Money laundering and terrorist financing - Decoding these mysterious words
The notions of money laundering and terrorist financing (or financing of terrorism) almost always come hand in hand. This creates the illusion that we are essentially talking about the same thing, when in fact, the two are very different.
In the simplest terms, money laundering is the process used to conceal the origins and ownership of the money that has been generated as a result of criminal activity. The money coming from the criminal activity is considered ‘dirty’, so ‘launders’ use this process to make it look ‘clean’: as a result of the process, the proceeds seem to have originated from a legitimate source. A few common crimes associated with the process are drugs/human trafficking, corruption, prostitution, illegal arms smuggling. The process is utilized by criminal organisations in a systematic and large-scale manner in order to fully exploit criminal activities.
Based on the above description, one would think that money laundering is a concept known only in the modern world. Quite the contrary: even though the phrase “money laundering” was first used at the beginning of the 1900s, and criminalization of the activity is also recent, the origins of the practice of disguising income that is a result of crime can be found all the way back in the 13th century B.C. Pirates back then were masters of laundering valuable articles they have seized from ships they’ve attacked. Alphonse “Al” Capone, one of the most famous mob gangsters ever existed, was a master of money laundering: his estimated annual $100,000,000 worth of illegally gained proceeds were laundered through a series of businesses. Even his incarceration was not a result of being caught for money laundering – he was found guilty of a $1,000,000 tax evasion. However, Al Capone’s imprisonment was what forced criminals to become much more organised, making it harder for authorities to detect these crimes. Of course, now, with today’s advanced technology and globalization, the practice of money laundering has taken on new dimensions. The methods have become increasingly sophisticated and authorities and governments are in need of newer means to be able to fight these crimes.
Terrorist financing, to simply define means providing funds or other property, directly or indirectly, with the sole purpose and intention that these funds be used for terrorist activities: to further terrorism or to initiate terrorist acts to be carried out. This may even involve legitimate funds coming from legitimate sources, parallel to those funds originating from criminal activities. The financing of terrorism and the fight against it gained international attention after the events of September 11: that was when it became obvious that all the measures in place were still not sufficient.
A key difference between preventing money laundering and countering the finance of terrorism is that, as seen clearly from the above definitions, while a money launderer seeks to disguise the origin of illicit funds, a person funding terrorism, on the other hand, may use legitimate funds to pursue illegal goals. If the two are so different, why are they so closely associated all the time? The reason for that is the two groups use similar methods and techniques to evade authorities’ attention and to protect the identity of their sponsors and the ultimate beneficiaries of the funds. Therefore, even though the differences have to be kept in mind when implementing anti-measures, these instruments will have the same roots and logic and most of them can be used against both crimes.
The EU framework: a brief history
As discussed above, the increased scale of money laundering and terrorist financing, the new methods and globalization have led to heightened awareness in modern times by all regulatory entities – including the European Union. This led to the First Directive to combat money laundering in 1991 (Directive 91/308/EEC). Since the existence of the Single Market by its nature provides assistance and opportunities for money laundering and funding of further crime, the European Directives pay special attention to the cross-border cooperation as well.
The notion of “Directive” in the EU terminology means a piece of legislation that sets out goals for the Member States to achieve. However, it is up to each country’s legislative body to determine how to reach these goals and implement them into their regulatory framework. A stronger legislative act within the EU is a Regulation, which is binding and must be applied throughout the EU, without individual implementation by the Member States. (Read more about the acts of the EU here.)
The First Directive in 1991 was rather short but extremely important: it provided the initial framework for the subsequent Second and Third Directives. It already established key preventative measures – most of which are still in use, in a modified and improved form, such as customer/client identification, record-keeping and central methods of reporting suspicious transactions.
The Second Directive (Directive 2001/97/EC) updated the measures of the First Directive: it broadened the scope, which now included currency exchanges, money transmitters, and investment firms. Besides these changes, the EU has adopted a broader definition of money laundering, meaning that now more activities were covered by the Directive. This was also the legislation that first added these obliged entities the authority to identify, trace, freeze, seize and confiscate any property and proceeds linked to criminal activities – these rights and obligations are amongst the most important ones in the framework up to today.
The Third Directive (Directive 2006/70/EC) has tightened the regime: it was now also applicable to non-financial businesses and professions such as lawyers, and it contained targeted measures to fight the financing of terrorism. It has also introduced the different levels of customer due diligence: enhanced due diligence for politically exposed persons and simplified due diligence in case of low-risk situations.
The current legislation: AMLD4
The Fourth Directive, AMLD4 (EU 2015/849) is the latest legislative act in the area of anti-money laundering and counter-terrorist financing, currently in force. The implementation deadline of the Directive for the Member States was 26 June 2017.
