India: FATF SERIES – ARTICLE 1- FATF – THE GLOBAL FISCAL REGULATOR

The Financial Action Task Force (FATF), a multi governmental body instituted to monitor and curb illegal cross border financial transactions, has been gaining tremendous significance in today's day and age. The FATF has been granted the status of a quasi-fiscal regulator by member nations which has further enhanced its importance in the current global political landscape. In the FATF ecosystem, the size of the economy, including its fiscal transactions and regulations, rather than the demography or the size of the nation per se determines a nation's status.

We, at ELP, recognizing the significance of FATF, India's growing economic position on the global map and the impending Mutual Evaluation of India by FATF (scheduled later this year) are publishing a three part series on FATF. As part of this series we will cover:

Article 1: On FATF - Its role as the global fiscal regulator;

Article 2: India's position at the FATF and history thereof;

Article 3: How India needs to prepare for the Mutual Evaluation by FATF scheduled in November 2023.

Please find below the first part of this series: "FATF - Its role as the global fiscal regulator"

The world today is going through a significant political turmoil, which is re-aligning the entire trade and economic equilibrium between nations. Treaties and Conventions signed post the Second World War have drastically reduced the occurrence of physical wars between countries. However, financial crimes and acts of terrorism now pose a different challenge impacting the economies of nations, which can potentially wreak havoc that outgrows the effects of a physical war.

A crucial aspect of such fiscal challenges is the financial system of the country and its inter-linkage with the international financial system. There have been instances of financing of illegal activities in the jurisdiction of another nation which could be classified as an act of war. Further, the subtle manner in which these activities can be carried out would, without exposing nations, cause significant damage to nations that fall prey to such illegal acts. To trace and curb such transactions and activities, it was considered critical that a system, network, or a multi-governmental body be established and activated. The intent was to not just monitor but also recommend regulations to be legislated in various member countries that would facilitate exposing the conduct of such activities and assist in curbing such activities.

In and around 1987, the menace of drug crime and drug trafficking caused by certain nations was impacting not just the well-being but also the economy of various developed and developing nations. The proceeds of drug crimes were making their way into the financial systems of various countries which resulted in money laundering and later into terrorist financing. To curb this menace, it was decided to identify a mechanism that would go to the root of the cause and nip it in the bud. It was thus decided to create a system that would monitor financial transactions and consequently control the flow of funds that were directed towards conduct of such illegitimate businesses. It was believed that with the development of such a monitoring mechanism, international financial transactions would be under check and the proceeds of the drug trade could not be routed through these financial systems in the case of cross- border flow of funds.

CREATION OF THE FATF

To overcome this insurmountable challenge faced by nations, especially in relation to the fight against drug trafficking and laundering of its proceeds, it was decided to convene a Financial Action Task Force (FATF) at the G7 Summit held in Paris during July 1989.

The FATF was established by the G7 Summit to examine and develop measures to combat money laundering, which was finding its way into funding illegal activities such as drug cartels and trade. The FATF originally included G7 countries, the European commission and eight other countries (viz. Australia, Austria, Belgium, Luxembourg, Netherlands, Spain, Sweden, and Switzerland). The FATF was given the responsibility to examine money laundering techniques and trends, review the action already taken at national or international levels, and to set out measures necessary to combat money laundering.

Over a period of time, the FATF has been a very effective watchdog in not only regulating and curbing drug related money laundering activities but also curbing laundering proceeds of other crimes, and terrorist funding. Since its formation in July 1989, FATF has progressively developed as a global regulator of financial systems and transactions and played its role as an international regulator of such financial systems. The various steps taken by the FATF since its inception in July 1989 are briefly given here:

• In April 1990, less than a year after its creation, the FATF issued a report containing a set of 40 recommendations in order to provide a comprehensive action plan to fight money laundering.
  • These recommendations included placing certain regulatory obligations not only on the conventional financial institutions, but also on certain sectors which are traditionally prone to money laundering activities such as casinos, dealers in precious metals and stones, real estate agents, etc., who were included under 'designated non-financial businesses and professions' (DNFBPs);
  • With evolving money laundering trends, various persons/sectors were covered within the ambit of DNFBPs, which now includes virtual assets and crypto assets as well as trust and company service providers (since 2019) and legal professionals (since 2022);
  • In 2003, it was recommended that for 'politically exposed persons' (PEPs), enhanced due diligence (EDD) should be undertaken by financial institutions/DNFBPs;
  • In 2022, the FATF further strengthened the global beneficial ownership rules in the FATF Standards to stop criminals from hiding their illicit activities and dirty money behind secret corporate structures.

