Abstract
The Fund’s Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) program represents an important contribution to the international community’s response to money laundering and terrorist financing over the past decade. The program originally focused primarily on (a) AML/CFT assessments – as part of the Reports on the Observance of Standards and Codes (ROSC) program and of the Financial Sector Assessment Program (FSAP) – and (b) capacity development activities. Following guidance provided by the Board in 2011, money laundering, terrorist financing and related predicate crimes issues (hereinafter also referred to as financial integrity issues) are being raised in the context of surveillance when they are judged to affect domestic and balance of payments stability. Moreover, some recent Fund-supported programs have also incorporated financial integrity issues.
Introduction
1. For more than a decade, the Fund has made important contributions to the efforts of the international community to combat money laundering1 and terrorist financing. 2 Traditionally, the key aspects of the Fund‘s Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) program have been: (a) assessments of countries’ compliance with the AML/CFT standard established by the Financial Action Task Force (FATF–see Box 1), and (b) capacity development (CD) activities. The assessments of the FATF standard have formed part of both the Reports on the Observance of Standards and Codes (ROSC) program and the Financial Sector Assessment Program (FSAP). The CD activities have, since 2009, been mostly externally funded. These CD activities, which continue to be an important part of the Fund’s AML/CFT program, are described in more detail in Appendix II.
The Financial Action Task Force
Membership: The FATF was established by the G-7 countries in 1989 in response to mounting concern over money laundering. Its membership has grown from 14 countries, at its inception, to 34 jurisdictions and two regional organizations, at present, representing most major financial centers in all parts of the globe.
The FATF network: The FATF is complemented by eight FSRBs and is considering granting the FSRB status to a ninth regional body.6 Together, they represent some 180 countries around the world.
Recommendations: The FATF 40 Recommendations constitute the international standard for AML/CFT and, since February 2012, for combating the financing of proliferation of weapons of mass destruction. They encompass a broad range of issues including the regulation of services provided by financial institutions and some nonfinancial businesses and professions, cross-border movements of currency, the transparency of legal entities, substantive and procedural criminal law, institutional capacity, sanctions, as well as domestic and international cooperation.
Peer review, transparency and follow-up: Part of the FATF’s and FSRBs’ mandate is to conduct “mutual evaluations” (or peer reviews) of their members, publish the results of these reviews and follow-up on the progress made by the assessed countries in addressing the main deficiencies identified in the course of the evaluation. As a result, the majority of the Fund’s members have committed at ministerial level to implementing the FATF standard as well as undergoing regular mutual evaluations.
Role of the IFIs: Both the Fund and the World Bank are observers to the FATF. Staffs of both institutions participate in the FATF working groups and plenary meetings, which take place three times per year. Staff conduct assessments of countries’ AML/CFT regimes using the same methodology as the FATF/FSRBs.
2. The Executive Board last undertook a review of the AML/CFT program in 2011. Two main conclusions arose from the 2011 Board discussion:
First, Directors recognized that AML/CFT assessments are an important part of the FSAP and ROSC programs and saw merit in exploring ways to strengthen AML/CFT assessments, including the possibility of conducting targeted, risk-based assessments; and
Second, the majority of the Board endorsed the coverage of AML/CFT issues and their related predicate crimes in the context of surveillance on a mandatory basis, in specific circumstances where problems with money laundering, terrorist financing, or predicate crimes3 may undermine the stability of the member’s domestic financial system, may have important spillover effects on other members and, while not affecting the financial system, may still undermine the member’s external stability.4
3. Following the Board’s guidance, Fund staff has been active in the following areas:
FATF Cooperation: Fund staff worked with Bank staff, the FATF, the FATF-Style Regional Bodies (FSRBs), and other key stakeholders on the development of a new AML/CFT standard and assessment methodology that are more risk-based. The revised standard was adopted on February 16, 2012, and staff informed the Board of the main changes to the AML/CFT standard in August 2012 (Information Note).5 In addition, staff worked closely with the FATF to develop a new assessment methodology that focuses to a greater extent than before on the effectiveness of AML/CFT regimes. Finally, in response to recent developments that had an impact on Fund-supported programs, staff stepped up cooperative efforts with the FATF to adopt procedures to achieve greater quality and consistency of future assessments.
Fund activities (mainly surveillance and Fund-supported programs): Staff completed a guidance note that identifies a number of considerations related to the inclusion of AML/CFT issues in surveillance on a mandatory basis, and in financial stability assessments under the FSAP. Specifically, the guidance note provides that AML/CFT issues should be discussed (a) in the context of surveillance when they undermine a member’s balance of payments and domestic stability, or the effective operation of the international monetary system and (b) in the context of financial stability assessments, when they threaten the stability of the domestic financial system. Since then, staff has worked closely with departments to implement this new framework in specific Article IV consultations. Separately, staff has also responded to the greater demand for coverage of financial integrity issues in the context of Fund-supported programs.
4. The purpose of this paper is to:
Seek the Executive Board’s endorsement of the FATF 2012 Recommendations and of the 2013 assessment methodology (see section on the revised AML/CFT standard and assessment framework, below);
Report on progress on the integration of AML/CFT issues in Fund surveillance and program work (see section on the coverage of financial integrity issues in surveillance and Fund-supported programs, below); and
Propose an adjustment to the ROSC and FSAP policies concerning AML/CFT to ensure that AML/CFT information is incorporated into all FSAPs while introducing flexibility in the nature and scope of the AML/CFT analysis (see section on the inclusion of financial integrity issues in the FSAP, below).
