Compliance focus:

Country risk assessment – white lists and black lists

The initial and on-going risk assessment is the foundation of any compliance system regardless of its scope. There are a number of compliance processes reliant on country risk assessments and a reasonable methodology for country risk assessment is vital.

The ability to achieve the correct balance between regulatory risk and country risk assessments can be hindered by the existence and use of “white and black lists” by regulators which are often reflective of political factors, limited, unreliable or based on old data.

Black lists

Country risk, in conjunction with other risk factors, provides a useful indicator of potential money laundering risks. The Wolfsberg Principles include evaluating factors that may result in a determination that a country poses a higher risk and are listed here with some notable examples of blacklists below. (See Table 1)
 
Table 1: 
 

CATEGORY OF RISK DATA SOURCE 
It is subject to sanctions, embargoes or similar measures   United Nations (“UN”) Sanctions Committee Lists
 
It is identified by the Financial Action Task Force (“FATF”)
as non-cooperative in the fight against money laundering or
identified by credible sources as lacking appropriate
money laundering laws and regulations
 
  FATF “black list” can be found at

 

It is identified by credible sources as
providing funding or support for terrorist activities
 
The U.S. Dept. of the Treasury Executive Order 13224  
It is identified by credible sources as having significant
levels of corruption, or other criminal activity
 
International Narcotics Control Strategy Report
(INCSR) Department of State

 

ML.TF FATF 40 recommendations plus nine special recommendations
Financial Secrecy Index (Tax Justice Network)
U.S. International Narcotics Control Strategy Report (Volume II)
Financial Transparency and Standards World Bank: Business Disclosure Index
 IDA Resource Allocation Index (Financial Sector)
 World Economic Forum, Global Competitiveness report
 (Strength of Auditing and Reporting and Regulation of Securities)
Public Transparency and Accountability International IDEA Political Finance Database
 International Budget Partnership – Open Budget Index
 IDA Resource Allocation Index (Transparency, Accountability and Corruption)
Political and Legal Risk Freedom House – Freedom in the World & Press Freedom Index
 World Economic Forum, Global Competitiveness report (Institutional Strength)
 Bertelsmann Stiftung Transformation Index 2012 – Rule of Law
Corruption Risk TI CPI Perception of Public Corruption

Whilst A to C are examples of black lists, it would be controversial if D was ever cited as an official black list as there are particular difficulties when identifying significant levels of corruption and crime in order to devise a black list of countries but various indexes are available. By way of example,

HSBC’s failure to observe official U.S. warnings about the risk of money laundering in Mexico1 according to the INCSR report was not the main charge.

White lists

The Third EU Money Laundering Directive refers to third country equivalence2 requiring decisions to be made on whether third countries have anti-money laundering/combating terrorist financing systems that are “equivalent” to those in the EU. This information may then be used to allow exemptions for certain aspects of customer due diligence. An example of a white list is Schedule 3 of the Money Laundering Regulations of the Cayman Islands.

Confusion and difficulties may however arise in the use of white and black lists. Firstly, the country risk assessment serves many purposes within the compliance system and the needs of those differ. Further, within the last few years, both sanctions and corruption compliance have been added to existing AML and AFT compliance systems of many institutions and country risk can have different implications for those. Finally, black lists will usually increase regulatory risk and hinder business unnecessarily.

In conclusion, any country risk assessment should be based on credible sources, have more than one set of results, be fit for purpose and be updated periodically. Fortunately, an independent non-profit institution, the Basel Institute on Governance, provides since April 2012 the Basel AML Index, an expert-developed country risk assessment solution. The beauty is that it can be applied according to the purpose and application of the assessment.

Basel AML Index3

The following features of the Index make it a valuable resource:

  • It provides on-going independent verification of the sources selected to ensure that they are credible and relevant sources to identify money laundering/terrorist financing risks.
  • Its project methodology4 scales and weights the risk factors to give an overall assessment of a country’s vulnerability to money laundering.
  • There are options for users to tailor the weightings as a tool for the application of the rating to compliance processes using sub-indicators which may be selected and deselected to apply to processes more appropriately. (See Category of Risk Chart)

Countries are listed as the most vulnerable to money laundering and terrorism financing, based on their poor performance by indicators and measurements that have been used in the index. The main factors are inadequate money laundering legislation and terrorist financing, however additional variables and factors are also considered. It aggregates various external sources and raw data into one index.

