From antiquity to date, the global war against money laundering

Money laundering is as old as trade. Among the earliest reported cases of money laundering was among Chinese traders more than 2000 years ago.

On 14 March 2024, the European Union Commission communicated to the European Union Council and parliament that Kenya had met the criteria to be added to the EU’s list of countries with significant money laundering deficiencies. By virtue of being in the list, EU member states are advised to apply enhanced due diligence when dealing with Kenya. Similarly, the United Kingdom (UK) has added Kenya to its list of ‘High-Risk Third Countries’ under the UK’s Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017. Both the EU and UK actions come hot on the heels and are a consequence of Kenya being grey listed by the Financial Action Taskforce, FATF. Prior to these developments, most people had never heard of FATF and did not imagine that the rest of the world cared much about Kenya’s anti-money laundering (AML) efforts. So why is everyone so concerned about our AML processes and why do they consider it their business?

Money laundering is as old as trade. Among the earliest reported cases of money laundering was among Chinese traders more than 2000 years ago. The traders needing to circumvent government regulations, would convert the profits from their trade into moveable assets which they would then ship out of the jurisdiction of the authorities that they needed to hide from. In the more recent times, money laundering gained notoriety and eventually got its name in the Prohibition era (1920-1933) in the United States of America (US). The ban on alcohol during this era led to the growth of organized crime as criminal gangs sought to supply prohibited drugs under the government’s radar. This saw the rise of gangsters such as Alphonse Capone, better known as Al Capone. Al Capone made millions of dollars which he reportedly hid from the authorities by opening cash intensive laundromats. He would claim that his wealth was from laundering clothes. The illicit money that needed to be laundered eventually became too much for the laundromats and the gangs in Chicago needed to move it to jurisdictions with lax laws.

Al Capone was eventually indicted and jailed for tax evasion in 1931. To avoid a similar fate, one of Al Capone’s contemporaries and the father of modern money laundering, Mayer Lanskey, began laundering money by placing the illicit funds in Swiss banks. He would then loan the deposited money to other foreign banks creating transactions that made it harder to trace the original source of the money. From this very early stage, three important elements of money laundering are already evident: its link to drug trafficking, its cross jurisdictional nature and the important role of the banking sector. Mayer Lanskey eventually built a gambling empire, the other usual suspect in money laundering. He was never convicted of money laundering and died a free man in 1983. 

In a bid to curtail money laundering by the likes of Lanskey, the US Congress passed the Bank Secrecy Act of 1970. This Act required financial institutions to adequately identify their customers, report all transactions above USD 10,000, maintain proper records of transactions and report suspicious activity. Though the Act was initially resisted as one that violated privacy rights, it was eventually upheld by the US Supreme Court in 1974. By 1980, the Act was fully operational in the US and as many AML practitioners will immediately note from the listed requirements of the Act, it became the template for AML laws across the world including the Kenyan Proceeds of Crime and Anti-Money Laundering Act of 2009. The US would go on to pass other AML laws the most significant of which was the Money Laundering Control Act of 1986 that made money laundering a federal crime in the USA and was the first dedicated national AML law. 

Given the cross jurisdictional nature of money laundering, it was inevitable that the rest of the World needed to be involved for the US efforts to bear fruit. This has largely been, and continues to be, achieved through two main routes. The first is through multilateral organisations and international laws while the second is through the regulation of the global banking system. 

On the international agencies space, the United Nations (UN), the largest multi-lateral organization, has played a key role. Since 1984, it has passed various declarations against trafficking in narcotic drugs. In 1988, the UN adopted what became the backbone of international AML efforts, the UN convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances. The Convention, better known as the Vienna Convention was ratified by Kenya in 1992. The convention provides measures against drug trafficking and money laundering and provides for international co-operation. The UN continues to focus on the fight against illicit financial flows through global co-operation and has since passed other conventions on the subject. Clause 16.4 of the Sustainable Development Goals (SDGs), that the World seeks to achieve by 2030, calls for the significant reduction of illicit financial flows, asset recovery and the combating of all forms of organized crime. The UN established a specialized agency in 1997, the United Nations Office on Drugs and Crime (UNODC) to lead the fight against organized crime.

The UN’s AML efforts have been supplemented by and in some ways implemented through other more specialized multilateral agencies and informal groups. Three are of note. One is the Organisation for Economic Co-operation and Development (OECD), an organization that had initially been formed to help reconstruct Europe after World War II. It has since morphed to an organization that offers a platform for developed western nations to discuss economic matters, influence and support global development. The second is the Group of Seven (G7) Nations which is a political and economic forum formed in 1973 by the US, UK, Canada, France, Germany, Italy and Japan. The European Union was to later join the G7 as a non-enumerated member. The third is the FATF.

The G7 heads of states plus the president of the European Commission in a meeting held in Paris in 1989 passed an economic declaration that noted the drug problem as a significant problem. Consequently, the summit convened a Financial Action Task Force (FATF) of the conference participants and ‘other countries interested in these problems’. The taskforce which is what we now call FATF was to assess the status of money laundering and recommend adaptation of legal and regulatory systems aimed at preventing the utilization of the banking system and financial institutions in money laundering. The FATF is hosted within OECD.

