Slide 1

Professor Michael Mainelli, Executive Chairman, The Z/Yen Group

[An edited version of this article first appeared as "Anti-Anti Money Laundering, Feed-Back or Fed-Up", The Journal of Risk Finance, The Michael Mainelli Column, Volume 6, Number 4 , Emerald Group Publishing Limited (November 2005) pages 386-372.]

Regulation Without End, Or Means

The increasing crush of regulation needs a poster child. Perhaps the authorities have created that poster child in “anti-money laundering regulations” (AMLR). How can anyone object to AMLR? How can anyone be ANTI-Anti-Money-Laundering? Well, as we shall see later, they can – particularly when AMLR seem to be about tax enforcement rather than stopping terrorists or immobilising organised crime.

This article makes two points: firstly, it is difficult to support AMLR without cost/benefit analysis and, secondly, it is difficult to support AMRL when there is no feed-back. For instance, here is the substance of an actual discussion between a US AMLR authority and the author showing the current futility of invoking cost/benefit analysis:

Author: “So, what are you doing with the thousands of reports you receive from overseas authorities?”
US authority: “Well, we’re looking at them.”
Author: "But I thought you said you have no staff and spend most of your time travelling in order to support awareness events?”
US authority: “Yes.”
Author: “So, you go through several hundred thousand reports per annum yourself over evenings in foreign hotels?”
US authority: “Well, clearly not.”
Author: “Clearly. So what use do the reports serve?”
US authority:  “Well, if they prevent one twin towers disaster…”
Author: “Yes, of course, but if you don’t look at the reports, how is a future disaster going to be prevented?”
US authority: “Well, we’ll certainly need the reports for the forensics.”

Background to a Regulatory Overload

The European Union (EU) is developing a Third Money Laundering Directive which is due to be published later in 2005. The new directive will consolidate and update the First and Second Money Laundering Directives (1991 and 2001 respectively) in particular by ensuring that the EU’s AMLR are in line with the Financial Action Task Force’s (FATF’s) revised Forty Recommendations. Draft articles for the proposed directive were issued in March 2004 and a formal proposal was issued in May 2004. The financial services industry in the UK has been subject to AMLR since the introduction of the Money Laundering Regulations 1991. These requirements have been enforced with increasing vigour by the Financial Services Authority in the last few years.

The requirements were increased by the passage of the Proceeds of Crime Act (PoCA) in 2002 which extends the definition of money laundering. PoCA combined and simplified the Criminal Justice Act of 1996 and the Drugs Trafficking Act of 1994. The Terrorism Act of 2000 (as amended by the Anti-Terrorism, Crime and Security Act in 2001) now provides the law on terrorist financing. Additionally the Guidance Notes issued by the Joint Money Laundering Steering Group (JMLSG), a group of financial services trade associations, are used as a practical guide on implementing the regulations.

Prior to the Money Laundering Regulations 2003, AMLR applied only to banks and financial services institutions. The 2003 Regulations have extended AMLR to a number of other sectors, most notably accountants and lawyers. This has resulted in AMLR applying to approximately 19,000 organisations in the UK. The UK gives the appearance of implementing international requirements with a rigour not matched in other jurisdictions and exceeds international requirements in a number of aspects. It has been suggested that this level of implementation could result in a competitive disadvantage that is not matched by benefits in terms of a safer and more law-abiding environment.

"The effectiveness of the AML regime will not increase with more money spent on it” - Senior Money-Laundering Reporting Officer of a major European investment bank

It is likely that there still remain a few regulatory gaps in AMLR. High-Street bookmakers represent one such gap, falling outside AMLR and providing an easy path towards financial legitimacy. The gap in AMLR for High-Street bookmakers is currently being examined by National Criminal Intelligence Service (NCIS). Another gap involves payments for overseas intellectual property, which is then written off. It is believed that further research into money laundering typology may reveal other regulatory gaps.

The Corporation of London and the Institute of Chartered Accountants in England & Wales commissioned Z/Yen to investigate AMLR and UK competitiveness in 2004/2005. This investigation assessed the perceived costs and benefits of UK Anti-Money Laundering Requirements (AMLR) compared with other jurisdictions including the USA, Germany, France and Italy. It was carried out between September 2004 and March 2005 and involved 34 personal interviews and an online survey that received 386 responses. From the report (published in June 2005), I wish to draw attention to two of the many themes which emerged during the investigation:

The Level Of Regulation And AMLR-Related Costs Are High In The UK

One very clear message, with which virtually everyone (overseas and local) agreed, is that the financial services industry in the UK has a more rigorous, and more costly, implementation of the international AMLR than any other major financial centre. In the UK, more business sectors fall within AMLR than in other countries. Examples of these additional sectors include lawyers and accountants. Perceptions of current costs, past cost increases and future cost increases are higher from UK respondents than from international respondents.