The FATF Mutual Evaluation Reports recommendations are used and weighted as the primary source to reflect countries compliance and implementation of AML/CTF regulations. Additionally, related aspects such as banking secrecy, corruption, financial regulations, judicial strengths and civil rights are factored in. This provides a holistic and comprehensive risk score to identify a country’s overall risk level and its financial vulnerability but these can be filtered out to suit specific risk assessment and compliance process needs.

The Basel AML Index comes with a number of disclaimers5 and of note since there is no objective standard in creating a composite index, choices and judgments on variables and weightings are based on a qualitative expert assessment of the variables.

Nonetheless, since the user is able to select and deselect all 14 indicators then the solution is far better than the commercial alternatives currently available. 

Basel-Index_Weighting-PieChart.jpg

If the Basel Institute was unable to obtain more reliable data then most institutions compliance personnel are unlikely to improve on that.

Whilst the weighting is fixed, users may filter indicators to suit the purpose but the compliance audit should check that filters are not used to give precedence to commercial factors.

The Basel AML Index was developed and is maintained by the Basel Institute on Governance which is an independent not-for-profit competence centre specialized in corruption prevention and public governance, corporate governance and compliance, anti-money laundering, criminal law enforcement and the recovery of stolen assets.

The Institute is based in Switzerland and has a multidisciplinary and international team working around the world with public and private organizations. Its mission is to tangibly improve the quality of governance globally, in line with relevant international standards and good practices.6 

Endnotes 

  1. State Department INCSR reports
  2. But note that the proposed 4th Directive will remove the provisions relating to positive “equivalence”, and the customer due diligence regime will become even more risk-based whereby the use of exemptions on the grounds of purely geographical factors will be less appropriate.
  3. The Index is available as a public version of a limited number of countries or by subscription as a comprehensive rating of over 200 countries. “Basel Institute Launches AML Risk Index”, B. Monroe, MoneyLaundering.com, April 25, 2012
  4. The Basel AML Index Project Description 2013
  5. The ranking is based on a composite index, meaning it provides a simplified comparison in the area of money laundering/terrorist financing that scores summarize a complex and multidimensional issue, and should not be viewed as a factual or quantitative measurement of money laundering/terrorist financing activity or as a specific policy recommendation for countries or institutions. Also, the Index does not calculate for a margin of error, uncertainty analysis or sensitivity analysis.
  6. The Institute is composed of four divisions, the International Centre for Asset Recovery (ICAR), the division for Public Governance, the division for Corporate Governance and Compliance, and the International Centre for Collective Action (ICCA).
     

 

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Lisa M. Bowyer

Lisa Bowyer is a successful project manager and intelligence expert with a high level of understanding of the purpose and risks of regulation, international legal and regulatory requirements and the drivers and strategies of financial markets and products. Highly skilled in drafting of inter alia, legislation, other mandatory provisions, guidance, and policies and procedures, she has an excellent appreciation of policy determining law and regulation.  Prior to joining Liberty, Lisa was a member of the management of the Cayman Islands Monetary Authority, and had been a consultant in the Insurance Firms Division of the FSA (UK) and manager in the Financial Advisory Services Division of KPMG in the UK.

Prior to her career as a regulatory professional she was an academic for 9 years with distinguished publications in the field of insurance and regulation.  She received her first law degree in 1991, her Masters degree in 1994, and her doctorate in 1999.

 

T. +1 (345) 525 5010
E. lisa@liberty.ky 
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Liberty Consulting

Prior to joining Liberty, Principal Consultant Lisa Martine Bowyer was a member of the management of the Cayman Islands Monetary Authority, and had been a Consultant in the Insurance Firms Division of the FSA (UK) and Manager in the Financial Advisory Services Division of KPMG in the UK.

She is a successful project manager and intelligence expert with a high level of understanding of the purpose and risks of regulation, international legal and regulatory requirements and the drivers and strategies of financial markets and products.


Highly skilled in drafting of inter alia, legislation, other mandatory provisions, guidance, and policies and procedures, she has an excellent appreciation of policy determining law and regulation.

Prior to her career as a regulatory professional she was a academic for 9 years with distinguished publications in the field of insurance and regulation. She received her first law degree in 1991, her Masters degree in 1994, and her doctorate in 1999.

 

 

Liberty Consulting Ltd
PO Box 10489
Grand Cayman KY1-1005
Cayman Islands

T. +1 (345) 525 5010
E. lisa@liberty.ky