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ANALYSIS: The Top 5 AFC trends for 2023 – from sanctions, crypto, beneficial ownership and gambling to Europe’s weaknesses in smaller jurisdictions

RUSSIA SANCTIONS: Author Nigel Webb writes: "There is a growing view that the truly monumental level of sanctions being applied to Russia is not really having the desired effect and I predict that this view will strengthen during 2023. This will in turn place a greater pressure on the financial sector to take a rather broader and more searching view of KYC than has been the case historically."

By <strong>Nigel Webb</strong>
By Nigel Webb

Managing Director
Interpath Advisory

IT’S NOT EVERYDAY I am invited to stare into the crystal ball in an attempt to see into the future. 

So it is with some trepidation that I accept the challenge of looking into what the key trends in Financial Crime might be as we sail gracefully into 2023.

Join me in the next few paragraphs, for a deeply personal and nuanced view of what I think we may be talking about as the months ahead unfold.

Here are my Top 5 predictions of what’s about to happen over the next 12 months:

1. Sanctions

Let’s start the (crystal) ball rolling with a look at the world of sanctions.

In the same way that many of us came to regard FATCA (Foreign Account Tax Compliance Act) as the US Treasury’s way of making us pay to collect their taxes for them, one might regard sanctions as a way of making the financial services sector carry the burden for implementing the US and others’ foreign policies.

Sanctions are essentially about making life difficult for parties upon whom the US and other government and international bodies wish to apply pressure. Sanctions are nothing new, but the advent of a war in Ukraine has both increased the number of sanctioned parties, as well as throwing a bright light on the more angst-inducing question of sanctions effectiveness.

Whilst the OFAC manual tells us in some detail how we are meant to operate sanctions in terms of connections between companies, directors, and shareholdings, it has become very clear during 2022 that sanctions can and are being evaded with ease through the use both of complex ownership and trust structures as well as more subtle forms of corporate control and control over individual assets.

‘There is a growing view that the truly monumental level of sanctions being applied to Russia is not really having the desired effect and I predict that this view will strengthen during the year’

The question of control is a particularly interesting one since it can be achieved through enormous numbers of very subtle methods, ranging from entirely discretionary trust structures through to debt structures, nominees and even under-the desk legal agreements.

There is a growing view that the truly monumental level of sanctions being applied to Russia is not really having the desired effect and I predict that this view will strengthen during 2023.

This will in turn place a greater pressure on the financial sector to take a rather broader and more searching view of KYC than has been the case historically. Running a few director names through World Check is not necessarily going to satisfy your obligations in the way we might have hoped in the past.

2. Crypto

There are mixed signs here and further analysis of hedgehog entrails may be necessary for a full forecast. On the one hand, there has been a distinct cooling of the fervour for trading cryptos by the masses. The so-called crypto winter has schooled those who thought that this was an infinite bear market and lots of students and others who have been ‘dabbling in crypto’ have lost their gains if they were lucky, and their shirts if they weren’t so fortunate.

On the other hand, slowly but surely, the established financial community has started to get involved in crypto and we are starting to see the licensing of brokers, exchanges, market makers and other market participants by conventional financial regulators.

‘The trend here is a rolling wave of regulation across the Virtual Assets space, with the wild west increasingly being swept away by a better regulated market operated by rather more familiar names’

Indeed, some familiar names in the wholesale markets business have decided to chance their arms by treating crypto as just another asset class to add to their existing portfolios. You can’t make money broking FX spot these days, but there is still money to be made broking the increasing menagerie of crypto product types.

So perhaps the trend here is a rolling wave of regulation across the Virtual Assets space, with the wild west increasingly being swept away by a better regulated market operated by rather more familiar names.

The fun will be driven out of the market, some will say. Others will see new opportunities in a safer sandpit behind which there is real liquidity.

And yet I still sense problems lurking here.

Crypto in its purest form is still a traded asset without an inherent value beyond its own supply and demand. The effort to establish Tether and other stablecoins is an attempt to address this void in the middle of Crypto but its success is still rather uncertain. And don’t even get me started on the ‘digital art’ being sold through the medium of Non-Fungible Tokens (NFTs).

Maybe it’s an age thing. I’m not convinced.

My crystal ball tells me that despite huge progress establishing regulation in the space, litigation will continue unbounded and 2023 will provide many further reasons to place trust in gold bars and conventional financial markets before trusting the Emperor’s New Clothes being offered by the peddlers of tokens. But I should move on.

3. Beneficial Ownerships

This could have been the year in which establishing Beneficial Ownership should have become a simple matter of referring to the relevant government-provided Business Registries and hey presto, any doubts about who might own a corporate structure, no matter how complex, would have been resolved.

For ten years or more, outfits like Transparency International have been banging the drum for corporate registers to be in the public domain as the ultimate antidote to the myriad issues identified by the Panama Papers, the Paradise Papers, and many other embarrassing data leaks since.

It even seemed that the EU was behind this with all sorts of suitable provisions being made in the 4th, and particularly the 5th European Money Laundering Directive (MLD).

But then, just when you thought it was safe, on November 25 last, the Court of Justice of the European Union effectively banged the brakes on and invalidated that provision of the MLD in an amazing about turn – prompted by concerns about individuals’ right to privacy.

This isn’t the first time that the EU has looked a little schizophrenic in its decision making and there can be little doubt that the decision has set back the cause of AML by introducing doubt where once there appeared to be clarity of direction. But there is hope in 2023 despite the mixed messages.