Previous Executive Board Discussions of the AML/CFT Program
Starting in the late 1990s, the Fund endorsed the international standards on banking, insurance, and securities regulation and supervision, which included AML measures.
In 2000, the Fund responded to a call from the IMFC to expand its work in the area of AML. In 2001, it recognized the FATF 40 Recommendations as the appropriate standard for combating money laundering, intensified its AML work and, after the events of September 11, 2001, extended it to CFT.
In 2002, AML/CFT was added to the list of 11 areas where standards and codes are useful to the operational work of the Fund and for which assessments are undertaken. The Fund conditionally endorsed the (then) FATF 40+8 Recommendations as the relevant standard, and agreed that AML/CFT ROSCs prepared by the FATF/FSRBs could be submitted to the Fund/Bank Boards (following a pro forma review conducted by staff).
In 2004, the Executive Board agreed to make AML/CFT assessments and technical assistance a regular part of the Fund’s work.
In 2006, the Executive Board reaffirmed the principle, established in 2004, that every FSAP should be accompanied by a comprehensive AML/CFT assessment and specified the modalities under which this principle should be implemented, namely, that AML/CFT assessments should be conducted approximately every five years and, to the extent possible, within 18 months of the FSAP mission.
In 2011, the Executive Board reviewed the Fund’s AML/CFT program and gave strategic guidance on further integration of AML/CFT and related issues into the Fund’s surveillance and financial stability assessments under the FSAP. It also provided guidance to shift towards targeted, risk-based AML/CFT assessments in cooperation with the FATF and other key stakeholders.
In 2012, staff briefed the Executive Board about the main changes to the AML/CFT standard adopted by the FATF in February 2012.
The Revised AML/CFT Standard and Assessment Framework
A. Move Toward a More Risk-based Approach to AML/CFT
5. At the time of the Executive Board’s June 2011 discussion of the Fund’s AML/CFT program, the FATF was in the process of revising the AML/CFT standard. Directors noted that the comprehensiveness of the FATF standard set a high benchmark, compliance remained low, assessments were resource intensive, and country-specific issues may not have received full attention. They saw merit in exploring ways to strengthen AML/CFT assessments, including the possibility of conducting targeted, risk-based assessments. Directors agreed that the methodology for conducting such assessments and criteria for the selection of issues to be assessed with respect to specific countries needed to be developed in cooperation with the FATF, FSRBs, and other stakeholders. In line with this guidance, Fund and Bank staff proposed to the FATF a shift from comprehensive to targeted, risk-based assessments, paying greater attention to the specific threats and vulnerabilities of the assessed country.
6. In February 2012, the FATF adopted a revised set of Recommendations and interpretative notes which, together, constitute the new AML/CFT standard. As reported in the Information Note, the most important changes in the standard from the Fund’s perspective are:
The increased prominence of the so-called risk-based approach to AML/CFT;
The inclusion of tax crimes in the list of designated predicate offenses to money laundering;7
The greater emphasis on action against corruption;8 and
The limited extension of the standard to proliferation financing-related issues.9
7. The revised AML/CFT standard pays greater attention to the level of money laundering or terrorist financing risks. The most significant change in this respect is the new requirement (included in FATF Recommendation 1) on countries to identify, assess, and understand the risks of money laundering and terrorist financing that they face, and, on the basis of that assessment, ensure that measures to prevent or mitigate money laundering and terrorist financing are commensurate with the risks identified. Countries should also require financial institutions and designated non-financial businesses and professions to identify, assess, and take effective action to mitigate their money laundering or terrorist financing risks.
8. These changes are welcome and, subject to the Executive Board’s endorsement of the revised standard, will have implications on the Fund’s AML/CFT program. The revised AML/CFT standard, including through its extension to proliferation financing-related issues, provides a strong basis for Fund advice to protect the integrity of the international financial system. The risk-based approach to implementing AML/CFT measures is in line with the Board’s 2011 guidance. In addition, the inclusion of tax crimes as predicate offenses to money laundering will provide greater opportunities for the Fund to offer policy recommendations on tax issues such as international tax coordination and information sharing.10
9. The FATF also adopted the revised assessment methodology and procedures in February and October 2013, respectively. While the shift to a risk-based framework did not go as far as staff would have liked, the new assessment framework reflects a significant move to incorporate analysis of each country’s context, including money laundering or terrorist financing risks and the effectiveness of the AML/CFT measures in mitigating these risks. The new approach was also supported by independent academics in a recent review of the global framework for AML/CFT assessments.11 Areas of greater importance and risk should receive greater attention. For example, if the assessed country is a center for company registration, assessors should look more closely at beneficial ownership requirements than they would in another country. As a result of these changes to the methodology, assessments should yield more relevant and meaningful information than previously and create stronger incentives for AML/CFT regimes to focus on risks (see Box 3).
2013 Methodology for Assessing Compliance with the FATF Recommendations and Effectiveness of AML/CFT Systems
The new methodology includes two interrelated components: It focuses equally on the legal and regulatory frameworks and on the results achieved from their implementation against the country’s specific ML/FT risk profile. It provides for an interrelated, two-step approach that consists of a mainly desk-based assessment of technical compliance with the AML/CFT standard, followed by an on-site assessment of the effectiveness of the AML/CFT regime as measured by the extent to which specific objectives are being met.
