Analysis: Winning the battle against the Gulf's dirty laundry

With its strategic trading position, it is little surprise the Gulf has been used as a thoroughfare for illicit funds. But banks, regulators and technology firms are clubbing together in the fight against financial crime, and hope to wash corruption out of the system for good.
By Sarah Townsend
Wed 12 Apr 2017 09:24 AM

In US television series Breaking Bad, the lead character manufactures high-grade narcotics in a ‘superlab’ beneath an industrial laundry. He invests the proceeds from his illicit drug trade into a local car wash business.

The metaphor is clear: the protagonist cleans up his dirty money by putting it through its own wash and dry cycle. Unfortunately, in real life, the process of illegal money laundering is far more complex and subtle.

In February, new details emerged of a $20bn money laundering operation that stretched its tentacles from head honchos in Russia to 96 countries, including the UAE, via a network of shady companies that used the world’s biggest banks to process their funds.

The UAE was said to have received more than $434m between 2011 and 2014 from the scheme, run by criminals with links to the Russian government and dubbed ‘Global Laundromat’ by the Organised Crime and Corruption Reporting Project, which uncovered it in an international media blitz.

Eleven UAE-registered companies were named in a list of ‘shell’ companies through whose bank accounts some of the money was filtered. And two UAE banks, Emirates NBD and Abu Dhabi Commercial Bank (ADCB), were among the 50 bank families that received the largest amounts of money, allegedly handling $357m and $26m, respectively.

The story highlights the challenges facing law enforcement agencies, banks and businesses in fighting financial crime, or ‘fincrime’. Even before the latest Laundromat data was published — revealing the extent of the UAE’s unwitting links to what experts have termed an “ingenious” illegal operation — the Gulf was no stranger to the problem, with several cases coming to light in the past two years alone.

A probe in Ras Al Khaimah continues to uncover evidence of embezzlement of public funds following allegations of a $1.5bn fraud at a key development body in the emirate last year. In Abu Dhabi, 20 people were arrested in February on suspicion of involvement in a bogus car investment portfolio and they face charges including fraud and money laundering. And the Dubai branch of Dutch Bank ABN Amro was fined $640,000 by Dubai Financial Services Authority (DFSA), regulator of Dubai International Financial Centre (DIFC), in 2015 for perceived deficiencies in its anti-money laundering systems.

The results of the DFSA’s investigation into ABN-Amro’s DIFC branch in 2015 did not allege that any money laundering took place.

A report by PwC in February concluded that financial crime in the Middle East is as hard to tackle as ever. With increasing economic, political and cybersecurity risks, the region’s businesses remain vulnerable, with the four most commonly reported types of economic crime being asset misappropiation, cybercrime, bribery and procurement fraud.

Trade-based money laundering (TBML) — the process of disguising and moving the proceeds of crime across borders via trade transactions rather than currency exchange or cash deals — was also highlighted as a threat. This type of laundering is harder to detect, yet 20 percent of 150 UAE-based respondents to PwC’s survey said their business may be at risk to TBML but no measures had been taken to limit it.

Further, an alarming 40 percent indicated that their organisations had never performed a fraud risk assessment. The cost of falling victim to financial crime, even indirectly, is significant. Eleven percent of UAE respondents said it had cost their organisation between $5m and $100m in the previous 24 months.

“It’s hard to generalise about the risks facing a particular region, as there are always good people in bad countries and bad people in good countries,” says Nick Robinson, PwC’s Middle East partner and forensic services leader. “But GCC countries have the three conditions [identified by sociologist Donald Cressey in the ‘Fraud Triangle’ theory] that increase the risk of fraud: pressure, opportunity and rationalisation.

“The macroeconomic environment [brought about by low oil prices] means people are under pressure to meet targets amid budget cuts and changes to departmental functions. Many of them are working in regional offshoots away from the head office, giving them more opportunity. All of these factors give them scope to rationalise their behaviour.”

Michael Shepard, US-based global anti-money laundering, sanctions and financial crime leader at Deloitte, adds: “[Financial crime] is definitely a stay awake issue for C-suite executives at major financial institutions in the Gulf and beyond. It is one of the hottest topics in the world.

