Wednesday, January 14, 2015

Yet to explode – non-proliferation compliance

Money Laundering Bulletin

Quietly ticking in the corner, the control of proliferation finance may not be at the top of every risk register but with international standards in place it cannot be disregarded, says Paul Cochrane.

Despite the huge risks involved in states funding weapons of mass destruction in breach of international non-proliferation rules, this problem has not received the same attention as anti-money laundering (AML) and combating the financing of terrorism (CFT) in compliance regimes. Only over the past two years has world’s senior AML body the Financial Action Task Force (FATF) started to address shortcomings, while the United Nations is moving from a decade of awareness building to pushing implementation.

The 1970 treaty and UN Resolutions

Non-proliferation is underpinned by the international Non-Proliferation Treaty, approved in 1970, which was aimed at preventing the spread of nuclear weapons and to further nuclear disarmament; it has been signed by 190 countries. (1)
Also, this year the UN commemorated 10 years since approving Security Council Resolution (UNSCR) 1540 (2004) on the non-proliferation of nuclear, chemical and biological weapons. The UN highlighted the “dangerous nexus between weapons of mass destruction (WMD) and global terrorism,” and stated it was moving from a decade of awareness-raising to a decade of “full and sustained implementation” of UNSCR 1540. (2) A comprehensive review is due to in 2016.
To date, 172 UN member states have submitted national implementation reports on the resolution to the special UN Committee 1540. However, enforcement has not been up to par: “It is one thing to sign up, another is the difference in practice on the ground, where there has not been much change. The private sector needs clearer guidance,” said Nikos Passas, a professor at the School of Criminology and Criminal Justice, Northeastern University in the USA.

Positive delay

A factor in weak implementation on the financial compliance side is that non-proliferation efforts have been quite successful at the political level: “We've not had a large number of countries adding military capabilities - nuclear, chemical or biological - in the past few decades, and a small expansion of nuclear weapons possessing states, but not a rapid one. Taken in the round, existing legislation has played a role in making sure proliferation has not accelerated,” said Dr Ian Anthony, director of the Stockholm International Peace Research Institute (SIPRI), and head of SIPRI’s European Security Programme.
That said, there were 160 incidents related to nuclear and radiological materials in 2012 alone, according to the International Atomic Energy Agency's (IAEA) incident and trafficking database, while a resolution related to UNSCR 1540 was recently introduced, UNSCR 2118 (27 September 2013), following the use of chemical weapons in Syria. (3)

The risk map

“Geographically, the main nuclear proliferation concerns…are in Asia, mainly in India, Pakistan and North Korea, and the only other one is Israel,” said Dr Anthony.
Indeed, of the 54 states listed on the UNSCR 1540 Committee's website as requesting assistance to implement the resolution, 18 are from the Asia-Pacific region. The other resolutions that relate to UNSCR 1540 concern the Democratic People's Republic of Korea (DPRK) and Iran, which have been subject to Targeted Financial Sanctions (TFS): UNSCRs 1718 (2006), 1874 (2009), 2087 (2013), 2094 (2013), and 1695 (2006) on the DPRK, and UNSCRs 1737 (2006), 1747 (2007), 1803 (2008), and 1929 (2010) on Iran.

Regulatory oversight

Despite the actions by the UN over the past decade, proliferation finance has not garnered the same attention as AML and CFT by regulators and the financial sector. In part this is because oversight has fallen on the UN, and not on specialised bodies better equipped to do evaluations, such as the Financial Action Task Force (FATF). For instance, countries considered prime proliferation risks such as North Korea and Iran have been on FATF watch lists for terrorism financing (TF) but not for proliferation financing (PF).