The starting point for assessors is to understand the country’s risks and context. The concept of “risk” takes account of the threats (e.g., criminals with money to launder); the vulnerabilities (e.g., weaknesses in the financial system that criminals will use to launder that money); and the harm caused (e.g., damage done by the original crime and the laundering). The notion of “context” includes:
The country’s situation (e.g., general makeup of the economy and financial sector);
The structural foundations of the AML/CFT regime (e.g., an effective judicial system, sound government institutions and rule of law); and
Other factors that affect the implementation of AML/CFT measures (e.g., level of corruption or maturity of the country’s regulatory regime).
This understanding of the country’s risks and context then guides:
The assessment of technical compliance, which looks at whether the country meets the requirements of the FATF Recommendations, principally as they relate to the legal and institutional framework.
The assessment of effectiveness, which looks at the extent to which eleven immediate outcomes12 are met. The predefined outcomes are central to a robust AML/CFT system. This assessment differs fundamentally from that of technical compliance; assessors must, for each outcome, use their judgment to reach a holistic conclusion as to how well a country is operating from an AML/CFT perspective. The focus is, therefore, on the extent to which the AML/CFT framework is producing the expected results.
Technical compliance and effectiveness are rated separately, but are considered together in the conclusions. These conclusions provide prioritized and integrated recommendations for AML/CFT regime improvements, focusing on the key deficiencies identified in the context of the country’s risks.
10. Like assessments against other standards, however, AML/CFT assessments are not audits, and do not, for example, evaluate the level of compliance of individual financial institutions. As a result, they cannot fully predict or prevent major money laundering or terrorist financing crises or financial crises that may result from or be affected by such events.
B. Quality and Consistency Controls
11. From the Fund’s perspective, AML/CFT assessments must be of high quality and consistent with the standard. This is important (a) to ensure that all member countries are treated uniformly, and (b) because the findings of AML/CFT assessments are increasingly incorporated into various areas of the Fund work – regardless of whether the assessments were conducted by the Fund or another assessor body.
12. The architecture for conducting AML/CFT assessments is unique because the Fund and the Bank rely on assessments conducted by others. Assessments may be conducted not only by the Fund and the Bank, but also by the FATF and the eight FSRBs. As mentioned above (Box 1), some 180 countries have now joined the FATF and/or an FSRB, and committed to undergo regular mutual evaluations. Ensuring the quality and consistency of AML/CFT assessments across the range of assessor bodies has been challenging.13 The FATF and FSRB assessments are peer reviews; they are, therefore, conducted by assessors with varying degrees of skills and experience, and the discussions leading to their approval have at times steered away from purely technical considerations. While the assessments are challenging and resource-intensive for all assessor bodies, experience has shown that the FATF assessments are generally of high quality while those of the FSRBs have been mixed.
13. AML/CFT assessment reports have been used by the Fund primarily in the context of the FSAPs (see Appendix I). Under the agreed burden-sharing arrangements, assessments conducted by the FATF, or one of the FSRBs, can be used for FSAP purposes to the same extent as Fund and Bank assessments. They are converted into a ROSC after a pro forma review by Fund staff: staff does not review the substance of FATF/FSRBs assessments but only ensures that the ROSCs adequately reflect the findings of the assessments. The pro forma review does not give staff an opportunity to address potential deficiencies in the report or in the way the assessment was conducted.
14. Over the years, the findings of AML/CFT assessments have also become increasingly relevant to the Fund’s surveillance and program work (see the next section below). In the area of surveillance, financial integrity issues are being discussed not only on a voluntary basis, but also, in some instances, on a mandatory basis. AML/CFT issues can also be relevant for Fund-supported programs when they are critical to achieving the program’s objectives or for financing assurances purposes. As recently demonstrated in the case of Cyprus, an unduly generous assessment report can give the authorities and other stakeholders a false sense of security about the adequacy of AML/CFT controls, that may not withstand the scrutiny associated with a Fund-supported program.
15. Recognizing the need to improve quality and consistency of assessments, the FATF has recently taken steps to ensure that all assessor bodies are positioned to provide consistently high quality reports. These steps include a stronger common foundation (such as mandatory training for all assessors, a clear report template and ex ante quality and consistency controls). In particular, the October 2013 Procedures for the FATF Fourth Round of AML/CFT Mutual Evaluations include an enhanced review mechanism that requires reviewers to be drawn from a global pool of qualified experts from the FATF, FSRBs, and the IFIs. The review process will be overseen by a FATF working group; three reviewers (or more) will be allocated to each assessment, and will comprise two reviewers from FATF delegations and one from another assessor body. The review process will begin at the stage of scoping the on-site assessment mission. Reviewers are required to ensure that the draft report reflects a correct interpretation of the FATF standard and application of the methodology, and to highlight areas where the analysis and conclusions are identified as being clearly deficient. Reviewers’ comments on the draft assessment report, along with the assessment team’s response(s), will be made available to FATF members in advance of the plenary discussion of the report.
16. Since the FATF’s internal procedures do not address quality and consistency of reports prepared by the other assessor bodies, the FATF also articulated in February 2014 universal procedures for AML/CFT assessments which (a) require all assessor bodies to have effective and robust mechanisms in place, with the same essential features as the mechanism adopted by the FATF, to ensure the quality and consistency of their reports,14 and (b) include an ex-post global quality control mechanism to deal with the risk that substandard reports are being adopted. With the assessed country’s approval, these procedures would also apply to Fund and Bank AML/CFT assessments. In order to preserve the integrity of the FSAP and ROSC programs, Fund and Bank staff will participate actively in the review process of other assessor bodies and, as necessary, refer problematical reports for the ex post review. If the assessor bodies do not implement the universal procedures and/or take corrective action to address deficiencies identified through the ex-post review process, their reports should not be published and the FATF may consider what further action may be necessary.
