Tuesday, March 22, 2016

If and when - to bank Iran: Anti Money Laundering and Combatting the Financing of Terrorism


The international agreement limiting its nuclear ambitions signed, Iran is 'open for business'. But US sanctions remain largely in place, adding to Western banks' caution in dealing with the Islamic Republic, so long a pariah state. The biggest challenge, says Paul Cochrane, will be to reintegrate the country's financial institutions into the international system when they have spent years adapting to and circumventing sanctions.

Financial sanctions were imposed by the United States following the revolution in 1979, and ramped up during the Clinton and George W. Bush administrations. Multilateral sanctions, imposed by United Nations Security Council resolutions (UNSCRs) and the European Union (EU) from 2007 onwards, especially in 2011, hit Iran even harder, narrowing an already limited window to operate in the international financial system.

“One of the Iranians' primary objectives was that the financial sanctions originating from the EU and UNSCRs were removed within the comprehensive nuclear deal, whereas they were less concerned about US financial sanctions as Iran has lived with those for over three decades, and the systems to move around US sanctions have been well oiled within the country,” noted Emad Kiyaei, executive director of the American Iranian Council. The Iranians' objectives have been largely met. The EU and UNSCR's sanctions have been significantly eased, although crucial designations remain concerning terrorist financing and human rights. Attention now turns to bring Iran's outmoded financial and compliance machinery up to current international standards.

The Financial Action Task Force (FATF), in October 2015, stated that it “remains particularly and exceptionally concerned about Iran’s failure to address the risk of terrorist financing and the serious threat this poses to the integrity of the international financial system”. The body warned that if Iran fails to take concrete steps to improve its CFT regime, it will consider calling on all countries and jurisdictions to strengthen counter measures against it. The message was repeated at the February 2016 plenary.

FATF's hesitation to act is not surprising – it voiced the same concerns in June 2014, with an October 2015 deadline that passed without any action - but reform is clearly needed. “Iran's banking sector is in a difficult situation given they have shouldered the majority of the burden of the strangling sanctions. Major reforms are required, with many Iranian economists agreeing that the banking sector is a ticking bomb in terms of deficiencies and shortcomings,” said Ali Vaez, Senior Iran Analyst at the Brussels-based International Crisis Group.

Private enterprise

Part of the problem is that smaller banks in Iran are almost designed to be sanctions-busting institutions. The more recent sanctions, especially those imposed on the Central Bank of Iran (CBI) and major state banks, forced change on the domestic financial system. “One phenomenon, witnessed under the (EU and UN) sanctions was the mushrooming of private banks. The Iranians needed ways to get around sanctions, so a lot of smaller banks were basically a part of a game of cat and mouse that allowed Iran to survive the storm of sanctions,” said Vaez.

The  fledgling institutions developed ties with small and medium-sized banks in Asia, particularly Malaysia and India, but also Russia, the United Arab Emirates (UAE) and Oman, to indirectly access the international system. Creative ways to move money proliferated - through trade-based money laundering (TBML) and barter, including the “gold for gas” deals with Turkey, which surfaced in 2014. Smuggling increased, empowering factions like the Iranian Revolutionary Guard Corps (IRGC) to take a direct role in the black market; so corruption spiked to keep trade alive, diverting it through non-official channels.

The restrictions imposed on Iran “led to the most comprehensive and innovative web of ML and circumventing ventures on a national level in the history of sanctions. The mechanisms for breaking sanctions have been institutionalised,” said Kiyaei. “A major cause of corruption, nepotism and cronyism is due to the reliance on so many players to circumvent the sanctions. It's a chronic problem, which does not bode well for a more transparent regulatory system to be put in place.”

Compliance - a culture of workaround

Any change in the short term will be difficult. The CBI brought in a formal AML regime in 2008, but a compliance culture has not been embedded in financial institutions - unsurprisingly, since many were previously encouraged to break rules to work around the sanctions. “There is now a mentality of constantly moving around restrictions, be it government-imposed sanctions on how to lead your life – censorship - or sanctions on the central bank, financial institutions and the economy. This has created, from an anthropological point of view, a crazy society, a tendency towards circumvention,” said Kiyaei.
Furthermore, there appears to be little political room to force through economic and banking reforms. “The difficulty is that (President Hassan) Rouhani almost exhausted his political capital to bring about this nuclear agreement, so there's less appetite for structural reforms,” said Vaez.

