF or 57 “Retailers generally have only partial knowledge of the transactions conducted by the customer (i.e., the transaction conducted in their particular shops)” (FATF Financial Inclusion Guidance, p. 43). 58 The Basel Committee on Banking Supervision has implemented an assessment program for country-level compliance with the Basel III Capital Accords, though the program does not assess compliance with Basel Committee standards and guidance across the board (April 2012 Basel III regulatory consistency assessment program). See http://www.bis.org/publ/bcbs216.pdf. 59 For the schedule of mutual evaluations as of April 2014 for FATF and FSRBs, and conducted by FATF, FSRBs, IMF, or the World Bank, see http:// www.fatf-gafi.org/media/fatf/documents/assessments/Global-Assessment-Calendar.pdf. In countries such as Mexico, which is both a FATF and an FSRB member, FATF’s policy is that FATF members that are also members of FSRB(s) will undergo a joint evaluation by these bodies. 60 See, e.g., http://allafrica.com/stories/201404100466.html (9 April 2014). 61 As of June 2014, FATF is currently reviewing the ICRG process, to align it with the new 4th Round of Mutual Evaluation follow-up processes. 16 an FSRB, or are referred by any FATF member pressure for countries to improve their AML/CFT country. Each ICRG-reviewed country is provided regimes. an opportunity to participate in face-to-face meetings with the relevant ICRG regional review FATF’s tiers of public lists of high-risk jurisdictions— group to discuss the report, as well as the chance colloquially referred to as the “grey, dark grey, and to develop an action plan with FATF to address black lists”—trigger four different possible calls the identified deficiencies. The agreed action for action by FATF (determined by consensual plan, which is not a public document, provides the agreement among FATF member countries during basis for evaluating progress. FATF specifically a thrice yearly FATF Plenary meeting) as shown in requests high-level political commitment from Table 1. each reviewed jurisdiction to implement these action plans, which are updated as reforms are FATF itself has no independent sanctioning implemented. FATF publically reports progress authority. However, Recommendation 19 states (or lack of progress) on the action plan and its that countries should require financial institutions underlying rationale, providing significant peer to apply enhanced due diligence when this is called Table 1. FATF’s Public Lists, as of June 2014 Number of FATF Listing Categories FATF Call for Action Countries BLACK (with call for “The FATF calls on its members and other 2 counter-measures) jurisdictions to apply counter-measures to High-risk and noncooperative protect the international financial system from jurisdictions the on-going and substantial money laundering and terrorist financing risks emanating from the jurisdictions.” BLACK “The FATF calls on its members to consider the 4 Jurisdictions that have not made risks arising from the deficiencies associated with sufficient progress in addressing the each jurisdiction.” deficiencies or have not committed to an action plan developed with the FATF to address the deficiencies DARK GREY “The FATF is not yet satisfied that the following 0 Jurisdictions not making sufficient jurisdictions have made sufficient progress on their progress action plan agreed upon with the FATF. The most significant action plan items and/or the majority of the action plan items have not been addressed. If these jurisdictions do not take sufficient action to implement significant components of their action plan by xx, then the FATF will identify these jurisdictions as being out of compliance with their agreed action plan and will take the additional step of calling upon its members to consider the risks arising from the deficiencies associated with the jurisdictions.” GREY “The FATF calls on these jurisdictions to complete 22 Jurisdictions that have made the implementation of action plans expeditiously “high-level political commitment and within the proposed timeframes. The FATF to address the deficiencies through will closely monitor the implementation of these implementation of an action plan action plans and encourages its members to developed with the FATF” consider the information [FATF] presented [on the countries].” Source: FATF. http://www.fatf-gafi.org/topics/high-riskandnon-cooperativejurisdictions/documents/public-statement-june-2014.html and http://www.fatf-gafi.org/topics/high-riskandnon-cooperativejurisdictions/documents/fatf-compliance-june-2014.html 17 for by FATF and “apply countermeasures when met the technical requirements of FATF standards. called upon to do so by the FATF.” FATF’s calls to Effectiveness was used only as a variable to adjust action have historically been heeded, particularly the ratings. The new Assessment Methodology with respect to countries listed as high risk and dramatically changes this dynamic by introducing, noncooperative.63 in addition to the technical assessment component, a component analyzing the effectiveness of the For grey-listed countries the consequences may be evaluated AML/CFT regime—that is, the extent less severe than for black-listed countries, including to which the regime actually accomplishes its those for which counter-measures are called for, objective to prevent money laundering and terrorist though still substantial, potentially affecting not just financing. For example, the new Assessment the decision making of foreign financial institutions Methodology calls for judgments on whether the with respect to business in the country in question, prescribed AML/CFT preventive measures are but also the contracting and investment decisions commensurate to particular risks faced, which of companies across the economic spectrum. 