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Oct 2008
As China's market opens up and trade becomes more globalized, the flow of funds has become increasingly complex and difficult to monitor. This presents significant opportunities for money launderers: organizations and individuals that manage the flow of funds from illegitimate sources through to the legitimate economy.
It is estimated that up to 10 percent of money in circulation globally has its origins in crime. Money laundering accounts for two to five percent of world GDP, making it the world's third-largest business after oil and foreign exchange. China's rapid expansion makes it particularly vulnerable to money laundering, as the development of effective systems of risk management and control lags behind the rapid expansion of the economy.
China has proven that its legislation has met the required standards to warrant admission into the Financial Action Task Force (FATF) in June last year, but developing appropriate legislation is only the first step to controlling the expanding money laundering industry. The FATF is an inter-governmental body whose purpose is to develop and promote international policies to combat money laundering and terrorist financing. Further to passing legislation, the Chinese government needs to ensure compliance with the requirements as well as develop appropriate systems for monitoring and enforcing penalties for violations.
Meanwhile, it is the responsibility of the institutions concerned to make sure that they fully understand the requirements of the law and have implemented appropriate systems to comply. Furthermore, the FATF made a number of key recommendations to Chinese legislators in its 2007 report, which included urging organizations to develop anti-money laundering processes in order to comply with the current law and also with likely future regulations. Two key areas of weakness were identified by FATF: failure to conduct adequate customer due diligence and correctly reporting suspicious transactions.
Customer due diligence is a key part of developing a robust anti-money laundering system. This involves the concept of "knowing your customer," ensuring that the customer is appropriately identified with original documentation and that the institution has an understanding of the nature of business for corporate customers. Nearly 50 percent of (money laundering) violations documented in the FATF report were related to failures to meet customer due diligence (CDD) requirements, a figure which reveals significant failings in the area by financial institutions.
The FATF also recommended some specific areas to focus on in order to fully comply with requirements. Examples of these include appropriate identification of legal persons (directors, etc.) of companies, a requirement that customer due diligence should be ongoing, risk-based and enhanced for politically-exposed persons, and that a threshold should be set for additional CDD in relation to occasional or one-off transactions. Furthermore, a specific recommendation was made that any failure to meet CDD requirements should be reported as a suspicious transaction to the appropriate authorities.
Another area which is fundamental to the effectiveness of the overall anti-money laundering strategy is reporting and investigating suspicious and unusual transactions. Although financial institutions are required to do this by law in China, the process is ineffective and indiscriminate. In China, more than eight million suspicious transaction reports were made between 2004 and 2007. In contrast, the PricewaterhouseCoopers Anti-Money Laundering Survey conducted in the U.K. reported a low level of suspicious transaction disclosure, with the majority of institutions reporting less than six transactions per year.
The lack of discretion in reporting highlights a key problem in the effectiveness of suspicious transaction reporting in China. It is so prescriptive that it is seen as procedure rather than judgement. This can mask failures in internal control such as inadequate training in anti-money laundering techniques and can waste vital resources that could be spent identifying more pressing issues.
While China clearly recognizes the importance of implementing a strategy against money laundering and has taken the first steps in putting this in place, it is evident that there is still a long way to go. As the law develops and the regulatory system becomes clearer, better resourced and more effective, it is essential that relevant institutions maintain a watchful eye over their compliance requirements, learn from their experiences elsewhere, and prioritize the realization of their money laundering strategy.
This article is reproduced from its original publication entitled "China's Fight Against Money Laundering" in the October 2008 issue of Insight magazine, AmCham Shanghai's monthly business magazine. Copyright 2008 by The American Chamber of Commerce in Shanghai (AmCham Shanghai). Reprinted with permission.
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