If there was any doubt about the scale of the task he faces, Iran was ranked number one in the Basel Institute on Governance's AML Index 2015, as well as in 2014, with the caveat that it was boosted to the worst spot by lack of data on the sector available from the CBI and the local financial sector (see my MLB article on Iran in 2014). Gauging the true extent of Iran's AML deficiencies is therefore difficult: with its well-entrenched siege mentality, the government in Tehran is not tuned into transparency.

“When you cut off Iran from the world, the world is cut off from Iran, so when a major part of the economy goes into the shadows then regulatory transparency measures are almost impossible to implement. What is interesting is that the Iranians are obsessed with statistics – the data is actually pretty decent - just access to it from outside entities is deemed a national security issue at a time of sanctions, and there's an access problem as there's no presence of Western (financial services) outfits,” added Kiyaei.

Iranian financial institutions have also encountered obstacles when trying to access lists of designated individuals and entities under sanctions, because - in a cold irony - the relevant software could not allowed to be traded under the EU and US sanctions. While this has been lifted, restrictions remain in be sold to them under EU and US sanctions. Although this bar has been lifted, restrictions remain on sale of software with possible nuclear or military application.

“The Iranians wanted access to the Bankers Almanac (for due diligence in correspondent banking) but the software vendors were accused of breaching sanctions. The Iranians have been going around in circles as they can't buy information to do AML checks,” said Nigel Kushner, CEO of W Legal Limited in London. “I'd be surprised if the majority of banks have any reputable screening in place.”

Unacceptable risk

Iranian financial institutions are struggling for re-acceptance by their peers overseas, which might also act as a discouraging break on moving to adopt international standards and take compliance seriously. Iran has been readmitted to SWIFT, the secure payments messaging network used by banks globally, but its banks still need to find correspondent banks to handle their transactions.

The newer “private banks haven't necessarily got the knowledge or track record which some counterpart banks are looking for, so they will suffer in that aspect. Many (Western) banks are taking the line: the money we will make is not worth the exposure. I've not seen any signs of clearing banks jumping back into the Iranian market, and an additional issue at the moment in London is Iranian banks can't find a clearing bank,” said Kushner.
Similarly, Western banks are reluctant to enter Iran amid ongoing uncertainty over sanctions - whether they might "snap back," as envisioned in the Joint Comprehensive Plan of Action; the country's domestic environment; and substantial past fines for violations by US regulators. “Big banks remain reluctant to re-engage in the Iranian market out of fear the (nuclear) deal is not as sustainable as it appears given opposition (by certain political factions) in Tehran and Washington DC, while banks paid huge fines for previous work with Iran so are very risk adverse,” said Vaez. 

Some of the fines are fresh in the corporate memory: in November 2015, Deutsche Bank was fined US$258 million, and in October 2015, France's Credit Agricole was fined US$800 million by the New York State Department of Financial Services for violating sanctions on Iran and Syria. In 2014, France's BNP Paribas was fined nearly US$8.9 billion for violating US sanctions against Iran, Sudan and Cuba.

These fears are reinforced by US government statements that it is not yet time for business-as-usual with Iran. In addition, past recommendations and regulatory settlements restricting trade with Iran often still stand. “In 2011, the US said Iranian banks were a source of concern for ML, so foreign banks will have to do enhanced due diligence, and secondly, many of the large UK clearing banks have been fined by US enforcement agencies over the past several years and entered into settlement agreements. In many cases they're not to have any dealings with Iran or Iranian banks, and the US said (in January) the easing of sanctions does not supersede these agreements. So some banks have their hands tied behind their backs,” said Kushner.

Image via Wikicommons.

Tuesday, March 08, 2016

Shaky foundations – Money Laundering and Real Estate Compliance

Tourist accommodation and high-end residencies are considered convenient vehicles for laundering illicit money.

Real estate has only recently started to come under the regulatory AML spotlight shone on other sectors, says Paul Cochrane, and not before time.

Money laundering into real estate (MLRE is the acronym in AML circles) has not garnered the same attention as the drug trade, sanctions enforcement or combating the financing of terrorism (CFT). Indeed, as Louise Shelley, founder and director of the Terrorism, Transnational Crime and Corruption Centre (TraCC) at George Mason University, Virginia, USA, observes, there has been surprisingly little research done globally on MLRE compared to other sectors.
“We have so little data on MLRE in general. We don't know how much is related to corruption, transnational crime or terrorism. I think the problem is as bad or worse than a few years ago,” she said. Shelley recalled how, in her testimony to the US House of Representatives financial services committee's task force to investigate terrorism financing in September (2015), she stressed that "if there are no reporting requirements in this area, then there's an enormous loophole that can be used." (1)

Regulatory oversight

The US is not alone in not treating MLRE as an AML priority. At the Financial Action Task Force (FATF) plenary in Brussels in October (2015), MLRE was suggested as a future typology topic, but was turned down. Instead half of the meeting was spent on ways to curb Islamic State (IS). “This doesn't mean MLRE is not an issue but it is seemingly not a priority,” said a senior source from European AML body Moneyval. The latest FATF 'Guidance for Real Estate Agents' was published in 2008 (2). “A big issue is that FATF has not really focused on this, never issuing best practices or a risk-based approach for real estate agents,” he added.