17. Staff proposes to change the current practice of converting all externally-prepared AML/CFT assessment reports into ROSCs upon staff’s pro forma review.* Moving forward, staff proposes to convert these reports into ROSCs only (a) in the context of an FSAP, and (b) when these reports have undergone a quality and consistency review in conformity with the universal procedures, and are not clearly deficient.15 By participating in the global review process, staff will contribute to ensuring that any concerns about particular reports are addressed effectively, collectively and in a timely manner by the broader FATF/FSRBs community. Accordingly, and with the introduction of robust quality and consistency controls by all assessor bodies, staff anticipates that the likelihood of a final assessment report being clearly deficient is low.
18. A pilot phase of assessments under the new methodology is now called for. Lessons drawn from the first five assessments of FATF members16 may result in adjustments in the assessment methodology, procedures, or both. As a further means of ensuring a correct and consistent application of the new methodology, the FATF and Asia-Pacific Group on Money Laundering (APG) have proposed that other assessor bodies, including the IFIs, participate in the first assessments of their members.17 The participation of Fund staff in the first FATF and APG assessments would ensure the optimal implementation of the revised methodology. Although staff would play an active role in these assessments, it would not be subject to the FATF and APG’s instructions,18 and the final report would not be a Fund report, but a FATF, or joint FATF/APG mutual evaluation report. The Fund will be conducting its own first assessment (of Italy) under the revised methodology in January 2015, and staff is considering inviting FATF and possibly FSRBs experts to join the assessment team to allow for greater sharing of experiences among assessor bodies. The initial stages (i.e., the technical compliance analysis) of the first two FATF assessments are currently underway; early indications are that, despite the initial intention to lighten the assessment burden, assessments conducted under the new methodology will be as resource-intensive as in the past, if not more.
19. In conclusion, overall, the revisions of the AML/CFT standard, assessment methodology and procedures are welcome developments. The 2012 FATF Recommendations (with their greater attention to money laundering or terrorist financing risks) and the 2013 assessment methodology (with its emphasis on the effectiveness of AML/CFT systems) will contribute to assessments that focus on areas of particular concern in the assessed countries, and address these concerns in a pragmatic way. Staff expects future assessment reports to be more meaningful, both for the assessed countries and the broader AML/CFT community including the Fund, and to provide clear and prioritized advice tailored to the countries’ circumstances. The new set of procedures adopted by the FATF should ensure greater quality and consistency of assessments across all assessor bodies. On the basis of the above, staff recommends the endorsement by the Executive Board of the 2012 FATF Recommendations as the relevant standard for AML/CFT ROSCs and AML/CFT inputs into other areas of Fund and Bank work, and of the 2013 assessment methodology as the basis for assessments against the 2012 standard.
Coverage of Financial Integrity Issues in Surveillance and Fund-Supported Programs
A. Surveillance
20. As noted above, in 2011 the majority of the Board19 endorsed the coverage of AML/CFT issues and their related predicate crimes in the context of bilateral surveillance and modular financial stability assessments under the FSAP. In particular, AML/CFT issues should be discussed when they threaten a member’s balance of payment and domestic stability or the effective operation of the international monetary system on a mandatory basis (in the context of surveillance) or the stability of the financial system (in the context of stability assessments under the FSAP).20
21. There are a number of ways in which money laundering, terrorist financing or related predicate crimes (e.g., corruption, tax crimes, and fraud) can undermine the stability of a country’s financial system or its broader economy. These include the following:
Weak AML/CFT frameworks may lead to impeded or lost access to global financial markets. In an effort to protect their financial sectors, national supervisors, often in response to FATF/FSRBs calls for action, are increasingly prohibiting their banks from dealing with financial institutions from countries with actual or perceived weaknesses in their AML/CFT frameworks, or at least, to subject transactions with institutions from such countries to stricter conditions. In addition to limiting access to global financial markets, this may increase these countries’ costs of trade financing.21
Domestic stability can also be threatened by criminal activities. For instance, significant levels of tax crimes (e.g., VAT fraud and tax evasion) may affect the government’s revenue stream to a point where its fiscal balance is severely undermined. The potentially adverse effects on financial stability that may arise from large scale “Ponzi schemes” in the financial sector have been well-publicized and may undermine a country’s economy including through large-scale bank insolvencies that ensue when bank’s balance sheets are not properly valued, or by large outflows of capital from the banking system as the scale of the fraud becomes known.
22. The negative effects of money laundering, terrorist financing, or related predicate offenses will typically be transmitted through a country’s financial system. For instance, the injection of large amounts of criminal proceeds arising from corruption, tax evasion, or drug trafficking may subject a country’s banking system to volatile inflows and outflows that can threaten its stability. Incidents of terrorism and terrorist financing may undermine the stability of a country’s financial system – either because of a history of terrorist incidents or through the effect of a single but significant event.
23. However, there are circumstances in which money laundering, terrorist financing or related predicate crimes will have an adverse effect on the stability of the broader economy without necessarily directly involving the financial system. This will be the case particularly in countries where illegal transactions are conducted in cash and the proceeds of crime are never introduced into the banking system. This phenomenon, itself, may impede the development of the country’s banking system which in turn would impede economic growth. Beyond their effect on the banking system, however, these cases may undermine broader macroeconomic stability in at least two important ways: (a) economic policymakers will have great difficulty in gaining a real understanding of the state of the economy and in formulating sound economic policies; and (b) large illegal sectors can represent deadweights on formal economies resulting in sub-optimal growth. In extreme cases, unchecked criminal activity can rise to the level of threatening state functions and the rule of law, with associated adverse economic effects.
