Jason Sharman examines 20 years of international anti-money agreements and assesses their effectiveness in the face of the growing costs incurred ensuring compliance with international standards.
It is now just over 20 years since the first international anti-money agreements were concluded. Notable amongst these are the 40 Recommendations compiled by the Financial Action Task Force (FATF), which have come to define the international state-of-the-art in anti-money laundering (AML) standards.
At the time they were first created, AML rules were seen as another front in the ‘War on Drugs’. Since then, the monitoring and implementation of AML standards have morphed into a global industry. Rather than just the rich countries that originally comprised the FATF membership, over 180 states have now signed up to the 40 Recommendations, which have since been augmented by the 9 Special Recommendations on the financing of terrorism. A vast array of financial institutions, from banks to brokers, insurance firms to casinos, money remitters to hedge funds, have now been conscripted into monitoring their clients for signs of suspicious financial activity. All this has imposed substantial costs on governments, private financial firms, and, indirectly, consumers, with the burden being especially significant for International Financial Centres.
While this broadening and deepening of the global AML regime can be taken as evidencing the extraordinary strides made since the early 1990s, it is disconcerting how seldom the most obvious questions about this system are asked. First amongst these is whether AML standards actually work. That is to say, is there any less money laundered now than there was 20 years ago? Is there any less predicate crime that gives rise to these dirty funds in the first place? Despite all the evaluations performed by the FATF, other international organisations, national governments and the army of private AML experts that has grown up, it is striking that these sort of first-order questions are almost never asked, let alone answered. Although definite answers are elusive, I argue these hard questions should be asked. For all the time, effort and money devoted to combating money laundering over the last few decades, there is very little evidence that the standards have done much good in achieving their original aims.
The appropriate starting point for this enquiry is to re-examine what AML standards were supposed to do. Although money laundering is now defined to include all crimes that produce profits, as noted, the original priority was the fight against the drug trade. Frustrated by the failure of the prohibition regime, policy-makers sought to attack the financial flows that constituted the motive for drug trafficking. Traffickers seek illicit profits, which are often too large to be spent on everyday consumption, especially for drug king-pins. Hence the need to disguise the illegal origins of the funds, and thus money laundering. To the extent that the authorities could prevent the laundering or (even better) seize the proceeds of drug crime, they would undermine the incentives that drove trafficking, and thus reduce the drug trade overall. More or less the same logic has seen AML rules expanded to other profit-driven crimes. Thus while the proximate goal of AML systems is, rather obviously, to reduce money laundering, the ultimate aim is to reduce profit-driven crime in general. So in judging the success or failure of AML standards these two concerns (the scale of money laundering, and the incidence of profit-driven crime) provide the logical benchmarks to be applied.
Surprisingly, however, one can read through thousands of pages of FATF reports, covering everything from football to free-trade zones, without finding much, if any, attention devoted to these measures. Instead, the international surveillance and monitoring system that judges almost every country to see whether they have ‘the right stuff’ in AML terms has tended to foster a bureaucratic game of goal displacement: means to an end have become ends in themselves. For example, rather than a suspicious transaction reporting system being assessed on the grounds of its contribution to reducing money laundering and predicate crime, having a reporting system becomes an end in itself. This tendency towards goal displacement, of means becoming ends, has also filtered through to private firms, thanks to pressure exerted by national regulators, themselves keen to obtain a good FATF scorecard.
While there is a rhetorical commitment to measuring effectiveness, the extent of this seems to be counting the number of convictions and totals of assets seized. In most countries these numbers are very low, which would tend to indicate that the AML system is not very effective. But even putting this to one side, there is the fact that the number of convictions is a very ambiguous measure of success. Is a high number of convictions good news (because lots of launderers are being caught) or bad news (because lots of laundering is going on)? Clearly having a few or no convictions is similarly ambiguous. There is also the point that giving the world’s many dictatorial governments (for whom the rule of law is a foreign concept) an incentive to ‘find’ money launderers will probably result in the conviction of innocent individuals.