• In October 2001, the FATF issued 8 special recommendations to disrupt cashflow of terrorist organisations.
  • This was an immediate action to develop clear standards to prevent terrorist financing in light of the terrorist attacks of 9/11 in the United States;
  • In October 2004, the FATF published the 9th Special Recommendation on terrorist financing in relation to cash couriers;
  • In February 2012, the FATF published revised Recommendations (refer to Annexure 1), to cover issues such as the financing of weapons of mass destruction.

Over the years, the FATF has continued to refine and strengthen its recommendations, in order to ensure that countries have stringent tools to tackle money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction.

One of the examples of the effect of FATF's Recommendation is the establishment of Financial Intelligence Units (FIUs) in several countries (Recommendation 29), that serve as a national centre for receipt and analysis of information relevant to money laundering, associated predicate offences, and terrorist financing. These FIUs usually form a part of the Egmont Group, an international organisation for fostering cooperation amongst FIUs for improved communication and interaction.FIU- Ind, India's FIU is also a part of this Group.

Recognising the essential role and efforts of the FATF in setting global standards to combat money laundering and terrorist financing, the United Nations Security Council (UNSC) adopted a resolution - UNSCR 2462 in March 2019, which urges all countries to implement FATF Recommendations.

In order to ensure compliance of the Recommendations, FATF conducts Mutual Evaluations across countries to analyse the implementation and effectiveness of measures to combat Anti-Money Laundering/Combating Financing of Terrorism (AML/CFT).

CONSTITUTION OF THE FATF

• The FATF is headed by a President who convenes and chairs the meetings of the FATF Plenary, the Steering Group, oversees the FATF Secretariat and takes all decisions and actions necessary to achieve the objectives of the FATF. The President is the principal spokesperson for the FATF and represents the FATF worldwide.
• The current President of the FATF is Mr. T. Raja Kumar of Singapore who was appointed on 1 July 2022, with his tenure extending to 30 June 2024. The internal structure of the FATF consists of the following:

• The Plenary: It is the decision-making body of the FATF and consists of the Member jurisdictions and organisations. Decisions are taken by consensus after conducting Mutual Evaluations on a country-to-country basis.
• The Steering Group: The FATF Steering Group is an advisory body chaired by the President. The composition of the Steering Group is decided keeping in mind the maximum effectiveness in taking forward the FATF's work as well as having abalanced representation of differentgeographic regions.
• The Secretariat: The FATF Secretariat supports the functions of the FATF, and the Executive Secretary. The Secretariat staff are responsible to and act in accordance with the instructions of the President.

FATF Styled Regional Bodies (FSRBs)

• In early years of its existence, FATF primarily focused on its member nations, which were developed countries. However, it was soon realised that to combat money laundering, which was taking an increasingly globalised form, there was a need to expand the network from developed countries to developing/non-member countries. FSRBs were hence set up. FSRBs are regional bodies comprising of a group of member nations of that region.
• The FSRBs are Associate Members designated by the FATF that participate in the work of the FATF. Till date, 9 FSRBs have been established and they commit to:

1. Endorse the FATF Recommendations, guidance and other policies as determined by the FATF for combating AML/CFT;
2. Promote effective implementation of the FATF standards in their member jurisdictions through the conduct of systematic Mutual Evaluations and follow-up processes; and
3. Participate in the development of the FATF standards, guidance and other policy for combating AML/CFT and other threats to the international financial system.