64 would have a bearing on the overall effectiveness of a country’s AML/CFT regime. A country with Unfortunately there is little empirical evidence negligible domestic capital markets and high use analyzing the aggregate economic impact on of cash might be found to have an ineffective AML/ countries of appearing on these lists; the economic CFT regime if it is spending significant money and effects of criminal flows of funds have also not been staff resources policing its companies’ registries extensively studied by economists to date. 65 and securities sector, instead of focusing on the area of high risk. Conversely, an effective AML/ New Assessment Methodology CFT regime for a sophisticated financial center and Financial Inclusion providing easily usable incorporation services would need to include close attention and devote Assessment Methodology Components and Their significant resources to such issues (Pesme and Van Relationship Der Does 2014). Given the potential political and economic consequences, fear of negative Mutual Evaluation The effectiveness and technical assessments are Reports has historically steered some countries linked enquiries. In the majority of cases, a low level toward “over-compliance” with aspects of the of technical compliance will probably result in a FATF Recommendations—sometimes with a low level of effectiveness. For example, the lack of particular adverse impact on financial inclusion appropriate laws and regulations to combat money (Isern and de Koker 2009). The assessment laundering and terrorist financing would mean that methodology used before the 2012 revisions to authorities do not have a sufficient legal basis to the FATF Recommendations primarily evaluated prevent—or possibly even to investigate—financial the extent to which a country’s AML/CFT regime crime and other illicit activities. 66 This technical 63 In FATF’s February 2014 Public Statement regarding Iran and North Korea, e.g., FATF called on its members and other jurisdictions to apply counter-measures (which could be interpreted as including sanctions) “to protect the international financial system from the on-going and substantial money laundering and terrorist financing risks emanating from the jurisdictions.” http://www.fatf-gafi.org/topics/high-riskandnon- cooperativejurisdictions/documents/fatf-public-statement-oct-2013.html. See, also, Wright (2008). 64 See Byron (2014). Further, see Halliday, Levi, and Reuter (2014). 65 While the literature is minimal, the IMF has published research examining the macroeconomic impacts of some countries faced with AML/ CFT sanctions. See IMF (2011, pp. 82–83). 66 Many countries, e.g., have AML laws and regulations that comply with the FATF Recommendations, but they lack FATF-compliant CFT laws and regulations. See, e.g., http://www.fatf-gafi.org/topics/high-riskandnon-cooperativejurisdictions/documents/public-statement-feb-2014. html. Indeed, a primary motivation for FATF public listing of many countries currently listed is nonexistent or deficient CFT laws and regulations. 18 deficiency would generally also dictate low AML/ • Other contextual factors that could influence the CFT effectiveness levels in the country. way AML/CFT measures are implemented and how effective they are (such as the maturity and It is also possible that a highly technically compliant sophistication of the regulatory and supervisory country does not have an AML/CFT regime that regime in the country, the level of corruption, and addresses its risks with a similarly high level of the impact of measures to combat corruption or effectiveness. This possibility is particularly relevant the level of financial exclusion).69 to financial inclusion. A country might, for example, have technically compliant AML/CFT measures Technical Compliance Component in place that protect its formal financial services The technical compliance component of the new against criminal abuse, but which in turn are so Assessment Methodology evaluates the design strict or expensive to comply with that the majority of a country’s legal, regulatory, and supervisory of the population is compelled to use informal framework for AML/CFT against FATF’s technical services. requirements, for example, whether the country has criminalized money laundering and terrorist The starting point for every assessment, applicable financing as prescribed and whether the required to both the technical compliance component and regulatory authorities were created and endowed the effectiveness component, is the assessors’ with relevant powers. The technical compliance identification, understanding, and assessment of assessment does not consider whether laws and the country’s risks and context, in the widest sense, authorities are effective, but merely whether they and elements that contribute to them. 67 In this exist and are sufficient to meet FATF’s technical regard, there are four broad areas assessors should standards. For each of the FATF Recommendations, consider—risks, materiality, structural elements, assessors should reach a conclusion about the and contextual factors: 68 extent to which a country complies (or not) with the standard. There are four possible levels of technical • The nature and extent of the money laundering compliance: compliant, largely compliant, partially and terrorist financing risks in the country. compliant, and noncompliant.70 • The circumstances of the country affecting the materiality of different Recommendations (e.g., Effectiveness Component the makeup of its economy and its financial sector). High-Level Outcome, Intermediate Outcomes, • Structural elements that underpin the AML/ and Immediate Outcomes. The Assessment CFT regime (e.g., political stability; a high-level Methodology defines effectiveness as the “extent commitment to address AML/CFT issues; stable to which the defined outcomes are achieved.”71 institutions with accountability, integrity, and The “High-Level Outcome” for any AML/CFT transparency; the rule of law; and a capable, regime under evaluation is that “[f]inancial systems independent, and efficient judicial system). and the broader economy are protected from the 67 For additional information on the key pillars of the risk assessment, see FATF (2013c, p. 21). 68 See Assessment Methodology, pp. 5 and 130. The Mutual Evaluation Report template calls for a section setting out the country’s main policies and objectives for combating money laundering and terrorist financing, “noting where there are also wider policy objectives (such as financial inclusion) which affect the AML/CFT strategy” and calls on assessors to “note any other contextual factors that might significantly influence the effectiveness of the country’s AML/CFT measures,” including such issues as financial exclusion (Assessment Methodology, Annex II—Mutual Evaluation Report Template, p. 130). 