The Financial Action Task Force (FATF) decision to return Iran to its so-called ‘blacklist’ may provide the US additional justification to take punitive action against non-US financial institutions that engage in certain Iran-related transactions, says Nick Turner at Steptoe & Johnson.
On 21 February 2020, the FATF announced that Iran would join North Korea on the group’s list of “high-risk jurisdictions subject to a call for action.” Popularly known as the “blacklist”, the call for action identifies jurisdictions with severe anti-money laundering and counter-terrorism financing (AML/CTF) deficiencies, as assessed against the FATF’s 40 Recommendations.
Like a quarantine, the FATF is now urging its members to adopt “effective counter-measures” to prevent the spread of illicit finance and proliferation risks from Iran. Meanwhile, the United States has gained an additional justification for restricting access to the US financial system for non-US banks that engage in certain Iranian transactions.
Iran’s Failure to Act
As described in the FATF’s public statement following its most recent plenary meeting, the decision to add Iran to the call for action was based on the Iranian government’s failure to implement legal and regulatory changes agreed to in June 2016, when the FATF removed Iran from the blacklist and suspended then-existing counter-measures after the adoption of the Joint Comprehensive Plan of Action (JCPOA).
Since June 2016, the FATF has monitored Iran’s progress against an “Action Plan” of steps required to keep the country from returning to the list of high-risk jurisdictions.
Chief among Iran’s AML/CTF shortcomings was its failure to manage terrorism-financing risks by ratifying and implementing the UN Convention against Transnational Organized Crime (the Palermo Convention) and the International Convention for the Suppression of the Financing of Terrorism (the Terrorist Financing Convention).
While the FATF gave Iran credit for implementing a cash declaration regime, enacting amendments to the country’s Counter-Terrorist Financing Act and Anti-Money Laundering Act, and adopting an AML by-law, six big-ticket items remained from the 2016 Action Plan:
(1) Adequately criminalising terrorist financing and removing an exemption for groups “attempting to end foreign occupation, colonialism and racism”;
(2) Identifying and freezing terrorist assets in line with relevant UN sanctions resolutions;
(3) Ensuring an adequate and enforceable customer due diligence regime;
(4) Demonstrating how authorities are identifying and sanctioning unlicensed money/value transfer service providers;
(5) Ratifying and implementing the Palermo Convention and the Terrorist Financing Convention and clarifying Iran’s capability to provide mutual legal assistance to other governments; and
(6) Ensuring that financial institutions verify that wire transfers contain complete originator and beneficiary information.
The FATF’s public statement emphasises that Iran will remain subject to scrutiny until the country “implements the measures required to address the deficiencies identified with respect to countering terrorism-financing in the Action Plan.”
In light of the above deficiencies, between June and October 2019, the FATF took the preliminary step of urging world governments to adopt enhanced reporting requirements and increase scrutiny of Iranian financial institutions, their overseas branches and subsidiaries, and non-Iranian banks operating in Iran.
With its most recent decision, the FATF re-imposed the remaining counter-measures suspending in June 2016 and called “on its members and urges all jurisdictions to apply effective counter-measures, in line with Recommendation 19 [of the FATF Recommendations].”
The full text of Recommendation 19 (“Higher-risk countries”) states:
“Financial institutions should be required to apply enhanced due diligence measures to business relationships and transactions with natural and legal persons, and financial institutions, from countries for which this is called for by the FATF. The type of enhanced due diligence measures applied should be effective and proportionate to the risks.
Countries should be able to apply appropriate countermeasures when called upon to do so by the FATF. Countries should also be able to apply countermeasures independently of any call by the FATF to do so. Such countermeasures should be effective and proportionate to the risks.”
