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The Evolution of International AML and CTF Standards: A Review of the Revised FATF Recommendations

Fasken
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Financial Institutions Bulletin

On February 16, 2012 the Financial Action Task Force (FATF) released revised FATF Recommendations, which re-organize and streamline the original FATF Forty Recommendations on international anti-money laundering (AML) standards and the Eight (later expanded to Nine) Special Recommendations on Terrorist Financing and introduce some important changes. Most of the revised FATF Recommendations – now 40 in all – include interpretive notes that provide guidance on implementation. The FATF Recommendations address new and emerging risks and, importantly, will allow countries to choose to implement a more flexible risk-based approach that would allow countries, financial institutions and others affected to focus scarce resources on higher-risk areas.

The first FATF Recommendation – which requires countries, financial institutions and others to assess money laundering (ML) and terrorist financing (TF) risks and to apply a risk-based approach to identified risks – is new, elevating previous guidance to a Recommendation. Most of the former counter terrorist financing (CTF) Special Recommendations have been integrated throughout the revised FATF Recommendations, although three Recommendations (5, 6 and 8) deal specifically with CTF issues. Reflecting an expansion of FATF's mandate in 2008, a new Recommendation 7 addresses the implementation of targeted UN financial sanctions dealing with the proliferation of weapons of mass destruction.

This Bulletin summarizes some of the revised FATF Recommendations that are of particular interest.

Recommendation 1 – Assessing Risks and Applying a Risk-Based Approach

This new recommendation advises each country, financial institution and designated non-financial business and profession (DNFBP) to take steps to identify and assess the ML and TF risks it faces on an ongoing basis. At a country level, this assessment is expected to inform changes necessary to the country's legal and administrative regime for AML and CTF, assist in the prioritization and allocation of resources, and make information available to financial institutions and DNFBPs for their own risk assessments.

Where higher risks are identified, the legal regime should be updated, and either financial institutions and DNFBPs will be expected to adopt enhanced or specific measures, or ensure that this information is incorporated into their own risk assessments to manage and mitigate these risks. Except where higher-risk measures are mandated, a risk-based approach permeates the FATF Recommendations. Countries may permit the adoption of simplified measures for some FATF Recommendations where they (and financial institutions) have identified lower risks based on risk assessments. In addition, countries may permit financial institutions and DNFBPs to adopt simplified customer due diligence (CDD) (also see Recommendation 10) and other simplified measures for lower-risk activities, provided that they have taken appropriate steps to identify and assess their own ML and TF risks, and have policies, controls and procedures to manage and mitigate those risks appropriately. This is in line with the internationally accepted approach to risk management: net risk equals the inherent risk(s) of an activity after mitigation by the quality of the risk management of that activity. In limited circumstances, where there is a lower risk, countries may decide not to apply certain Recommendations to particular types of financial institutions or activities, or where a financial activity (other than money transfer) is carried out by a legal person on an occasional or very limited basis. Simplified CDD measures are not acceptable where there is a suspicion of ML or TF, or in a higher-risk scenario.

Accordingly, it is possible that (1) simplified CDD and other measures will be permitted by countries for certain activities and/or (2) countries will allow reporting entities to take simplified measures where they have assessed the risk of a specific activity as lower. Higher-risk activities may mandate enhanced CDD and other measures. Reporting entities operating in multiple regions of a country or internationally would adjust their approach to specific activities depending on both the country assessment and their own assessment of risk related to the activity in that area. While a risk-based approach would allow institutions to take a more flexible and sophisticated approach, this may require institutions to adopt more complex programs for risk assessment and compliance. Institutions will have to be able to justify the choices they make, and must be prepared to adjust how they address specific risks as a result of re-assessments of those risks both by themselves and by the countries in which they operate.

Recommendation 7 – Targeted Financial Sanctions Related to Proliferation

Reflecting FATF's expanded mandate to deal with proliferation issues, this new Recommendation urges countries to implement targeted financial sanctions to comply with United Nations Security Council resolutions related to the prevention, suppression and disruption of proliferation of weapons of mass destruction and its financing. Countries should have mechanisms for communicating designations of persons and entities to financial institutions and DNFBPs with clear guidance on obligations to take action to freeze targeted funds and other assets. Financial institutions and DNFBPs are expected to report on frozen funds and assets and on actions taken in compliance with the prohibitions to competent authorities, which information should be effectively utilized. Countries are also expected to monitor and ensure compliance by financial institutions and DNFBPs with laws related to non-proliferation.

