Unveiling the Secrets of Anti-Money Laundering (AML) Efforts
Efforts to police illicit gains have a history stretching back centuries. Anti-money laundering (AML) refers to the modern web of laws, regulations, and procedures aimed at uncovering illicit funds disguised as legitimate income.
Money laundering encompasses actions aimed at concealing financial movements that originate from crimes ranging from tax evasion and drug trafficking to public corruption and the financing of groups designated as terrorist organizations.
AML legislation emerged as a necessity due to the growth of the financial industry, the lifting of capital controls, and the ease of conducting complex chains of financial transactions. According to a high-level United Nations panel, annual money laundering flows stood at about $1.6 trillion, accounting for 2.7% of global gross domestic product (GDP) in 2020.
Key Takeaways
- Anti-money laundering (AML) laws, regulations, and procedures reduce the ease of hiding profits from crime.
- Criminals launder money to make illicit funds appear to originate from law-abiding and innocuous sources.
- Financial institutions combat money laundering with Know Your Customer (KYC) and Customer Due Diligence (CDD) measures.
Know Your Customer (KYC): The First Line of Defense
Regulatory compliance at financial institutions begins with a process known as Know Your Customer (KYC). The KYC process determines new clients’ identities and ensures that their funds originate from legitimate sources.
Money laundering typically unfolds in three steps, and KYC aims to thwart laundering efforts from the first step, especially when customers attempt to store funds in financial accounts. The process involves:
- Depositing illicit funds into a financial system
- Conducting a series of repetitive transactions to obscure the illicit origin of the funds (referred to as “layering”)
- Converting the funds into legitimate-looking assets including real estate, financial instruments, and commercial investments
During KYC, financial institutions screen new customers against high-risk lists, such as criminal suspects, convicts, individuals and companies under economic sanctions, and politically exposed persons, including foreign officials and their associates.
Customer Due Diligence (CDD): Continuous Monitoring
KYC extends beyond the preliminary stages of opening an account. Throughout the account’s lifetime, financial institutions are obliged to conduct ongoing Customer Due Diligence (CDD), which entails maintaining accurate and up-to-date records of transactions and customer information. In some cases, existing customers may be added to sanctions and other AML watchlists over time, necessitating routine checks for regulatory risks and compliance issues.
According to the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN), the four core CDD requirements are:
- Identifying and verifying the customer’s personally identifiable information (PII)
- Identifying and verifying the identity of beneficial owners holding a stake of 25% or more in a company opening an account
- Understanding the nature and purpose of customer relationships and compiling risk profiles
- Monitoring suspicious transactions and updating customer information
If suspicious patterns or anomalies indicate potential money laundering activities, institutions must file Suspicious Activity Reports (SARs) to the relevant financial authorities for further investigation.
Anti-Money Laundering in the U.S.
AML regulations in the U.S. significantly expanded after the Bank Secrecy Act (BSA) was passed in 1970. This act required financial institutions to report cash deposits exceeding $10,000, collect identifiable information of account holders, and maintain records of transactions.
Further legislation throughout the 1980s, 1990s, and 2000s aimed to fight drug trafficking, enhance financial surveillance, and curb terrorist financing.
By early 2021, the Anti-Money Laundering Act of 2020—the most comprehensive overhaul of U.S. AML regulations since the Patriot Act—started requiring entities like cryptocurrency exchanges, arts and antiquities dealers, and private companies to meet the same CDD standards previously targeted at financial institutions. The Corporate Transparency Act component of this legislation removed existing loopholes for shell companies to evade AML measures.
International Anti-Money Laundering Efforts
Fueled by initiatives from the European Union (EU) and other jurisdictions, global enforcement gained traction in 1989 with the formation of the Financial Action Task Force (FATF), an intergovernmental body developing international standards to prevent money laundering and terrorist financing.
Some of the key international frameworks and organizations include the FATF’s 40 Recommendations, compliance programs by the International Monetary Fund (IMF) and the United Nations (U.N.), the Council of the European Union’s Anti-Money Laundering Directive (AMLD), and the Basel Committee on Banking Supervision.
Anti-Money Laundering and Cryptocurrency
Cryptocurrency’s increasing adoption has drawn substantial attention among AML professionals. Virtual currencies provide an added layer of anonymity, making them a convenient tool for illicit fund movements. According to cryptocurrency tracing firm Chainalysis, illicit activities accounted for around $23.8 billion worth of cryptocurrency transactions in 2022.