69 FATF makes a distinction between “structural elements” and “other contextual factors,” though there could be overlap among them. Structural elements define the baseline environment relevant to AML/CFT, whereas “other contextual factors” connote a broader universe of factors bearing on overall technical compliance and effectiveness (including unique, context specific factors that may not be easily grouped in the three other key criteria). 70 In exceptional circumstances, a Recommendation may also be rated as not applicable (Assessment Methodology, p. 11). 71 Assessment Methodology, p. 14. 19 threats of money laundering and the financing of Box 7. Immediate Outcomes Indicating terrorism and proliferation, thereby strengthening an Effective AML/CFT Regimea financial sector integrity and contributing to safety and security.”72 Three “Intermediate Outcomes” Money laundering and terrorist financing risks   1.  are understood and, where appropriate, actions contribute to the “High Level Outcome,” and they coordinated domestically to combat money entail that laundering and the financing of terrorism and proliferation. • Policy, coordination, and cooperation mitigate the International cooperation delivers appropriate   2.  information, financial intelligence, and money laundering and financing of terrorism risks. evidence, and facilitates action against criminals • Proceeds of crime and funds in support of and their assets. terrorism are prevented from entering the financial Supervisors appropriately supervise, monitor,   3.  and regulate financial institutions and defined and other sectors or are detected and reported by nonfinancial businesses or professions these sectors. (DNFBPs) for compliance with AML/CFT • Money laundering threats are detected and requirements commensurate with their risks. disrupted, and criminals are sanctioned and Financial institutions and DNFBPs adequately   4.  apply AML/CFT preventive measures deprived of illicit proceeds. Terrorist financing commensurate with their risks and report threats are detected and disrupted, terrorists are suspicious transactions. deprived of resources, and those who finance Legal persons and arrangements are prevented   5.  terrorism are sanctioned, thereby contributing to from misuse for money laundering or terrorist financing, and information on their beneficial the prevention of terrorist acts.73 ownership is available to competent authorities without impediments. The assessment of effectiveness should not directly  6. Financial intelligence and all other relevant information are appropriately used by focus on the Intermediate or High-Level Outcomes, competent authorities for money laundering but rather on evaluating the extent to which a and terrorist financing investigations. country achieves 11 “Immediate Outcomes” (see Money laundering offenses and activities are   7.  Box 7). investigated, and offenders are prosecuted and subject to effective, proportionate, and dissuasive sanctions. To guide assessors, the Assessment Methodology Proceeds and instrumentalities of crime are   8.  includes for each Immediate Outcome a box with confiscated. characteristics of an effective AML/CFT regime Terrorist financing offenses and activities are   9.  investigated, and persons who finance terrorism with respect to the outcome in question. These are prosecuted and subject to effective, boxes set out the situation in which a country is proportionate, and dissuasive sanctions. effective at achieving the outcome in question and 10. Terrorists, terrorist organizations, and terrorist financiers are prevented from raising, moving, provide the benchmark for the assessment. They and using funds, and from abusing the also correlate the Immediate Outcome with the nonprofit sector. primarily relevant FATF Recommendations.74 11. Persons and entities involved in the proliferation of weapons of mass destruction are prevented from raising, moving, and using In addition, for each Immediate Outcome there is a funds, consistent with the relevant UN Security list of “Core Issues” to be considered in determining Council Resolutions. if the outcome is being achieved, together with Assessment Methodology, p. 15. a.  examples of information and specific factors to 72 Assessment Methodology, p. 14. 73 Assessment Methodology, p. 14 74 Predictably, at least elements of Recommendation 1—the RBA—are recognized as correlating with a large number of Immediate Outcomes: Immediate Outcome 1 and Immediate Outcomes 3–10. 20 support a conclusion on the issue in question. The system should help to focus the attention of Core Issues are the mandatory questions assessors countries that are not promoting inclusion or should seek to answer to get an overview of how have adopted exclusionary AML/CFT measures. effective a country is under each outcome. Assessors may also recommend practical steps that countries should take to address financial exclusion For each Immediate Outcome there are four risk. In these cases, the assessments may have a possible ratings for effectiveness, based on beneficial impact on financial inclusion policies. the extent to which the identified Core Issues and characteristics are addressed: high level of For countries that have adopted financial inclusion effectiveness, substantial level of effectiveness, measures involving simplified CDD, the effectiveness moderate level of effectiveness, or low level of assessments will put a premium on the quality and effectiveness. documentation of the risk assessments performed, both by policy makers and providers, as assessors Elements of effectiveness assessment relevant will be looking for evidence to substantiate a claim of to financial inclusion. Most of the Immediate lower money laundering and terrorist financing risk. Outcomes have at least some relevance to financial If providers are permitted to apply simplified CDD inclusion, though Immediate Outcomes 1, 3, and measures where risks have not been adequately 4 are the most directly relevant. 