On July 1, China will become the next president of the Financial Action Task Force (FATF or GAFI), the global standard-setter for international anti-money laundering. After serving as the vice president of FATF over the last year, China’s assumption of the presidency will provide Beijing with the unique opportunity to set the FATF agenda over the next year, when it will preside over the FATF plenary sessions and determine which financial crimes issues it considers most important.
Yet there are reasons to be concerned about China’s presidency. First, China’s own financial crimes compliance (FCC) house is not in order. While the exact amount of illicit financial activity occurring within China and exported by China remains difficult to quantify, some analysts estimate that the number of illicit financial outflows from China may be as high as one trillion dollars over a decade. According to a 2014 study undertaken by Global Financial Integrity, a group monitoring illicit financial flows, illicit outflows from China between 2002 and 2011 totaled approximately $1.08 trillion.1
Second, China has serious deficiencies in its own anti-money laundering/combating the financing of terrorism (AML/CFT) system that allow drug traffickers, money launderers, sanctions evaders, and other illicit actors to exploit the Chinese financial system. According to the FATF’s most recent Mutual Evaluation Report of China, the country has failed to effectively implement measures designed to prevent shell companies from being used to launder money or finance terrorism; prevent terrorist organizations from raising and moving funds; require lawyers, accountants, and other professionals to abide by AML/CFT regulations; and impose measures to target proliferators of weapons of mass destruction.
While FATF assessors routinely find regulatory and compliance shortcomings in the countries they evaluate, China’s AML/CFT regulatory regime was judged to have low effectiveness across a range of important issues – so low that a plausible case exists to recommend China into FATF’s International Cooperation Review Group process, where it would be reviewed for these failures and be required to work with FATF to remedy these deficiencies.2 Awkwardly, this could happen at the same meeting where China assumes the FATF presidency.
Third, there have been a number of high-profile instances in recent years of major Chinese companies engaging in clear violations of financial crimes laws and regulations, including economic sanction prohibitions, raising concerns about China’s commitment to the anti-money laundering/combatting the financing of terrorism (AML/CFT) mission. U.S. law enforcement and regulatory agencies identified instances of Chinese firms intentionally evading and violating U.S. economic sanctions and export controls on Iran, including by knowingly shipping U.S. products to sanctioned jurisdictions and lying to U.S. investigators about the activity. This includes major Chinese companies such as ZTE and Huawei.3 Such activities undoubtedly run afoul of AML/CFT global standards, which emphasize the need to prevent proliferation financing, sanctions evasion, and export control violations. Yet Beijing is very unlikely to take any actions against these entities for these violations. This raises serious concerns that the Chinese government is not sufficiently dedicated to the fight against illicit finance and financial crime, which is critical to leading the global standard-setting body.
China’s shortcomings are made more pressing because of its upcoming role as the FATF president.
FATF has become recognized as the standard-setter for international AML/CFT compliance global standards. Countries increasingly pay attention to – and care about – how they are evaluated and scored under FATF’s standards. Law enforcement agencies, regulators, and the private sector worldwide have increasingly focused on the risks that AML/CFT shortcomings pose to national security, economic prosperity, and companies’ bottom lines.4
China is taking on more than a titular role as FATF’s president; countries serving as the FATF president have enormous power to set the FATF agenda for the next year, and presidents have used this power to define which challenges to the integrity of the international financial system they think most important, including trade-based money laundering,5 the use of virtual currencies by terrorist organizations and other actors,6 and the need to work more closely with the financial technology (FinTech) community to more effectively combat financial crime.7
For example, over the last year, under the leadership of the United States and FATF President and Assistant Secretary of the Treasury for Terrorist Financing and Financial Crime Marshall Billingslea, FATF has pursued meaningful efforts to set global standards related to virtual currency, terrorist financing, and the proliferation of weapons of mass destruction.8 Under the U.S. presidency, FATF has focused on tackling AML/CFT challenges in the virtual currency space and, as part of these efforts, issued a revised interpretive note to Recommendation 15, which clarifies important requirements related to the regulation of virtual currency exchangers and others with respect to their AML/CFT obligations.9
China’s own FCC failures and its assumption of the presidency threatens to undermine the premier status of the organization. Further, if China is not committed to the AML/CFT mission, it may fail to prioritize critical issues or ignore addressing critical deficiencies in the global financial system because they highlight shortcomings in its own compliance regime.
In addition, there are concerns about whether China can assume the FATF presidency without many of the typical political and diplomatic constraints that impact Chinese foreign policy. China’s assumption of the presidency is another instance of the country taking a leadership role in an important international standards-setting body. But a significant reason for FATF’s credibility is its technical nature, and there are good reasons to question whether China can avoid playing politics and letting its particular foreign policy concerns influence its presidency. For example, will the Chinese view the presidency as an opportunity to impact particular financial centers like Hong Kong in ways that serve its parochial interests? Likewise, how will China treat issues related to Taiwan, which is a member of the Asia/Pacific Group on Money Laundering (a FATF-style regional body associated with FATF)? How China addresses these political issues during its presidency will speak volumes about its maturity to helm the international standards-setting body.
