Money laundering is a form of financial crime where criminals take illegally obtained funds and disguise its origins to appear to be from a legitimate source.
When criminals generate money, they have to conceal the identity, source or destination of these funds to avoid alerting law enforcement to their criminal activity. The ill-gotten money is considered ‘dirty’ and the process of ‘laundering’ this money makes it appear ‘clean’ so it can be used as legal funds.
Anti-money laundering refers to the procedures undertaken by financial institutions to monitor for, identify and report any activity where criminal activity is suspected.
A Brief History of Anti-Money Laundering
With early anti-money laundering legislation dating back to Prohibition in 1930s America, the Bank Secrecy Act was introduced in the United States back in 1970. This act, known as the BSA, was one of the earliest efforts to identify and prevent money laundering.
Nearly 20 years later, a number of countries and organisations teamed up to form the global Financial Action Task Force (FATF) with the mission of developing and promoting international standards in order to prevent money laundering.
The September 11th terrorist attacks (and subsequent Patriot Act and similar global legislation) led to an all new, heightened emphasis on comprehensive money laundering laws to fight the financing of terrorism and criminal activity.
Why is Anti-Money Laundering Important?
It has been estimated the amount of money being laundered globally is anywhere between 2 and 5% of global GDP, or $1.7 trillion to over $4 trillion. And this is considered a low estimate.
What’s more, money laundering often accompanies devastating criminal undertakings such as terrorist financing, bribery, smuggling, drug trafficking, embezzlement and many other nefarious activity.
Today’s anti-money laundering regulations combine money laundering (source of funds) with terrorism financing (destination of funds).
While financial institions have a moral obligation to combat money laundering and the financing of terrorism, they also have to, by law, comply with regulations requiring them to monitor and track their customers and transactions – and to report any suspicious activity.
Having rigorous anti-money laundering procedures also protects their brand reputation, and reduces the risk of civil and criminal penalties for non-compliance or negligence.
How does Anti-Money Laundering Work?
The process of laundering money involves three steps: placement, layering and integration. Placement involves criminals entering their ‘dirty’ money into the financial system. They will be looking for ways to ‘launder’ their money and make it appear to be legitimate.
Next, criminals ‘layer’ transactions to further hide the source of their ill-gotten funds and distance the money from its criminal origins. As the money moves around, it creates a web of transactions. These ‘layers’ make it hard for authorities to identify, or indeed prove, if the money was in fact, laundered.
The final stage of money laundering integrates the funds into the financial system as legal tender. Often, the funds are absorbed into the economy through legitimate transactions such as art, luxury cars, jewellery or property. The funds are
used very carefully from legitimate sources to create an acceptable explanation for the money’s origin.
Across the world, nations have developed AML legislation with strict guidelines for financial institutions and other regulated businesses to follow in order to satisfy their regulatory requirements. These include:
- USA: US Patriot Act and the Bank Secrecy Act
- Europe: EU Sixth Anti-Money Laundering Directive (6AMLD)
- Canada: The Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA)
- Australia: Anti-Money Laundering and Counter-Terrorism Financing Act
While regulatory guidance for money laundering varies across the world, businesses are generally required to undertake a number of critical steps in order to be compliant. These often include:
Know Your Customer
Anti-money laundering checks must be undertaken on each customer or entity initiating a relationship with a regulated organisation.
Know Your Customer (also known as KYC) is a legal obligation that regulated businesses need to satisfy. By verifying their customers before opening an account or processing a transaction such as a property purchase, organisations must take steps to ensure their legitimacy.
In a KYC check, customers typically have to provide proof of identity, address and sometimes other information related to the situation at hand.
Depending on the type of relationship and risk involved, individuals may also be screened against sanctions lists, examined for any political exposure, CCJs or credit checks.
Additionally, firms must continue to monitor their customers throughout the entirety of their relationship with them. While initial KYC checks satisfy AML regulatory requirements at the point of an individual becoming a customer, things can change drastically in a short space of time.
For example, a typical low-risk client at the point of onboarding may be elected into public office a few years later, at which point they would become a Politically Exposed Person (PEP) and would be exposed to far higher risk of financial crime and must be treated with adequate caution.
Similarly, regulatory bodies such as the FATF, the US Department of the Treasury, Her Majesty’s Treasury and the EU all have detailed requirements for financial institutions to verify customers against lists of sanctioned individuals, companies and countries.
Just this week, further sanctions on Russia were announced by the US Treasury Department. Cited as: “additional actions to ensure that the Kremlin and its enablers feel the compounding effects of our response to the Kremlin’s unconscionable war of aggression”, the latest bout of sanctions for Russia extend to Putin’s reputed girlfriend and other members of the Moscow elite, and businesses connected with the Kremlin including a former Olympic rhythmic gymnast and member of parliament.
Suspicious Activity Reports (SARS)
As part of being a regulated organisation, financial institutions must commit to filing reports of any suspicious activity which may indicate money laundering or terrorist financing. These are called Suspicious Activity Reports or SARs.
SARs provide law enforcement with valuable information on potential criminal activity and protects the organisation from the risk of laundering the proceeds of crime and from committing a money laundering offence if they were aware of it taking place and failed to act.
Whether an organisation knows for certain or just suspects money laundering, they must, by law, submit a SAR.