The looming unknowns in trying to implement Counter Terrorism Financing (CTF) program.
I’m not an expert. At all.
Let me set the record straight. I am not a subject matter expert in AML or CTF. I’m writing this article to perhaps highlight a few points and hopefully have someone who is an expert, answer them.
Remittances and CTF
Remittances as you know are the low hanging fruit. Invariably quite a few payment start-up get attracted by cross-border money transfers.
The numbers are just right – US$ 600 Billion market. Average cost of sending money is 8% (as per World Bank and the number is deceptive). Space dominated by big 3 players: Western Union, MoneyGram and Ria Financial. Lots of perceived room for disruption.
While working with startups or even incumbents, one question that comes up many times, is the whole compliance program. Anti-Money Laundering, Know Your Customer and Counter Terrorist Financing.
It is this last element (CTF) that I want to talk about today.
Banks are de-risking at a massive scale today (Read the following four articles to understand the de-risking regime a whole lot better):
- World Bank Survey Confirms: De-Risking a Huge Issue.
- Strangulation by Regulation.
- Can’t find MSB Friendly Banks? Go ahead, scream. No one is listening.
- Banking De-Risking: The Domino Effect Is Now In Full Force.
What is brought up again and again in the de-risking process is the money laundering aspect in remittances and the possibility of this money contributing towards terrorist financing.
Money Laundering Threat
Let me address the money laundering aspect of it. Remittances are workers in foreign countries sending back their hard earned money back home to their families for purposes of family maintenance. This means house rent, school fees, groceries, utilities, medical expenses, clothes, funerals, etc.
The average amount remitted back home varies from country to country, but for a vast majority of them it is about US$ 1000 or less.
Adequate details are captured on the send side as to who the sender is, etc. and on the receiving side, things have improved drastically. Most remittances are now being credited directly into a bank account or a mobile money wallet, both of which are KYC’d financial purse.
For the vast majority of remittances that are sent abroad and cashed on the receiving end, proper IDs are collected of users and in some cases, photographs and fingerprints of the people cashing money out (albeit I will admit, photographs and biometric s capture is a very small segment, but growing).
Within this strict perimeter, there isn’t much liquidity for money launderers to launder money. Any halfway decent AML control will very quickly catch the structuring, and velocity checks will ensure that too many people trying to send money to the same person, is not possible.
Dilip Ratha who is an authority on the subject of remittances, has time and time again cited there is little or no data (evidence) to suggest that remittances have been used for purposes of money laundering. It just doesn’t make financial sense. You would need 1000s of people on each side, just to be able to launder a marginal amount. You’d have more luck with buying diamonds and getting on a plane and selling them in a different country.
This is not to say that money laundering does not happen. Crime is always one step ahead, but because the flow of liquidity through the remittance pipes is so restricted, the effort is not worth the output.
Because of the de-risking problem, more and more authorized cash is being transported out from the US to other countries and that money is finding its way to be laundered once it flows into an economy on the other side. Read a great article on this issue published in the Wall Street Journal: Losing Count: U.S. Terror Rules Drive Money Underground.
Money has been channeling across borders ever since it was first invented. Progressively, we have instilled better control mechanisms and it is fair to say, today, our control mechanisms are better than ever.
Which brings me to the subject of terrorism financing. Let’s start with the definition.
The short definition as provided by Google is:
Terrorism financing is an activity that provides financial support to designated terrorist groups. A government that maintains a list of designated terrorist organizations will also use laws to prevent money laundering being used to finance those organizations.
To get a better understand, read this definition as provided by Isle of Man: Financial Service Authority:
What is Terrorist Financing?
In general terms, the financing of terrorism is the financial support, in any form, of terrorism or those who encourage, plan or engage in terrorism. Terrorist financing differs from money laundering in that the source of funds can either be legitimate, such as an individual’s salary, or illegitimate, often the proceeds of crimes such as selling pirate DVDs, fraud or drug trafficking.
