By Steven Beck, Head of Trade and Supply Chain Finance, Asian Development Bank, and 
Alexander R. Malaket, CITP, CTFP, President, OPUS Advisory Services International Inc and Deputy Head of Executive Committee, ICC Banking Commission
Fighting crime and supporting economic growth need to coexist a lot more effectively. Recent reports about the scale of money laundering, aided and abetted by reputable banks and legal firms, are shocking. Have we really made much of a dent in stemming the flow of illicit funds through the global financial system since 9/11?
A key unintended outcome in this battle has been to undermine efforts of countries—particularly small developing ones—to expand and create jobs through trade. Asian Development Bank’s (ADB’s) Trade Finance Gaps, Growth, and Jobs Survey confirmed the existence of a significant global trade-finance gap in the range of US$1.5 trillion annually. Unmet demand for trade financing is particularly acute for small and medium-sized enterprises, especially persistent in developing and emerging markets. The United Nations’ Addis Ababa Declaration of Financing for Development identifies sufficient trade finance as critical to achieving the UN’s Sustainable Development Goals (SDGs).
To help close the gap, ADB has developed a new diagnostic tool—a trade-finance “scorecard”. Launched in September, the ADB Scorecard will trigger new solutions to challenges posed by regulation designed to prevent money laundering (AML) and financing of terrorism (CFT). The aim is to enhance regulatory efficacy to boost access to trade financing while enhancing efforts to combat financial crimes.
What is the ADB Scorecard?
The Scorecard examines issues that impact the effectiveness of measures to fight money-laundering and terrorist financing while addressing market gaps caused partly by unintended consequences of compliance with these regulations. Regulatory expectations may be misaligned with the risk profile of the activity being regulated, or over-cautious finance providers might throw the baby out with the bathwater by exiting markets or discontinuing relationships deemed too risky. This can happen even when the underlying business is legitimate.
The ADB Scorecard is informed by and complements the work of the Financial Action Task Force (FATF), the Financial Stability Board (FSB) and numerous national regulatory authorities—as well as consultations with industry. Uniquely, it rates issues, not entities or organizations, and is meant to launch inclusive, solution-oriented dialogue between international bodies, regional and national regulators, and banks. ADB will host this new engagement channel and is planning a meeting with key stakeholders in the second quarter of 2019 to drive solutions on agreed issues raised by the Scorecard.
The diagnosis: the “Seven Elements of Effective Regulation”
The ADB Scorecard’s diagnostic element is comprised of “Seven Elements of Effective Regulation”. They are a useful and unique diagnostic lens through which specific transaction-level regulatory issues can be assessed.
Broader applications for this diagnostic framework will be discussed at next year’s stakeholder meeting. The meeting will also be a chance to explore how to put the scores on a more robust and methodical footing so they can potentially be used by national regulators for benchmarking.
1. Consistency. How consistent is regulatory guidance, interpretation and implementation across borders?
2. Risk alignment. Are regulatory and compliance requirements aligned to the risk profile of the activity being regulated?
3. Co-design. Does the design and deployment of regulation include market dialogue, consultation or engagement?
4. Communication. Does communication between key stakeholders flow effectively? Does communication across jurisdictions, including information and data-sharing, support effective regulation and compliance?
5. Technology and data. Are technology and data available and leveraged to inform regulation and compliance? Do industry stakeholders collect and provide the necessary data? How well is this done in developing regions?
6. Enforcement. Are regulatory and compliance requirements appropriately and consistently enforced?
7. Quality control. Are a feedback process and a quality-control discipline designed into regulation?
The “Five Issues: Perceived or Actual Regulatory Requirements”
The Scorecard highlights five key transaction-level issues that contribute to market gaps. These issues are assessed against the diagnostic tool to provide a clearer picture of how to address them in ways that also bolster efforts to fight financial crimes.
Party identification (Party ID). Trade-finance banks must validate the identity or legitimacy of parties in a transaction if they’re not clients or counterparties. This information can be difficult to acquire, but this doesn’t mean that the requirement should not exist.
Price. The need for bankers to validate the reasonableness of product pricing to combat invoice-padding and related money-laundering activity.
Non-customer due diligence (NCDD). The degree of due diligence required on non-clients is unclear for many stakeholders.
Exams. Compliance is assessed by examiners through periodic audits of bank operations. But differing interpretations of regulations can add complexity and cost to the due-diligence process.
Overcompliance. Banks may go beyond regulatory requirements, possibly refusing to support transactions (often in developing markets) due to lack of data on non-client participants.
The diagnostic table below considers the five transaction-level issues against the macro issues. Scorecard users can ask, for example: How consistently does non-customer due diligence arise across jurisdictions? Or how is data and technology utilised in addressing the price-validation requirement across jurisdictions? Ratings are done on a global basis.
Rating (1-10): 1–3: Little or None; 4–6: Some; 7–8: Significant; 9–10: High. (*Across the interactions between international entities, regulators and banks)
Five Issues: Perceived/Actual Regulatory Requirements
Consistency
Risk Alignment
Co-Design
Communication
Data and Technology
Quality Control
Enforcement
Party ID
7
2
1
3
1
3
5
Price
8
9
1
5
1
5
5
NCDD
4
5
4
7
6
7
6
Exams
3
2
3
6
2
2
2
Overcompliance
4
3
2
2
4
2
2
Next steps in the evolving role of the Scorecard
At the upcoming stakeholder meeting, agreement will be sought on concrete actions to resolve issues identified in the Scorecard, as well as the Scorecard’s potential applications and how to make it more robust.
We need to do better in combatting crime and terrorism in the financial system. And we need to reduce unintended consequences from those efforts. A frank, robust and honest discussion between banks, national regulators and international regulators is required. ADB is well aware that regulatory issues can be sensitive, and as a neutral multilateral development bank, it is well placed to host this discussion.
This is an opportunity to enhance domain knowledge about trade financing and its importance to achieving the SDGs. Similarly, there are opportunities to reshape industry perceptions of regulation and compliance, as illustrated by reports of “overcompliance” by banks that widen the trade-finance gap. Clarity on required compliance levels versus perceived compliance thresholds will reduce overcompliance and contribute to enhancing availability of trade finance in markets that most need it.
The collection and provision of industry and regulatory data, global adoption of the Legal Entity Identifier and technology such as data registries offer opportunities to advance the efficacy of AML/CFT regulation while mitigating unintended adverse impacts that worsen the trade-finance gap. Data is expected to come from industry sources, regulatory authorities and academic research and analysis, including leading international institutions, policy bodies and think tanks. The inaugural edition of the Scorecard is devised on the basis of industry knowledge and expertise, with the explicit intention of starting a process around data collection that will underpin efforts to strengthen aml/cft and close market gaps going forward.
The ADB Scorecard and ensuing activities come as access to trade financing is becoming critically important and when inclusion demands that financial resources be available where and as needed.
At the same time, stamping out financial crimes is a fundamental and shared obligation. The Scorecard will help by advancing the design, deployment and enforcement of effective regulation, driving enhanced clarity between stakeholder groups and pinpointing root problems to speed their resolution.
This is a golden opportunity. By participating in a candid discourse and taking ownership of the issues, we can generate solutions that fight crime, boost trade finance and advance the SDGs.