Lit fuse – proliferation finance & compliance for containment

Money Laundering Bulletin, 17 May 2023

North Korea, already nuclear, is working on ever more powerful weapons; Iran remains set on acquiring the capability; and both may, with others, be building chemical and biological arsenals: the stakes could not be higher and so funds are on offer to match. The incentive to circumvent export controls and sanctions, often with state support, and the vast range of dual-use components in scope make, writes Paul Cochrane, for the most complex investigative and preventive threatscape.

Counter Proliferation Financing (CPF) is becoming an increasingly important third goal of international policies and programmes designed to attack and reduce illicit financial movements. With concerns about the development of nuclear weapons by sanctioned regimes in North Korea and Iran growing, governments have been focusing on how to implement Financial Action Task Force (FATF) guidance on CPF, which has been deepening since the global anti-money laundering and terror finance body in 2020 amended Recommendation 1, and its Interpretive Note, to require countries and entities to identify, assess, understand and mitigate their PF risks. (1) CFP also covers other chemical and biological weapons that could cause mass casualties.

In 2021, FATF updated its guidance on PF risk assessments and implementing mitigation measures, while certain countries have carried out their first national risk assessments (NRAs) on PF; they include the UK, the USA and Australia. (2)

In regulator's sights

“A main focus of the industry over the past several months has been PF and sanctions, with the regulators having taken a key interest on the back of national implementation of CPF requirements, including PF risk assessments, being assessed in the next round of FATF mutual evaluations,” said Dr Noemi També, a Luxembourg-based financial crime consultant and associate fellow at the Royal United Services Institute (RUSI). 

Third pillar

This move to frame CPF alongside AML (anti-money laundering) and CFT (combating the financing of terrorism) has been fuelled by the changing geopolitical landscape of an increasingly unstable world. Since the ratification of United Nations Security Council Resolution 1540 in 2004, the United Nations has required countries to prevent the proliferation of weapons of mass destruction (WMD) to and by non-state actors. (3) Governments have responded by tasking AML/CFT obliged entities to look for proliferation finance and sanctions evasion by North Korea and Iran: the former has been able to develop nuclear weapon with little or no cooperation with other UN member states or engagement with the International Atomic Energy Agency (IAEA). Iran, meanwhile, denies developing a bomb: in 2003, Supreme Leader Ayatollah Khameni issued a fatwa banning use of nuclear weapons, although he is 84 and may not remain in power much longer – what will happen after his death is unknown.

Under amendments to the UK’s Money Laundering Regulations in 2022), the UK Financial Conduct Authority (FCA) now expects all financial services businesses that it regulates to carry out risk assessments and monitor and report suspicions of PF. Dr També said the deadline was tight: revisions to the MLRs were announced in September 2022 with any changes in controls to be implemented by 1 April 2023. There was “no honeymoon period ...to get up-to-speed" she said, adding that more practical and detailed guidance would be helpful.

Invasion fallout

The heightened regulatory focus has further sharpened with the imposition of sanctions on Russia following its invasion of Ukraine in February 2022: the US, European Union (EU), UK and others have sought to limit Moscow's procurement of sensitive technologies and materiel that could assist its prosecution of the war machine. (4)

Louis Reitmann, Research Associate at the Vienna Center for Disarmament and Non-Proliferation (VCDNP), told MLB that the invasion has raised concerns around proliferation finance: “Over the past 20 years, only a relatively small expert community has looked into PF, specifically on North Korea and Iran. The wider community has only really woken up to sanctions and exports controls as being significant tools for non-proliferation in the context of the war in Ukraine, and in how quickly the [sanctions] regime [on Russia] developed, as such regimes usually take years to be put in place.”

