Sharan Gill, writer, lawyer and CGj contributor, reviews a new report highlighting the relatively neglected connection between money laundering and environmental crime.
The reality put forward in a new report by Finance for Biodiversity (F4B) – Breaking the Environmental Crimes-Finance Connection – is stark and unequivocal. Environmental crime is one of the top five most profitable global criminal enterprises, generating up to almost US$300 billion annually. Associated tax revenue losses amount to nearly US$30 billion per annum. Coming on the heels of the high-level commitments to reduce climate change risks and environmental destruction made at COP26 – the 26th Conference of the Parties to the United Nations Framework Convention on Climate Change – these figures are staggering. The stakes are high, illustrated by fact that nearly half the world’s tree species are at risk of extinction. This is a clarion call for enforcing the accountability of the financial actors involved.
The report, published on 12 January this year, was prepared for the UK Government–sponsored Global Resource Initiative (GRI), a taskforce assigned to provide recommendations to the UK government on greening its international supply chains. Immediately clear from this report is that the issues and the corresponding proposals are of direct relevance to stakeholders and financial institutions (FIs) around the world. It makes a strong case for due diligence measures for FIs, among others, to adapt to a changing regulatory landscape, warning that they need to adopt their own methodology before this gets imposed on them at high cost.
The limitations of conventional AML rules
While different jurisdictions have their own particular anti–money laundering (AML) rules, the legislation and regulation in this area focuses on preventing the proceeds of criminal acts from being disguised as legitimate funds. The new report explores in detail the application of AML regulations in relation to environmental crime and highlights the practical difficulties arising in this relatively untested area of law.
Despite the differences between jurisdictions, global standards for determining offences have been put forward by the Financial Action Task Force (FATF), the global money laundering and terrorist financing watchdog. A specific crime that causes profits to be laundered within AML is referred to as a ‘predicate offence’, that is the underlying criminal activity that generates proceeds to be laundered. Illegal mining is a typical example of a predicate offence within the context of environmental crime, an activity that results in profits that may be laundered through the financial chain. The report argues that FIs, often unwittingly, incentivise environmental crimes by investing in, or providing capital for, enterprises that benefit from criminal activity. Through the profits made from these investments, these institutions effectively launder the proceeds of environmental crime.
The question is: why is this not already within the ambit of AML rules? FIs are required to report knowledge or suspicion of money laundering through suspicious activity reports. To identify suspicious activities, FIs employ mechanisms to screen investments, but the report highlights the way environmental crimes are slipping under the radar. Going back to the illegal logging example, if land which is illegally logged is subsequently used for agricultural production, the FI that finances the business which produces the food from that land is effectively laundering the proceeds from illegal logging. Under current application of AML laws, however, this investment is technically legal, essentially because the linkage to illegal logging does not actually appear on the FI’s balance sheet.
This problem is more widespread than it would initially seem. FIs tend to invest in nature-dependent sectors such as food and infrastructure, the profitability of which can be increased through environmental crime. Again, from the illegal logging example, there is a strong incentive to perpetrate environmental crime, as this drives startup costs down and increases profitability of the operations.
Lurking behind opaque supply chains
The report concedes that FIs are generally unaware that they are complicit in laundering the proceeds of environmental crime and often do make an attempt to scrutinise their supply chain. However the often complex supply chains make it difficult to identify environmental crimes, more so when there is blending of sourcing from both legal and illegal origins in supply chains. This makes it especially difficult to ascertain culpability.
The report underscores that even when an offence has been detected in the supply chain, there are rarely legal repercussions for FIs, which is hardly conducive to encouraging consistency in monitoring supply chains. Worse, it effectively renders AML laws ineffective when sources of legitimate financing are fully aware of, and indeed may be implicitly benefiting from, economic activities linked to environmental crimes.
The key, the report argues, is to enforce culpability beyond the balance sheet. There needs to be better tracking of environmental crimes and identification of guilty parties. It is likely that AML rules will eventually be tightened to expand their application and public demand will drive regulators to enforce these rules more effectively. The report points to several global precedents in this direction that are rapidly gaining momentum in the financial world and will have major implications for FIs that do not initiate a framework of due diligence to address these risks.
Global regulatory initiatives
To date, AML regulation has been applied to environmental crime mostly in the context of the illegal wildlife trade. More recently, according to the report, the practical application of AML rules has been applied to a broader range and number of environmental crimes. New mandatory environmental due diligence requirements will soon come into force in key jurisdictions.
The 2018 AML Directive of the European Commission (EU) explicitly references environmental crime. The EU’s proposed Environmental Crime Directive will widen the range of offences covered, and will increase legal certainty by providing specific and clear descriptions of criminal offences. The new rules will also impose punitive sanctions such as withdrawal of permits, disqualifications and exclusion from access to public funding, including tenders.