The interpretive notes to Recommendation 19 list nine examples of counter-measures to be adopted by governments through their national AML/CTF regimes in respect of higher-risk countries (i.e., Iran and North Korea). These are:
(1) Requiring financial institutions to apply enhanced due diligence measures such as those described in FATF Recommendation 10 in respect of the higher-risk country;
(2) Introducing enhanced reporting measures for financial transactions involving the higher-risk country;
(3) Refusing the establishment of subsidiaries or branches or representative offices of financial institutions from a higher-risk country (or otherwise considering the state of the country’s AML/CTF systems);
(4) Prohibiting financial institutions from establishing branches or representative offices in the higher-risk country;
(5) Limiting business relationships or financial transactions with the higher-risk country or persons therein;
(6) Prohibiting financial institutions from relying on third parties located in the higher-risk country to conduct customer due diligence;
(7)Requiring financial institutions to review and possibly terminate correspondent relationships;
(8) Requiring increased supervisory examination and/or external audit requirements for branches and subsidiaries of financial institutions based in the higher-risk country; and
(9) Requiring increased external audit requirements for financial groups with respect to any of their branches and subsidiaries located in the higher-risk country.
As noted above, three of the counter-measures (2, 8, 9) were reintroduced against Iran between June and October 2019. Additionally, the interpretive notes state that governments should take steps “to ensure that financial institutions are advised of concerns about weaknesses in the AML/CTF systems of other countries.”
The FATF is not a regulator, and, apart from promoting AML/CTF standards and the issuance of public reports, it has few means of enforcing its call for action against countries that choose not to adopt some or all of the above counter-measures. Indeed, Recommendation 19’s interpretive notes merely provide “examples” of counter-measures and state that counter-measures should be “proportionate to the risks,” a determination made at the national level.
A Win for the Trump Administration
As far as the United States is concerned, Iran is already subject to strict counter-measures, including having been designated as a “jurisdiction of primary money laundering concern” by the US Treasury Department’s Financial Crimes Enforcement Network (FinCEN) under Section 311 of the USA PATRIOT Act.
Meanwhile, the Treasury Department’s Office of Foreign Assets Control (OFAC) and the US State Department administer economic sanctions restricting almost all trade between US persons and Iran and secondary sanctions designed to discourage non-US persons from engaging in a broad range of Iranian transactions.
While the United States has lobbied heavily for Iran’s inclusion on the FATF blacklist, the FATF, currently led by Xiangmin Liu of the People’s Republic of China, is nonetheless regarded as reasonably neutral as far as intergovernmental bodies go, making it hard to pin Iran’s failure to implement its own Action Plan on the United States.
Naturally, the US government is likely to use FATF’s call for action as a basis for haranguing countries that fail to impose strict counter measures. Whereas many governments, including the European Union, have resisted upholding US secondary sanctions, all FATF members have agreed to uphold the call for action in principle by virtue of their membership in the body.
Indeed, both the US State and Treasury Departments have issued statements in favor of the FATF’s decision, urging countries to adopt effective counter-measures.
Risks for Banks
As demonstrated by numerous US Treasury Department actions, the United States expects foreign financial institutions to implement AML/CTF controls with regard to terrorism-financing risks in addition to guidance from international organisations. Banks that fail to do so risk losing access to the US financial system, regardless of how their home governments implement the FATF counter-measures.
In July 2012, the US Treasury Department sanctioned China’s Bank of Kunlun for engaging in significant transactions with sanctioned Iranian banks. The bank now appears on OFAC’s List of Foreign Financial Institutions Subject to Correspondent Account or Payable-Through Account Sanctions (the CAPTA List).
In February 2018, FinCEN issued a Notice of Proposed Rulemaking naming Latvia’s defunct ABLV Bank as a financial institution of primary money laundering concern under Section 311 of the USA PATRIOT Act. Among a litany of compliance deficiencies, ABLV Bank failed to consider typologies highlighted by the UN Panel of Experts on North Korea with regard to North Korean front companies.
More recently, in August 2019, OFAC added Lebanon-based Jammal Trust Bank to the List of Specially Designated Nationals and Blocked Persons (the SDN List) for engaging in transactions with entities associated with Hizballah, a group designated as a terrorist organisation, like the Central Bank of Iran.
With the FATF call for action, the US government has an additional justification for taking punitive action against non-US financial institutions that engage in transactions involving Iran. The risk is especially high for transactions involving entities named by OFAC as Specially Designated Global Terrorists (SDGT) and banks with weak AML/CTF controls.