75 Moreover, the assessed and are actually high, the effectiveness of Assessment Methodology’s general mandate to the AML/CFT regime in question could be assessed assessors to consider a country’s specific money negatively, which in turn could have a chilling effect laundering and terrorist financing risk picture; the on financial inclusion policy making going forward materiality of different Recommendations in that in that country. country’s case; structural elements, such as political stability and the rule of law; and contextual factors, In general, the effectiveness component of the including the country’s level of financial exclusion, new round of assessments will emphasize unique introduces the opportunity for financial inclusion country conditions and factors more strongly than considerations to play a major role in effectiveness under the previous Assessment Methodology, which assessments. primarily focused on technical compliance with FATF standards. The new Assessment Methodology The following topical areas cutting across various requires assessors to tailor their approach to the Immediate Outcomes merit highlighting, as set profile of the country in question more than the forth in Box 8. previous assessment methodology when designing, scoping, and performing their assessment; further, Implications of effectiveness assessments for the effectiveness component will be country financial inclusion. Effectiveness assessments may specific—including weighing the money laundering have a significant positive impact on countries that and terrorist financing risks of financial exclusion. have not yet fully embraced financial inclusion. On the one hand, this liberates policy makers from Assessment questions regarding the measures a “one size fits all” mentality out of step with their that were taken to promote financial inclusion and on-the-ground realities. On the other hand, there whether the application of AML/CFT measures will be less scope for reliance on assessments from prevent the legitimate use of the formal financial other countries as potential benchmarks.76 75 The Assessment Methodology also makes the point that the Immediate Outcomes are not independent of each other. In many cases an issue considered specifically under one Immediate Outcome will also contribute to the achievement of other outcomes (Assessment Methodology, p. 19). 76 South Africa’s CCD-related reforms of the mid-2000s, e.g., were studied by other countries considering similar financial inclusion approaches, but some countries waited to see how FATF assessors would judge these measures in the 2009 South Africa Mutual Evaluation Report before proceeding with their own national initiatives. 21 Box 8. Effectiveness Assessments: What Are the Specific Opportunities for Advancing Financial Inclusion? Financial inclusion can be included as an area of by the FATF Recommendations to bring excluded increased focus—In the scoping note prepared in populations into the world of traceable formal finance. advance of a mutual evaluation, the nature and extent Informal and unregulated services may be of financial exclusion and measures taken to increase assessed—Assessors may ask for data regarding financial inclusion could be included in the list of the size, composition, and structure of the country’s areas for increased focus by the evaluators (FATF financial sector and its informal or unregulated 2013e, p. 8). sector to determine the relative size, importance, Risk and associated alignment of risk-based and materiality of each. If a substantial volume of measures for lower-risk financial inclusion products transactions in a given country falls outside the formal, and services must be assessed—Core Issues to regulated sphere, it could be evidence of regulatory be considered in relation to Immediate Outcome 1 and supervisory approaches that are ineffective at (regarding risk assessment and mitigation) focus on achieving Immediate Outcome 3 (regarding regulation the overall quality of the country’s money laundering and supervision). The examples of specific factors that and terrorist financing risk mitigation systems. could support conclusions on Immediate Outcome 3 Assessors are specifically required to consider how include the extent to which supervisory and regulatory risk assessments were used to justify exemptions and measures inhibit the use of the formal financial system.b to support the application of simplified measures for Financial exclusion and the promotion of financial lower-risk scenarios. In view of the importance of inclusion may be probed—Immediate Outcome 4 risk assessment and mitigation to the revised FATF (regarding institutional risk management and Recommendations, risk-related questions also feature compliance) invites the question whether the manner in the assessment of a number of other Immediate in which AML/CFT measures are applied prevents the Outcomes, especially Immediate Outcomes 3 and 4. legitimate use of the formal financial system and what Levels of financial exclusion to be considered— measures are taken to promote financial inclusion. Assessors are called on to consider various structural For example, the overall national regulatory and and contextual factors relating to a country when supervisory approach in a country, among other factors, assessing the effectiveness of its AML/CFT regime. could trigger “over-compliance” by providers, that is, The level of financial exclusion is specifically AML/CFT controls that are disproportionate to the risks mentioned as a factor to be considered.a Given the of serving financially excluded customers, preventing formal recognition of financial exclusion as a money potential customers from legitimate use of the formal laundering and terrorist financing risk in the approval financial system, and perpetuating financial exclusion. by FATF Ministers of the organization’s 2012–2020 mandate, the stage is set for assessors to evaluate negatively the effectiveness of AML/CFT regimes Assessment Methodology, p. 6. a.  that poorly take advantage of the flexibility afforded Assessment Methodology, pp. 97–98. b.  