24. Money laundering, terrorist financing and related predicate crimes may also have adverse spillover effects on the stability of other countries. For example, extensive criminal activities in one country may lead to illicit transfers from and large short-term capital flows to another country with potentially destabilizing effects on that country’s economy. The availability of money laundering services in one jurisdiction may encourage and facilitate tax evasion in neighboring countries with adverse effects on their fiscal positions. Spillovers can also be transmitted through non-balance of payments channels, such as market contagion (e.g., financial fraud in a domestic bank triggers transmission when it defaults on interbank liabilities). Such spillovers may be of such nature and magnitude as to significantly affect global stability.
25. The 2012 staff Guidance Note sets out a number of specific questions and criteria that guide staff in determining whether financial integrity issues should be included in surveillance. These questions and criteria help staff assess (a) the impact of financial integrity issues on the stability of a country’s financial system; (b) the threats to financial sector stability arising from predicate crimes; (c) the adverse effect of financial integrity issues on the stability of the broader economy; and (d) their adverse spillover effects and the impact on global stability. When financial integrity issues are included in surveillance, staff provides the authorities with policy advice on the measures that should be taken to address the threats presented by money laundering, terrorist financing, or different types of predicate crimes (see examples in Box 4). In some instances, these threats can also be addressed by other Fund policies (e.g., the 1997 Guidance Note on the Role of the Fund in Governance Issues), or other standards and codes (e.g., the Code of Good Practices on Fiscal Transparency or the Basel Core Principles for Effective Banking Supervision).
Selected Cases of AML/CFT Inclusion in Article IV Consultations (Since 2011)
Indonesia. Indonesia was publicly identified by the FATF as a jurisdiction not making sufficient progress in addressing strategic shortcomings in its AML/CFT framework. Although the authorities enacted, in February 2013, a new CFT law that focused on the criminalization of terrorist financing, the FATF remained concerned about deficiencies in the CFT framework. Addressing these concerns is important to protect Indonesia’s financial sector from heightened scrutiny from foreign financial institutions, avoid possible countermeasures, and facilitate an exit from the FATF monitoring process. To this end, staff advised the authorities to make further efforts to strengthen the AML/CFT regime.
Italy. The authorities saw the cost of corruption to the economy to be a significant drag on business. The level of tax evasion in the country was also a concern. Staff acknowledged the authorities’ efforts in tackling both crimes, including the conduct of more risk-based tax audits, the lowering of thresholds for cash transactions and the adoption of a new anti-corruption law. In 2012, the authorities’ efforts against tax evasion had raised higher revenue than during the previous year. Staff advised that further strengthening the AML tools (including by criminalizing self-laundering and reinforcing due diligence regarding persons entrusted with prominent public functions) could strengthen anti-corruption efforts, and that stepping up efforts to combat tax evasion would raise revenue and more fairly distribute the tax burden. It highlighted that further initiatives, including strengthening and making greater use of AML tools to tackle tax evasion, broadening the scope of false accounting offenses, and providing the revenue authority with access to suspicious transaction reports related to tax crimes would also support the authorities’ efforts.
Singapore. The large size and rapid growth of assets under management and weaknesses identified during the 2008 AML/CFT assessment exposed Singapore’s financial sector to the risk of being used as a harbor or conduit for illicit assets. Staff welcomed measures already in place or in the process of implementation (including making tax evasion a predicate crime for money laundering, bolstering the framework for international tax cooperation and sharing of tax information), as well as Singapore’s commitment to undergo a comprehensive AML/CFT assessment in 2015. Staff advised the authorities to make further efforts to address previously identified deficiencies regarding transparency of beneficial ownership of companies and trusts established or operating in Singapore. Staff further advised strengthening the effective implementation of the AML/CFT standards, particularly by pursuing tax evasion as a predicate crime, and ensuring that service providers report suspicious transactions and close accounts where evidence of beneficial ownership is incomplete. This will help address the reputational risk that may arise from opaque ownership structures in the offshore wealth management sector.
26. Judgment and flexibility is being exercised by staff in the application of these questions and criteria. Staff is analyzing member countries’ economic developments from a financial integrity perspective on an ongoing but flexible basis. The greater the potential impact of money laundering, terrorist financing and related predicate crimes on a members’ domestic or balance of payments stability, the more intensive staff’s engagement. Working closely with the Strategy, Policy and Review, Monetary and Capital Markets, and Fiscal Affairs, and the relevant area Departments, the Legal Department’s engagement has ranged from participation in missions (when financial integrity issues are particularly complex or require specialized knowledge), the drafting of briefs and questions for the mission members, to less resource-intensive desk-based reviews of Article IV policy notes and staff reports. Staff also provides, where needed, HQ-based support to country teams during missions. The elaboration, in the Guidance Note, of clear criteria coupled with the Legal Department’s outreach efforts have made inclusion of financial integrity issues in surveillance more transparent and thus more acceptable to members.
27. Since 2011, financial integrity issues have been included on a mandatory basis in a number of Article IV Consultations. These include Afghanistan, Greece, Indonesia, Iraq, Italy, Iran, Libya, Nigeria, Pakistan, Singapore, Turkey, and Russia. These engagements – of a varying degree of intensity – have highlighted key financial integrity issues for the authorities and provided tailored policy advice to address money laundering or terrorist financing per se, as well as corruption, tax evasion, smuggling, fraud, organized crime, weak compliance with the AML/CFT and/or anti-corruption standards, lack of transparency of corporate vehicles, integrity of economic citizenship programs, and concerns about financial and non-financial sector supervision. Box 4 provides more detail on the inclusion of financial integrity issues in some Article IV consultations.
