Article

by Roger Jones

Over the last decade, and longer in some countries, the financial services industry globally has been subject to an ever-increasing volume of antimoney laundering and anti-terrorism legislation and regulation. However, not only have world trade and money transmission volumes increased in the intervening period, but also the complexity plus the number of industries and professions becoming subject to this regulation have created a new set of circumstances.

Many readers will be aware of the Financial Action Task Force (FATF), which is headquartered in the OECD in Paris and develops rules on money laundering and terrorist financing on which relevant legislation/regulation in FATF member states is increasingly based. FATF has published 40 Recommendations and nine Special Recommendations (SRs) on the subject, but most of these documents are fairly high level in nature with detailed requirements being subject to the implementing laws and regulations of FATF member states. Consequently, whilst the underlying objectives are the same, significant differences can and do occur in the detailed implementation of the Recommendations.

The UK approach

The remainder of this article discusses how one state, the UK, has addressed these issues, particularly in relation to payments derived from trade finance operations. It is not intended to imply that this is the only approach or applicable to all jurisdictions, but readers may find it of interest to compare how these issues have been or are being addressed in their own countries, since these differences between countries have to be faced by multi-country banks operating in multiple jurisdictions.

First, it is useful to repeat below FATF Special Recommendations Vl and Vll, which are arguably the most important SRs in connection with payments.

- Vl Alternative Remittance SRVI reads: "Each country should take measures to ensure that persons or legal entities, including agents, that provide a service for the transmission of money or value, including transmission through an informal money or value transfer system or network, should be licensed or registered and subject to all the FATF Recommendations that apply to banks and non-bank financial institutions. Each country should ensure that persons or legal entities that carry out this service illegally are subject to administrative, civil or criminal sanctions."

- Vll Wire Transfers SRVII says: "Countries should take measures to require financial institutions, including money remitters, to include accurate and meaningful information (name, address and account number) on funds transfers and related messages that are sent, and the information should remain with the transfer or related message through the payment chain. Countries should take measures to ensure that financial institutions, including money remitters, conduct enhanced scrutiny of and monitor for suspicious activity, funds transfers which do not contain complete originator information (name, address and account number)."

Why have I included SRVl? The reason is that whilst it tends to apply principally to emigrant remittances, it is important to ensure that alternative remittance systems are not used to avoid the originator information requirements for wire transfers.

Although the UK is a sovereign state, for the purpose of implementing SRVll, the European Union is being treated as a single jurisdiction with the main implementation measure being EU Regulation 1781/2006 on information on the payer accompanying transfers of funds, which came into force on 1 January 2007. As the title indicates, the main purpose is to implement the requirement in SRVll to include originator information with the transfer or related payment message.

However, neither the FATF Interpretative Note to SRVll nor the EU Regulation specifically addresses payments originating from trade transactions. This is not an issue for the vast majority of international trade, which is settled on open account terms by means of clean payments. However, payments to settle trade finance instruments such as letters of credit, collections and guarantees, plus some others, can give rise to uncertainty on how they should be treated. Consequently, the UK considered that additional guidance was needed.

Principles vs rules

Before discussing this in more detail, it may be appropriate to say a word about principles vs rules-based regulation. The main UK financial services regulator, the FSA, is moving increasingly towards principlesbased regulation which, instead of requiring explicit compliance with detailed rules, requires firms to comply with a number of principles and develop an appropriate risk policy applicable to an individual firm's business. Whilst this allows more scope for individual firms to tailor their risk policies to their own business mix, the converse is that the regulator also needs to apply subjective judgement in determining whether a firm's risk policy is appropriate. This requires a high degree of professionalism on both sides, and the UK Guidance is intended to provide a framework within which this can be accomplished. Although the Guidance does not have statutory effect, it is approved by a Treasury (Finance Ministry) Minister and courts are required to take account of it.

Trade finance Guidance

The Trade Finance section of the Guidance first makes it clear that it is complementary to and does not replace other parts of the Guidance referring to verification and due diligence requirements. However, it then proceeds to explain how this should be applied to the three main trade finance instruments, i.e., letters of credit, collections and guarantees with specific reference to payments, followed by a briefer reference to other instruments and techniques. It also makes it clear that it constitutes a minimum requirement that firms should use as a basis for their own risk policies, which should be documented.