“There are external pressures on the region, as the markets are trying to attract investment and position themselves as global financial centres, and to do that they must prove they have the right compliance regimes in place.

“There are internal pressures, too. After a slew of negative stories post-financial crisis [such as the Swiss Leaks scandal], no one wants to be on the front pages of the newspapers as having a regulatory or ethics issue.”

Financial crime is a pressing issue for the UAE and Saudi Arabia, for another reason. The two countries are gearing up to undergo assessment by the Financial Action Task Force (FATF), the global inter-governmental body set up by member states in 1989 and responsible for developing and upholding policies to combat money laundering and terrorist financing.

ADCB was among more than 90 banks implicated in the Global Laundromat money laundering operation.

The FATF recommendations are a framework of measures that member states are required to implement, and countries are subject to a four-to-12-month review every seven years or more to ensure they are maintaining standards.

If they fall short, they receive a negative report and risk being named and shamed as “unsatisfactory” or, worse, “high risk and non-cooperating”, which equates to being blacklisted. There are only a few countries with that status, including Iran, Iraq, Afghanistan, Syria and Ethiopia.

Bhavin Shah, Dubai-based Middle East regulatory and financial crime partner at Deloitte, says: “The FATF review assesses whether your country has an effective fincrime fighting framework in place.

The review process is tough, and the report straight away affects the reputation of the country and every financial institution in it.”

Saudi Arabia’s review begins in October 2017, and the UAE’s in June 2019. Although both countries received satisfactory status in their last reviews in 2010 and 2008, the methodology was tightened up in 2013 with requirements to assess not only how robust a framework is in place, but how well it is being implemented and enforced.

“Now is not a good time to rely on your old review, that would be misguided,” warns Shah.

The UAE representative of the Middle East and North Africa (MENA) FATF was contacted for comment but had not responded at the time of going to press.

Jonathan Brewer, a professor at Kings College London who helped to write the FATF recommendations, says the reports “pull no punches if countries are not up to scratch”. And RAK International Corporate Centre head of international companies, regulations and operations, Gail Johnson Goring, who was previously legal counsel for the Cayman Islands Monetary Authority and a certified evaluator for the Caribbean FATF, says it is a “gruelling experience for all involved and if you don’t score well, you’re in trouble”.

In 2014, the UAE ratified a new anti-money laundering law intended to clamp down on financial crime. The legislation imposes penalties on convicted money launderers, including jail terms of up to ten years, fines of up to $136,000, or both. Businesses face fines of up to $272,000.

The law also penalises board members and employees who fail to report corruption, and gives legal protection to whistleblowers. Experts note it includes a significant amendment; instead of previously criminalising the proceeds from certain specified offences, it is funds related to “any felony or misdemeanour” — much broader.

Emirates NBD says it is firmly committed to combating financial crime and money laundering.

Dubai established the Dubai Economic Security Centre in April 2016 to fight financial crime, and the UAE Central Bank now has an online system for filing reports of suspicious transactions. But despite the beefed up frameworks, challenges remain.

Experts note terrorism financing is hard to detect because it is often legal proceeds that are funnelled into an organisation, rather than the proceeds of crime. There are also challenges in identifying the many ways by which dirty money is made ‘clean’. Real estate has long been a target.

The 2006 documentary Cocaine Cowboys showed how South American drug money indirectly financed the construction of much of Miami — and the authorities are aware of this. In January, the US Treasury launched a crackdown, issuing ‘geographic targeting orders’ (GTO) requiring US title deed insurance firms to identify the beneficial owner of companies that paid wholly in cash for real estate in Manhattan and Miami.

However, criminals are also getting smarter. It is now rare to see money laundered in huge piles of cash, as was common in the past with proceeds from drug smuggling, war lords and blood diamonds. Trade-based money laundering is more common, via under- or over-invoicing, misdescription of goods, and so on. With the Gulf occupying a strategic trading position between East and West it is especially vulnerable, experts say, citing industries such as gold and jewellery.