Usually, the focus of scrutiny for potential terrorist financing activity will be the end beneficiary and intended use of the money or assets. A terrorist financier may only need to disguise the origin of the property if it was generated from criminal activity but in the vast majority of cases they will seek to disguise the intended use i.e. the act of terrorism.
Terrorist financing often involves a complex series of transactions, generally considered as representing three separate phases.
Collection: Funds are often acquired through seeking donations, carrying out criminal acts or diverting funds from genuine charities.
Transmission: Where funds are pooled and transferred to a terrorist or terrorist group.
Use: Where the funds are used to finance terrorist acts, training, propaganda etc.
Like the traditional three phase model for money laundering, this model is rather simplistic and outdated. Rather than getting caught up in trying to establish whether activity relates to a particular phase of the traditional model, the relevant person should ask themselves – “do I know, suspect or have reasonable cause to suspect that the property in question is terrorist property or being used to fund terrorist activity?”
The United Nations 1999 International Convention for the Suppression of the Financing of Terrorism explains terrorist financing in the following way: “”Any person commits an offence within the meaning of this Convention if that person by any means, directly or indirectly, unlawfully and wilfully, provides or collects funds with the intention that they should be used or in the knowledge that they are to be used, in full or in part, in order to carry out” (a) An act which constitutes an offence within the scope of and as defined in one of the treaties listed in the annex (see 1-9 below); or (b) Any other act intended to cause death or serious bodily injury to a civilian, or to any other person not taking an active part in the hostilities in a situation of armed conflict, when the purpose of such act, by its nature or context, is to intimidate a population, or to compel a government or an international organization to do or to abstain from doing any act.”
The Convention also indicates that a person still commits an offence even if:
the funds are not used to carry out an offence in (a) and (b) above;
a person attempts to commit an offence as described above;
a person participates as an accomplice in an offence as above; and
a person organises or directs others to commit an offence as above, or contributes to the commission of one or more offences as above by a group of persons acting with a common purpose, where the contribution is intentional and is made with the aim of furthering the criminal activity or criminal purpose of the group, where such activity involves the commission of an offence as above, or is made in the knowledge of the intention of the group to commit an offence as above.
It is a great definition, but one that is also troubling. Here are some scenarios that are noteworthy (this are actually possible scenarios and not theoretical):
Example # 1
- A father receives money in Pakistan from his son in Chicago, USA who is a legal immigrant. Every month, he sends his father US$ 800, which is roughly Rs 80,000 in Pakistan. Father is an old man, who has zero ties to terrorism and/or any terrorist.
- This old man, also is a religious man who visits his local mosque 5-times a day to pray. Every Friday, the old man gives donations to his local mosque for Rs. 1,000 (or US$ 10).
- Unbeknownst to the old-man, the head preacher of this mosque, divides the total collection and 1/5th of the collection goes to an organization that is classified as a terrorist organization by Pakistan (not the US).
So, here are the questions:
- What this remittance transaction a Terrorism Financing transaction from the US side? if no, why not?
- What this remittance transaction a Terrorism Financing transaction from the Pakistan side? If no, why not?
- How can a bank / money transmitter in the US be blamed for this, if the US$ 10 were contributed to a terrorist organization – what could they have done to prevent it?
- Likewise, what more can a local bank / money exchange company do, to ensure such a transaction does not take place?
I have two more such examples.
Example # 2
- A family received money every month from UK. The father works in London, as a legal, and sends back home GBP 500 every month to Cairo. This is about 6,300 Egyptian Pounds.
- The wife and her kids depend on this money dearly. They pay about GBP 90 as rent. The remaining amount goes towards food, clothing, utilities, savings, etc.
- The landlord is a periphery member of a banned terrorist organization both in the US and in Egypt. Because the transaction with the landlord is in cash, no flags go up.
So again, how can this be avoided. Neither the sender nor the receiver have any a priori information about the connection of the landlord to a terrorist organization. The two entities (Sender/Receiver) indirectly just contributed to terrorism financing (this is how any US legal eagle / prosecutor would see it). How can this possibly be avoided?