The Guidance acknowledges that the ability of a firm to assess the money laundering or terrorist financing risks posed by a particular trade transaction will depend on the amount of information that it has about that transaction and the parties to it. This will be determined by the firm's role in the trade finance operation, and the amount of information available may vary. Where possible, when assessing risks, firms should take into consideration the parties involved in the transaction, the countries where they are based, the nature of the goods and other factors such as the value of the transaction.

The following may illustrate this. Many firms see regular patterns of business, for example from a particular industry segment or geographical area of the world. They may well become familiar with the business, but could then be asked to handle what is to them an unusual transaction. In such cases, it would be reasonable for them to have a closer look at the transaction. They should, for example:

- make additional enquiries into the ownership and background of the instructing party and/or the beneficiary of the transaction, taking further steps to verify information on the identity of key individuals;

- check the transaction against warning notices from the ICC's International Maritime Bureau;

- refer the transaction to ICC Commercial Crime Services for bill of lading, shipping and pricing checks; and

- attend and record relationship meetings with the instructing party. Conversely, where regular business is involved, the checks could include:

- doing more detailed checks on a small number of transactions chosen at random; and

- building up a record of the pattern of a customer's (i.e., the instructing party's) business to facilitate identification of unusual transactions.

Due diligence

With one or two minor exceptions, the originator of a payment is regarded as the instructing party, which may not necessarily be an existing customer of the firm. It is the instructing party on which due diligence must be undertaken. It is open to firms to undertake additional due diligence on other parties in accordance with their own risk policy.

A number of examples are given of instructing party, e.g., for an export (inward) letter of credit the instructing party is the issuing bank. Where a payment is being made, the originator would normally be the bank effecting the payment. But whether the payment comes within scope of the Regulation depends on whether the beneficiary is another financial institution as described in the Interpretative Note, or a commercial party. However, there are so may possible variations and permutations that the UK banking industry is developing a series of questions and answers to cover some of the more common situations.

There are also provisions for enhanced due diligence, where determined under a firm's risk policy, plus more detailed monitoring dependent on the type of transaction. Such monitoring techniques could range from random after-the-event monitoring, to checking receivables in any form of securitization transaction to determine if they are legitimate.

New payment methods

In October 2006, FATF published a report on new payment methods (NPM), some of which may be applicable to trade transactions. The report also gives more detail on NPM risk assessment, typologies and case studies. Whilst these are not in general directly relevant to trade transactions, they do give a good idea of the way the market is developing and could possibly be used.

A good illustration is digital precious metals, which are a relatively new online system that involves the exchange of options or the right to purchase an amount of precious metals at a specific price. The reason for mentioning this is that the issuers of digital precious metals use the term "digital currency" to describe the barter arrangement they facilitate and, of course, barter and counter trade are also used in trade transactions.

The future

With the increase in global terrorism, which needs funds to sustain it, it seems likely regulation of the type described above will increase. As good corporate citizens, banks generally wish to assist the authorities, but there is no doubt these requirements can be resource intensive and add to transaction costs. Consequently, the industry is working with the authorities at both international and national levels to seek to devise efficient and cost-effective solutions. SWIFT, for example, is looking to upgrade validation on some of their payment messages.

Some readers may come from countries where legislation/regulation of this kind does not yet exist and may wonder how it affects their firms. Note that whilst local business may not be affected now, there is likely to be an increasing impact from cross-border business. The reason is that legislation and regulation in many countries is requiring banks not only to undertake increasing levels of due diligence on correspondent banks with whom they deal, but also, in accordance with Special Recommendation Vll, to require certain information such as the originator's name, address and account number on incoming payment orders before processing them.

For trade transactions, if due diligence of the type described earlier reveals any unusual circumstances, business could well be required to refuse to process them and/or to report to their local authorities. It's time to take notice.

Roger Jones is Chairman of the ICC UK Banking Committee. His email is roger.jones@apacs.org.uk