OCTOBER 16. 2024

By Naresh Minocha, Consulting Editor

REFORM FATF's Mechanism Against Money Laundering.

The global anti-money laundering body, Financial Action Task Force (FATF's) latest report on India has got a lot of positive reportage.

Named Mutual Evaluation Report of India (MERI), it marks a substantial improvement over FATF's previous MERI published in 2010. Released on 19th September 2024, the Report requires guarded welcome as it is silent on certain key issues.

The silence is deafening on 2016 demonetization, which actually turned out to be an institutionalized driver of money laundering (ML). Same is the case with the electoral bonds (EBs), which too institutionalized ML.

The Report has also not banked on ML concerns flagged by Comptroller and Auditor General (CAG) in its reports. MERI has also not touched on big spurt in ML resulting from botched implementation of Goods and Services Tax (GST). It has also not delved into misuse of statutory corporate social responsibility (CSR) funds for ML & nexus between CSR-Trusts controlled or aligned with politically exposed persons (PEPs).

Some of issues would be elaborated later in this column to drive home the need for FATF to reform. Time has come to enlarge FATF's 40 recommendations on AML and countering the financing of terrorism (CFT).

FATF, an inter-governmental entity, should consider incorporating 41st recommendation, specifying ML risks and safeguards for big-bang tax reforms such as GST. The risk of tax frauds and other crimes is very high during the transition period till new taxation system gets stabilized.

Its 42nd recommendation should deal with foreseeing risks & planning AML safeguards before unleashing tectonic moves such as demonetisation. This disruptive move is undertaken ostensibly to target black money that awaited laundering.

At least four countries resorted to demonetisation during the period when FATF's 4th round of mutual evaluations were conducted. Is FATF's ostrich-like stance on demonetisation justified?

As MERs are prepared by peers, each MER should be ranked by an independent evaluation group (IEG). The World Bank (WB) Group has a standard practice of asking IEG to evaluate & comment on each project completion report prepared by WB staff.

In fact, time is ripe for independent evaluation of effectiveness of FATF & its recommendations keeping in view findings of latest Basel AML Index. FATF should also make it a standard operating procedure (SOP) to factor in IMF's country-specific AML-CFT studies with the corresponding MERs. IMF unveiled its new AML-CFT strategy in December 2023.

Basel AML Index is an independent ranking that assesses countries' ML/TF risks and capacity to counter them. It is prepared by Switzerland's Basel Institute of Governance (BIG). It draws on 18 indicators in five domains measuring different factors that contribute to high ML/TF risks.

As put by BIG release, "The 12th Public Edition of the Basel AML Index reveals that the average global ML/TF risk level increased from 5.25 in 2022 to 5.31 in 2023, where 10 is the maximum risk."

It says: "Similar to last year, risks increased in four of the five domains measured by the Basel AML Index: corruption and bribery; financial transparency and standards; public transparency and accountability; and political/legal risks. Scores for the quality of anti-money laundering and counter-financing of terrorism (AML/CFT) frameworks remained static."

It adds: "Most concerning is a drop in the effectiveness of AML/CFT systems, as our analysis of Financial Action Task Force (FATF) data shows. Even when countries have robust AML/CFT systems on paper, globally we are struggling to make these do what we desperately need them to do - prevent the misuse of the global financial system to funnel money from corruption and organised crime and to fund terrorism."

The relevance of this column's proposals gets reinforced if one reckons FATF's perception about its 40 recommendations mooted in 2004 and updated/revised periodically since then.

As put by FATF, its recommendations are "the building blocks for an effective framework to combat money laundering and terrorist financing. But what is essential, is that they are implemented effectively, not merely transposed into a national, legal, regulatory or operational framework, as a click-box exercise. The measures need to be adapted to a country's national context and mitigate the specific risks it faces."

A few basics before we return to discussion on deficiencies in latest MERI as well as FATF system. The deficiencies identified in first MERI were removed in phases. This was reported by India to FATF in its follow-up reports with last and 8th one submitted in June 2013.

After a gap of 11 years, India should have been, by now, fully compliant with FATF's 40 recommendations. The latest MERI found the country "partially compliant" on three recommendations. These are A) Recommendation Number 8 pertaining to non-profit organisations (NPOs); B) Recommendation No. 12 relating to politically exposed persons (PEPs): and C) Recommendation No. 28 pertaining to Regulation and supervision of Designated non-financial businesses and professions (DNFBPs).

As for the remaining 37 recommendations, India is "compliant" with 11 recommendations and "largely compliant" with the balance 26 recommendations.

As put by MERI, "India's largest money laundering risks are related to fraud including cyber-enabled fraud, corruption, and drug trafficking."

The Report has identified 11 "priority actions" that Modi Government ought to take. These include: 1) undertake "more comprehensive financial network analysis especially on ML techniques associated with trafficking in human beings and migrant smuggling"; 2) aim to "reduce the number of pending trials in ML case"; and 3) make "major changes to address delays relating to the prosecution of TF cases".

Consider now FATF's 'Consolidated Assessment Ratings' of more than 200 countries/jurisdictions updated on 10th October 2024. This would help us realize how much more efforts India has to make to be fully compliant with FATF's 40 recommendations.

