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Virginie’s Blog – Entity Data Management Falls Down Cross Border

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In the same week that the Royal Bank of Scotland’s US ops were slapped with a cease and desist order by the Fed for anti-money laundering (AML) and risk management failures (see more on which here), the International Monetary Fund (IMF) produced a working paper on the state of cross border AML compliance highlighting the dire state of the industry in identifying customers correctly in a global environment. The report certainly provides more fuel for the fire being stoked by the US Office of Financial Research (OFR) in terms of highlighting the problems related to the lack of a globally adopted legal entity identification (LEI) standard.

Penned by the IMF’s Concepcion Verdugo Yepes, the paper therefore assesses countries’ compliance with the AML and Combating the Financing of Terrorism (CFT) international standard during the period 2004 to 2011. To this end, it states: “We find that overall compliance is low; there is an adverse impact on financial transparency created by the cumulative effects of poor implementation of standards on customer identification; and the current measurements of compliance do not take into account an analysis of money laundering/financing terrorism risk, thereby undermining their credibility and the relevance of some of the policy recommendations taken on their basis.”

The paper assesses the countries against the FATF recommendations for dealing with AML, of which there are 40 and nine special recommendations. It also examines seven specific components of compliance: legal; institutional; financial institutions’ prevention; non-financial institutions’ prevention; informal sector prevention; entity transparency; and international cooperation.

The report notes that, in general, smaller, less connected financial systems are less compliant with the standard. Unsurprisingly, the stronger the regulatory framework in the country, the higher the compliance rates. However, it also indicates that in certain areas, larger systems are also particularly vulnerable due to a lack of standards adoption.

The annexes (from page 31 onwards) provide an interesting visual reference point for how poorly most countries are performing in ensuring entity transparency, for example. The gap between the “advance” economies and the “emerging and developing” economies is not as marked in this particular area, indicating that it is a truly global problem. The need for better hierarchical entity information is therefore a key recommendation stemming from the working paper, and one which, no doubt, the OFR will be able to use to its own ends in championing its recent work in the LEI space (see more on which here). The paper states: “in many countries the prevention of money laundering/financing terrorism is still hampered by difficulties in identifying or lack of commitment to identify the ultimate beneficial owners of funds/assets.”

Customer due diligence within financial institutions is also highlighted as an area that demonstrates particular weakness in system functionality resulting in a low compliance rate of 22.1%. It seems that RBS’ US operations are not alone in their compliance challenges.

The report indicates there is also a serious problem with regards to how the industry deals with and tracks data about non-financial institutions, which is the area most in need of improvement (nearest to 0% in the diagram), according to the paper. It notes that the identification of Financial Action Task Force (FATF) designated non-financial businesses and professions, such as trust and company service providers, is a particular problem.

As well as highlighting the fact that overall compliance with these AML and CFT standards is low, the paper also seeks to determine the reasons why this is the case in order to feed back this data into a comprehensive policy reform agenda. It highlights a combination of technical standards adoption issues and cultural, economic and political challenges that need to be tackled to this end.

However, it also notes that these findings are dependent on the individual countries’ willingness to share this data about its compliance, therefore noting that some findings should be taken with a pinch of salt.

As for next steps, the author notes: “Our findings carry potentially significant policy implications. At the national level, achieving high compliance requires implementing a combination of reforms, including strengthening domestic governance, and improving the coordination of efforts against money laundering/financing terrorism between countries, regulators and private actors. At the international level, the standard and the assessment of countries’ compliance with it need to be better designed to capture countries’ risk for money laundering/financing terrorism (by capturing threats as well as vulnerabilities).”

The paper suggests that a comprehensive review of the AML/CFT space is long overdue at an international level and that country regulators should get on the case ASAP. One can expect to hear much more about this issue going forwards, as the IMF feeds back this data into the overall regulatory overhaul process going on across the globe.

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