Almost two-thirds of UK respondents said that AMLR were too severe in proportion to the risks of money laundering. Overall, UK-based organisations do not comply because they perceive AMLR as representing good business practice or as being effective at combating money laundering, on the contrary two-thirds of UK-based organisations comply with AMLR in order to avoid sanctions from the authorities. Just over half of organisations from other jurisdictions comply because they believe that AMLR in their country represent good business practice.

The table below shows the percentage of respondents who thought the attractiveness of each country mentioned had decreased, remained unchanged or increased as a result of AMLR (respondents who answered ‘Don’t Know’ have been removed).

Country

UK

USA

Germany

France

Italy

Attractiveness Decreased

36%

40%

12%

20%

23%

Attractiveness Remained Unchanged

46%

47%

78%

70%

62%

Attractiveness Increased

18%

13%

10%

10%

15%

The rigorous implementation of international AMLR has not yet had a severe impact, either negative or positive, on the competitiveness of the UK as a financial centre. Respondents perceive that factors such as service levels, transaction costs, confidentiality and the size of the market are more important to competitiveness than AMLR.

The UK is perceived as being more heavily regulated than other major financial centres. However, UK AMLR are not perceived as being more effective at detecting and deterring money laundering than the regulations in other jurisdictions. There are similar perceptions about the level of effectiveness of AMLR from UK respondents and international respondents. While cost/benefit analysis of AMLR is exceedingly difficult, nevertheless without feed-back it is impossible – we can only deal with perceptions.

As the Likelihood Of Being Caught Is The Biggest Deterrent To Money Launderers – Future Expenditure Might Be Usefully Redirected

The risk of being caught and the severity of punishment are seen as the two main deterrents to money launderers. Raising the perceived likelihood of being caught and raising awareness of severe punishment are likely to reduce money laundering. However, analysing a ‘cost perception score’, based on the answers to cost questions, and relating this to an ‘effectiveness perception score’ based on answers to effectiveness questions, suggested that very high AMLR costs may reduce the perception of AMLR effectiveness. People who have experienced very high costs tend to feel less positive about AMLR in general and about the effectiveness of AMLR in particular.

If very high AMLR costs reduce the perception of AMLR effectiveness, then further expenditure on AMLR might be more effectively directed at increasing perceived effectiveness of the current requirements rather than at increasing the level of regulation. One way of achieving this increase in perceived effectiveness might be to increase the perceived likelihood of money launderers getting caught. Perhaps the most effective way of increasing the perceived likelihood is to publicise the successes of the authorities and raise awareness of convictions, prison sentences and asset confiscations.

Many professionals perceive that AMLR could be made more effective by better collective pooling of AML intelligence about criminal activity. In the UK the National Criminal Intelligence Service (NCIS) has an important role in receiving AML intelligence and disseminating this to the relevant law enforcement authorities. NCIS however, does not currently have sufficient resources to perform this role as effectively as it might. There were numerous comments about a lack of ‘feed-back’ from NCIS on the pooled information and its effectiveness. While the Proceeds of Crime Act 2003 (PoCA) covers all businesses, the Anti-Money Laundering Regulations 2003 do not apply to all types of business.

What We Have Here Is A Failure To Communicate

The most significant gap is the communications gap – a lack of feed-back. We asked people what they believed to be the main intention of AMLR in their country. 60% of respondents thought the main intention of AMLR was to detect and deter organised crime receipts; 24% thought the main intention of AMLR was to reduce the scope for tax evasion; only 16% thought AMLR was directed at stopping terrorism. Clearly, the more the AMLR the more cynical people are about the intentions – tax revenues. Basic systems theory (e.g. Stafford Beer or Norbert Wiener) emphasises the fundamental role of feed-back in systems success or failure.

People in financial services institutions tend to see only the increased administration, increased costs and increased time spent on AMLR. Feed-back to financial services institutions regarding the quality and quantity of Suspicious Activity Reports (SARs) is inadequate. Organisations that produce SARs get virtually no feed-back on the value of their reports. These organisations cannot improve the value of their reports. Increased feed-back would probably result in fewer, but better researched, and more qualified, reporting. Lack of feed-back, combined with severe penalties and personal liability, leads organisations to over-report. For example, a high proportion of SARs that NCIS currently receive, record ‘suspicious’ by not illegal transactions.