ROLE OF THE FATF

• The FATF is an international policy making body, which leads global action to tackle money laundering, terrorist and proliferation financing. The objectives of the FATF are to:

1. Protect financial systems and the broader economy from threats of money laundering, financing of terrorism and proliferation, thereby strengthening financial sector integrity and contributing to safety and security;
2. Work to generate the necessary political will to bring about national legislative and regulatory reforms in these areas to prevent illegal activities and the harm they cause to society.
3. Undertake research on emerging money laundering trends, and means of funding terrorism, promote global standards to mitigate such risks, and assess and monitor whether countries are taking effective action in this regard.

• In total, over 200 countries and jurisdictions have committed to implement the FATF's Standards as part of a co-ordinated global response to preventing organised crime, corruption, and terrorism. Countries and jurisdictions are assessed with the help of FSRBs and other global partners such as the IMF and World Bank.
• The FATF Plenary holds countries to account if they do not comply with the Standards. Certain instances of actions taken by the FATF Plenary are:

• Democratic People's Republic of Korea (DPRK) has been placed in the Black List since FATF has serious concerns about the threat posed by DPRK's illicit activities related to proliferation of weapons of mass destruction (WMD) and its financing. FATF has called on its members to advise their financial institutions to give special attention to business relationships with DPRK through enhanced scrutiny.

• Iran remains on the Black List for failing to fulfil compliance under its action plan, including failure to enact UN's Convention against Transnational Organised Crime and Protocols (Palermo Convention) and Terrorist Financing Conventions in line with FATF's Standards. Counter measures on Iran were suspended, owing to Iran's commitment in June 2016 to address its strategic deficiencies. However, non-compliance with such commitments has resulted in FATF once again calling upon its members to apply counter measures against Iran in February 2020.

• FATF's 2020 report stated that the UAE had not demonstrated effective supervision of real estate agents and precious stones and metal dealers and was a safe haven for wealthy individuals facing Western sanctions. Therefore, UAE was added to the Grey-List.¹

• Democratic Republic of Congo (DRC), Mozambique and Tanzania were added in the Grey-List in October 2022 for having strategic deficiencies in their AML/CFT regimes;

• Russian Federation has been suspended from membership of the FATF in February 2023 on account of the continuing and intensifying war of aggression against Ukraine which runs counter to the FATF's principles.

MEMBERSHIP TO THE FATF

• A country is required to be strategically important to become a member of the FATF. The key considerations for deeming a country to be strategically important are:
• Quantitative indicators - such as the size of gross domestic product (GDP), the size of banking, insurance, etc.
• Qualitative indicators - such as the impact of a country on the global financial system, level of commitment to combat money laundering and terrorist financing (AML/CFT), etc.
• Additional considerations such as fulfilment of financial sector standards and participation in other relevant organisations.

• A country is granted membership of FATF if it satisfactorily fulfils the technical compliance of the essential FATF recommendations within 3 years. Based on the Plenary report, a country must fulfil its shortcomings, after which it can be allowed to participate as an Observer from the next Plenary meeting.
• Within 3 years, Mutual Evaluation of the country is to be conducted and membership is granted if the outcome of the Mutual Evaluation is satisfactory.
• If the Mutual Evaluation is not completely satisfactory, then the country should provide a clear commitment at political/Ministerial level to reach the expected results within a reasonable timeframe (i.e., a maximum of 4 years).
• India became a member of the Asia Pacific Group (APG), an FSRB, in March 1998 and subsequently in 2006, it became an Observer at FATF.
• As a part of its Membership, a joint FATF/APG Mutual Evaluation team visited India in 2009 for on-site assessment of India's compliance with the 40+9 Recommendations of FATF based on which the FATF Plenary adopted the Mutual Evaluation Report (MER) of India on 24th June 2010. On 25th June 2010, FATF admitted India as the 34th Country Member of FATF. (India also became a part of the Eurasian Group (EAG), another FSRB, in December 2010).
• However, since India had not met all the FATF membership criteria, the Plenary also decided that India should report at each Plenary on the progress made in the implementation of the Action Plan. India continued to report back to the FATF periodically till February 2013 post which (in June 2013) it was recommended that India be removed from the regular follow-up process.
• India is now scheduled to be assessed in the fourth round of Mutual Evaluations which are to take place this year starting with a technical compliance review in the month of May 2023 up till an on-site assessment in November 2023.