Building a picture

Meanwhile, the scale of MLRE could be eye-watering, based on the limited research available. “Real estate accounted for up to 30% of criminal assets confiscated in the last two years, demonstrating this as a clear area of vulnerability,” stated FATF in its June 2013report 'Money Laundering and Terrorist Financing Vulnerabilities of Legal Professionals'. Shelley's research has shown that in Colombia between 1997 and 2004, some US$10 billion was laundered into real estate, with only a fraction of the amount confiscated. Her studies have also shown high rates of suspected MLRE in Turkey and the United Arab Emirates (UAE). She highlighted tourist accommodation and high-end residencies as convenient vehicles for laundering illicit money, with cash-based economies particularly vulnerable.
More recent cases show MLRE is a serious concern. In 2014, an international drugs trafficker was convicted by a Miami, Florida court for laundering over US$14 million in narcotics proceeds by buying high-end real estate and luxury vehicles. (3)
In the UK, a report released by Transparency International-UK in February (2015) stated that, between 2004 to 2011, more than UK£180 million (US$276 million) worth of property was brought under criminal investigation as the suspected proceeds of corruption. (4)

Political recognition

Such exposure has prompted the UK to start taking MLRE more seriously. In a speech in Singapore in July (2015), Prime Minister David Cameron said that with “UK£122 billion [US$187 billion] of property in England and Wales owned by offshore companies we know that some high-value properties – particularly in London – are being bought by people overseas through anonymous shell companies, some of them with plundered or laundered cash.” (5) There are more than 100,000 property titles in Britain registered to overseas firms according to Cameron and the TI-UK report.
This concern may be heightened by FATF's explicit reference to MLRE exposure in its standards. Recommendation 22 states that “customer due diligence and record-keeping requirements set out in Recommendations 1, 11, 12, 15, and 17, apply to designated non-financial businesses and professions (DNFBPs)... including the buying and selling of real estate.” Meanwhile Recommendation 20 states that real estate agents are another gatekeeper in terms of assessing risk and carrying out due diligence.  

No laughing matter

But there is recognition that the real estate sector has generally not been abiding by the Recommendations. "Whenever I go to do evaluations it borders on the comical when we meet real estate agents. The level of due diligence is far behind any other gatekeepers,” said the Moneyval source. “I'd say the biggest vulnerability is that those involved in real estate transactions, usually the agent or a notary, don't see the risk or appreciate it. What we see in Moneyval countries is that they don't really conduct any due diligence, especially on sources of funds.”

How many, sorry, few reports?

In the UK suspicious activity reports (SARs) from the real estate sector accounted for 0.05% of overall filings from October 2013 to September 2014, according to the National Crime Agency (NCA). “Our judgment is that the level of reporting is too low by the government, private sector, and the National Association of Real Estate Agents,” said Nick Maxwell, Head of Advocacy and Research at TI-UK. He chalked this down to a lack of awareness in the sector, not least since anyone can set-up as a real estate agent.
The UK's Office of Fair Trading issued fines against three real estate agents for almost UK£250,000 (US$384,593) in March 2014, but since HM Revenues & Customs took over responsibility for AML enforcement, in April 2014, there have been no further sanctions. 
“There's not been any action yet [by HMRC], so there's little reason for real estate agents to fear sanctions to improve standards. It is not just real estate agents but also professional enablers, as transactions include lawyers, accountants, and financial service providers, which should be covered by AML regulations,” added Maxwell. “But with hundreds of millions being laundered, if you compare that to the fines, it is questionable if fines are a deterrent.”

No cases in Eire

In Ireland, MLRE has not surfaced as a prevalent issue. “I never encountered an instance of money laundering through real estate deals. There have been fairly well documented incidents of mortgage fraud, but actual laundering schemes, I've not personally seen that,” said Shane Martin, a Regulatory Compliance Director at Walkers, an international financial law firm in Dublin, and a former regulator at the country's central bank. 