28. Going forward, financial integrity issues will continue to be discussed on a mandatory basis in a limited number of Article IV consultations. Staff will raise them in those cases where the risks they pose are of sufficient magnitude that they become relevant under the Integrated Surveillance Decision. The methodology utilized for this purpose will continue to be guided by the questions and criteria outlined in the 2012 Guidance Note.
B. Fund-supported Programs
29. In a limited number of cases, AML/CFT measures have been incorporated into conditionality under Fund-supported programs. 22 The reasons for the relevance of these issues have varied. For example, in the case of Cyprus, addressing weaknesses in the AML/CFT financial sector supervision was considered necessary to obtain adequate financing assurances, as other lenders expressed significant misgivings about the state of affairs in this area. In the case of Greece, implementation of AML/CFT measures is helping improve fiscal revenue, strengthen financial sector supervision, and undertake necessary structural reforms to improve the business environment (see Box 5). In the case of Afghanistan, addressing deficiencies in economic and financial sector governance, including with respect to money laundering, terrorist financing, financial fraud, corruption, and drug trafficking, was considered critical to achieve the program objectives.
Financial Integrity Issues under the Fund-supported Program for Greece
From the outset of the Fund-supported program for Greece, addressing tax evasion and corruption in tax administration was considered crucial to support fiscal consolidation.23 According to estimates, unreported income for 2009 for the self-employed alone (e.g., doctors, accountants and lawyers) stood at a lower bound of €28 billion. This is to be compared with a GDP for 2009 of €235 billion and a tax base of €98 billion. At the tax rate of 40 percent, the foregone tax revenues would have accounted for 31 percent of the budget deficit shortfall in 2009.24
In July 2011, in an effort to support revenue administration efforts, the authorities committed to make a more effective use of available AML tools.25 In this context, financial institutions play a crucial role since they are likely to possess relevant information relating to suspected tax evasion that may be relevant for the tax administration. Enforcing reporting requirements by the banking supervisor and creating the necessary synergies between the Financial Intelligence Unit (FIU), the tax authorities, and the judicial authorities, was therefore needed.
In March 2012, two AML-related prior actions were introduced in the program. They sought to (a) clarify the Bank of Greece’s rules on financial institutions’ obligations to detect and report to the FIU transactions suspected of being related to the proceeds of tax evasion and (b) introduce measures to ensure that complaint reports related to confirmed unpaid tax debts arising from an audit were transmitted to the prosecution services and to the FIU (as required under the system in place). These prior actions were implemented and, since then, staff has continued to monitor the implementation of the AML framework in support of the anti-tax evasion efforts and to provide capacity development to the Bank of Greece to create risk-based supervisory tools focusing on tax evasion issues.
In parallel, anti-corruption measures have been gradually stepped up. The current program includes a commitment by the authorities to align their anti-corruption legal framework with relevant international standards and the implementation of an anti-corruption plan. In addition, an anti-corruption coordinator has been established to ensure the coherence and effectiveness of the authorities’ efforts.
30. Moving forward, financial integrity issues will continue to be raised in the context of Fund-supported programs when they are critical to financing assurances or to achieving program objectives. As in the case of surveillance, these issues may either relate to money laundering or terrorist financing as such, or to the underlying predicate criminal activities (such as tax evasion, corruption, drug trafficking, or financial fraud). In such cases, staff will provide the authorities policy advice on the measures that should be taken to address the threats presented by money laundering, terrorist financing, or different types of predicate crimes.
Inclusion of Financial Integrity Issues in the FSAP
31. The FSAP policy includes a mandatory link between FSAPs and comprehensive AML/CFT assessments. In 2004, after an initial pilot phase, the Executive Board decided to make AML/CFT assessments a regular feature of the ROSC program and of the FSAP.26 The current policy requires that every FSAP incorporate a full AML/CFT assessment which should be conducted approximately every five years27 and, to the extent possible, within 18 months before or after the relevant FSAP mission.28 This applies to the financial stability assessments which, for the 29 jurisdictions with systemically important financial sectors, must take place every five years as a mandatory part of the Fund’s bilateral surveillance under Article IV of the Fund’s Articles,29 except when they are conducted as a separate financial stability module,30 which, in practice, is rare. Inclusion of AML/CFT issues in the FSAP process is intended to enable Fund and Bank staff to incorporate financial integrity issues into broader financial sector reform efforts. The IMF Executive Board reaffirmed its decision in 2006 and 2011, noting that AML/CFT assessments are an important part of the ROSC and FSAP programs.31
32. The treatment of the AML/CFT standard by the Fund and the Bank is unique for several reasons. First, it is the only standard for which a comprehensive assessment is mandatory in all FSAPs irrespective of the level of risks to the financial sector. Second, unlike other standards, there is no latitude under the existing policy for targeted (as opposed to comprehensive) assessments. Third, as mentioned above, it is also the only standard for which the IFIs accepts assessments prepared by other assessor bodies (i.e., the FATF and FSRBs) for the purposes of the ROSCs and the FSAPs.
