Understanding the risks of money laundering in Sri Lanka

In light of Sri Lanka’s inclusion in the European Union’s (EU) list of high-risk countries for money laundering, and the subsequent rejection of this list by the European Council last week, this LKI Ex-plainer examines the key aspects of money laundering, the emerging challenges and its impact in Sri Lanka. It also explores vital domestic and international legal instruments in force to combat money laundering

By Nilupul Gunawardena and Shihan Maharoof

The EU blacklist of countries with deficient anti-money laundering (AML) and counter-terrorist fi-nancing (CTF) frameworks, which included Sri Lanka, was unanimously rejected by the European Council last week.1 The European Commission will now have to propose a new draft list of high-risk third countries that will address the concerns of the EU member states.

In 2018, the European Commission listed Sri Lanka as a country with deficient AML and CTF frame-works. Subject to a new methodology2 which reflected the stricter criteria of the 5th Anti-Money Laundering Directive (Directive (EU) 2018/843), the European Commission re-published their list in February 2019, including Sri Lanka as one of the 23 countries with strategic deficiencies in their anti-money laundering and terrorist financing regimes that pose significant threats to the financial sys-tem of the EU.3 While the rejection of the list may be of temporary relief to Sri Lanka, it certainly does not absolve Sri Lanka of the incumbent responsibility to strengthen its AML and CTF frame-works in compliance with international standards and requirements. 

In light of these developments it is essential to understand the key aspects of money laundering and its implications for Sri Lanka as an emerging financial hub of the region.  

1. What is money laundering?

• Money laundering is a process by which unlawfully acquired proceeds are made to appear to have been derived from a legitimate source.4
• Money laundering follows a three-stage process that involves transferring the cash acquired from illegal activities into financial institutions, obliterating the trail and the origin of the funds, and finally, reintroducing the money back into the legitimate economy, creating an impression of legitimacy.   

2. How does money laundering impact society?

• Money laundering is intrinsically interwoven with criminal activity. Thus, it allows criminals to expand their operations with the accumulated laundered wealth, sourcing further finan-cial activity. 
• It provides corrupt public officials and individuals a method of concealing wealth acquired through unlawful activities such as extortion, kick-backs, bribes or misappropriation of pub-lic funds.5
• Money launderers often use front companies, to commingle the proceeds of unlawful activi-ty with legitimate funds. These can result in the crowding out of private sector business by criminal organisations.
• Money laundering can potentially shift the centre of the economic power to criminal organi-sations. Power thus accrued can have a corrupting effect on all levels of the society and ef-fectively weaken the social fabric and ultimately the democratic institutions of a state. This would inevitably lead to a serious erosion of the rule of law. 
• It can also distort the true economic state of a country.
• Money laundering is a primary method by which terrorist organisations fund their activities.6  
• Licensed financial institutions are frequently used in money laundering. The more laundered money that runs through these institutions, the more volatile they become. This volatility can threaten the bona fide investors. 
• The United Nations Office on Drugs and Crime (UNODC) estimated that approximately $ 1.6 trillion, that is 2.7% of global GDP was laundered in 2009.7

3. What are the problems in combating money laundering?

• The increasing methods and sophistication of money laundering provide countries with a complex and dynamic challenge. 
• With the growing complexities of the e-transaction systems and the increasing number of transnational transactions, banks and financial institutions can find it difficult to manage cross-border and multi-jurisdictional anti-money laundering compliance requirements.8
• A key issue is the lack of capacity to investigate and keeping personnel informed of the changes in the regulatory requirements and rapidly evolving technologies used in money laundering. 
• The ‘interception rate’ for money-laundering at the global level remains very low. Less than 1% of the proceeds of crime, laundered via the financial system are seized and frozen.9
• The key responsibilities of financial and non-bank institutions regards ‘Know Your Customer’ (KYC) and Customer Due Diligence (CDD) rules, which makes it incumbent on these entities to ensure that they have all the information on their customers, before they enter into a fi-nancial transaction with them and that ensuing transactions are in conformity with the in-formation that is available.
• These entities have the obligation to prove that they acted in probity on the basis of the in-formation collected and in conformity with the KYC and CDD rules applicable to these trans-actions.
• Financial institutions act as the first line of defence against money laundering, and recent cases highlight the difficulties that arise for authorities to police the wave of cash that is washed through the banking system.10  