While reporting entities are presumably already complying with applicable Canadian laws, the effect of this Recommendation may be increased monitoring and enforcement of these laws. Reporting entities will need to ensure that they have appropriate compliance systems in place to meet applicable legal requirements.

Recommendation 10 – Customer Due Diligence

This updated standard identifies when financial institutions should be required to undertake CDD measures, including when carrying out occasional transactions above the applicable designated threshold, which remains unchanged at USD/EUR 15,000, or that are wire transfers subject to CDD measures under another Recommendation.

The extensive interpretive note to this Recommendation identifies CDD measures that reporting entities should undertake in respect of customers and beneficial owners. Life insurance companies are now expected to undertake CDD measures with respect to beneficiaries at the time they are designated (names are to be taken) and at the time that a party is paid out (the identity of beneficiaries is to be verified). Life insurance policy beneficiaries are a relevant risk factor in determining whether enhanced CDD measures are appropriate. Financial institutions are advised to adopt risk management procedures establishing the conditions under which a customer may conduct business with the institution before identification has been verified. An institution should be able to monitor large or complex transactions that are unusual given the nature of the relationship with a customer.

A risk-based approach does not apply to circumstances where CDD should be required, but instead may be used to determine the extent of measures taken in light of assessed risk. To assist financial institutions with the establishment of a risk-based approach to CDD, when assessing risks related to types of customers, countries or geographic areas, and products, services, transactions and delivery channels, institutions are advised to consider variables related to these risk categories, which may increase or decrease risk and therefore impact on the level of CDD appropriate in the circumstances. Examples of variables include the purpose and regularity or duration of the relationship, and the size of the transaction.

The interpretive note provides examples of customer, country or geographic, and product, service transaction or delivery channel risk factors that may (but do not necessarily) indicate a higher-risk situation. These include the following:

  • the business relationship is conducted in unusual circumstances (e.g. significant unexplained geographic distance between the financial institution and the customer);
  • non-resident customers;
  • legal persons or arrangements that are personal asset-holding vehicles;
  • anonymous transactions (which may include cash); and
  • non-face-to-face business relationships or transactions.

Where risks are assessed as higher, enhanced CDD measures commensurate with those risks are expected to be carried out. Additional information may be required, examples of which are listed, and enhanced monitoring may be appropriate.

The interpretive note also provides examples of potentially lower risk circumstances, including the following:

  • life insurance policies where the premium is low (e.g. an annual premium of less than USD/EUR 1,000 or a single premium of less than USD/EUR 2,500);
  • insurance policies for pension schemes if there is no early surrender option and the policy cannot be used as collateral;
  • a pension, superannuation or similar scheme that provides retirement benefits to employees, where contributions are made by way of deduction from wages, and the scheme rules do not permit the assignment of a member's interest under the scheme; and
  • financial products or services that provide appropriately defined and limited services to certain types of customers, so as to increase access for financial inclusion purposes.

The interpretive note also posits that a country could reasonably allow financial institutions to apply simplified CDD measures where an adequate assessment indicates that the ML or TF risk is lower. The note helpfully suggests examples of circumstances in which customer, country, or product, service, transaction or delivery channel risk factors may suggest a potentially lower-risk situation. Countries' and financial institutions' risk assessment may identify variations in risk between different regions of a country. It is also noted that an assessment of lower risk for identification and verification purposes may not necessarily mean lower risk for monitoring purposes. Simplified CDD measures may be permissible, such as the verification of a customer's identity and beneficial ownership after the establishment of a business relationship, reduced frequency of information updates, reduced levels of ongoing monitoring, or no requirement to collect certain information.

As noted above, where countries permit it, a risk-based approach to CDD may allow reporting entities to re-allocate their AML and CTF compliance program resources based on their own assessment of risks related to their activities. This would allow CDD to reflect institutional self-assessment of risks in specific situations, but institutions will have to be able to justify their approach. Where a country's legal regime currently provides for exemptions from the application of certain AML requirements, it is unclear whether those exemptions will be retained or replaced by a risk-based approach which requires some level of compliance even if the risk is determined to be lower.