The Ratings show the extent to which a country's measures are effective. The assessment is conducted on the basis of 11 immediate outcomes, which represent key goals that an effective AML/CFT system should achieve.

India has got "Substantial level of effectiveness" (SE) rating for 6 of the 11 immediate outcomes. SE means "The Immediate Outcome is achieved to a large extent. Moderate improvements needed."

The country has received "Moderate level of effectiveness" (ME) rating on the remaining five immediate outcomes. ME means "The Immediate Outcome is achieved to some extent. Major improvements needed."

These five parameters include: a) Money laundering offences and activities are investigated and offenders are prosecuted and subject to effective, proportionate and dissuasive sanctions and b) Terrorists, terrorist organisations and terrorist financiers are prevented from raising, moving and using funds, and from abusing the NPO sector.

The ME ratings on these counts are disappointing if one factors in how demonetisation was trumpeted as a means to break the back of terrorism.

The country didn't get a single "High level of effectiveness" (HE) rating. This rating means: "The Immediate Outcome is achieved to a very large extent. Minor improvements needed." Similarly, India completely avoided "Low level of effectiveness" (LE rating). LE means "The Immediate Outcome is not achieved or achieved to a negligible extent. Fundamental improvements needed."

Prior to FATF's 2010 report, the first MERI was conducted by FATF-style regional body (FSRB) named Asia/Pacific Group on Money Laundering (APG) in March 2005. At that time, FATF had not inducted India as its member country.

APG, which is an associate member of FATF, found India non-compliant with global AML/CFT on several counts. Its APG report stated: "India has not undertaken any comprehensive threat assessment of money laundering or terrorist financing. Its legislative efforts have been concentrated on fighting tax evasion and the large black money component in its economy."

India belatedly conducted its first National Risk Assessment (NRA) in 2021 and second one in 2022. Both of these reports have not been made public. The third NRA is expected to be conducted in 2025.

Modi Government is obsessed with secrecy, unlike several other FATF members whose respective NRA reports are only a click away on the Internet. Even Pakistan is not scared of making public the summarized version of its NRA.

In the absence of NRA reports in public domain, Indian public is in dark about the ML & TF risks, apart from other security threats it is facing.

As put by FATF, "A risk assessment allows countries to identify, assess and understand its money laundering and terrorist financing risks. Once these risks are properly understood, countries can apply AML/CFT measures that correspond to the level of risk."

The Modi Government, of course, did not gauge the ML risks before unveiling demonetization in November 2016. A lot of evidence exists on how demonetization benefited hoarders of black money. They laundered it white through diverse means that were reportedly used extensively during demonetization.

One evidence that needs recall is an official release dated 8th December 2016. It was headlined: "Income Tax Sleuths Unearth Innovative Methods of Laundering and Transportation of Cash at Mumbai, Nagpur and Ahmedabad."

Recall Prime Minister Narendra Modi's appeal to the poor on 3rd December 2016 to not return rich person's deposits parked in their Jan Dhan Accounts.

The best indicator to gauge whether demonetization, as surgical strike on money laundering, failed is: the percentage of demonetized notes that were returned to the banking system. This was whopping 99.3% for India, as compared to 94.2% in case of Trinidad & Tobago, which demonetized its USD 100 notes in December 2019. Even Kenya's September 2019 demonetization fared better with 96.6%.

The percentage of banned notes not pumped back into banking system shows the quantum of missing or hidden money. It can largely be perceived as the cash whose owners were scared of laundering it through demonetization channel.

No wonder then that Supreme Court judge, Justice B.V. Nagarathna described 2016 demonetization as a "way of converting black money into white". She noted this at a conference held at Hyderabad during March 2024.

Turn now to EBs scheme. It was banned by five-member Bench of Supreme Court on 15th February 2024 as it found the scheme unconstitutional on certain counts. Consider first Justice Sanjiv Khanna's 74-pages "separate opinion" for different reasoning on same conclusions arrived at by other (four) members of the Bench.

Justice Khanna pointed out that "Money laundering can be undertaken in diverse ways. Political contributions for a quid pro quo may amount to money laundering, as defined under the Prevention of Money Laundering Act, 2002." He contended this would also be an offence under the Prevention of Corruption Act, 1988.

He wrote: FATF has observed that "the signatory States are required to check money laundering on account of contributions made to political parties. Article 7(3) of the United Nations Convention against Corruption, 2003 mandates the state parties to enhance transparency in political funding of the candidates and parties. The said convention is signed and ratified by India."

He continued: "By ensuring anonymity, the policy ensures that the money laundered on account of quid pro quo or illegal connection escapes eyeballs of the public."

Reserve Bank of India (RBI) too flagged the inherent risks of EBs as enabler of money laundering twice in its letters sent to Finance Ministry in January and September 2017. The second letter conveyed serious reservations voiced by a Committee of Central Board of RBI. It flagged the risk of shell companies using EBs for money laundering.

After SC directed the Government and State Bank of India to make public data, the worst fears about dummy companies & EBs-accepting namesake political parties turned out to be true, as reported in papers.

With huge evidence of suspected transactions deciphered from EBs data & Supreme Court's verdict, FATF owes an explanation to the world for its silence on the grand money laundering, both in EBs and demonetization case.