33. The policy on AML/CFT for FSAPs has been successful in important respects. All but three countries that have had an FSAP during the period 2004–2013 have, at some point, been assessed against the 2003 FATF standard. The inclusion of AML/CFT assessments in the FSAPs has contributed to the global dissemination of the standard and deepened the international understanding of and attention to its provisions, and – as reflected in the greater integration of AML/CFT issues in Fund surveillance and supported programs – it has become increasingly clear that robust AML/CFT controls contribute to financial stability and development. In addition, numerous countries have joined the FATF/FSRBs network, while the FATF itself has expanded to include 28 of the 29 countries designated for mandatory FSAPs and 18 of the G-20 countries.32
34. The difficulty of aligning the FATF/FSRBs schedules with the FSAP timeline, however, has impeded the timely input of AML/CFT content into Financial System Stability Assessments (FSSAs)/Financial Sector Assessments (FSAs).33 While concerted efforts have been made to coordinate the timing of FSAPs and assessments carried out by the FATF/FSRBs, the different assessor bodies operate under different planning horizons34 and different assessment cycles,35 and most assessor bodies suspended their assessment programs during the 2009-2013 revision of the AML/CFT standard and assessment methodology.36 As a result, only 51 percent of assessments were completed within 18 months of the FSAP mission, and as indicated in the table below, in only about 30 percent of the FSAPs conducted since 2004 has it been possible to incorporate timely AML/CFT content in the FSSA. Timely input was not possible for the other approximately 70 percent of FSAPs either because an AML/CFT assessment already underway was finalized after the publication of the FSSA, the assessment was more than five years old, or because the assessment was conducted after the FSAP. In all these cases, the substance of the AML/CFT input was limited and outdated,37 thus frustrating the objective of incorporating financial integrity issues into broader financial sector reform efforts.38 Table 1 below summarizes how the current policy was implemented.
Practice of Providing AML/CFT Input for FSSA/FSAs Under Current Policy1
This table reports only on the practice of providing timely AML/CFT information into the FSSA and not whether the tenets of FSAP AML/CFT policy relating to timeliness and frequency of assessments was were technically observed.
Included rare circumstance when there was an FSAP re-assessment and there had been a significant deterioration of the AML/CFT environment since the last AML/CFT assessment, and agreement reached under the burden sharing agreement to bring next assessment forward.
Key findings were supported by a technical note (updating the information from the latest assessment, including from follow-up reports).
Policy allowed AML/CFT assessments to be completed up to 18 months after the FSAP mission. Thus, if an assessment was underway, but incomplete, the FSSA usually included reference to the timing of the forthcoming ROSC and the ROSC was circulated as a supplemental document after the FSSA.
Practice of Providing AML/CFT Input for FSSA/FSAs Under Current Policy1
| Optimal: Key Findings with a current ROSC | Second Best: Key Findings without a current ROSC | Sub-Optimal: No Key Findings | |
|---|---|---|---|
| Basis | From an AML/CFT assessment conducted within 18 months prior to the FSAP mission and finalized before the FSSA.2 | Country assessed under the most current methodology, more than 18 months and less than 5 years prior to the FSAP mission.3 | No full assessment under the most current by methodology by the time of the FSSA.4 |
| FSAPs: | 32% | 21% | 47% |
| 2004-2013 |
This table reports only on the practice of providing timely AML/CFT information into the FSSA and not whether the tenets of FSAP AML/CFT policy relating to timeliness and frequency of assessments was were technically observed.
Included rare circumstance when there was an FSAP re-assessment and there had been a significant deterioration of the AML/CFT environment since the last AML/CFT assessment, and agreement reached under the burden sharing agreement to bring next assessment forward.
Key findings were supported by a technical note (updating the information from the latest assessment, including from follow-up reports).
Policy allowed AML/CFT assessments to be completed up to 18 months after the FSAP mission. Thus, if an assessment was underway, but incomplete, the FSSA usually included reference to the timing of the forthcoming ROSC and the ROSC was circulated as a supplemental document after the FSSA.
Practice of Providing AML/CFT Input for FSSA/FSAs Under Current Policy1
| Optimal: Key Findings with a current ROSC | Second Best: Key Findings without a current ROSC | Sub-Optimal: No Key Findings | |
|---|---|---|---|
| Basis | From an AML/CFT assessment conducted within 18 months prior to the FSAP mission and finalized before the FSSA.2 | Country assessed under the most current methodology, more than 18 months and less than 5 years prior to the FSAP mission.3 | No full assessment under the most current by methodology by the time of the FSSA.4 |
| FSAPs: | 32% | 21% | 47% |
| 2004-2013 |
This table reports only on the practice of providing timely AML/CFT information into the FSSA and not whether the tenets of FSAP AML/CFT policy relating to timeliness and frequency of assessments was were technically observed.
Included rare circumstance when there was an FSAP re-assessment and there had been a significant deterioration of the AML/CFT environment since the last AML/CFT assessment, and agreement reached under the burden sharing agreement to bring next assessment forward.
Key findings were supported by a technical note (updating the information from the latest assessment, including from follow-up reports).
Policy allowed AML/CFT assessments to be completed up to 18 months after the FSAP mission. Thus, if an assessment was underway, but incomplete, the FSSA usually included reference to the timing of the forthcoming ROSC and the ROSC was circulated as a supplemental document after the FSSA.