China’s assumption of the FATF presidency comes at a key moment for the organization. While FATF grows in importance, a number of key issues will challenge its continued, strengthened role. For example, while one of FATF’s primary strengths since its inception has been its focus on technical evaluation of countries’ AML/CFT programs, the organization risks being pulled into political debates about certain problem countries. The most notable example of this is Iran, which was subject to FATF countermeasures that were subsequently suspended following the Joint Comprehensive Plan of Action (JCPOA) nuclear accord. While Iran has continued to fail to fulfill its Action Plan requirements under the FATF process, the organization has not yet re-imposed countermeasures.10 Whether FATF re-imposes these countermeasures at the next plenary will be a major test of the organization’s willingness to confront Iran’s continued failure to meet global AML/CFT standards.11
China’s credibility gap in its own AML/CFT structure creates additional concerns about how the pre-eminent standards-setter for AML/CFT issues can be led by a country whose track record is problematic.
The FATF Mutual Evaluation Report of China issued earlier this year identified several areas of concern, including illegal fundraising, fraud, trafficking in illicit drugs, corruption and bribery, tax crimes, counterfeiting of products, and illegal gambling.12 Beyond these money laundering and illicit finance concerns, China is also the world’s largest market for the illicit wildlife trade, estimated globally at between $7 and $23 billion annually.13 This trade is a source of revenue for money launderers, poachers, and terrorist organizations.14 While the exact size of illicit financial activity in China is not known, it may reach into the tens or hundreds of billions of dollars annually given the size of the Chinese economy, historic estimates of illicit funds flows, and evidence of illicit activity in certain sectors.
In addition, senior members of the Chinese leadership, including the Chinese Communist Party (CCP), continue to be implicated in corruption schemes, including those identified by the International Consortium of Investigative Journalists, which found evidence of corruption and the use of front and shell companies to hide assets outside of China by family members of senior CCP leaders.15 Troublingly, in 2018 the president of INTERPOL, a Chinese national named Meng Hongwei, disappeared mysteriously and was subsequently arrested for bribery.16
This is not to say that significant anti-money laundering and combatting the financing of terrorism risks, along with other financial crime risk, must preclude China from leading the international standards-setter for these issues. For example, the United States, as the hub of the global financial system, is naturally exposed to significant FCC risk. Because most U.S. dollar transactions flow through the United States and the U.S. dollar serves as the backbone of most international transactions, money launderers, drug traffickers, tax evaders, and other criminals routinely try to exploit the U.S. financial system to move and launder funds and hide and spend the proceeds of their illicit activities.17
The difference is that the United States has taken significant steps to ensure that its financial sector has mitigated those risks by developing and implementing a complex and expansive list of laws and regulations to ensure that entities operating in the relevant sectors are equipped to detect, disrupt, and deter illicit financial crime.18 According to FATF’s 2016 Mutual Evaluation Report, “The AML/CFT framework in the U.S. is well developed and robust. Domestic coordination and cooperation on AML/CFT issues is sophisticated and has matured since the previous evaluation in 2006.”19
China, by contrast, does not appear to have taken sufficient steps to effectively mitigate that risk across a range of critical areas, as it is required to do under AML/CFT global standards. Indeed, China suffers from a credibility deficit. While past presidents have received certain low scores during their mutual evaluation process, including the United States for issues related to passing and implementing meaningful beneficial ownership legislation, the recently issued FATF Mutual Evaluation Report of China is significantly more concerning. During the FATF mutual evaluation process, assessors determined that China’s AML/CFT regime had low effectiveness in a number of key areas,20 including:
These weaknesses pose significant risks to the integrity of the Chinese financial system but also raise serious questions about China’s fitness as the FATF president. China’s Mutual Evaluation Report suggests that the country has not taken sufficient steps to address the most significant vulnerabilities in the global financial system.
Beyond the weaknesses identified during the FATF mutual evaluation process, China’s AML/CFT credibility gap is widened by its treatment of its own financial sector. While U.S. and European banks have been subjected to significant regulatory scrutiny for AML/CFT over the last 20 years, the international community has only recently begun to focus on Chinese financial institutions, and there are reasons to be concerned that Chinese financial institutions do not abide by the same strict standards.
First, the Chinese financial system is characterized by a lack of transparency. For example, China makes it extremely difficult for U.S. auditors to check important financial information for Chinese companies that are listed on U.S. stock exchanges.40 This practice significantly reduces transparency into these companies’ operations and raises significant risks of fraud, particularly to U.S. investors.
Second, recent episodes of illicit activity by Chinese financial institutions raise real questions about China’s willingness or capacity to enforce international AML/CFT laws and standards when they run counter to Chinese political and national security interests. For example, the U.S. Treasury Department issued a finding in 2017 that China-based Bank of Dandong was a primary money laundering concern because it served as a conduit for North Korea to access the U.S. and international financial systems, including facilitating millions of dollars of transactions for companies involved in North Korea’s WMD and ballistic missile programs, in contravention of United Nations Security Council resolutions.41
This Chinese bank had significant operations through China, including connectivity to other Chinese financial institutions. China’s inability or unwillingness to stop Bank of Dandong from violating UN sanctions on North Korea casts doubt on the Chinese government’s willingness to enforce strict AML/CFT laws and regulations when it may cut against its efforts to support or turn a blind eye to North Korean illicit activity.
