In a study published last year by financial-crime expert Ronald Pol, he concluded that the global AML system could be “the world’s least effective policy experiment”. Personally, I would have guessed that that accolade belonged to the global war on (some) drugs, but perhaps Ronald has a point. He notes that the compliance costs for banks and other businesses could be more than 100 times higher than the amount of laundered loot seized.
Cash or charge? (CC-BY-ND 4.0)
NFT available direct from the artist at TheOfficeMuse (CC-BY-ND 4.0)
These comments remind me of those of Rob Wainwright, then Director of Europol, when talking about the great success of the continent’s $20 billion per annum anti-money laundering regime. He said that “professional money launderers are running billions of illegal drug and other criminal profits through the banking system with a 99 percent success rate”. This concurs with the figure given in The Economist. Although we are only intercepting a miserable one percent of the dirty money, the costs that the regime impose on the finance sector are staggering. Yet these enormous costs achieve nothing. The Money Laundering/Terrorist Financing (ML/TF) regime is, according to the Journal of Financial Crime 25(2), “almost completely ineffective in disrupting illicit finances and serious crime”.
Direction of Travel
It’s going to get worse, of course. In the UK, many organisations are not yet compliant with the EU’s Fifth Anti-Money Laundering Directive (5MLD) and there is a Sixth Anti-Money Laundering Directive (6MLD) on the way. And the reach of the Financial Action Task Force (FATF) is being extended into cryptospace, so there’s no way to get round the bureaucracy. A couple of years ago FATF extended their recommendations to include cryptocurrency exchanges and wallet providers (together referred to as Virtual Asset Service Providers, or “VASPs”). This meant that all countries should apply anti-money laundering and anti-terrorist financing controls to these businesses: that is, customer due diligence (CDD), suspicious activity reports (SAR) and, importantly, the “Travel Rule” that aims to prevent money laundering by identifying the parties to a transaction when value over a certain amount are transferred.
The decision to apply the same travel rule on VASPs as on traditional financial institutions was greeted with some dismay in the cryptocurrency world, because it meant that service providers must collect and exchange customer information during transactions. The technically non-binding guidance on how member jurisdictions should regulate their ‘virtual asset’ marketplace included the contentious detail that whenever a user of one exchange sends cryptocurrency worth more than 1,000 dollars or euros to a user of a different exchange, the originating exchange must send identifying information about both the sender and the intended recipient to the beneficiary exchange. The information must also be recorded and made available to “appropriate authorities on request”.
However, when speaking at the “V20 Virtual Asset Service Providers Summit” in 2020, Carole House from the Financial Crimes Enforcement Network (FinCEN) said that they want to see this threshold reduced to $250 for any transfers that go outside the US because their analysis of SARs filed from 2016 and 2019 showed the mean and median dollar values to be $509 and $255 respectively. Almost all the transactions began or ended outside the U.S.
Note that the information demand is quite extensive. According to the FATF Interpretive Note to Recommendation 16, the information should include name and account number of the originator and benefactor, the originator’s (physical) address, national identity number (or something similar) or date and place of birth. In essence, this means that counterparty’s personal information will sent around the web. Simon Lelieveldt, a former Head of Department on Banking Supervision at the Dutch Central Bank, is very well-informed and level-headed about such things, and even he called this a “disproportional silly measure by regulators who don’t understand blockchain technology”, which may be a little harsh even if not too far from the truth.
Surely the extension of the travel rule signals that it is time for a rethink. We need to begin with the fact that live in a world of data science, machine learning and artificial intelligence (AI) and understand that we cannot tackle crimes such as money laundering without machine brains to help us. This line of AI-centric thinking can be more disruptive than might seem at first glance because it suggests an alternative vision of regulation where we do away with a lot of the expensive barriers to entry to the financial system, those pot holes for criminals but chasms for legitimate users and instead use machine brains to police what is happening inside the system.
