Legislative deep dive: Understanding high-risk countries in AML/CTF frameworks

In the complex world of Anti-Money Laundering (AML) and Countering Terrorism Financing (CTF), the concept of high-risk countries plays a crucial role. Here we’ll explore the legislative drivers surrounding high-risk countries, digging into their significance, how they're determined, and the implications for financial institutions and businesses worldwide.

Understanding high-risk countries

At its core, high-risk countries are those that don't have strong enough systems in place to fight financial crimes like money laundering and terrorism funding.

These countries pose a higher risk to the global financial system and require enhanced due diligence measures when engaging in business or financial transactions.

The concept of high-risk countries isn't just a theoretical exercise; it's deeply embedded in international and national legislative frameworks. Understanding these legislative underpinnings is crucial for compliance professionals and businesses operating in the global marketplace.

International legislative framework

The Financial Action Task Force (FATF)

At the heart of the international framework for identifying and dealing with high-risk countries is the Financial Action Task Force (FATF). Established in 1989, the FATF is an intergovernmental organisation that sets global standards for AML/CTF efforts.

The FATF's 40 Recommendations form the basis of most national AML/CTF legislation worldwide. Recommendation 19 specifically addresses higher-risk countries, stating that financial institutions should be required to apply enhanced due diligence measures to business relationships and transactions with natural and legal persons from countries for which the FATF calls for this.

The type of enhanced due diligence measures applied should be effective and proportionate to the risks.

FATF high-risk and other monitored jurisdictions

The FATF maintains two public lists of countries with weak AML/CTF regimes:

1. High-risk jurisdictions subject to a Call for Action (often referred to as the "black list")
2. Jurisdictions under Increased Monitoring (often called the "grey list")

These lists are updated three times a year following FATF plenaries.

• The blacklist identifies countries or jurisdictions with such serious strategic deficiencies that the FATF calls on its members and non-members to apply countermeasures.
• The grey list includes jurisdictions committed to resolving strategic deficiencies within agreed timeframes.

European Union (EU) Legislation

The EU has its framework for identifying high-risk third countries, largely based on but different from the FATF lists. The legal basis for this is found in the EU's Anti-Money Laundering Directives (AMLDs), particularly the Fifth AMLD.

Article 9 of the Fourth AMLD empowers the European Commission to adopt delegated acts to identify high-risk third countries. This results in the EU's list of high-risk third countries, which is regularly updated and published in the Official Journal of the European Union.

National Legislative Approaches

While international bodies like the FATF and supranational entities like the EU provide overarching frameworks, individual countries often have their legislative approaches to high-risk countries.

United States

In the U.S., the primary AML legislation is the Bank Secrecy Act (BSA), as amended by the USA PATRIOT Act. Section 311 of the PATRIOT Act gives the Secretary of the Treasury the authority to designate a foreign jurisdiction, institution, class of transactions, or type of account as being of "primary money laundering concern”.

The Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury, issues advisories on high-risk jurisdictions based on FATF publications and other sources.

United Kingdom

Post-Brexit, the UK has established its own autonomous sanctions regime through the Sanctions and Anti-Money Laundering Act 2018. The UK now maintains its list of high-risk third countries, which is based on, but not identical to, the FATF lists.

The UK's Money Laundering Regulations 2017 (as amended) require regulated entities to apply enhanced due diligence measures in dealing with high-risk third countries.

Australia and New Zealand

In Australia, the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 provides the legislative framework. The Australian Transaction Reports and Analysis Centre (AUSTRAC) issues guidance on high-risk jurisdictions, largely following FATF recommendations.

While in New Zealand the Department of Internal Affairs in association with the New Zealand Police, provide their own guidance, also closely aligned to the FATF recommendations. 

Implications for AML-captured reporting entities

The identification of high-risk countries has significant implications for AML-captured reporting entities operating globally.

Enhanced due diligence (EDD)

When dealing with customers or transactions involving high-risk countries, entities are typically required to apply EDD measures. This may include obtaining additional information on the customer, the source of funds and the purpose of the transaction.

Risk assessments

Reporting entities must factor in country risk in their overall risk assessments. Transactions or business relationships involving high-risk countries will generally be classified as higher risk.

Transaction monitoring

There may be a need for heightened transaction monitoring for customers or transactions associated with high-risk countries.

Regulatory reporting

Some jurisdictions require specific reporting related to transactions involving high-risk countries.

De-risking

In some cases, reporting entities may choose to terminate or restrict business relationships with entities in high-risk countries, a practice known as de-risking.

Challenges and criticisms

While the concept of high-risk countries is crucial for AML/CTF efforts, it's not without challenges and criticisms.

Lack of uniformity

Despite efforts at international coordination, there are still discrepancies between various high-risk country lists (FATF, EU, national lists), which can create compliance challenges.

Over-compliance

Fear of regulatory action can lead to over-compliance, where companies apply unnecessarily stringent measures to all transactions involving certain countries, potentially hampering legitimate business.

De-risking concerns

Wholesale de-risking of entire countries or regions can have unintended consequences, potentially driving financial transactions underground and hampering financial inclusion efforts.

Rapidly changing landscape

The status of countries can change relatively quickly, requiring constant vigilance and updates to compliance systems and an additional burden on compliance professionals.

Political sensitivities

The designation of countries as high-risk can be politically sensitive, potentially affecting diplomatic relations.

Future trends

As the global fight against money laundering and terrorist financing evolves, we can expect to see several trends in the legislative approach to high-risk countries.

Greater harmonisation

Efforts are likely to continue towards greater international harmonisation of high-risk country lists and associated requirements.

Technology-driven solutions

Advanced analytics and AI may play a larger role in assessing country risk and applying appropriate due diligence measures. Reliance on technologically enabled compliance rules and risk assessments will also likely grow in importance.

Focus on effectiveness

There may be a further shift towards more nuanced, risk-based approaches rather than blanket categorisations of entire countries.

Increased scrutiny of specific sectors

Rather than focusing on entire countries, there may be more targeted approaches to high-risk sectors within countries.

Emphasis on beneficial ownership

With the growing global focus on beneficial ownership transparency, this is likely to become an increasingly important factor in assessing country risk.

Conclusion

The legislative framework surrounding high-risk countries is a crucial component of global AML/CTF efforts. While it presents challenges, it also provides a structured approach to managing risks associated with cross-border financial activities.

For compliance professionals and businesses operating internationally, staying abreast of changes in high-risk country designations and understanding the nuances of different legislative approaches is essential. As the global financial landscape continues to evolve, so too will the approaches to identifying and mitigating risks associated with high-risk jurisdictions.

By maintaining a balanced, risk-based approach, reporting entities can navigate these complex waters effectively, contributing to the global fight against financial crime while facilitating legitimate international business and finance.