Obstacles to change

Opposition to regulation plays its part.“The agents know the problem, but if the sector was better regulated and required to report SARs, it would mean a lot of real estate deals would come apart, especially foreign deals, as laundered money usually goes into more expensive property,” said Shelley. “In the US, it would need Congress to enact legislation, and if justified in terms of national security, there may be some change.”
Jurisdictions have also been turning a blind eye to MLRE due to the capital inflows. Dubai, in the UAE, is a case in point. A compliance officer at an Arab bank, who asked not to be named, said that MLRE was a primary cause of the 2008-9 financial crisis in the region, and is an ongoing problem. “Of course it is happening. It is known and the talk of the town, but that is it,” he said.

Company registers

That said, some jurisdictions are getting more serious about MLRE, partly due to the heightened international focus on corruption, tax information-sharing, and transparency of company ownership. In the UK, the Land Registry is slated to publish data later this year on foreign ownership of real estate in England and Wales to heighten transparency about beneficial ownership in the sector. In the US, 17 non-governmental organisations sent a letter to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) asking to repeal certain provisions granted to the real estate sector in the Patriot Act in 2002. (6).
Media exposures about shell companies driving up property prices in New York have also had an impact (7). This was followed up in July by New York City requiring new disclosure requirements on shell companies buying or selling property (8) and on January 13 this year, FinCEN imposed Geographical Targeting Orders that will require certain US title insurers, which play a central role in most property transactions, to report the beneficial ownership details of companies used to pay "all cash" for high-end residences in Manhattan, New York and Miami-Dade County, Florida.(9)
“New York's decision on beneficial ownership came at the same time as Cameron's announcement, and these [together with the FinCEN orders] are promising policy developments. We are seeing an era of secret ownership of property coming under pressure,” said Maxwell.
The Fourth EU Money Laundering Directive (4MLD) – to be implemented by July 2017 – also fosters increased transparency of property ownership, requiring EU member states to hold information on beneficial owners of all corporate and other legal entities in a national central register. How such requirements are applied will be key to any success. “The CEPI-CEI (European Council of Real Estate Professions) recognises the need to have strong rules in place at a European level. It is vital that those rules are proportionate to the risk involved and do not represent an unreasonable burden on professionals working in the sector,” said a spokesperson.
But even if real estate agents file more SARs and carry out effective due diligence, supervision at the national level remains an issue.“In many countries there are not enough resources to supervise the financial sector, so who will supervise the real estate sector? Another issue is that the new methodology of FATF is very focused on higher risk areas, so if the real estate sector is considered to not pose significant risk, then resources will not be allocated,” said the Moneyval source. Some countries are also deregulating real estate agencies. “If they don't know the number of agents nationally, how can they know what the market looks like to supervise it?”

4. 'Corruption On Your Doorstep: How Corrupt Capital Is Used to Buy Property in the UK,' Transparency International-UK -

Islamic Finance: Closer to the spotlight

Accounting and Business

While there is clearly a demand for more socially sustainable banking, Islamic finance experts are calling for a slow and steady approach to developing the sector. Paul Cochrane reports

Oman has introduced a new Islamic banking regulatory framework and amended laws to level the playing field with conventional finance.