Part III. The Road marks a remarkably productive period of rapid Ahead—Opportunities for evolution in standards and guidance on AML/CFT. Country-Level Progress and As FATF and FSRBs turn their attention to their Foreseeable Challenges new round of mutual evaluations, a new chapter Meriting Further Attention opens—one in which country-level leadership applying the revised FATF Recommendations and The flurry of FATF actions in 2012 and 2013— guidance can inform future global discussion of including the FATF Ministerial declaration that what works to build AML/CFT regimes that are financial exclusion presents money laundering and both financial-inclusion friendly and effective terrorist financing risks, the adoption of the revised at combatting money laundering and terrorist FATF Recommendations, the guidance on financial financing. There are both current opportunities inclusion and on new payment products and for progress and foreseeable challenges meriting services, and the new Assessment Methodology— further attention. 22 Opportunities for Progress realities as to both money laundering and terrorist financing risk and financial inclusion. 79 Sharing Since 2011, 77 FATF has made significant progress of such documentation will help to build global toward enabling countries to align financial inclusion understanding about the diversity of country and financial integrity objectives through risk-based contexts in which policy makers are seeking to policy making. The onus is now on country-level align simultaneous pursuit of financial inclusion and policy makers to take advantage of the additional financial integrity.80 guidance and clarity and demonstrate “results on the ground.” By building the evidence base of Foreseeable Challenges approaches that achieve this alignment, countries Meriting Further Attention will be advancing an increasingly important domestic policy agenda while also helping FATF A “test and learn” approach presupposes that not and their peers committed to combatting financial everything will work out as anticipated. Countries exclusion. must therefore be prepared to give feedback to FATF about what is working and what is not, To build this evidence base, policy makers must whether directly, in the case of FATF members, or also develop their own understanding of the fast- indirectly, through their respective FSRBs, so that evolving landscape of providers capable of serving these unforeseen challenges emerging from the financially excluded populations. New models new standards and guidance are understood and that hold potential for inclusion—and bring new addressed. customers into the traceable world of electronic transactions—also raise new risks that both policy Other challenges are by their nature more makers and providers will best address through foreseeable, and while they may not be appropriate knowledge-sharing. for FATF guidance (or may not yet be ripe), they nonetheless merit further country-level attention Though the new round of mutual evaluations will and global discussion and analysis. yield more country context-specific reports than under the previous assessment methodology, Assessor capacity and judgment. Assessors there will still be value in cross-country dialogue. participating in mutual evaluations are picked from a In particular, in 2014 the effectiveness assessment wide range of institutions and countries with varying is being tested on developing countries for the perspectives, awareness, and capacity levels. As a first time. There will be a vital period of “test and 78 result, country assessor teams and the authorities in learn” by both FATF and countries to fine-tune the the countries they are assessing will have different new processes—processes with important potential interpretations on the nature, type, and extent of to counter the incentives for an overly conservative risk; the approach to be used to measure risk; and approach that could perpetuate financial exclusion. its relative weighting in the overall assessment given that judgment will be involved when considering a Countries also have an opportunity—and a strong risk assessment (Pesme and Van Der Does 2014). interest—to document thoroughly their domestic A number of steps—such as strengthened training 77 The initial FATF guidance on financial inclusion was adopted in June 2011. See FATF (2011). 78 The Democratic Republic of Congo and Ethiopia are the first developing countries to undergo a mutual evaluation with the revised Assessment Methodology. (Neither country has had a full mutual evaluation under the previous methodology.) 79 As noted, the specifics of a country’s context must inform its national risk assessment, and the rationale and evidence behind specific AML/ CFT regulatory and supervisory decisions should be documented looking ahead to a mutual evaluation sometime in the future. 80 Policy maker appetite for such sharing and building of global understanding can be seen in the establishment of the Alliance for Financial Inclusion’s Financial Integrity Working Group. See http://www.afi-global.org/about-us/how-we-work/about-working-groups/financial- integrity-working-group-fintwg. 23 of assessors and upstream quality control of draft “Proving” low risk. While the FATF actions Mutual Evaluation Reports—have already been taken discussed above introduce significant guidance to strengthen the quality and consistency in the regarding lower-risk scenarios, countries have assessment process. Moreover, since the timetable been left for the time being to explore how low- for the new round of mutual evaluations stretches risk situations are “proven.” The issue is important over approximately seven years, country and assessor because the FATF Recommendations explicitly awareness and capacity can be built incrementally. permit countries “in strictly limited circumstances and where there is a proven low risk of money Deepening understanding of financial exclusion laundering and terrorist financing, decide not to risk and factoring it into national risk assessments. apply certain Recommendations to a particular The nature and extent of financial exclusion risk type of financial institution or activity” (emphasis has yet to be systematically studied. Indeed the supplied).82 On the one hand, this leaves the door February 2013 FATF Guidance on National Money open to responsible country-level experimentation, Laundering and Terrorist Financing Risk Assessment which can contribute incrementally to the global does not mention financial exclusion. As a knowledge base. On the other hand, some countries consequence, countries currently are challenged may be reluctant to take advantage of this flexibility to think through largely for themselves the specific until