TBML is hard to detect because on paper it can look like ‘business as usual’. A report by the DFSA in January claimed the risks had risen among financial service providers in the DIFC as trade finance boomed in recent years. DFSA CEO Ian Johnston says: “There is an increased focus globally on TBML risks. Given the importance of trade to this region, regulators need to effectively oversee and supervise trade finance without hindering actual trade.”

Says Deloitte’s Shepard: “Fincrime monitoring used to be about scrutinising any high value transaction because it could be dirty money. Today, it’s not just about putting in place a system to check any amount above ‘X’.

“You have to really understand the risks of each client — who’s the beneficial owner of his account, what do I anticipate he’s going to do, why hasn’t he done that, what is the reason for spikes in activity? A business model may have changed but then again it might not have. This customer may have been a dormant or ‘sleeper’ customer and all of a sudden is doing high-risk transactions in large amounts and/or frequency.

“The complexity of transaction monitoring has gone up leaps and bounds over the past ten years.”

Emirates NBD notes the concerns held by banks when it comes to fincrime. A spokesperson said in a statement to Arabian Business following reports of the bank’s links with the Russian Laundromat: “This highlights the difficulty in the global fight against illicit criminal funds, particularly where the bank may be one of the victims of a scheme designed to disguise and launder the funds through reputable jurisdictions and institutions.”

Victor Matafonov, group chief compliance officer at Emirates NBD, told a fincrime event in Dubai in February: “We are in a region surrounded by sanctions and other political and financial risks, yet we are also playing catch up in terms of [compliance] procedures, some of which may have only have been in place for the last five-ten years.”

A shortage of fincrime monitoring skills does not help. “There is a war on talent,” says Deloitte’s Shah. “The subject has evolved fast over the past ten years and not many experts exist.”

The solution is technology. As the financial crime landscape becomes increasingly complex, cutting-edge digital solutions, such as Blockchain, augmented reality and artificial intelligence (AI), are required to identify suspicious transactions. Banks will also have to stay ahead in terms of cybersecurity, as any cyber attack on a financial institution is, ultimately, a financial crime.

Deloitte’s global financial services industry leader Bob Contri says: “What we will see more of in the future is the deployment of sophisticated transaction monitoring software, which applies cognitive analytics to complex algorithms to really learn who the bad customers are and what the anomalies are.

“These systems can track on a live basis any number of filters: are these persons on a wanted list or global sanctions list, and what other transactions are associated with them?

“Continuing to do this manually is unreliable and expensive. How do you monitor hundreds of thousands of transactions, in real time, with the human eye?”

Khalid Shaikh, head of compliance at Mashreq Bank, agrees: “We are talking about trillions of dollars passing through the bank each day — it’s difficult to tackle.”

Yet, in working to combat financial crime, authorities must strike a balance between reducing financial risk and promoting financial inclusion, experts warn. In the years since 9/11, US regulators have ratcheted up requirements on US banks, encouraging them to ‘de-risk’ customers where necessary.

Banks are now required to look through global correspondent bank accounts (including in the GCC), and move high-risk accounts elsewhere. This is a good thing, as it reduces banks’ overall money laundering risk, but it can have a negative impact, says Deloitte’s Shepard. “It forces de-risked institutions into the shadows because they’ve got to nest somewhere.”

As banks stop doing business with high-risk countries or institutions, de-risked account holders end up gravitating towards alternative money service businesses, or ‘hawalas’, which are prevalent in the Arab world and may not have the right procedures in place, thereby perpetuating the cycle, he says.

As well as digital solutions, increased government sharing is key. The government sits on a lot of intelligence, and could publicise data on money laundering typologies, which crimes are hot and ‘red flags’ to look out for, so banks become wiser.

HSBC Middle East regional head of compliance Sonali Goiporia says: “We need robust data from governments because financial institutions have limited resources.” A transparent legal and court process, enabling the public to obtain information about past crimes, is another element.

Abdul Qader Obeid Ali, chairman of the UAE Internal Auditors Association, which collaborated with PwC on its report, said this year: “Economic crime is a major issue we are facing in the Middle East. We are all required to engage in efforts to mitigate against and investigate it.”

With stakeholders working together in the fight against fincrime, it may become easier to detect and intercept corruption. But, at the moment, criminals are often several steps ahead.

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