MUTUAL EVALUATIONS

• FATF Mutual Evaluations are peer reviews, where members from different countries assess another country. An MER provides an in-depth description and analysis of a country's system for preventing criminal abuse of the financial system as well as focused recommendations to the country to further strengthen its system.
• A complete Mutual Evaluation may take up to 18 months and is carried out as per strict guidelines outlined by the FATF in a comprehensive report outlining the procedure to be followed. It mainly comprises of two parts, effectiveness and technical compliance:
• Technical compliance: the process starts 6 months prior to the scheduled visit of the assessment team for review. This is a desk-based review, conducted based on information provided by the assessee country on the laws, regulations and any other legal instruments it has in place to combat money laundering and the financing of terrorism and proliferation. Further, pre-existing information drawn from country's early MER, follow up reports and other credible or reliable source of information may be relied upon.
• Effectiveness: this is the main component of the Mutual Evaluation and the focus during the on-site visit. During this visit, the assessment team will require evidence that demonstrates that the assessed country's measures are working and deliver the right results.

Prior to on-site visit

• An assessment team is formed at least 4 months prior to the scheduled onsite visit and comprises of 5-6 expert assessors (comprising of at least one (i)legal, (ii) financial and (iii) law enforcement experts), principally drawn from FATF members, and is supported by members of FATF Secretariat. In joint Evaluations, i.e., Evaluation by FATF as well as FSRBs, the assessment team will also include an assessor from the relevant FSRB.
• A preliminary draft Technical Compliance annex is shared with the assessee country 4 months prior to the onsite visit and provides for 11 Immediate Outcomes and underlying Core Issues, which will form the focus area during the on-site visit. The assessee country is provided an opportunity to comment on the draft Technical Compliance annex, and thereafter the revised draft Technical Compliance annex is shared with the country at least 2 weeks prior to the on-site visit.

On-site visit

• On-site visit, which is usually upto 2 weeks, is the best opportunity to clarify issues relating to the assessee country's AML/CFT system. The assessors review the 11 immediate outcomes relating to effectiveness of the system and clarify any outstanding technical compliance issues. Attention is paid to areas where high money laundering and terrorist financing risks are identified.
• Meetings with private sector or other non-governmental representatives are an important part of the visit. If the assessors have a concern that presence of government officials may inhibit openness of the discussion, the assessors may have to be granted an opportunity to meet with such bodies or persons in private.

Preparation of MER and plenary meetings

• Within 6 weeks of the on-site visit, the assessment team prepares and sends a draft MER to the assessee country for initial discussion of the findings in the report and its recommendations. Face to face meetings with the assessee country to discuss draft MER and Executive Summary (ES) are prepared 8 weeks prior to the plenary meeting, and thereafter the final draft MER and ES are placed before the Plenary. After the report is adopted and published, the country under review is expected to address any identified shortcomings and is subject to post-assessment monitoring. According to FATF, the completion of assessment and publishing of MER is merely 'a starting point for the country to continue strengthening its measures to tackle money laundering and terrorist financing'.

BENEFITS FOR NATIONS ON BEING A MEMBER OF THE FATF

• The FATF identifies jurisdictions with weak AML/CFT measures in two FATF public documents i.e., Black List and Grey List, that are issued 3 times a year. Countries categorized under the Black or Grey Lists may face certain economic sanctions with regards to their transactions with other jurisdictions, which can impact trade relations and economy of the countries placed under such Lists. According to a report of the IMF, the point estimate for the effect of Grey-Listing on total capital inflow of a country was measured to be ?7.6, meaning that the country's capital inflow is expected to decline by 7.6 percent of GDP when the country is Grey-Listed.²

• Consequently, countries which are members of the FATF/ FSRB and/or are not designated either under the Grey or Black List can be considered as having gained a status to undertake global financial transactions without being subjected to larger scrutiny.