The result has been quite a scramble lately by obliged entities to understand the PF risks, typologies and the red flags to look out for, with RUSI taking an active role through its CPF Technical Assistance Programme. (5) “A lot of the financial industry needs guidance and support about PF, as many are struggling to understand how it differs from sanctions regimes and how to leverage existing anti-money laundering (AML) and counter terrorist financing (CTF) frameworks. Counter proliferation finance (CPF) is not black and white - you can’t expect a traditional compliance analyst to necessarily understand the technicalities of dual-use goods,” said Dr També.

FATF has tried to lay down basic definitions, as a result, saying that weapons of mass destruction (WMD) proliferation refers to the “manufacture, acquisition, possession, development, export, trans-shipment, brokering, transport, transfer, stockpiling or use of nuclear, chemical or biological weapons and their means of delivery and related materials (including both dual-use technologies and dual-use goods used for non-legitimate purposes).” The financing of proliferation refers to the “risk of raising, moving, or making available funds, other assets or other economic resources, or financing, in whole or in part, to persons or entities for purposes of WMD proliferation.”

Knowledge state

The training need was highlighted by a joint RUSI-ACAMS (Association of Certified Anti-Money Laundering Specialists) survey on attitudes and understanding of proliferation finance in the global financial industry, published in 2020. (6) It found that international banks had greater understanding of PF risks than smaller financial institutions, with 57% of international banks being familiar with these issues, compared to 35% of regional banks, 32% of national banks and 35% of non-banking respondents. Only one-fifth of respondents said they received sufficient guidance from governments on PF risks.

On the plus side, 60% of respondents worked for an organisation with a compliance function that incorporated CPF, with that figure higher in international banks (76%). The majority (66%) however did not conduct standalone PF risk assessments. “Large financial institutions, in particular hubs, have specially designated teams for PF, which you wouldn’t typically see at smaller institutions as they have less of an international footprint and less resources,” said Dr També.

The RUSI-ACAMS survey showed that certain regions were more aware of PF risks than those in other regions: with 70% saying they were aware of proliferation red flag and typologies, compared to 60% in Asia, 58% in Europe, 51% in the USA, and 53% in the rest of the Americas. Also, 59% of Middle East respondents said they had read the latest FATF guidance on PF (2018) compared to 51% in Asia, 50% in Europe, 56% in Africa, 42% in the USA, and 45% in the rest of the Americas. Unsurprisingly, 63% of Middle East respondents said they were uptodate on the latest PF advisories and guidance related to Syria and Iran, compared to 29% in Africa, 38% in Asia, 44% in Europe, and 51% in the US and the rest of the Americas.

Synergies – useful and dangerous

PF bears comparison with terrorist financing techniques, said Dr També, in that it involves raising funds, disguising and then placing these in the financial system for use. The particular challenge lies in the potential for PF activity to appear completely legal. Funds may derive, for example, from a restaurant or a fishing business, for example, support by government agencies subject to sanctions.

“The moment there is a nexus with North Korea the activity is illegal and violating UN sanctions,” she noted. “The challenge is obviously establishing the connection with North Korea, as proliferators are very good at making sure every issue is disguised and geographically divorced.”  

This is the cross-over with traditional AML measures, such as identifying the ultimate beneficial owner of a company. “The North Koreans find facilitators to circumvent sanctions - incorporation service providers that create seemingly legitimate front companies to trade in sanctioned goods, and to buy maritime vessels,” said Reitmann.

A more particular challenge is identifying dual-use goods. “Even though there are export contol lists and sanctions lists to be checked, dual-use goods can be in a gray area, whether for peaceful purposes or weaponisation,” said Emad Kiyaei, Director of the Middle East Treaty Organisation (a coalition of civil society and disarmament activists) and co-author of a ‘Middle East Free of Weapons of Mass Destruction: A New Approach to Nonproliferation’.