there are other examples to follow.83 money laundering and terrorist financing risks flowing from transactions in the cash economy by Reducing incentives for provider-level over- populations excluded from, or underserved by, the compliance and taking stock of its consequences. formal financial system.81 Given that over-compliance at the provider level (which perpetuates or exacerbates financial At the same time, a majority of countries have not exclusion) increases national-level (and in some yet conducted a national risk assessment. There is cases international-level)84 money laundering and therefore an important opportunity to introduce this terrorist financing risk, policy makers have an subject explicitly into their risk assessment planning impetus to seek ways to reduce incentives for over- and to build regional and global understanding on compliance and create incentives for those providers the subject country by country. Doing so will be willing to offer lower-risk products and services. A vital to providing a balanced picture of national first step is gaining a better understanding of the money laundering and terrorist financing risks—one dynamics shaping compliance behavior generally that also focuses appropriate attention on the risk- at the country level, regionally, and internationally, mitigating benefits of increased financial inclusion. as well as the specific drivers of over-compliance.85 81 Countries could leverage the national risk assessment tools offered by the World Bank and IMF to scope the nature and extent of their financial exclusion risk. The World Bank offers a “Financial Inclusion Product Risk Assessment Module” (for formal financial inclusion products) to complement its National ML/TF Risk Assessment Tool. In the World Bank tool, specifically, national risk levels are based on overall threat and vulnerability levels. High levels of financial exclusion would be incorporated in the vulnerability assessment, which has a bearing on the overall national risk. For more information about the World Bank tools, see FATF Financial Inclusion Guidance, p. 69. 82 FATF Recommendations, Interpretive Note to Recommendation 1, p. 31. 83 It has been observed that “the requirement that low risk must be proved or demonstrated is problematic in respect of new products and services such as mobile money. The language creates a regulatory deadlock: proof and demonstration requires evidence and evidence can only be generated by launching and testing the product. Yet, the product cannot be launched without a facilitative regulatory framework that can only be shaped within the context of the low-risk exception and exemptions. When the text of the FATF Recommendations and interpretative notes are amended, it would be helpful if the word ‘proven’ is not used in this context. Language that supports a thorough and objective risk assessment and a reasonable and justifiable conclusion about the risk profile of a product will be more appropriate to financial inclusion products than language requiring proof and demonstration” (de Koker 2011). 84 See, e.g., Box 5. Further, FATF has acknowledged that over-compliance by regulators and financial institutions may increase overall money laundering and terrorist financing risks (FATF Financial Inclusion Guidance, p. 18). 85 Some of these drivers are outside the control of country-level policy makers. For example, the high profile $1.9 billion fine imposed on HSBC by U.S. authorities (http://www.reuters.com/article/2012/12/11/us-hsbc-probe-idUSBRE8BA05M20121211) figures among the key drivers of a phenomenon referred to by global banks as “financial crime related de-risking,” triggering their exit from entire markets and market segments that wary compliance officers assess to create too great an exposure for the profitability of the business in question. 24 Though the revised FATF Recommendations associated with the SIM cards used. Moreover, enshrine the RBA as Recommendation 1, these SIM-based financial identities, coupled with which is intended to inform all the subsequent the feasibility of mapping transaction flows down Recommendations, there is no explicit standard to the level of specific cell phone towers and agent and/or guidance provided for addressing over- locations offer both providers and law enforcement compliance, which undermines the purpose new means of discerning suspicious transactions of the RBA: the proportionate allocation of and finding perpetrators of financial crime. If readily limited resources applicable to both country- available phone usage data and patterns, coupled level supervision and enforcement and provider with geo-tagged location data that pinpoint the compliance. For example, if the law allows whereabouts of the customer, are added to the providers to adopt simplified due diligence picture, law enforcement’s capacity to identify and measures in relation to a lower-risk product but apprehend anyone using mobile financial services they elect to apply the same CDD measures across for criminal purposes increases considerably. the board, it is appropriate to explore the extent to which this disproportionate allocation impinges At the same, the data privacy dimensions of on their ability to mitigate higher money laundering this changing landscape are a subject of fervent and terrorist financing risks—as well as the extent international debate. 87 Many of the countries to which such compliance practices contribute to standing to benefit most from the financial financial exclusion risk. inclusion potential of these developments will also be among those least likely to have effective data Deepening the conversation on “financial identity,” privacy protection in place or the resources to considering both its law enforcement and privacy address related newly emerging consumer risks. dimensions. The landscape of financial identity In countries where corruption is high, the risk of at the base of the economic pyramid is changing misuse of personal data may be high as well. rapidly with the spreading of mobile financial services among poor populations around the The policy questions triggered are complex for world and large-scale initiatives such as India’s country-level policy makers, and even more so Aadhaar national digital identity system. 