The decentralized nature of cryptocurrencies presents significant challenges to conventional AML regulations. Technologies and analytical tools, such as those provided by Chainalysis, Elliptic, and TRM Labs, are continually developed to flag suspicious crypto wallets, exchanges, and transactions related to organized crime, hacking, ransomware, and more.
Inside the U.S.
Cryptocurrencies in the U.S. tend to fall in an unregulated market category with few explicit regulations. Nevertheless, AML enforcement has adapted, employing laws like the Bank Secrecy Act and the Foreign Corrupt Practices Act (FCPA) in regulatory actions against crypto exchanges.
Outside the U.S.
Globally, there are concerted efforts to introduce more formal rules. One of the most anticipated frameworks is the FATF Travel Rule, aimed at collecting and sharing beneficiary information for cross-border cryptocurrency transactions.
Furthermore, U.S. residents are mandated by law to report receipts of multiple related payments exceeding $10,000 to the Internal Revenue Service (IRS).
How Is Money Laundered?
Money launderers often funnel illicit funds through associates’ cash-generating businesses, fabricate inflated invoices via shell companies, pool transactions, break them into smaller sums, and cycle them between financial conduits.
Distinguishing AML, CDD, and KYC
- AML: Legally recognized rules for preventing money laundering actions.
- CDD: Practices to detect and report AML violations.
- KYC: Screening and verifying new clients, a component of CDD.
Can Money Laundering Be Stopped?
While aggressive AML enforcement efforts aim to limit money laundering activities, stopping them entirely remains an elusive goal. Nevertheless, these measures do hinder criminals by elevating the risks and complexity of laundering illicit funds.
The Bottom Line
Anti-money laundering regulations play a crucial role in deterring financial crimes and protecting consumers and businesses. Through comprehensive regulatory measures and industry cooperation, AML efforts continue to evolve, aimed at safeguarding the integrity of financial systems worldwide.
Related Terms: Money laundering, Bank Secrecy Act, Terrorist financing, Cryptocurrency, Financial Action Task Force.
References
- U.S. Treasury Financial Crimes Enforcement Network. “What Is Money Laundering?”
- United Nations, Department of Economic and Social Affairs. “Tax Abuse, Money Laundering and Corruption Plague Global Finance”.
- Swift. “What Does KYC Mean?”
- United Nations, Office on Drugs and Crime. “Money Laundering”.
- Swift. “The KYC Process Explained”.
- Federal Financial Institutions Examination Council, Bank Secrecy Act/Anti-Money Laundering Infobase. “Politically Exposed Persons”.
- Financial Industry Regulatory Authority. “Frequently Asked Questions (FAQ) Regarding Anti-Money Laundering (AML)”.
- U.S. Treasury Financial Crimes Enforcement Network. “Information on Complying with the Customer Due Diligence (CDD) Final Rule”.
- Corporate Finance Institute. “Anti-Money Laundering”.
- U.S. Treasury Financial Crimes Enforcement Network. “History of Anti-Money Laundering Laws”.
- U.S. Treasury Financial Crimes Enforcement Network. “BSA Timeline”.
- U.S. Office of the Comptroller of the Currency. “Bank Secrecy Act (BSA): BSA & Related Regulations”.
- U.S. Treasury Financial Crimes Enforcement Network. “FinCEN Informs Financial Institutions of Efforts Related to Trade in Antiquities and Art”, Pages 1–2.
- JD Supra. “FinCEN Crypto & Ransomware Guidance: Will 2022 Bring More Changes?”
- International Monetary Fund. “The IMF and the Fight Against Money Laundering and Terrorism Financing”.
- Chainalysis. “Crypto Money Laundering: Four Exchange Deposit Addresses Received Over $1 Billion in Illicit Funds in 2022”.
- Atlantic Council. “Cryptocurrency Regulation Tracker”.
- European Council. “Anti-money Laundering: Council Adopts Rules Which Will Make Crypto-asset Transfers Traceable”.
- Financial Action Task Force. “Virtual Assets: Targeted Update on Implementation of the FATF Standards on Virtual Assets and Virtual Asset Service Providers”.
- Internal Revenue Service. “Form 8300: Report of Cash Payments Over $10,000 Received in a Trade or Business”.
- Internal Revenue Service. “Cash Payment Report Helps Government Combat Money Laundering”.
- Institute of International Banking Law and Practice. “Trade Based Money Laundering—A Primer”.
