The legal framework for combating money laundering and terrorist financing may eventually lead to a decision by financial actors to de-risk. This observation follows recent concerns at the European level, including those raised by the European Banking Authority regarding de-risking practices in three position papers published in March 2021, as well as the launch by the FATF of a new project in February 2021 to study the unintended consequences of incorrect implementation of the Financial Action Task Force (FATF) standards.
1. De-risking: definition
The FATF would define de-risking as a loss or limitation of access to financial services resulting from financial institutions terminating or restricting business relationships with categories of customers in order to avoid rather than manage risk.
The European Banking Authority (EBA) prefers to describe this phenomenon as a practice whereby financial institutions may refuse to enter into or decide to terminate business relationships with certain customers whom they associate with a significant risk of money laundering and/or terrorist financing (ML/TF).
2. The reasons for de-risking
The reasons for de-risking are not specific to any one factor, but rather multiple factors to be considered on a case-by-case basis and in relation to the financial activity carried out. Some examples: low anti-money laundering and counter-terrorist financing (AML/CTF) risk appetite, increased but necessary regulatory pressure requiring in specific circumstances to de-risk prospects/clients who do not comply with their AML/CTF obligations, reputational risk or profitability concerns.
3. Clients concerned
The decision to terminate business relationships or refuse to enter into a relationship will be made on the basis of an assessment of individual client files, taking into account legal requirements and detected red flags.
Entities subject to the service obligation may not provide services to entities for which risk mitigation cannot resolve the potential compliance and reputational risks mentioned above. Therefore, many applicants may be considered for de-risking, for example and separately those active in a regulated sector without a licence, with weak or deficient AML/CTF systems, involved in environmental safety or health risks or even established in high risk third countries.
3. The consequences
The consequences of de-risking, as the FATF would put it, may lead to the introduction of new risks and greater opacity in the global financial system, as customers will turn to less regulated or unregulated channels. This raises several issues, including:
- The inability to track information on payers/payees, parties to wire transfers in accordance with Regulation (EU) 2015/847 or more broadly FATF Recommendation 16 on travel rules
- The possible negative decline of suspicious transaction reporting
4. The proper application of the risk-based approach as a solution to de-risking
The risk-based approach (RBA) should be the cornerstone of an effective AML/CTF system and therefore, through appropriate risk mitigation, address de-risking practices. In its updated guidelines on money laundering and terrorist financing risk factors, the EBA underlines the need for financial institutions to strike a balance between financial inclusion and mitigating money laundering and terrorist financing risks.
By Julien Leroy, Senior Legal Adviser at the ABBL
This article follows the publication of several articles on compliance in the French monthly Droit & Patrimoine (September 2021, N°316), including Julien Leroy’s article: “De-risking: l’ombre des règles relatives à la lutte contre le blanchiment des capitaux et le financement du terrorisme sur l’inclusion financière?”.