86 for multilateral bodies including FATF and those These developments challenge a simple, binary interested in financial consumer protection more understanding of an “anonymous” account broadly.88 They also are not to be ignored. or transaction versus one where a customer is “identified” and that identity is verified. As observed Optimizing the linkages among financial inclusion, above, when customers move from using cash to a stability, integrity, and consumer protection. Both mobile wallet with strict limits on the amounts and country-level policy makers and increasingly also frequency involved and number of other parties international financial sector standard-setting with whom they can transact, the money laundering bodies simultaneously pursue the objectives of and terrorist financing risk may remain low while financial inclusion, financial stability, financial minutely specific “financial identities” emerge, integrity, and financial consumer protection. 86 http://www.uidai.gov.in/ 87 See, e.g., Financial Times (2014). 88 An example is the G20/OECD Financial Consumer Protection Task Force, which produced the G20’s High Level Principles on Financial Consumer Protection. Principle 8, Protection of Consumer Data and Privacy, provides as follows: “Consumers’ financial and personal information should be protected through appropriate control and protection mechanisms. These mechanisms should define the purposes for which the data may be collected, processed, held, used and disclosed (especially to third parties). The mechanisms should also acknowledge the rights of consumers to be informed about data-sharing, to access data and to obtain the prompt correction and/or deletion of inaccurate, or unlawfully collected or processed data.” http://www.oecd.org/daf/fin/financial-markets/48892010.pdf 25 There is increasing understanding that, at the CGAP. 2012. “Financial Inclusion and the Linkages level of outcomes, these four objectives are to Stability, Integrity and Protection: Insights from interdependent and may be mutually reinforcing.89 the South African Experience.” Washington, D.C.: In practice, at the policy-making level, the linkages CGAP. http://www.cgap.org/sites/default/files/ are less well known, and policy makers face choices Working-Paper-Insights-from-the-South-African- that are often unnecessarily framed as trade- Experience-Nov-2012_0.pdf offs. Important country-level work is currently underway to deepen understanding on how policy ———. 2013. International Remittances and makers can optimize the linkages among the four Branchless Banking: 2013 Landscape. Slide objectives, maximizing synergies and minimizing presentation. Washington, D.C.: CGAP, 12 July. trade-offs and other negative outcomes. 90 In http://www.slideshare.net/CGAP/international- the AML/CFT context, of course, the pair-wise remittances-through-branchless-banking. linkages between the objectives of inclusion and integrity loom particularly large, as they underlie Chatain, Pierre, Andrew Zerzan, Wameek Noor, the formal recognition of financial exclusion as a Najah Dannaoui, and Louis De Koker. 2011. money laundering and terrorist financing risk in the “Protecting Mobile Money against Financial approval by FATF Ministers of the organization’s Crimes: Global Policy Challenges and Solutions.” 2012–2020 mandate. 91 Directions in Development. Washington, D.C.: World Bank, February. References Corkery, Michael. 2014. “Immigrants from Latin Basel Committee on Banking Supervision. 2014. America and Africa Squeezed as Banks Curtail “Sound Management of Risks Related to Money International Money Transfers.” The New York Laundering and Financing of Terrorism.” Basel Times website, 6 July. http://dealbook.nytimes. Committee Document, January. com/2014/07/06/immigrants-from-latin-america- and-africa-squeezed-as-banks-curtail-international- ———. 2012. “Basel III Regulatory Consistency money-transfers/?_php=true&_type=blogs&_ Assessment Programme.” April. http://www.bis. php=true&_type=blogs&_r=1 org/publ/bcbs216.pdf CPSS (Committee on Payment and Settlement Byron, Rejaul Karim. 2014. “Steps against Money Systems). 2012. “Innovations in Retail Payments: Laundering under Review.” The Daily Star website, Report of the Working Group on Innovations 14 February. http://www.thedailystar.net/steps- in Retail Payments.” Bank for International against-money-laundering-under-review-11229 Settlements, May. 89 In November 2012, the G20 Financial Ministers and Central Bank Governors explicitly recognized the importance of the inter-relationship among these objectives, commending FATF and the other financial sector standard-setting bodies for their growing commitment “to provide guidance and to engage with the GPFI to explore the linkages among financial inclusion, financial stability, financial integrity and financial consumer protection” (Communiqué of the G20 Finance Ministers and Central Bank Governors, Mexico City, 4–5 November 2012). 90 See, e.g., CGAP (2012). In its capacity as Co-Chair of the Subgroup of the GPFI focused on engagement with the standard-setting bodies, the UK Department for International Development (DFID) funded CGAP as GPFI Implementing Partner to conduct the rapid research initiative documented in this report, to inform the work of the Subgroup. Similar rapid research exercises on the linkages among inclusion, stability, integrity, and consumer protection have now been carried out in Pakistan and Russia as well, and reports are forthcoming. 91 Recent research by the World Bank further explores the pairwise linkage between inclusion and integrity in the context of cross-border remittances, which may be particularly timely given the recent actions by banks in the United Kingdom and other countries (see Box 5). Although this phenomenon is not new, it deserves further exploration and new evidence that could contribute to a potentially fundamental rethinking of the calibration of risks in international finance. See Todoroki, Noor, Celik, and Kulathunga (2014). 26 de Koker, Louis. 2011. “Aligning Anti-Money Financial Times. 2014. “European Court of Justice Laundering, Combating of Financing of Terror and rules EU data collection laws illegal.” Financial Financial Inclusion: Questions to Consider When Times, 8 April. FATF Standards Are Clarified.” Journal of Financial Crime, Vol. 18, No. 4, pp. 361–86. Halliday, Terence C., Michael Levi, and Peter Reuter. 