4. Some examples of the most high-profile money laundering cases

• In 1998, Russian criminals laundered an estimated $ 89.1 billion [conversion done using year average of 1998] through shell banks in Nauru. They were able to do this because Nauru re-portedly allowed its banks to function without verifying the identities of its customers or questioning where deposited money came from.11 Consequently, Nauru is included in the Financial Action Task Force’s (FATF) blacklist of countries, occupying a high risk for interna-tional financial transactions.
• In 2012, Standard Chartered Bank in the United Kingdom was accused by New York's De-partment of Financial Services (DFS), for helping the Iranian government to circumvent US money laundering regulations to the tune of an estimated $ 191.8 billion over 10 years.12
• President Ferdinand Marcos channelled a purported fortune of $ 10 billion into various off-shore bank accounts, foundations and valuable assets making it difficult to be identified and located. To date, approximately only $ 4 billion has been accounted for.13 

5. Combating money laundering in Sri Lanka 

• Anti-money laundering policies refer to all regulations and laws that mandate financial insti-tutions to proactively monitor their clients in order to prevent money laundering and cor-ruption.14
• The Sri Lankan Parliament has enacted three acts to combat money laundering:

Prevention of Money Laundering Act No. 5 of 2006

The Financial Transaction Reporting Act No. 6 of 2006 

The Convention on the Suppression of Terrorist Financing Act, No. 25 of 2005 (CSTFA)

5.1. Prevention of Money Laundering Act No. 5 of 2006 

• The Money Laundering Act was passed prohibit money laundering in Sri Lanka and to pro-vide necessary measures to combat and prevent money laundering. 
• The Act defines money laundering as “engaging directly or indirectly, in any transaction in re-lation to any property which is derived or realised directly or indirectly, from any unlawful activity or from the proceeds of any unlawful activity.”15
• The Act further criminalises “receiving, possessing, concealing disposing of, bringing into Sri Lanka, transferring out of Sri Lanka, or investing in Sri Lanka, any property which is derived or realised, directly or indirectly, from any unlawful activity or from the proceeds of any un-lawful activity.”16 

5.2 The Financial Transaction Reporting Act No. 6 of 2006

• The Act established the Financial Intelligence Unit (FIU), an independent institution within the Central Bank of Sri Lanka and acts as the National Agency to collect information relating to suspicious financial transactions. This facilitates the prevention, detection, investigation and prosecution of the offence of money laundering.
• Through guidelines issued by the FIU, all financial institutions are required to maintain rec-ords of transactions and of correspondence relating to transactions for a period of six years from the date of transaction.17
• Financial institutions are required to report any transaction exceeding Sri Lankan Rupees 1,000,000 to the FIU.18
• The Director of the FIU reports to the Governor of the Central Bank through an Assistant Governor with regard to its general administrative functions.  However, suspicions transac-tions reported to the FIU are handled independently by the FIU together with the law en-forcement agencies (LEAs).

6. Why is it important for Sri Lanka?  

• With the tighter anti-money laundering regulations in the US and Europe, criminals are mov-ing their money laundering activity into countries with lax regulations to avoid detection. This puts pressure on regional financial investigation units, financial institutions and associ-ated stakeholders to improve their anti-money laundering (AML) practices.
• Sri Lanka is on the European Commission’s blacklist of countries at risk of money launder-ing.19 Although Sri Lanka is not a leading regional financial hub at the moment, with the upcoming Port City and the Government’s ambition to make Sri Lanka a global financial centre, it re-mains vulnerable to money laundering and financing terrorism.20 
• Financial Action Task Force (FATF) added Sri Lanka to its Public Statement entitled “Improv-ing Global AML/CFT Compliance: On-going process,” also known as the “grey list.”21 
• Therefore, Sri Lanka is required to implement an action plan to address several vulnerabili-ties, including improving mutual legal assistance, issuing customer due diligence rules for designated non-financial businesses and persons, and enhancing risk-based supervision which are the key gaps identified for immediate compliance.22

7. What are the global initiatives and has Sri Lanka met the global standards?

• Sri Lanka is a member of the Asia Pacific Group (APG) on Money Laundering, a FATF-style re-gional body.
• Sri Lanka’s FIU is a member of the Egmont Group of FIUs. 
• The global standards for AML are based on the recommendations by the FATF, which is the global regulator.23
• The FATF recommendations set out the essential measures that countries should have in place to:24

identify the AML/CFT risks, and develop policies and strengthen domestic coordina-tion;

pursue money laundering and terrorism financing; 

apply and ensure preventive measures for the financial sector and other designated sectors;

establish powers and responsibilities for the competent authorities (e.g., investiga-tive, law enforcement and supervisory authorities) and other institutional measures; and

enhance the transparency and availability of beneficial ownership information of le-gal persons and arrangements; and facilitate international cooperation.