With AMLD4 comes again an extended scope: as for the definition of “criminal activity”, tax crimes are now included in the Directive, and with regards to obliged entities, providers of gambling service providers and persons trading in goods for cash payments of at least €10,000 are now brought under the scope of AMLD4.
Under AMLD4, corporate and other legal entities are required to obtain and hold accurate and current information on their beneficial ownership. This information is also put into a central register, which is available to competent authorities, financial intelligence units (FIUs).
An innovation of AMLD4 is that it allows for, and even endorses, electronic identity verification: it allows obliged entities to verify customers remotely using electronic means, as a part of their Know Your Customer (KYC) processes.
AMLD4 is famous for a greater emphasis on a risk-based approach (the word “risk” is mentioned 149 times in the Directive). A risk-based approach means that countries, state authorities, as well as the private sector, should have an understanding of the money laundering and terrorist financing risks to which they are exposed and apply measures against these in a manner and to an extent which would ensure mitigation of these risks. According to AMLD4, risk-based assessments need to be carried out at European, Member State, and individual institution level and be kept up to date. This emphasis is also present in the rules on customer due diligence. As the different levels of customer due diligence are worth their own article, here we only mention that based on the risk assessment carried out by an obliged entity, in low-risk situations carrying out a simplified customer due diligence is sufficient, however, in high-risk situations (e.g. in case of politically exposed persons), enhanced due diligence measures are necessary.
These above are some of the key updates of AMLD4 compared to the Third Directive. Those interested in a more thorough comparison can take a look at this comparison chart.
The result of further advanced technology and new threats: AMLD5
“Innovation leads and regulation follows.” This common saying is definitely true in the case of AMLD5. On 5 July 2016, in response to terrorist attacks in Europe in 2015/2016, the leak of the Panama Papers, and the rapid advancement of technology – which criminals are more than happy to take advantage of – the EU Commission published proposals (AMLD5) to amend AMLD4. Originally, the Commission intended for AMLD4 and AMLD5 to become effective simultaneously, however, the process was not this quick, and the implementation deadline for AMLD5 (EU 2018/843) is 10 January 2020.
AMLD5 is technically an extension of AMLD4: it does actually implement new rules but extends and further specifies the existing ones. The main intention is to improve and bring boundless transparency in business activities and company ownership within the EU. AMLD5 also addresses the significant risks associated with cryptocurrencies.
Let’s see some of the major changes in AMLD5.
- A key change of AMLD5 is extending the scope of the rules to new entities, such as providers engaged in exchange services between virtual currencies and fiat currencies. Because of their anonymity, virtual currencies are more likely to be used for money laundering and terrorist financing purposes. Now, with this new scope, these exchange platforms will have to apply customer due diligence measures the same way any traditional financial institution does, and customers will have to be registered.
- AMLD5 also implements a reduced threshold (from €250 to €150) for anonymous prepaid cards in order to fight and prevent criminal activities, since these anonymous cards are likely to be used in money laundering and terrorist financing.
- Another example is related to Letterbox Companies.Letterbox Companies are considered the hub of corruption, money laundering, and transnational organised crime. Under AMLD5, anyone will be able to access information about the real owners of these companies in the EU. This can reveal corruption and tax evasion as well as fulfilling AML purposes.
The European Commission’s Factsheet will provide more information to those further interested in the novelties of the AMLD5.
What does the future hold?
Even though AMLD4 is fairly new, and the Member States still have a little bit of time to implement AMLD5, discussions on the next steps and next stage in the battle against money laundering and terrorist financing have already begun in the EU.
What will this next step be? That is for the future to decide but a surprising turn of events is possible: instead of AMLD6, we are more likely to see the first general EU regulation in this area – AMLR. As mentioned above, regulation means it is applied directly in the Member States, without the need for separate implementation by the Member States.
The need for the adoption of a regulation instead of a directive has been brought on by the problems recently experienced in connection with the effectiveness of the AML regime of the EU. Because of the need for implementation, there are differences in the approach of different Member States and sometimes opposed conclusions are drawn: this is extremely problematic in the EU where obliged entities are providing cross-border services. The differences do not only lead to ineffectiveness but also a general confusion amongst these entities. The solution, therefore, could be stronger harmonization in the form of regulation.
Whatever the actual approach is going to be within – or outside of – the European borders, one thing is clear: in today’s globalised world, criminal organisations are getting a lot bigger and sneakier than Al Capone ever was, and we need to fight against money laundering and terrorist financing activities with all available technology and resources.