Efforts to police illicit gains have a history stretching back centuries. Anti-money laundering (AML) refers to the contemporary web of laws, regulations, and procedures aimed at uncovering illicit funds disguised as legitimate income.
Money laundering, a term arising from this regulatory regime, consists of actions taken to conceal financial movements underlying crimes ranging from tax evasion and drug trafficking to public corruption and the financing of groups designated as terrorist organizations.
AML legislation was a response to the growth of the financial industry, the lifting of capital controls, and the growing ease of conducting complex chains of financial transactions. A high-level United Nations panel has estimated annual money laundering flows total at least $1.6 trillion, accounting for 2.7% of global GDP in 2020.
- Anti-Money Laundering (AML) laws, regulations, and procedures reduce the ease of hiding profits from crime.
- Criminals launder money to make illicit funds appear to have law-abiding and innocuous origins.
- Financial institutions combat money laundering with Know Your Customer (KYC) and Customer Due Diligence (CDD) measures.
Know Your Customer (KYC)
Regulatory compliance at financial institutions starts with a process sometimes called Know Your Customer (KYC). KYC determines the identity of new clients and whether their funds originated from a legitimate source.
Money laundering can be divided into three steps. The KYC process aims to stop money laundering at the first step when customers attempt to store funds in financial accounts.
- Depositing illicit funds into a financial system.
- Placing a series of transactions, usually repetitive and voluminous, to obfuscate the illicit origin of the funds known as “layering.”
- “Cleaning” and “washing” the funds by converting them into real estate, financial instruments, commercial investments, and other acceptable assets.
During the KYC process, financial institutions will screen new customers against lists of parties that pose a higher than average risk of money laundering: criminal suspects and convicts, individuals and companies under economic sanctions, and politically exposed persons, which encompass foreign public officials and their family members and close associates.
Customer Due Diligence (CDD)
KYC extends beyond vetting a customer in the initial stages of opening an account. Throughout the account’s lifetime, financial institutions must conduct customer due diligence (CDD), or maintain accurate and up-to-date records of transactions and customer information for regulatory compliance and potential investigations. Certain customers may be added over time to sanctions and other AML watchlists, warranting checks for regulatory risks and compliance issues on an ongoing basis.
According to the U.S Treasury’s Financial Crimes Enforcement Network (FinCEN), the four core requirements of CDD in the U.S. are:
- Identifying and verifying the customer’s personally identifiable information (PII)
- Identifying and verifying the identity of beneficial owners with a stake of 25% or more in a company opening an account
- Understanding the nature and purpose and compiling risk profiles of customer relationships
- Monitoring suspicious transactions and updating customer information
CDD may try to uncover and counter money laundering patterns such as layering and structuring, also known as “smurfing”—the breaking up of large money laundering transactions into smaller ones to dodge reporting limits. For example, financial institutions have instituted AML holding periods that force deposits to remain in an account for a minimum of days before they can be transferred elsewhere.
If patterns and anomalies indicate money laundering activities, suspicious transactions in U.S. jurisdictions must be reported in Suspicious Activity Reports (SARs) to relevant financial agencies for further investigation.
Anti Money Laundering in the U.S.
AML regulations in the U.S. expanded after the Bank Secrecy Act (BSA) was passed in 1970 and constitutionally upheld by the U.S. Supreme Court in 1974. Financial institutions were required to report cash deposits of more than $10,000, collect identifiable information of financial account owners, and maintain records of transactions.
Additional legislation was passed in the 1980s amid increased efforts to fight drug trafficking, in the 1990s to enhance financial surveillance, and in the 2000s to cut off funding for terrorist organizations.
Banks, brokers, and dealers now follow a complex regulatory framework of conducting due diligence on customers and tracking and reporting suspicious transactions. A written AML compliance policy must be implemented and approved in writing by a member of senior management and overseen by an AML compliance officer.
Effective early 2021, the Anti-Money Laundering Act of 2020, the most sweeping overhaul of U.S. AML regulations since the Patriot Act passed after the 9/11 terrorist attacks in 2001, subjected cryptocurrency exchanges, arts and antiquities dealers, and private companies to the same CDD requirements as financial institutions.
The Corporate Transparency Act, a clause of the Anti-Money Laundering Act, eliminated loopholes for shell companies to evade anti-money laundering measures and economic sanctions.
FinCEN, a bureau of the U.S. Department of the Treasury, issues guidance and regulations that interpret and implement the BSA and other AML laws. FinCEN’s guidance and regulations provide detailed instructions for financial institutions on how to comply with AML requirements.
In addition to these federal laws, many states have their own AML statutes and regulations. These state laws often mirror the federal requirements but may include additional provisions. Financial institutions must comply with both federal and state AML laws.
International Anti Money Laundering
The European Union (EU) and other jurisdictions had adopted similar anti-money laundering measures to the U.S. Anti-money laundering legislation and enforcement assumed greater global prominence in 1989, when a group of countries and. nongovernmental organizations (NGOs) formed the Financial Action Task Force (FATF).