 

• In accordance with the requirements of the FATF recommendations, Sri Lanka has signed and ratified all important international agreements, namely the Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances,25 United Nations Convention Against Convention Transnational Organized Crime,26 the United Nations Convention Against Cor-ruption27 and the Convention for the Suppression of the Financing of Terrorism.28 
• FAFT requires countries to rapidly, constructively and effectively provide the widest possible range of mutual legal assistance in relation to money laundering, associated predicate of-fences and terrorist financing investigations, prosecutions, and possible extraditions.29 
• The various international agreements entered into by Sri Lanka and the domestic legal in-struments such as the Money Laundering Act and Financial Transaction Reporting Act pro-vide a sound legal basis for assistance and, where required, extradition. 

8. Conclusion 

• Sri Lanka is a member of various regional and international bodies fighting money launder-ing. Additionally, Sri Lanka has passed numerous legislations to comply with the internation-al requirements and standards. 
• However, gaps exist within the legal framework of Sri Lanka. Notably, Sri Lanka lacks laws to monitor the financial activities of non-profit organisations, such as trusts and charities, some of which may be used as a front for money laundering. The FIU is in the process of strengthening the legal framework to effect the necessary legal provisions, in collaboration with the Attorney General’s Department, to eliminate the gaps identified by the FATF and the APG.  

9. Key readings 

• Financial Crimes consulting Group. (2016). Societal Costs of Money Laundering [Online]. Available at:   http://financialcrimes.com/societal-cost-of-money-laundering/ [Accessed on 13 Nov 2018]
• International Compliance Official. What is money laundering? [Online]. Available at: https://www.int-comp.org/careers/a-career-in-aml/what-is-money-laundering/ [Accessed on 13 Nov 2018

[Nilupul Gunawardena is a Research Fellow at the Lakshman Kadirgamar Institute of International Relations and Strategic Studies (LKI). Shihan Maharoof is a Research Assistant at LKI. The authors acknowledge with appreciation the editorial assistance and comments given by Joan Moonesinghe, former Director of Bank Supervision, Central Bank of Sri Lanka, and independent consultant on financial regulation, and the feedback given by C. A. H. M. Wijeratne, Additional Secretary (Legal) Ministry of Foreign Affairs. The opinions expressed in this article are the authors’ own views. They are not the institutional views of LKI, and do not necessarily represent or reflect the position of any other institution or individual with which the authors are affiliat-ed.]

Footnotes

1 The New York Times. (2019). EU Nations Reject Commission Money Laundering Blacklist. [online] Available at: https://www.nytimes.com/aponline/2019/03/07/world/europe/ap-eu-europe-money-laundering-.html [Accessed 8 Mar. 2019].

2 European Commission. (2019). Commission Staff Working Document. [online] Available at:

ttps://ec.europa.eu/info/sites/info/files/swd_2018_362_f1_staff_working_paper_en_v2_p1

_984066.pdf [Accessed 8 Mar. 2019].

3 European Commission. (2019). European Commission - PRESS RELEASES - Press release - European Commission adopts new list of third countries with weak anti-money laundering and terrorist fi-nancing regimes. [online] Available at: http://europa.eu/rapid/press-release_IP-19-781_en.htm [Ac-cessed 8 Mar. 2019].

4 United Nations Office on Drugs and Crime. (2018). Introduction to Money Laundering. [Online]. Available at: https://www.unodc.org/unodc/en/money-laundering/introduction.html?ref=menuside [Accessed 20 Nov 2018].

5 Ibid. 

6 Ibid. 

7 United Nations Office on Drugs and Crime. (2011). Estimating Illicit Financial Flows Resulting from Drug Trafficking and Other Transnational Organized Crimes. [Online]. Available at:  https://www.unodc.org/documents/data-and-analysis/Studies/Illicit_financial_flows_2011_web.pdf [Accessed 22 Nov 2018].

8 TATA Consultancy Service Ltd. Anti-Money Laundering: Challenges and Threats. [Online]. Avialiable at: https://www.tcs.com/content/dam/tcs/pdf/Industries/Banking%20and%20Financial%20Services/Anti-Money%20Laundering%20-%20Challenges%20and%20trends.pdf [Accessed 22 Nov 2018].

9 Nations Office on Drugs and Crime. (2011). Estimating Illicit Financial Flows Resulting from Drug Trafficking and Other Transnational Organized Crimes. [Online]. Available at:  https://www.unodc.org/documents/data-and-analysis/Studies/Illicit_financial_flows_2011_web.pdf [Accessed 22 Nov 2018].

10 Henning, P. (2015).The Challenges of Fighting Money Laundering.  [Online] New York Times. Avail-able at: https://www.nytimes.com/2015/08/04/business/dealbook/the-challenges-of-fighting-money-laundering.html [Accessed 25 Nov 2018].