Recommendation 7 signals change

However, since its recent comprehensive review, FATF has become more proactive on the PF front. It has since 2012), a new Recommendation 7 that requires countries to implement targeted financial sanctions to fight proliferation, and comply with UNSCRs on the prevention, suppression and disruption of WMD and their financing.
“I think proliferation finance (PF) is not totally integrated into the AML world, as we still speak of AML and TF, and not together with PF,” said a member of the secretariat for European FATF-style regional body MONEYVAL: “This is because it is a relatively new topic for the AML world, since 2012, when the FATF Recommendations were revised,” said the official.
Indeed, last year, in May 2013, FATF guidance was updated, regarding “The Implementation of Financial Provisions of United Nations Security Council Resolutions to Counter the Proliferation of Weapons of Mass Destruction”. Meanwhile at the FATF Experts' Meeting on Targeted Financial Sanctions [TFS] in Paris this June (2014) experts indicated there was a need “to improve global compliance with the preventive measures" contained in Recommendation 7.”
The complexities of countering PF were reflected in the fact that during the FATF discussions that lead to Recommendation 7, some delegates resisted a new recommendation, believing PF should be incorporated into Special Recommendation 3, on TFS for terrorist financing, based on UNSCRs 1267 (1999) and 1273 (1999). Assessments under Special Recommendation 3 are very technical, said specialists during these debates, resulting in generally low compliance, and there was concern the same would apply to PF. However, PF's special designation by FATF could be a compliance drawback. “It was decided to have a standalone recommendation, and it really is, as if you look at the Recommendations they all tie into each other, but with PF, it is different,” said the MONEYVAL secretariat member.
Now, it is not really a matter of criminal law, or a terrorism offence; it is purely sanctions requiring financial institutions to freeze assets of persons who are financing WMDs. In fact, there are no references to Recommendation 7 in the others, except for Recommendation 1, which speaks of assessing risks, while the recommendations on investigations only refers to ML and TF. Basically, FATF took measures but maybe didn't go all the way to find the answers [to addressing the issue].”
This is a concern as it could be held to imply that PF is contained within itself, and not applicable to the same mechanisms to prevent and detect ML and TF. Recommendation 10 for instance, on customer due diligence, requires the identification of individuals listed on terrorism finance lists, but does not mention PF.

Data dearth

This has made compliance in the financial sector harder, lacking such lists as well as the data needed to curb PF that differs from CFT. “It is much more difficult to do a risk-based assessment for proliferation related measures than CFT measures, which are largely linked to the identity of people, so provided good information at an institution about the person targeted it allows a system to track and trace them,” said Dr Anthony. “But proliferation is about trying to make a connection between a financial and a commercial transaction, and a bank may have no information about the transaction - what were the items concerned and who was the end user? If you don't have that information a risk assessment is difficult, and to set up internal systems based on risk profiling.”

No single point of reference

Another complicating factor is that standards to counter PF are not uniform. “They are not the same if you look at the UN, the EU [European Union] or the US, and FATF is trying to work with UNSCRs that don't deal with nationally imposed sanctions,” said Mr Passas.
Complying with multiple standards is impacting on implementation. FATF's first mutual evaluation reports (MERs) to include Recommendation 7, on Norway and Spain (October, 2014), resulted in low scores on proliferation financing. A factor was delays in applying targeted financial sanctions, which can be traced back to ongoing debates to write the new FATF standards into the EU’s fourth anti-money laundering directive. 
“When the UN designates a person on a list, the EU takes a while to implement it, so there is a delay in implementation by EU member states, unless a country has domestic legislation in place to implement a UNSCR directly into law, which many don't. This is a significant shortcoming as the (UN) text says 'freeze without delay'. It seems the same issues faced with freezing terrorism financing assets will happen for PF. It is still early days,” said the MONEYVAL member.
The evaluation reports however highlighted other issues with PF compliance - weak policy and operational coordination between export control authorities and AML/CFT authorities on combating proliferation financing.
To Mr Passas, this is one of the challenges of countering proliferation, as it requires a multidisciplinary approach that includes the private and public sectors. “One area where FATF has done good work is bringing together stakeholders of trade, customs, and government. These kind of multidisciplinary approaches are key, but they've not been followed up."
It is at the trade level that dual use goods – items that can be also used for manufacturing WMDs – are not being adequately checked, with the majority of cargo moved internationally not subjected to inspection. In the US for instance, “only 1-3% of containers are being subjected to some kind of non-intrusive scanning to confirm if the contents match the declared cargo manifests,” notes Mr Passas.
Furthermore, trade and service mis-invoicing enables proliferation sanctions to be evaded. “Businesses have to increase trade transparency and accountability. Unless there are efforts to know this, the vulnerability of sanctions and tax evasion and so on is there,” said Mr Passas.

3) UNSCR 2118 obliges states to “inform the Security Council of any violation of UNSCR 1540, including acquisition by non-State actors of chemical weapons, their means of delivery and related materials in order to take necessary measures therefore.”

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