Recommendation 12 – Politically Exposed Persons

Foreign politically exposed persons (PEPs) (whether a customer or beneficial owner) represent higher risk. Specified enhanced CDD measures should be undertaken when foreign PEPs are identified.

Financial institutions should be required to take reasonable measures to determine whether a customer or beneficial owner is a domestic PEP or a person who is or has been entrusted with a prominent function by an international organization. In a higher-risk business relationship with that person (i.e., applying a risk-based approach in respect of the domestic PEP), institutions should be required to apply specified measures referred to in the Recommendation.

The interpretive note to this Recommendation suggests that financial institutions should take reasonable measures to determine whether the beneficiaries (or the beneficial owner of beneficiaries) of a life insurance policy are PEPs – at the latest – at the time of a payout on a policy. Where higher risks are identified, in addition to normal CDD measures, a financial institution should be required to inform senior management before a payout is made, conduct enhanced scrutiny of the policyholder business relationship, and consider making a suspicious transaction report.

Recommendation 17 – Reliance on Third Parties

This Recommendation potentially provides added flexibility as it now recognizes that competent authorities in a country may permit a financial institution to rely on a third party that is part of the same financial group to perform certain CDD measures through a group AML and CTF program, provided that the group applies CDD and record-keeping requirements in line with the Recommendations dealing with CDD, record-keeping and PEPs and group wide internal controls, and where these programs are supervised by a relevant competent authority in the home jurisdiction for the financial group.

Recommendation 18 – Internal Controls and Foreign Branches and Subsidiaries

Financial groups should be required to implement group-wide AML and CTF programs, which have policies and procedures for sharing information within the group. Non-domestic branches and subsidiaries should apply AML and CTF measures consistent with the home country requirements implementing the FATF Recommendations. The interpretive note suggests that where the host country minimum AML and CTF requirements are less strict than those of the financial group's home jurisdiction, branches and subsidiaries in host countries should be required to implement the stricter home country requirements to the extent that the laws of the host country permit.

Recommendation 19 – Higher-Risk Countries

Financial institutions should be required to apply enhanced due diligence measures to business relationships and transactions with natural and legal persons, and financial institutions, from countries for which this is called for by the FATF. Countries should be able to apply appropriate countermeasures when called upon to do so by the FATF and independently. The interpretive note provides examples of countermeasures, which include the following:

  • refusing the establishment of subsidiaries or branches or representative offices of financial institutions from the country concerned, or otherwise taking into account the fact that the relevant financial institution is from a country that does not have adequate AML/CFT systems;
  • prohibiting financial institutions from establishing branches or representative offices in the country concerned, or otherwise taking into account the fact that the relevant branch or representative office would be in a country that does not have adequate AML/CFT systems;
  • prohibiting financial institutions from relying on third parties located in the country concerned to conduct elements of the CDD process;
  • requiring financial institutions to review and amend, or if necessary terminate, correspondent relationships with financial institutions in the country concerned; and
  • requiring increased supervisory examination and/or external audit requirements for branches and subsidiaries of financial institutions based in the country concerned.

Recommendations 24 and 25 – Transparency and Beneficial Ownership of Legal Persons and Legal Arrangements

The interpretive notes to these recommendations state that all companies and express trusts created in a country should be registered in a company registry or trust database and that countries should require their company registry or data holders to facilitate timely access by financial institutions, DNFBPs and other countries' competent authorities to the public information they hold. The interpretive note also states that countries should consider facilitating timely access by financial institutions and DNFBPs to a register of shareholders of members of a company containing details regarding shareholdings. Similarly, countries should consider measures to facilitate access to information on trusts held by various parties by financial institutions and DBFBPs undertaking CDD measures. These suggestions would, if adopted, potentially be of significant assistance to reporting entities in the course of their CDD activities.

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With the revised FATF Recommendations now in place, the focus now shifts to countries to take the next steps to assess their own legislative and administrative regimes, and to consult with stakeholders, about the implementation of these Recommendations.

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