A year after its creation, the FATF issued a report containing a set of forty recommendations. Though there have been amendments, the 40 recommendations provided a comprehensive action plan to fight money laundering and to date are used to assess the adequacy of a country’s AML regime. By 2004, the recommendations had been revised to 40+9 recommendations to include recommendations against terrorism financing. There are currently about 200 jurisdictions, Kenya included, that have committed to implement the FATF recommendations. In its first ten years of existence, the FATF applied a carrot approach and focused more on increasing awareness and building the AML capacity of countries. It was expected that most countries would then comply willfully. By 1999 however, FATF adopted more of a stick approach i.e., the name and shame approach and started listing non-Co-operative Countries and Territories (NCCT). The NCCT was the precursor of the grey list that Kenya now finds itself in. 

Being in the grey list, or even worse the blacklist, has significant reputational challenges that affect a Country’s attractiveness and ease of doing business. This is especially so given that most of the major world economies including the US, China and the EU are members of FATF. Also participating in FATF as observers are many of the most consequential development institutions including the African Development Bank (ADB), the International Monetary Fund (IMF), the UN and the World Bank. All these countries and institutions are thus bound to implement FATF’s recommendations. 

But in the event that a country finds being shamed not to be scary enough, then it has to contend with the other side of the AML arsenal, alienation by the global banking system. 

Just 9 days after the adoption of the Vienna Convention by the UN, the then Basel Committee on Banking Regulations and Supervisory Practices (now the Basel Committee) passed the Basel Statement of Principles for the Prevention of Criminal Use of the Banking System for the Purposes of Money Laundering. The principles call on central banks to ensure that banks properly identify their customers, discourage transactions that appear illegitimate and cooperate with law enforcement. The Basel Committee was established by the central bank Governors of the G10 countries in 1974 following disturbances in international currency and banking markets. The Basel Committee currently has representations from institutions in 28 jurisdictions. The Committee is housed within the Bank of International Settlements (BIS) which is the ‘central bank of central banks’. Established in 1930, the BIS is owned by 63 central banks representing countries that account for about 95% of the world GDP.

The Basel Committee’s AML principles state that banks should not offer services or active assistance in transactions where they have a good reason to suppose that the transaction is associated with money laundering. The Basel Committee supports the adoption of FATF standards and provides input in their development. Whereas the Basel Committee may not have means to enforce the implementation of AML principles across the Globe, some of their members do. To understand this, one needs to go back 160 years when the US dollar (USD), the famous ‘greenback’, began in earnest its journey to being the most consequential currency in the world. 

On 25 February 1863, President Abraham Lincoln of the US passed the National Currency Act into law. The Act established the office of the Controller of Currency (OCC) and tasked it with setting up a system of national banks and in administering a uniform national currency, the USD. OCC went on to issue the USD until 1900 when the dollar became a Federal Reserve note issued by the US federal government and was formally pegged to gold. In 1913, the Federal Reserve Act was passed. The Act established the Federal Reserve banks (the Fed) which eventually took up the role of regulating banks and administering the USD. In 1933, an additional regulator, the Federal Deposit Insurance Corporation (FDIC) was set up to maintain stability and confidence in the US financial system. Between them, the OCC, the Fed and FDIC regulate the US banking system and the use of the USD. All three are members of the Basel Committee. As such, they expect the banks that they license and regulate, and especially those that are internationally active, to as a minimum meet the Basel standards.

The above expectation has global ramifications given the reliance on the US dollar in global commerce. This reliance stems from a meeting held as the Second World War was drawing to a close. In July of 1944, forty-four nations met in the town of Bretton Woods in the US. The delegates wanted a solution that would achieve exchange rate stability and promote economic growth. In addition to setting up the IMF and the World Bank, the delegates from the 44 countries agreed to fix their currencies to the US dollar which was in turn fixed to gold. By 1958, the Bretton Woods system was fully operational and countries settled their international balances in US dollars. The Bretton Woods system came to an end in the early 1970s and currencies became floating rather than fixed against the US dollar. By then, the centrality of the US dollar in world trade was already firmly established. To date most of international trade occurs through the USD. 

This typically entails converting the local currency of the importing client into USD, transferring the USD between the buyer and the seller and then converting the USD into the local currency of the country of the exporter. The exchange of USD, i.e., clearing and settlement, requires the use of the US Federal Reserve Clearing System. To have access to this clearing system, a bank or its US branch needs to be licensed and regulated by the US banking regulators. Since almost all banks involved in international transactions need to transact in USD, banks globally that are not licensed in the US need a US licensed bank to act as a correspondent bank that does their USD clearing and settlement. For the correspondent bank to retain its license and avoid fines, which can be very substantial, it must ensure that it, as well as its clients (what are called respondent banks), remain complaint especially with AML requirements. 

If a country or bank is seen to not be compliant with the FATF recommendations, it means that it will either struggle to establish correspondent banking relationships or will be subjected to enhanced due diligence. By being grey listed, Kenya currently falls under the enhanced due diligence category which has the implication of slowed down and maybe more expensive transactions. In extreme cases, for instance in the event of a blacklisting, correspondent banks could de-risk by refraining from offering correspondent banking relationships to financial institutions in a country. This would mean that such a country is then locked out of all international trade involving USD.

As such to avoid being a pariah state a country must comply with FATF standards. Non-compliance would mean that a country is not meeting its international obligations and could lead to it being sanctioned. It could also lead to the country being locked out of international trade. It is therefore a good and necessary thing that the Kenya government was quick to reiterate its desire to remediate the gaps that led to our being grey-listed. Given the above context, not complying with the FATF recommendations and expectations is clearly not a viable option. It is in Kenya’s best interests therefore that we all work together towards getting the country out of the grey-list in the shortest time possible.