Nuclear ambitions are only one concern. “There is a huge biological and chemical industry worldwide that is dominated by non-state actors, so that changes the whole game,” said Kiyaei. The Chemical Weapons Convention, which banned the development, production or stockpiling of chemical weapons in 1997, ratified by 193 states, has been difficult to enforce as the toxins and chemicals listed are used in many key industries: “Non-state actors can make a dirty chemical weapon from chlorine, which is easily accessible,” Kiyaei observed. (7) Efforts to counter the proliferation of biological weapons are also complicated by rules on access: “Private laboratories are hard to enter due to privacy and intellectual property right laws, so it is difficult to know what they are doing and who is funding them,” he said.

The 1972 Biological Weapons Convention, ratified by 184 states, provides for voluntary national assessments, with no obligatory compliance. (8)

Bear and dragon

While North Korea and Iran remain the focus, Russia is also a current concern. “What Moscow is doing in terms of evading sanctions is using third party intermediaries in countries that have not applied sanctions, like the United Arab Emirates, Turkey, and Uzbekistan, so the same type of tactics used by North Korea and Iran for many years,” said Reitmann. The Financial Times, in May 2023, reported that Russia’s FSB spy agency was using smuggling rings to acquire sensitive European technology. (9) The country's ‘Serniya network' was accused by the US Department of Justice of undertaking “highly sensitive and classified procurement activities” for the FSB, including for its Directorate for Scientific and Technological Intelligence, known as ‘Directorate T'.
An October 2022 report by the Centre for a New American Security further noted that Russia was turning to “grey imports via the black market or through a chain of companies designed to conceal the end-user”. (10)

In the export control space, while Russia is the immediate threat, China is the longer-term concern, said Reitmann. “China is perhaps less of a focus in CPF, but definitely in export controls. The US is working very hard, and lobbying partners in Asia and Europe to adopt coordinated controls in the technology space, responding to China’s civil-military fusion strategy.” 

NOTES: 

1 - https://www.fatf-gafi.org/publications/financingofproliferation/documents/statement-proliferation-financing-2020.html 

2 - https://www.fatf-gafi.org/media/fatf/documents/reports/Guidance-Proliferation-Financing-Risk-Assessment-Mitigation.pdf 

3 - https://www.rusi.org/explore-our-research/publications/rusi-newsbrief/strengthening-role-unscr-1540-countering-proliferation-financing 

4 - https://ofac.treasury.gov/sanctions-programs-and-country-information/ukraine-russia-related-sanctions

https://www.consilium.europa.eu/en/press/press-releases/2023/02/25/10th-package-of-sanctions-on-russia-s-war-of-aggression-against-ukraine-the-eu-includes-additional-87-individuals-and-34-entities-to-the-eu-s-sanctions-list/

https://www.gov.uk/government/collections/uk-sanctions-on-russia

5 - https://www.rusi.org/explore-our-research/projects/counter-proliferation-financing-technical-assistance-programme;https://rusi.org/explore-our-research/projects/proliferation-financing-risk-assessment#aims-and-objectives 

6 - https://www.acams.org/en/media/document/18566;and https://www.acams.org/en/resources/acams-insights/counter-proliferation-financing-insights 

7 - Egypt, South Sudan, and North Korea have not ratified the Chemical Weapons Convention. Israel has signed by not ratified the convention - https://www.aljazeera.com/news/2021/4/29/visualising-chemical-weapon-attacks-in-the-middle-east 

8 - https://news.un.org/en/story/2022/11/1131097 

9 - https://www.ft.com/content/bf892731-2f1c-4c52-b90b-b44ca1911263?accessToken=zwAF-vCjPFcokdO_iScxLxxMUtO5C7RMoZESYw.MEQCIAeix8HnvitU8Fq2CGOmAOGfifyypKkdEVKJC974LttHAiBJM5nkWSevvgApkx-mAj0yUO5yt70TnHk0dn-3cHxqAQ&sharetype=gift&token=a126d782-d8cb-44b9-a8cf-4e7ee604d362 

10 - https://s3.us-east-1.amazonaws.com/files.cnas.org/documents/CNAS-Report-RussianTechnology-Oct22-TSP.pdf?mtime=20221019171136&focal=none