There is clearly inadequate feed-back on successful prosecutions, successful convictions and asset seizures. There is no feed-back on the quality and use of SARs. Financial institutions would benefit from the knowledge that their costs, time and effort have resulted in some positive outcome. The general public, and also money launderers, need to see that regulations and their enforcement are successful. Successful feed-back (pour encourager les autres) will raise the perceived likelihood of being caught, which has been shown in other fraud and criminal management to be the most effective deterrent. A clear link between AMLR and the crimes that affect the general public most (for example drug dealing and robbery) will lead to improved public perception of AMLR.

A good example of effective communication in a similar area is the UK’s Health & Safety Executive Public Register of Convictions that is published on the internet. A similar format could enhance general awareness of successful money laundering prosecutions. There are currently a number of organisations and agencies that publish and distribute newsletters regarding arrests and prosecutions for financial crime. These seem to have only a limited circulation and generally go to interested professionals rather than the general public. A widening of the circulation would probably raise awareness.

Perceptions Rather Than Rules

Communication from authorities and regulators to the financial services industry is essential or the situation will not improve. Some ideas that could improve AMLR practicality and effectiveness include:

  • ‘joined-up intelligence’ - many professionals believe that AMLR could be more effective with a collective pooling of AML intelligence about client activity, sort of an expanded Stock Exchange Mutual Reference Society for entities and individuals, possibly going internationally;

  •  feed-back to financial services institutions regarding the quality and quantity of Suspicious Activity Reports (SARs) appears to be inadequate. More feed-back on comparative statistics, e.g. benchmarking reports per overseas customers, or reports per average account % transaction or account activity per genuine cash outflow, would be a significant improvement;

  • feed-back on successful prosecutions and convictions to financial institutions – and greater general publicity of successful convictions and asset seizures appears to be inadequate - “this report resulted in a successful prosecution” would encourage compliance personnel to report similar typologies;

  • feed-back on new money-laundering methods (typologies) to look out for, again, appears to be inadequate and could be improved - a hit list of the latest wheezes for instance.

A need for better feed-back be viewed as good, simple advice for the FSA, NCIS, the Police, FATF, the EU, … etc. Closing the communications gap should be one of the easier things to put right. If the perceived effectiveness of AMLR improves, then the costs of implementing AMLR will probably be perceived as less of a burden. If we can improve the cost/benefit perception, then the Anti-Anti-Money-Laundering camp will have to restrain itself – if not, maybe the financial services industry should abandon supporting AMLR imposed by people who don’t bear the costs. While regulators and authorities are clearly trying to help stop terrorism, crime and tax evasion, they owe their unpaid enforcers (the financial services industry), and partial beneficiaries (ditto), the benefit of feed-back.

References

Mark Yeandle, Michael Mainelli, Adrian Berendt and Brian Healy Anti-Money Laundering Requirements: Costs Benefits and Perceptions, City Research Series, Corporation of London (June 2005),

Thanks

I would like to thank the Corporation of London and the Institute of Chartered Accountants in England & Wales for permission to use advance results from their research. I would also like to thank Mark Yeandle of Z/Yen Limited, the principal author of the report, for his advice and assistance on this article.


Professor Michael Mainelli, PhD FCCA FCMC MBCS CITP MSI, originally did aerospace and computing research followed by seven years as a partner in a large international accountancy practice before a spell as Corporate Development Director of Europe’s largest R&D organisation, the UK’s Defence Evaluation and Research Agency, and becoming a director of Z/Yen (This email address is being protected from spambots. You need JavaScript enabled to view it.). Z/Yen was awarded a DTI Smart Award 2003 for its risk/reward prediction engine, PropheZy, while Michael was awarded IT Director of the Year 2004/2005 by the British Computer Society for Z/Yen’s work on PropheZy. Michael is Mercers’ School Memorial Professor of Commerce at Gresham College (www.gresham.ac.uk).

Michael’s humorous risk/reward management novel, “Clean Business Cuisine: Now and Z/Yen”, written with Ian Harris, was published in 2000; it was a Sunday Times Book of the Week; Accountancy Age described it as “surprisingly funny considering it is written by a couple of accountants”.

Z/Yen Limited is a risk/reward management firm helping organisations make better choices. Z/Yen undertakes strategy, finance, systems, marketing and intelligence projects in a wide variety of fields (www.zyen.com), such as developing an award-winning risk/reward prediction engine, helping a global charity win a good governance award or benchmarking transaction costs across global investment banks.

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