China’s enforcement of AML/CFT laws internally, its commitment to financial transparency, and the effectiveness of their regime are the lacunas that affect its credibility. Combined with the failure to implement required United Nations Security Council resolutions and sanctions obligations, as well as scoring low and moderate effectiveness marks across a range of important FATF recommendations and obligations, China limps into the FATF presidency with a spotty AML/CFT track record and an uncertain commitment to financial transparency.
Despite all of this, China will now have the opportunity as the FATF president to set the FATF agenda, drive important developments in AML/CFT compliance, and articulate its commitment to the AML/CFT mission. In this regard, the FATF presidency is an opportunity for China to demonstrate the effectiveness of its regime and its willingness to cast political considerations aside as it enforces AML/CFT laws and regulations, even if it is embarrassing or cuts against Chinese domestic or foreign policy.
When China assumes the presidency on July 1, it will not be easy to overcome its credibility gap, but it can begin by placing some of the most challenging, but critical, issue areas for AML/CFT compliance on the FATF agenda.
At the top of its agenda should be a new FATF recommendation on information sharing, both within particular jurisdictions and across institutions with offices, branches, and affiliates across different jurisdictions. One of the most significant challenges financial institutions face is sharing data within their enterprises across jurisdictions and with peer financial institutions.42
These limits have major implications for fighting financial crime. Illicit actors do not limit their efforts to access the international financial system to one bank or one jurisdiction. They access different financial institutions in the same jurisdiction or the same institution in different jurisdictions. Information sharing can be critical for identifying networks of criminal activity and help multiple financial institutions detect, deter, and disrupt illicit financial activity.43
At the same time, such information sharing can raise significant public policy concerns. For example, sharing information across financial institutions can raise the risk that malign actors figure out that they are under suspicion, allowing them to move their assets. Likewise, financial institutions are often reluctant to share significant amounts of information with peer institutions for fear that revealing such data may provide their competitors with an unfair commercial advantage or access to trade secrets.44
An important way to square this circle and ensure that financial institutions are able to share information across jurisdictions and between financial institutions, while continuing to safeguard privacy and avoid tipping off offenders, is through the use of new technologies. As FATF itself has recognized45:
“A number of possible models are currently being developed which may encourage such voluntary sharing of information. It could include bilateral information exchange between financial institutions and/or shared KYC [know your customer] utilities and/or centralized data repositories, which capture key elements of customer and transaction information and disseminate such information to participating financial institutions with appropriate protocols and access controls. … These utilities and databases can be hosted by the authorities or the private sector or both through a public private partnership.”
Key to the effectiveness of these models is new technology that enables sophisticated analysis of this data in ways that can expose illicit networks while limiting the exposure of private and sensitive information.
Jurisdictions are currently in the nascent stages of promoting this type of sharing and innovation. For example, the United States has historically relied on Section 314(b) of the USA PATRIOT Act to encourage information sharing between financial institutions and FinCEN. The Federal Banking Regulators recently issued a joint statement providing guidance to financial institutions interested in using new technologies to augment their compliance programs.46 These steps are meant to provide financial institutions with some comfort in their efforts to share information. The guidance is crafted to encourage the incorporation of new technology that can greatly increase the effectiveness of information sharing efforts. Nevertheless, U.S. regulators are in the nascent stages of full-fledged encouragement and endorsement of new technologies to increase information sharing and combat financial crime.
Likewise, while FATF has recognized the incorporation of new technology as critical to fighting financial crime by facilitating information sharing, it has only issued nonbinding guidance for jurisdictions to consider as they decide how and whether to encourage efforts to deploy such technology.47 While this guidance is useful, FATF should take further steps, including by developing a new recommendation or official guidance for countries to put into place mechanisms to facilitate the use of new information technologies to safely and effectively share information both across jurisdictions and between financial institutions. Such a recommendation or interpretive note would ensure that jurisdictions are required to promote the adoption of these technologies to better share information to fight financial crime.
China should also use its year as the FATF president to address significant gaps in its own AML/CFT framework. First, Chinese regulators should work quickly and independently – assuming China is not under review in FATF’s International Cooperation Review Group process – to develop and implement a DNFBP compliance framework that meets its obligations under FATF recommendations and immediate outcomes. Second, Chinese companies, including nontraditional financial institutions, should be required to quickly implement the full requirements under United Nations Security Council resolutions for terrorist financing and proliferation financing. To date, China has been reluctant to champion proliferation financing regulations, in part because such an initiative is seen as directly impacting its relationship with North Korea. Whether China is willing to prioritize proliferation financing as the FATF president will be a key test of whether the country is able to take on a politically challenging issue in a way that puts international financial integrity before China’s own foreign policy interests and concerns. Addressing these gaps while serving as the FATF president will illustrate China’s commitment to the AML/CFT mission and serve as a model with similar deficiencies who want to join the fight against illicit finance worldwide.