The most careful studies of effectiveness (both in absolute terms and relative to the cost) have been done by those outside the system, for example scholars like Peter Reuter, Edwin Truman, Jackie Harvey and Michael Levi. Each of these observers notes the mismatch whereby we have an incredibly extensive and intrusive policy apparatus, but very little knowledge about the results produced. On the basis of the fragmentary evidence that is available, however, it is hard to see any impact that AML rules have made on the incidence of crime. The general conclusion is that the expansion of the AML regime owes more to a political imperative to ‘do something’ in response to hot-button issues like crime or terrorism, rather than any track record of success.
None of these reservations about the effectiveness of the system would matter as much if AML came cheap. But as those in IFCs know only too well, the compliance costs imposed by AML requirements are substantial and growing. A series of surveys of AML practice in the banking sector by KPMG have shown that banks have consistently under-estimated the cost of compliance, which is estimated to have grown by a cumulative total of 269 per cent since 2001. The large international banks surveyed by KPMG may in fact get off lightly compared with other firms covered by the AML system. In comparative terms, banks are used to meeting strict regulatory requirements, they have large compliance departments, and they routinely collect a good deal of information on their customers. They also may be better placed to pass on extra compliance costs to their customers. These factors are much less applicable when it comes to company formation agents or cheque-cashing services, for example. As a general rule of thumb, the smaller the business, the higher the proportional cost of regulatory compliance.
The distribution of costs may be uneven in other ways also. Since the advent of the FATF’s ‘Non-Co-operative Countries and Territories’ blacklist in 2000, small state IFCs have consistently been singled out as supposedly deficient in the fight against money laundering. (The evidence tends to tell a different story in terms of large countries, especially the United States, being the main laundering jurisdictions, but countries calling the shots in the international clubs are loath to admit their own faults.) The response in IFCs has involved exponential cost increases for both the public and private sector in meeting the demands of powerful outside countries and institutions. These have been exacerbated by a tendency towards double-standards. For example, IFCs have been rigorously held to ‘Know Your Customer’ standards mandating that all corporate vehicles must be able to be linked to their beneficial owner or owners. In contrast, countries like the United States, Britain, Canada and New Zealand have no such requirement, and thus allow the formation of exactly the type of anonymous shell companies that are so useful for those looking to launder money and engage in other serious crimes. Rather than just representing a hypothetical problem, untraceable shell companies from these countries have been used by Russian sanctions-buster Viktor Bout (biographied in Merchant of Death), in a major corruption scandal in Kenya (the so-called Anglo-Fleecing affair), in connection with a plane-load of North Korean weapons headed to Iran, and the Mexican Sinola drug cartel, among many others.
As we enter the third decade of anti-money laundering, it is thus time to ask simple, direct questions concerning the effectiveness of the system. Rather than caricaturing those questioning the effectiveness of AML systems as somehow ‘soft on crime’, the onus should be on those defending the status quo to show how the results justify the costs, direct and indirect, that have been incurred so far. It is a fundamental expectation that government policy should create more benefits for society than it does costs. So far there is little evidence that AML systems pass this test.
Professor Sharman’s latest book, The Money Laundry: Regulating Criminal Finance in the Global Economy, was published by Cornell University Press in 2011
Jason Sharman is a Professor at Griffith University in Brisbane, Australia. Sharman’s research is focused on the regulation of global finance, especially as relates to money laundering, tax, corruption and international financial centres. He has worked as a consultant with the World Bank, Asian Development Bank, Commonwealth Secretariat, Financial Action Task Force, the Asia-Pacific Group on Money Laundering, Pacific Islands Forum and in the private sector. He is currently working on his fifth book, investigating the effectiveness and diffusion of anti-money laundering policy. His work has been featured in major media outlets like the Economist and the New York Times, and has been taken as evidence by the United State Senate Homeland Security Committee.