11 Hitt, J. (2000). The Billion-Dollar Shack.  [Online] New York Times. Available at: https://www.nytimes.com/2000/12/10/magazine/the-billion-dollar-shack.html?pagewanted=1&_ga=2.240010763.942852779.1544106759-1673361091.1544106759 [Accessed 20 Nov 2018].

12 Whitehead, H. (2016). Top 5 Money Laundering Cases in the Last 30 Years. [Online] ICP. Available at: https://www.int-comp.com/ict-views/posts/2016/07/22/top-5-money-laundering-cases-of-the-last-30-years/ [Accessed 22 Nov 2018].

13 Fintechnews Singapore (2018). Asia’s Most Wanted Top Ten AML Cases. [Online]. Available at: http://fintechnews.sg/16105/fintech/asia-wanted-top-ten-aml-cases/[Accessed 10 Dec 2018]. 

14 ComplyAdvantage (2018). What is Anti-Money Laundering (AML) and Why is it Necessary? [Online]. Available at: https://complyadvantage.com/knowledgebase/anti-money-laundering/[Accessed 10 Dec 2018].

15 Parliament of the Democratic Socialist Republic of Sri Lanka (2006). Prevention of Money Launder-ing Act No. 5 of 2006. [Online]. Available at: http://www.oecd.org/site/adboecdanti-corruptioninitiative/39864395.pdf [Accessed 15 Dec 2018].

16 Ibid. 

17 Parliament of the Democratic Socialist Republic of Sri Lanka. (2006). Financial Transactions Report-ing Act, No. 6 Of 2006. [Online]. Available at: http://fiusrilanka.gov.lk/docs/ACTs/FTRA/Financial_Transactions_Reporting_Act_2006-6_%28English%29.pdf [Accessed 14 Dec 2018].

18 Parliament of the Democratic Socialist Republic of Sri Lanka. (2008). The Gazette of the Democratic Socialist Republic of Sri Lanka. [Online]. Available at: http://fiusrilanka.gov.lk/docs/Regulations/1555-9/1555_9(E).pdf [Accessed 14 Dec 2018].

19 European Parliament. (2018). MEPs Confirm Commission Blacklist of Countries at Risk of Money Laundering. [Online]. Available at: http://www.europarl.europa.eu/news/en/press-room/20180202IPR97031/meps-confirm-commission-blacklist-of-countries-at-risk-of-money-laundering [Accessed on 14 Dec 2018].

20 United States Department of State Publication, Bureau of Counterterrorism. (2018). Country Re-ports on Terrorism 2017. [Online]. Available at: https://www.state.gov/documents/organization/283100.pdf [Accessed 14 Dec 2018].

21 Financial Action Task Force. (2018). Improving Global AML/CFT Compliance: On Going Process. [Online]. Available at: http://www.fatf-gafi.org/publications/high-riskandnon-cooperativejurisdictions/documents/fatf-compliance-february-2018.html [Accessed 20 Dec 2018].

22 Ibid.

23 Financial Action Task Force. (2012). International Standards on Combatting Money Laundering and the Financing of Terrorism and Proliferation, The FAFT Recommendations. [Online]. Available at:  https://www.google.com/url?q=http://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/FATF%2520Recommendations

%25202012.

pdf&sa=D&ust=1551773696630000&usg=AFQjCNEBdvrkVcEEO9tpDVc4wrNj-KdGaw [Accessed 20 Dec 2018].

24 Ibid. 

25 United Nations. (1988). United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances. [Online]. Available at: https://treaties.un.org/Pages/ViewDetails.aspx?src=IND&mtdsg_no=VI-19&chapter=6&clang=_en [Accessed 20 Dec 2018].

26 United Nations. (2000). United Nations Convention against Transnational Organized Crime. [Online]. Available at: https://treaties.un.org/Pages/ViewDetails.aspx?src=IND&mtdsg_no=XVIII-12&chapter=18&clang=_en [Accessed 20 Dec 2018].

27 United Nations. (2003).United Nations Convention against Corruption. [Online]. Available at: https://treaties.un.org/Pages/ViewDetails.aspx?src=IND&mtdsg_no=XVIII-14&chapter=18&clang=_en [Accessed 20 Dec 2018].

28 United Nations. (1999). International Convention for the Suppression of Financing of Terrorism. [Online]. Available at: https://treaties.un.org/Pages/ViewDetails.aspx?src=IND&mtdsg_no=XVIII-11&chapter=18&clang=_en [Accessed 20 Dec 2018].

29 Financial Action Task Force. (2018).International Standards on Combatting Money Laundering and the Financing of Terrorism and Proliferation, The FAFT Recommendations. [Online]. Available at:  http://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/FATF%20Recommendations%

202012.pdf [Accessed 20 Dec 2018].