Recognising the significance of the FATF's identification of high-risk jurisdictions (Black List)/ Jurisdictions under increased monitoring (Grey List)

• Various member countries (especially developed nations) have issued governmental declarations that refer to the Black List/Grey List status denominated by the FATF on various nations, for directing higher level of scrutiny/EDD while dealing with such nations. A few illustrations of the same are set out hereunder:
• USA: With respect to the FATF-identified jurisdictions under the Grey List, the U.S. FinCEN (regulator in relation to financial crimes in USA) requires financial institutions in the U.S. to comply with due diligence obligations for foreign financial institutions. Additionally, with respect to jurisdictions under the Black List (currently the DPRK, Iran and Myanmar), the FinCEN has the power to prohibit any correspondent account relationships.³

• European Union (EU): The 4^th Money Laundering Directive of EU mandates that the European Commission should regularly update the List of high risk third country jurisdictions, which are countries with strategic deficiencies in their regimes on AML/CFT that pose significant threats to the financial system of the Union. Such identified high-risk third countries are subjected to EDD by financial institutions and other obligated entities of the countries forming part of EU. The said List takes into account information from the FATF.⁴

• The United Kingdom: The UK provides similar regulations as EU for EDD of high-risk third countries and the Financial Conduct Authority (FCA) regulates and supervises different sectors on actions they can take to counter risks... The List of high risk third countries identified in terms of UK's Money Laundering Regulations mirrors both jurisdictions of FATF, i.e., Black List and Grey List. The FCA has, in the past imposed fines on certain financial institutions/intermediaries that have failed to undertake EDD in relation to transactions with countries identified as high risk third countries.⁵

• Singapore: The Monetary Authority of Singapore (MAS) is responsible for pursuing allegations involving money laundering within the country's financial institutions. In pursuance of this, the MAS requires Financial Institutions to consider DPRK, Iran and Myanmar as high-risk jurisdictions, pursuant to FATF's classification of the said countries as Black List countries and apply EDD measures to mitigate the risks these countries pose to the international financial system.⁶

• Japan: Countries and regions identified by FATF as having deficiencies of anti-money laundering policy, etc. are deemed to have high risk in Japan. Currently, the Black List countries have been identified as high-risk countries and strict client identity verification is required for transactions and transfer of assets to persons residing or located in such countries.⁷

• India: The Reserve Bank of India (RBI) prohibits entities from non-compliant FATF jurisdictions from acquiring 'significant influence' i.e., >20% voting power in payment service operators. The Securities and Exchange Board of India (SEBI) requires securities market intermediaries to undertake EDD on clients from high-risk countries and prohibits foreign investments of more than 25% by high-risk countries in Alternative Investment Funds (AIFs). There are many other sanctions imposed by the Indian Authorities against high-risk countries identified by the FATF. Moreover, the Indian Banks' Association has prepared a guidance note providing an indicative List of high-risk customers, products, services, and geographies and advises banks to use such guidance.

Several of the above regulations were brought into effect based on India's last MER. Due to the COVID-19 pandemic, India could not be assessed in the fourth Mutual Evaluation of the FATF and is due for a Mutual Evaluation in November 2023. In the next segment of this series, we will be focussing on India, its membership in the FATF and its compliance with the FATF recommendations.

Annexure 1

FATF Recommendations (updated as on February 2023)

Footnotes

1https://timesofindia.indiatimes.com/business/india-business/explained-why-dubai-is-on-a-fatf-gray-List-and-what-it-means-for-india/articleshow/90068564.cms

2 https://www.imf.org/en/Publications/WP/Issues/2021/05/27/The-Impact-of-Gray-Listing-on-Capital-Flows-An-Analysis-Using-Machine-Learning-50289

3 https://www.fincen.gov/sites/default/files/shared/2016-27049.pdf , https://www.fincen.gov/sites/default/files/shared/2019-23697.pdf

4 https://finance.ec.europa.eu/news/anti-money-laundering-commission-updates-its-List-high-risk-third-country-jurisdictions-strengthen-2022-12-20_en

5 https://www.legislation.gov.uk/uksi/2017/692/regulation/33

6 https://www.mas.gov.sg/publications/fatf-statement/2023/february-2023-fatf-statement

7 https://www.amt-law.com/asset/res/news_2022_pdf/publication_0025005_ja_001.pdf

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