The CJEU ruling does not backtrack on the decision to establish the registers, it simply removes the provision that they should be publicly searchable. Suitably qualified agencies will still have the right to retrieve information from the business registries on demand. Not quite the Utopian promise of complete openness sought by Transparency International, but a significant step forwards, nonetheless.

My only doubt in all of this is in relation to the quality of the information gathered by these registries.

Companies House in the UK doesn’t set a very good example. The registry is still replete with companies for whom Elon Musk (not the real one) and Mickey Mouse are registered as directors trading at addresses that simply don’t exist and filing balance sheets that don’t balance. It is all very well gathering this information, but unless it is checked and validated prior to accepting it, the whole system falls foul of the old IT adage; Rubbish In – Rubbish Out.

We stand at the dawn of a massive opportunity as lots of new registries emerge during the year.  Let’s hope that in 2024, we will be congratulating ourselves on what high quality repositories of information we have created.  The crystal ball is a little hazy on that point.

4. Smaller jurisdictions

Ah, back to the crystal ball! I look deeply and I see small sandy islands and suitcases full of used notes. So let’s discuss small jurisdictions and their role in the financial crime ecosystem.

Anybody working in the world of financial crime will tell you that one of the biggest impediments to progress is the sheer amount of work which needs to be completed. In addition to business-as-usual, there is a seemingly unending wave of regulation and legislative change which we are expected to digest and implement.

If you think it’s bad for the financial institutions, imagine how bad it is for the regulators. It is a good general working principle that regulators never have as big a budget as they would like and therefore can’t afford the staffing levels that they would wish to have.

It’s also a good assumption that the salaries that regulators can afford will always be outstripped by the private sector. In many countries the regulators are therefore populated by industry veterans topping up their pensions, by a truly dedicated small core team of long-term staff, and by young freshly graduated students building up experience before being poached into the private sector.

‘This year will doubtless see further examples of this emerge as small jurisdictions struggle to manage the inherent conflicts of interest between promoting their countries as ideal homes for the most exotic financial services, whilst attempting to police their flock with very little resource and even less expertise’

Now consider how this model might apply in a tiny jurisdiction with a small population, in which there are few ‘experts’ in financial crime to start with, let alone to populate both the industry and a regulator.  Then consider that the government side often takes that tiny population of experts and divides them up into a central bank, an FIU and financial regulator and a Ministry of Finance. Nowhere does financial crime capability reach critical mass.

The world at large and the EU in particular is blessed with many such jurisdictions, and it is no surprise that many of these small countries have turned to promoting financial services as a way of bringing money into the economy.

This can be a toxic combination, and it hardly surprising that some of the biggest scandals have occurred in such jurisdictions when the rather unequal battle between the criminals and the poorly-staffed regulators has gone wrong.

This year will doubtless see further examples of this emerge as small jurisdictions struggle to manage the inherent conflicts of interest between promoting their countries as ideal homes for the most exotic financial services, whilst attempting to police their flock with very little resource and even less expertise.

The established regulators in larger jurisdictions would do well in 2023 to consider outreach to the small jurisdictions as a way of improving the financial services environment for all.

The FIUs as a community have been very good on this point, with the Egmont Group setting a wonderful example.

More could be done, and the learnings would flow in both directions if it were done properly. The EU already does this in a small way through the EU AML/CFT Global Facility and allied other bodies. More could be done and 2023 could be the year to see this happen.

5. Gambling

The crystal is darkening and shows just one last image of 2023. Gambling, or is it Gaming? Some people get very sensitive about the terminology. Much as the conventional financial services industry might beat itself up, they haven’t done a bad job of making life difficult for the world’s financial criminals over the last few years. There is still much to be done, but one of ways in which we can measure the success of AML activities in banks is to note how much of a feature AML is now becoming within the arena of Gambling, both conventional, but also now online.

It would be fair to say that those jurisdictions that have encouraged and welcomed online gaming have done so as part of a plan to build that business for the country. And it would be fair to say that this also has posed some degree of conflict when it comes to regulating that business.

Gambling regulators have for years seemed far more concerned about protecting consumers from themselves by promoting responsible gambling protocols rather than in considering the extent to which it can be easy to exploit online gambling for financial crime purposes. So-called Chip Dumping, intentionally losing to a covert confederate at online poker, and the use of money mules remain live issues despite full awareness within the industry.

Online cash in video games such as Fortnite and Counter-Strike have historically provided the backdrop for entirely unregulated marketplaces which have become a haven for AML breaches.

The poor quality of initial KYC checks of regulated firms as well as insufficiently broad ongoing transaction monitoring muddy the picture still further. For many gambling firms, there is far more attention paid to monitoring for evidence of cheating than there is for financial crime activities. 

But all of this is starting to change.

In the UK, we are starting to see the evidence of fines being generated for breaches of AML regulation, and not just for breaches of responsible gambling. With luck, 2023 will see a further increase in momentum with more regulators realising the role that they need to play in order to avoid becoming the weak back door for financial criminals.

I predict a significant increase in gambling related Suspicious Activity Reports (SARs), a notable and unjustified absence at the moment. With that increase in reporting will inevitably come a raising of the bar to criminal activity.

There can be little doubt that 2023 is going to be an exciting time. I have barely had had the chance to scratch the surface in this article. I didn’t even mention COVID, and the final page in that book has yet to be written, I suspect.

But now the crystal has gone dark. I am after all, a management consultant, and to hear more from the crystal, you will need to cross my palm with silver.

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