Expectation of MTOs are exactly this. That the money being sent should not end up contributing towards terrorism financing. Key phrase here is “should not end up”.
Example # 3
- A man in Toronto sends his brother in Nairobi money every month for his college. Unbeknownst to the regulators on either side, the sibling in Kenya also funnels local money to M-Pesa holders at the border of Kenya / Somalia, a few of which have direct linkages to terrorist organizations within Somalia. They just are not on any database…yet.
Question here is – current activists for terrorist organizations, who are mere foot-soldiers and funneling small amounts of money, how do they get noticed? How will they get on lists.
I can very easily see how an MTO on the sending side can easily get penalized by a regulator for having lax controls when it comes to CTF – but reality is very different.
All three examples are very specific: these are transfers of no known association to terrorism financing. There is no indicative element that can pop up or be monitored that can accurately point out to these transfers being flagged for TF.
…and herein lies our problem. I say it is our problem, because the repercussions can be great. Banks can close down operations in a specific country. Banking institutions can fail, economic ties with a particular government and/or financial sector can be cut off, even in worse case scenario sanctions be placed, all because we, today, do not have the capability to monitor where does legitimate money go and and exactly at what point does it turn into dirty (or terrorist) money?
Banks, MTOs, Payment Processors, Payment Networks, FX Brokers, Payout Agents, Central Banks and even Governments are shit scared of a terrorism financing transactions traversing their system. Shit scared!
The Dirty Dollar
There was some study done a few years ago, that showed that over 75% of all US Dollar currency notes have traces of cocaine on them. More than 75%. In some instances this was as high as 90% (Source: CNN).
The term for such notes is Contaminated Currency.
Yes, that crips US$ 100 Bill is not as kosher as you think it is. Imagine that. Now what were to happen if this newly printed bill ended up in the hands of a terrorist after a dozen or so exchanges.
- Would the Federal Reserve be charged?
- Would the US Treasury be fined by itself?
- Would JP Morgan Bank in NY be closed down as it was their till where this note was pushed out from?
- Will VISA Network be punished because it was their ATM that might has disbursed it overseas?
Obviously not. It is no fault of theirs, despite knowing that currency notes can be used for illegal and nefarious purposes. The world keeps churning.
Back to Banks & Money Transfer Operators…
Today, the threat of money laundering and terrorism financing is placing strains on genuine, licensed financial services operators, especially those involved in the remittance (money-transfer) vertical.
The Damocles sword is that access to banking, suspension of license, fines and jail times are a very real-threat to such financial services companies and their management.
New York’s DFS (Department of Financial Services) is proposing a strict law, where the Chief Compliance Officer would be responsible for all AML infractions.
Read a great article by the law firm of Pepper Hamilton: It’s tough to be a Chief Compliance Officer under New York’s proposed Anti-Money Laundering Rule.
All of us in the financial services industry have moral and legal responsibility to uphold the law and to counter any such threats. Leakages will be there. One cannot stop them. I think everyone agrees on this.
However, to have a near zero-tolerance policy is what is setting jitters in the industry. Financial Regulators in very certain (and uncertain words) have made it clear, that if a TF transaction goes through, which eventually might be a serious one (or not), the repercussions will be severe.
We need to sit down collectively and look at the problem and see how we can stop it. There has been too much Policing in this matter and things are starting to get out of control.
All the stakeholders need to come up with a better framework on…
- How to handle such transactions
- How to determine the severity of the transactions
- What prior knowledge was available at hand when such a transactions took place
- Let us not sensationalize the issue for purposes of politics, badges or votes.
- The framework has to be contextual
- The policy of fines, suspension, lawsuits, etc. also must be contextual and be clearly defined
- A perimter has to be set (somehow!) this is a difficult one, but it has to be set.
There are some brilliant minds in the industry who can come up with solutions and in many cases, are holding on to parts of a solution.
We just need to collectively debate it, think it through and come up with a framework that is flexible up, sometimes strict and sometimes forgiving, but one that is determined to root out the problem, without rooting out the whole forest.
This page was last updated on April 2, 2016.