Despite its high profile, Islamic finance is arguably still stuck in third gear. Valued at more than US$2 trillion worldwide, and having grown exponentially over the past decade, the niche financial sector nevertheless has yet to achieve the critical mass that will take it to the next level and challenge conventional finance more effectively.
Islamic finance is ethical finance. By eschewing debt, interest and speculation, the sector is trying to harness populist sentiments that oppose the darker side of conventional finance and which have been in full flow since the global financial crisis.
Omar Shaikh, executive board member of the Islamic Finance Council UK, says: ‘There seems to be an increasing narrative around ethical finance and Islamic finance converging. This is particularly poignant against the background of the financial crisis and ongoing banking scandals. Unfortunately it does not seem to be a one-off blip, as mis-selling, rate fixing and other scandals are repeatedly occurring, yet there seems no material systematic change in the banking framework. Considering this and the ongoing austerity measures, society is still hurting from the banking crisis, and people are eager to see a more socially conscious form of banking.’
In the wake of the sub-prime financial crisis, Islamic finance has garnered significant attention as an alternative financing model. Its instruments are considered better suited to financing infrastructure projects in cash-strapped, debt-averse developing countries, while its more ethical principles are fast colonising a growing niche in conventional finance.
Indeed, Turkey, which last year held the presidency of the G20 group of major economies, organised a meeting in Istanbul in May along with the Global Islamic Finance Development Center of the World Bank to discuss how Islamic finance can contribute to global economic recovery. Discussions are also under way between the Islamic Development Bank and China to use Islamic financing in the recently launched Asian Infrastructure Investment Bank (AIIB).
However, the instruments and mechanisms needed to allow the sector to capitalise on its virtues are not yet there. Shaikh says: ‘The current environment is certainly an opportunity for Islamic finance, but perhaps an opportunity that has come too early.’
The International Centre for Education in Islamic Finance (INCEIF), a university set up by Malaysia’s central bank to develop human capital for the sector, is actively researching ideas in the Islamic finance space. The goal is to have potential frameworks available when the timing is more opportune. Obiyathulla Ismath Bacha, professor of finance at INCEIF in Kuala Lumpur, says: ‘We are coming up with prototypes of how Islamic finance should be. The next issue is to apply them in practice, which has not happened yet as commercialisation has not taken place.’
Malaysia has grown into one of the world’s Islamic finance hubs because of its willingness to innovate. Bacha says: ‘The Malaysian position is “let’s experiment and keep to the spirit of sharia, although not necessarily to the letter”. That model has worked well, and that’s why we’re pioneers.’
One of the most crucial developments is Malaysia’s Islamic Financial Services Act, introduced in 2013 to provide a stronger legal platform to develop the sector. It set up a comprehensive regulatory framework covering the various Islamic financial contracts for products and services. Bacha says the law came into effect last year, and is seeking to change the way Islamic finance is carried out. It could become a global benchmark for the sector.

Tighter sharia compliance

He adds: ‘I’m sure there will be mis-steps that need corrections along the way, but if all goes according to plan, in 10-odd years the Islamic finance topography will be totally different. What has been happening until now is pseudo conventional banking that has come in for a lot of criticism, and it’s easy to see why.’
Islamic finance institutions have come in for criticism for not following sharia principles closely enough and for lack of transparency. This is attributed to the relatively recent arrival of the sector, which has only developed since the 1970s. As a new industry, needing to bring depositors on board, it could not be radically different from conventional banking because of the financial risks involved. However, as the sector has matured, it has started moving away from the path of least resistance and more in a sharia- compliant direction.
Such diversity has meant a lack of standardisation at a global level. As anyone who has ever been to an Islamic finance conference will confirm, this issue is well recognised, and invariably the subject of a keynote speech. But with the sector having grown by 17.6% between 2009 and 2013, and forecast to grow by an average of 19.7% a year to 2018, according to EY figures, not all observers agree that formal standardisation is needed to ensure growth. Instead, they believe the focus should be on making the sector truly sharia-compliant, while allowing for diverse solutions from that base.
Samer Hijazi FCCA, director in KPMG’s financial services practice, in London, says: ‘So much has been said about standardisation, but I’m not 100% sure it is that great an issue. The dealings between [the Islamic financial hubs of] the Gulf, the UK and Malaysia have not caused that much trouble. What I’d like to see is greater standardisation around governance and compliance frameworks, and what compliance and regulations are going on in the background, so that investors are confident they are dealing with a truly Islamic finance institution.’

Levelling the playing field

Shaikh sees such an approach helping align Islamic finance structuring and models across the board. The UK’s issuing of a sovereign sukuk (an Islamic bond) is an example – it was announced in 2007 but did not happen until 2013 when the necessary structures were in place and the regulatory framework amended. Another example is Goldman Sachs’ first US$500m sukuk, announced in 2012. Its structure was initially contentious and the bond didn’t float until two years later after issues had been resolved. When these sukuks finally floated, they were both heavily oversubscribed, indicating the interest in long-term structured returns.
Elias Moubarak, head of finance at law firm Trowers & Hamlins in the UAE, says: ‘Penetrating a market that doesn’t encourage that product means a tough sell. That’s why Islamic finance needs support at a policy level to create a level playing field. As we see policymakers react, we should see a regulatory regime develop that encourages socially sustainable investments.’
Such progress is afoot. Oman introduced a new Islamic banking regulatory framework and amended laws to level the playing field with conventional finance in 2012. The Gulf state issued a sovereign sukuk last year.
Hijazi thinks a slow and steady approach is best. While opportunities for greater Islamic financing abound, and there is clearly demand for more socially sustainable banking, he thinks the sector should consolidate further and strengthen its foundations before rolling out new instruments and services. ‘I wouldn’t want to go down the innovation route over the next 12 months,’ he says, ‘but get houses in order and go for innovation down the line.’

Photo of Muscat by Paul Cochrane