Fighting Financial Crime: It’s a Global Effort
It’s a combination of following the money, but also understanding the social connections and relationships across a lot of data sources.
As the dust settles on what was another tough year in the fight against financial crime, 2018 will be remembered for a number of high-profile scandals. Government regulators are coming under fire as most of the issues coming to light were long-standing and occurred under their watch. 2018 was a wakeup call and rallying cry for governments and the financial sector. Change is starting to happen, and these efforts are global. Against this backdrop, governments around the world are more aggressively enforcing current regulation, as well as actively identifying gaps and introducing new AML regulations in an effort to clamp down on financial crime, which currently comprises up to 5 percent of global GDP.
The U.K. introduced new legislation in January in the form of an Unexplained Wealth Order, allowing them to seize assets the owner can’t prove were purchased legitimately. The EU strengthened the European Banking Authority with the Fifth AML directive in June to extend AML compliance to digital currencies, tax services and art dealers as well as increasing customer due diligence requirements. And in the U.S., regulators urged private sector innovation and provided penalty relief for institutions experimenting with next-generation AML programs.
One positive outcome of this international effort is that smaller economies and countries that have traditionally served as tax or offshore havens are coming under increased scrutiny and pressure to ramp up monitoring, remove secrecy and stiffen regulation if they want to continue to work with EU and U.S. businesses and banks that have been stung by billions in non-compliance fines over the last decade. Rising rates of child poverty and homelessness and subsequent increases in costs of government and social programs are calling attention to the billions in lost revenue due to corporate tax evasion.
For example, the Panamanian law firm Mossack Fonseca, at the center of the Panama Papers scandal, shuttered its doors this year after revelations it was a vehicle for tax and international sanctions evasion. The firm, which was handling business for some 300,000 offshore companies, facilitated financial transactions for violent dictators, child molesters and operated political slush funds used to bribe local officials. Given what we know, it appears strange that in February 2016, Panama was removed from the Organization for Economic Co-operation and Development’s (OECD) gray list – an intergovernmental group committed to stimulating economic progress and world trade – just two months before the Panama Papers revelations. However, given the revelations of 2018, this is symptomatic of the malaise and inaction from all parties that is fortunately now starting to change.
This month under the threat of blacklisting, the Cayman Islands announced it was increasing economic substance requirements for foreign businesses to help meet its commitment as a member of the OECD. The organization’s anti-base erosion and profit shifting (BEPS) framework agreed upon by over 100 countries creates a “single set of consensus-based international rules to ensure that profits are taxed where economic activities generating the profits are performed and where value is created, rather than shifting profits to low or no-tax locations.”
What is becoming apparent is the scale of the problem. A June 2018 study from the National Bureau of Economic Research estimates that BEPS costs the U.S. 15 percent of its corporate tax collections and 20 percent for Europe as more than $600 billion dollars a year of profit are shifted to low-tax countries such as the Cayman Islands. And, the number of companies registered there ballooned to 106,291 this year, according to Cayman Finance – a record high. It’s a sought-after destination for multinational corporations, especially countries (the U.S.) that base tax residency by location of incorporation, because of its zero-tax policy. It paints a clear picture as to why the coffers are empty to fund new schools and hospitals.
Under the new rules, businesses that are not tax resident in another country would need to have enough economic activity physically happening on the island to justify the profits they make. Short version, if you’re going to be registered in the Cayman Islands, you need to actually do your business in the Cayman Islands. Though, the bill does stipulate that those activities could be outsourced to other local service providers. This law is expected to impact up to 20,000 businesses.
While it’s great that strides are being made to close loop holes for money launderers and tax evaders, there is still a need for all countries to join together in the fight against financial crime. We know from experience that economic sanctions are effective only when everyone applies them. The same is needed for tax havens. Any partial action to address those activities is just going to push them to the least regulated places. The Cayman Islands’ new rules will be a temporary thorn in the sides of the corporations registered there if it’s as simple as re-incorporating in another tax haven such as Singapore or Ireland. Or for criminals to use banks located in North Korea and Iran that are on the OECD watchlist for non-compliance.
The good news is, with the help of AI-based analytics, the next generation of AML and compliance solutions are better than ever at identifying financial crime. If we’re serious about working together to make an impact on the $1.9 trillion in financial crime-based transactions, it’s never been more achievable.