35. There is no longer a compelling need for Fund or Bank staff to conduct as many comprehensive AML/CFT assessments as they have done in the past. The original policy was motivated by a concern that, in the absence of an FSAP, members would not participate in an AML/CFT assessment. However, most Fund and Bank members are now also members of the FATF/FSRBs network and are therefore subject to regular AML/CFT evaluations irrespective of their participation in the FSAP.39 In an effort to better align its cycle with the five year cycle for mandatory FSAPs, the FATF recently redesigned its follow-up to mutual evaluations to incorporate a targeted assessment update (with an on-site mission and with re-ratings) five years after the first comprehensive evaluation against the 2012 standard. It is expected that FSRBs will adopt a similar approach. Moreover, the requirement for comprehensive AML/CFT assessments under every FSAP differs from the trend, across standards assessments more generally, toward targeted ROSCs.40
36. Going forward, staff proposes to focus its efforts on ensuring the timely input of AML/CFT information into every FSAP. Coverage of AML/CFT issues in FSAPs will remain mandatory and should, where possible, be based on a comprehensive quality41 AML/CFT assessment conducted by the IFIs or the FATF/FSRBs against the prevailing standard and finalized within a reasonable period prior to each country’s next scheduled FSAP. Five years after the first comprehensive assessments, coverage should be based on a FATF/FSRB targeted update and follow-up reports.42 Reliance on comprehensive assessments, or on targeted updates and follow-up reports, will enable staff to be in a strong position to prepare a ROSC43 and key findings for inclusion in the FSAP.44 Achieving this objective will require:
Ongoing coordination of FSAP and FATF/FSRBs assessment schedules;
Authorization to accept and conduct for ROSC purposes targeted updates in line with FATF/FSRBs processes and burden-sharing arrangements; and45
Full participation in robust quality and consistency controls as recently adopted by the FATF to mitigate the risks associated with the Fund’s and the Bank’s reliance on reports prepared by external assessor bodies.
37. Nevertheless, there will be instances where staff will need flexibility to draw on other sources of information in order to provide timely input in the FSAP. During an initial transitional period, this will frequently be the case because, considering that the new round of assessments has only just begun, comprehensive assessments under the new standard will not always be available. Even after that transitional period, however, there will be occasions – albeit rare – where a comprehensive assessment or a targeted update is outdated due to the inability to align the FSAP and FATF/FSRBs schedules. In either case, staff may need to prepare key findings on the basis of the best available information, including: the most recent assessment report; Fund surveillance or program reviews touching on AML/CFT related issues (including DARs relating to banking, insurance, and securities supervisory standards); and FATF/FSRBs follow-up and other reports (e.g., from the International Cooperation Review Group). As necessary, staff could potentially also join the FSAP mission for a review of the most significant AML/CFT issues for the country. In such cases, staff would present the key findings in the context of the current standard and methodology; however, staff would not prepare a ROSC or ratings.
38. The proposed approach would enable staff to always provide timely, substantive AML/CFT input into the FSAP, but does not obviate the need for increased and earlier coordination on AML/CFT in the FSAPs. The Fund and the Bank will continue to rely on the FATF and FSRBs mutual evaluation reports to serve the FSAP in instances where the IFIs cannot conduct the AML/CFT assessment themselves. Earlier coordination between the relevant Departments within both institutions (for example, prior to the Financial Sector Liaison Committee meetings)46 would prove helpful in reaching greater alignment of the FSAP and FATF/FSRBs schedules.
39. Greater consistency amongst the findings of the different standards assessment under the FSAP is also desirable. There is a direct correlation between certain requirements of the AML/CFT standard, on the one hand, and those of the standards for banking supervision, insurance supervision, and securities regulation, on the other.47 It is therefore important that the findings of the assessments under these standards be consistent. To this effect, a sharing of expertise often takes place in practice, for example, between the Fund’s experts on AML/CFT and on banking supervision for the assessment of Basel Committee Core Principle 29 dealing with abuse in financial services, but more in-depth and early coordination (for example prior to the onsite mission and prior to the finalization of the assessment) would be advisable.
40. The increased work on surveillance and Fund-supported programs, not surprisingly, has had resource implications for the Legal Department. Fortunately, these new activities have been carried out during a period when, because of the process of modifying the FATF standard, there have been few assessments. Accordingly, the resources that would normally have been devoted to carrying out the Fund’s share of assessments (6 to 7 assessments per year) have been devoted to surveillance and program work. However, in light of the fact that assessments under the new standard are beginning to take place, the existing resource complement will be insufficient if the Fund continues to carry out the same number of assessments. The problem will be exacerbated by the Fund’s participation in the FATF and FSRBs assessment review processes that are described in paragraphs 15 and 16 above. Moreover, it is not possible for the resources devoted to AML/CFT capacity development activities to be diverted to surveillance work because these resources are externally financed and targeted at capacity building. Accordingly, and taking into account the overall budget constraints and the priority that needs to be given to supporting the Fund’s core mandate, the intention is to reduce the number of Fund-led assessments to 2 to 3 per year. Staff will prioritize assessments of countries on a regular FSAP cycle and, as described above, rely on ongoing collaboration with the World Bank and the FATF/FSRBs to ensure that meaningful AML/CFT input is provided to every FSAP in a timely fashion.
Recommendations
41. In light of the above, staff recommends that Directors:
Endorse the revised FATF 2012 Recommendations and 2013 Methodology for assessing compliance with the FATF Recommendations and the effectiveness of AML/CFT systems;
Continue to support the direction taken by staff in including financial integrity issues in Article IV consultations and Fund-supported programs;
Endorse staff’s proposals to convert FATF/FSRBs assessments into ROSCs only when conversion is necessary for the purposes of the FSAP, and when the reports have been prepared in conformity with the FATF’s universal procedures for AML assessments and are not clearly deficient;*
Endorse staff’s proposal to generate targeted ROSC updates in line with the FATF/FSRBs processes and on the basis of extended burden sharing agreements; and
Endorse staff’s proposal to adjust the FSAP policy on AML/CFT to allow staff to derive key findings from the best available information in cases where there is no timely comprehensive assessment under the current standard and methodology.