The FATF is an intergovernmental body that devises and promotes the adoption of international standards to prevent money laundering. In October 2001, following the 9/11 terrorist attacks, FATF’s mandate grew to combat terrorist financing.
Those standards, the FATF’s 40 Recommendations, provide a framework for AML and Combating the Financing of Terrorism (CFT) regulations and policies in over 190 jurisdictions worldwide, covering CDD, transaction monitoring, reporting of suspicious activity, and international cooperation.
Other important international organizations in the fight against money laundering include the International Monetary Fund (IMF) and the United Nations (UN), and programs include the Council of the European Union’s Anti-Money Laundering Directive (AMLD) and the Basel Committee on Banking Supervision’s Customer Due Diligence (CDD) for Banks.
The IMF has pressed member countries to comply with international norms thwarting terrorist financing. The UN added AML provisions to address money laundering associated with drug trafficking in the 1998 Vienna Convention, with international organized crime in the 2001 Palermo Convention, and with political corruption in the 2005 Meridian Convention.
The Council of the European Union’s AMLD, a directive that sets out AML/CFT requirements for all EU member states, has been amended several times to reflect the changing risks of money laundering and terrorist financing. The Basel Committee on Banking Supervision’s CDD for Banks provides detailed recommendations for banks on how to identify and verify the identity of their customers.
Anti Money Laundering and Cryptocurrency
Cryptocurrency has drawn increasing attention among AML professionals. Virtual coins provide more anonymity to users, presenting criminals with a convenient solution to move funds. According to cryptocurrency tracing firm Chainalysis, addresses connected to illicit activity sent nearly $23.8 billion worth of cryptocurrency in 2022, up 68% from 2021.
The decentralized nature of cryptocurrency markets makes it challenging to implement and enforce AML regulations. Traditional AML frameworks are designed for centralized financial institutions but not so much for the decentralized cryptocurrency ecosystem, including decentralized finance (DeFi) protocols, asset-pegged digital currencies known as stablecoins, and crypto investments with self-contained money transfer features such as non-fungible tokens (NFTs).
Blockchain analysis and monitoring tools enable financial institutions and law enforcement to identify and investigate suspicious cryptocurrency transactions. Crypto forensic services like Chainalysis, Elliptic, and TRM Labs have the technology to flag crypto wallets, exchanges, and transactions tied to designated terrorist organizations, sanctions lists, political groups, government actors, and organized crime such as hacking, ransomware, scams, and contraband trafficking on darknet markets.
Inside the U.S.
In the U.S., cryptocurrencies are largely an unregulated market in that few regulations explicitly target the asset class by name. Instead, AML enforcement actions, such as those against crypto exchanges Binance and FTX, have been prosecuted under existing laws and statutes, such as the Bank Secrecy Act and Foreign Corrupt Practices Act (FCPA).
Only recently, under the Anti-Money Laundering Act of 2020, did U.S. companies become legally required to comply with financial screening regulations that apply to fiat currencies and tangible assets. Businesses that exchange or transmit virtual currencies qualify as regulated entities and must register with FinCEN, adhere to AML and CFT laws, and report suspicious customer information to financial regulators.
Outside the U.S.
More formal rules on intervening in virtual currency money laundering are expected to be introduced in the U.S. and abroad. Recent steps include an Internal Revenue Service (IRS) proposal and several European bills for financial platforms to report digital asset payments and transactions to national and transnational regulatory bodies, law enforcement agencies, and industry stakeholders.
On the global stage, the Financial Action Task Force (FATF) Travel Rule, an international AML framework that would require collecting and sharing beneficiary information for cross-border cryptocurrency flows, is being closely watched and gaining traction among regulatory bodies worldwide. Several countries have implemented or are in the process of implementing the FATF Travel Rule in their civil and criminal codes to increase the transparency and accountability of cryptocurrency transactions.
Some AML requirements apply to individuals. By law, U.S. residents must report receipts of multiple related payments totaling more than $10,000 to the Internal Revenue Service (IRS) on the IRS Form 8300.
How Is Money Laundered?
Money launderers often funnel illicit funds through associates’ cash-generating businesses, inflate invoices issued through shell companies, pool transactions together, divide them up into smaller amounts, and cycle them back and forth between financial conduits.
What’s the Difference Between AML, CDD, and KYC?
Anti-money laundering (AML) refers to legally recognized rules for preventing money laundering. Customer due diligence (CDD) refers to practices financial institutions implement to detect and report AML violations. Know your client (KYC) is the application of a component of CDD that involves screening and verifying prospective clients.
Can Money Laundering Be Stopped?
Aggressive AML enforcement can at best aim to contain money laundering rather than stop it entirely. Money launderers never seem to run short of funds, accomplices, technologies, and creative tactics for workarounds, though AML measures certainly make their lives harder.
The Bottom Line
Governments have evolved their approach to money laundering deterrence by establishing and revising regulatory controls that elicit proactive participation from financial institutions. Anti-money laundering is crucial for safeguarding consumers and businesses from financial crimes.