2014. “Global Surveillance of Dirty Money: FATF (Financial Action Task Force). 2011. FATF Assessing Assessments of Regimes to Control Guidance: Anti-Money Laundering and Terrorist Money-Laundering and Combat the Financing Financing Measures and Financial Inclusion. June. of Terrorism.” Urbana, Ill.: Center on Law and Globalization. http://www.lexglobal.org/files/ ———. 2012a. International Standards on Combating Report_Global%20Surveillance%20of%20Dirty%20 Money Laundering and the Financing of Terrorism Money%201.30.2014.pdf and Proliferation: The FATF Recommendations. February. IMF (International Monetary Fund). 2011. “Anti- Money Laundering and Combating the Financing of ———. 2012b. Financial Action Task Force Mandate Terrorism (AML/CFT)—Report on the Review of the (2012–2020). April. Effectiveness of the Program.” Washington, D.C.: IMF, 11 May. http://www.imf.org/external/np/pp/ ———. 2012c. Declaration of the Ministers and eng/2011/051111.pdf Representatives of the Financial Action Task Force, Report to G20 Leaders by the Financial Action Task Isern, Jennifer, and Louis de Koker. 2009. “AML/ Force. June. http://www.fatf-gafi.org/media/fatf/ CFT: Strengthening Financial Inclusion and documents/reports/Report%20to%20G20%20 Integrity.” Focus Note 56. Washington, D.C.: Leaders%20June%202012%20.pdf CGAP, August. ———. 2013a. Methodology for Assessing National Public Radio. 2014. “As Wire Transfer the Technical Compliance with the FATF Options Dwindle, Somali-Americans Fear a Lost Recommendations and the Effectiveness of AML/ Lifeline.” Morning Edition, 8 July. CFT Systems. February. Noor, Wameek. 2013. “Anti-Money Laundering ———. 2013b. FATF Guidance: Anti-Money Regulation and Financial Inclusion.” CGAP Blog, Laundering and Terrorist Financing Measures and 15 May. http://www.cgap.org/blog/anti-money- Financial Inclusion. February. laundering-regulation-and-financial-inclusion ———. 2013c. FATF Guidance: National Pesme, Jean, and Emile Van Der Does. 2014. Money Laundering and Terrorist Financing Risk “Assessing the Assessors: From Form to Assessment. February. Substance.” World Bank Blog, 6 February. https:// blogs.worldbank.org/psd/assessing-assessors- ———. 2013d. Guidance for a Risk Based form-substance. Approach: Prepaid Cards, Mobile Payments and Internet Based Payment Services. June. Ratha, Dilip. 2005. “Remittances: A Lifeline for Development.” Finance and Development , ———. 2013e. Procedures for the FATF Fourth Round December. http://www.imf.org/external/pubs/ft/ of AML/CFT Mutual Evaluations. October. http://www. fandd/2005/12/basics.htm. fatf-gafi.org/media/fatf/documents/methodology/ FATF-4th-Round-Procedures.pdf, p. 16. 27 ———. 2012. “Remittances: Funds for the Folks Wright, Robin. 2008. “Stuart Levey’s War.” The Back Home.” Finance and Development. http:// New York Times website, 31 October. http://www. www.imf.org/external/pubs/ft/fandd/basics/remitt. nytimes.com/2008/11/02/magazine/02IRAN-t. htm html?pagewanted=all&_r=0 Todoroki, Emiko,Wameek Noor, Kuntay Celik, and Annex I. Abbreviations Anoma Kulathunga. 2014. “Making Remittances Work: Balancing Financial Integrity and Inclusion.” AML Anti-Money Laundering Directions in Development , May. Washington, CDD Customer Due Diligence D.C.: World Bank. CFT Countering the Financing of Terrorism DNFBP Defined Nonfinancial Business or Profession U.K. Parliament. 2013. Written Ministerial FATF Financial Action Task Force Statement, Money Service Businesses, HM FIU Financial Intelligence Unit Treasury (10 October). http://www.parliament. FSRB FATF Style Regional Body uk/documents/commons-vote-office/October%20 GPFI Global Partnership for Financial Inclusion 2013/10%20October/2.CHANCELLOR-money- ICRG FATF’s International Cooperation Review service-businesses.pdf Group IMF International Monetary Fund Vlaanderen, Paul. 2010. FATF President’s KYC Know Your Customer Presentation at the 3rd Windsor Global Leadership MNO Mobile Network Operator Seminar on Regulating Transformational MSB Money Service Business Branchless Banking, March. http://www.oecd. MVTS Money or Value Transfer Service org/unitedkingdom/financialinclusionand NPPS New Payment Products and Services financialintegritycomplementarypolicyobjectives. OECD Organization of Economic Cooperation htm and Development OTC Over the Counter World Bank. 2013. Migration and Development P2P Person to Person Brief. Washington, D.C.: World Bank, April. http:// RBA Risk-Based Approach siteresources.worldbank.org/INTPROSPECTS/ U nited Nations Secretary General’s UNSGSA  Resources/334934-1288990760745/ Special Advocate for Inclusive Finance for MigrationDevelopmentBrief20.pdf Development No. 98 September 2014 Please share this Focus Note with your colleagues or request extra copies of this paper or others in this series. CGAP welcomes your comments on this paper. All CGAP publications are available on the CGAP Web site at www.cgap.org. CGAP 1818 H Street, NW MSN P3-300 Washington, DC 20433 USA Tel: 202-473-9594 Fax: 202-522-3744 Email: cgap@worldbank.org © CGAP, 2014 The authors of this Focus Note are Timothy Lyman and Wameek Valerie Schilling, Aniko Hrubi, Anne-Francoise Lefevre, as well Noor of CGAP. The authors would like to thank Louis de Koker, as Jean Pesme and Emily Reinhart of the World Bank’s Financial CGAP policy advisory consultant and professor of Law, Deakin Market Integrity Unit, for providing constructive comments and University, Australia, and Emiko Todoroki, senior financial sector technical input. The authors also received valuable input from specialist, the World Bank, who served as advisers to this project Kate Lauer and Olga Tomilova of CGAP. Michael Tarazi of CGAP and shared their valuable expertise and insights. The authors provided guidance in conceptualizing and setting the context would also like to thank the Secretariat of FATF, in particular for this Focus Note. The suggested citation for this Focus Note is as follows: Lyman, Timothy, and Wameek Noor. 2014. “AML/CFT and Financial Inclusion: New Opportunities Emerge from Recent FATF Action.” Focus Note 98. Washington, D.C.: CGAP, August. Print: ISBN 978-1-62696-056-5 epub: ISBN 978-1-62696-058-9 pdf: ISBN 978-1-62696-057-2 mobi: ISBN 978-1-62696-059-6 UKa from the British people