AML Isn’t Working
In other words, instead of trying to prevent criminals for getting in to the system, we should instead let them in and monitor what they are up to. If we force them to continue using cash, then we have no idea what they are up to! Whereas if we can persuade them to use electronic transactions of some kind, particularly those that leave an immutable record of criminality, then we would would actually be better off! Since cash cannot be tracked around the economy, we (society) have put in place a whole bunch of complicated and expensive rules about accounting for cash when it enters the financial system. But suppose there wasn’t any cash. Suppose there was only Bitcoin. In that case, as I pointed out some time ago, you wouldn’t need anti-money laundering (AML) regulations at all because you would be able to follow every coin around the blockchain!
Many observers, and Bitcoin fans in particular, say that this is nonsense because there are a variety of ways to jumble up and otherwise obfuscate the sources of value in transactions on the Bitcoin network. I never saw this as a realistic barrier to criminals though, and I noted that a simple rule that required banks to investigate any coins that had originated in anonymous wallets (or mixers) would be sufficient to stop the large-scale use. Also, you will remember that U.S. Department of Justice (DoJ) has already shown its intentions. You will remember they indicted Larry Harmon for creating the Bitcoin mixer “Helix” (in addition, Fincen fined him $60m last year) and have just arrested Roman Sterlingov, the alleged operator of Bitcoin Fog, a custodial bitcoin mixer that it says processed over 1.2 million BTC.
We erect (expensive) KYC barriers and then force institutions to conduct (expensive) AML operations, using computers and laser beams to emulate handwritten index cards and suspicious transaction reports (STRs). But as I have suggested before, suppose that KYC barriers were a lot lower so that more transactions entered the financial system. And suppose the transaction data was fed, perhaps in a pseudonymised form, to a central AML factory, where AI and big data, rather than clerks and STR forms, formed the front line rather than the (duplicated) ranks of footsoldiers in every institution. In this approach, the more data fed in then the more effective the factory would be at learning and spotting the bad boys at work. Network analysis, pattern analysis and other techniques would be very effective because of analysis of transactions occurring over time and involving a set of (not obviously) related real-world entities.
They have already taken a step towards this is in the Netherlands, where ABN Amro, ING, Rabobank, Triodos Bank and de Volksbank formed a consortium (Transaction Monitoring Netherlands, TMNL) to share data and identify unusual patterns in payments traffic that the individual banks cannot spot for themselves. Let’s hope they are successful, because estimates suggest that €16 billion of criminal money is laundered in the Netherlands each year from activities including drugs, human trafficking, child pornography and extortion.
Michael Harris, director of financial crime compliance at LexisNexis Risk Solutions, commented that the release of the FinCEN files highlighted the “myriad issues” with the UK Anti-money laundering (AML) system – an ineffective suspicious activity report (SAR) regime, the poor use of data and technology and a legal system that inhibits information sharing and a culture that allows companies to hide their beneficial owners through offshore registered entities. There are other related negative impacts too: I remember a discussion with the then-Treasury minister Andrea Leadsom at techUK back in 2015, during which she noted that CDD is itself a friction against a more competitive financial services sector because it serves to create a moat around the larger incumbents.
I think that UKplc should rethink compliance for competitive advantage. As part of a post Brexit project to boost British invisibles, we should take jurisdictional competition seriously and create a compliance regime built on new technology not and industrial age mishmash of shaky identification documentation and millions of suspicious transaction reports. It is time for some new thinking. Omar Magana wrote a very good piece of this for the Chartwell “Compass” magazine. He asked whether “the enforcement of a regulation that was created over 20 years ago for a fast-evolving industry, may not be the best approach”. Note that he is not arguing against regulation, he is arguing (as I do) for a form of regulation more appropriate for our age (for which I use the umbrella term “Digital Due Diligence”, or DDD) using artificial intelligence and machine learning to track, trace and connect the dots to find the bad actors. If you look at the work of Chainalysis and others
The benefits to the wider economy are obvious – more access to financial services as well as more interdiction of actual money launderers, terrorists, corrupt politicians and tax evaders. We all know that COVID-19 is accelerating the evolution of digital onboarding, and that’s great. But we need to move to the next level: DDD! Now that we live in a world where digital identity is becoming a thing (both for people and for organisations) it’s time to plan for a faster, more cost-effective and more transparent approach that is based on the world we are actually living in.
(This is an edited version of an article first published on Forbes, 3rd May 2021.)