In the UK, the proposed Environment Act will impose legal compliance on eligible members of the non-financial corporate sector to identify whether their commodities were illegally produced. While this does not currently affect FIs directly, there will be increased data available for scrutiny as a result. FIs without an existing methodology to deal with this avalanche of data face the risk of being caught left-footed.
In the US, the Lacey Act makes it illegal for anyone to purchase, import, export or acquire illegally captured animals, or illegal forest or animal products, across US state lines or international borders. Additionally, the proposed FOREST Act in the US aims to prohibit commodities produced on illegally deforested land from US markets and includes illegal deforestation as a financial crime statute. The benefits derived from such financing must also be included in these regulations, as they ultimately sustain business operations dependent on environmental crime.
Adopting a brand new ‘environmental crime free’ regulatory requirement would, the report points out, be complex and onerous, and would certainly meet significant resistance from the market. Nevertheless, the report argues that developments in AML are likely to follow a similar trajectory as those described above. Expect new rules requiring FIs to demonstrate the absence of environmental crime in their financing activities and requiring businesses, including financial institutions, to ensure that their value chains are absent of designated products or processes. Comparable regulations exist with anti–human trafficking laws, for example, to ensure the absence of slavery in value chains. The Kimberly process, which resulted in US regulations requirements that supply chains be free of ‘conflict diamonds’, is another compelling example.
One reason for the lack of impetus for companies to scrutinise their dealings and supply chain for the proceeds of environmental crime has been the lack of punitive action, whether in the form of sanctions or otherwise. The report argues that companies will increasingly be held accountable for a lack of supervision and control, however.
Tougher legal requirements and enforcement can be imposed with rapidity, particularly in response to major events. The report points out the precedent set after the 9/11 attacks, for example, when it was discovered that much of Al Qaeda’s financing had passed through US-based bank accounts. Congress rapidly passed legislation requiring improved know-your-customer practices at FIs. Similarly, in the UK, the Anti-Terrorism Act was amended to make it mandatory to immediately report knowledge of a person committing an offence related to funding terrorism or laundering terrorist funds. This had ripple effects across global financial reporting, especially for FIs who were not prepared to deal with the new reporting regulations.
Will the current heightened awareness of the global and serious consequences of environmental crime have a similar galvanising effect? Accountability has already come for the financial community in other parts of the environmental landscape. The Prudential Regulation Authority’s (PRA) supervisory statement SS3/19 identifies the expectation that a firm oversees and assesses risks imposed by climate change to the firm. In particular, the PRA expects that a Senior Management Function (SMF), will be appointed to accept personal responsibility for the identification and management of climate risks.
This is important as it drives personal accountability at senior management and board level and imposes personal liability should SMFs be in breach of their duties. While this does not currently apply to a broader context of environmental crime, one could see the potential for such regulatory actions to be imposed for environmental crime in the future.
The role of stakeholders
There is a growing community of actors advancing finance-related actions to eradicate environmental crimes, including those with a long track record such as TRAFFIC in addressing illegal wildlife trafficking, and new coalitions such as the recently established Environmental Crimes Alliance. Moreover, the report points out that ‘digitally powered innovations, from satellite imagery to blockchain, are rapidly removing the practical constraints to better understand where and how environmental crimes exist and intersect financial arrangements’. It argues that activist organisations and other advocates of environmental protection could go further and initiate civil action, which would play a vital role in establishing legal precedents and accelerate the more extensive use of AML rules.
There is thus an urgency for the financial community, and interested stakeholders, to develop and adopt more extensive due diligence measures to safeguard them from being unintended supporters, or beneficiaries, of environmental crime.
AML’s application as a due diligence tool is already widely implemented in risk management frameworks globally, but there are limitations in the scope of these frameworks relating to environmental crime. A more resolute application of these rules will be needed, according to this report, to stem the flow of illicit funds being represented as legitimate on balance sheets. AML rules can only go so far, however, and national regulators need to take the lead, guided by legal precedents in other jurisdictions and industries.
FIs themselves should take the first step to understand what these developments mean. Voluntary measures allow FIs to gradually adopt the regulations without excessive cost or requiring high upfront capacity. FIs need to embed environmental crime within their risk frameworks or risk mispricing their credit exposures. Impacted corporations unable to demonstrate the absence of environmental crime in their supply chain may face considerable risk to their operations and supply chain structures. Developing a standardised methodology to process the mountain of data that will inevitably result from increasing regulatory requirements will be crucial. Ultimately, all stakeholders need to be actively involved.
Sharan Gill is a lawyer and writer based in Hong Kong.
The report reviewed in this article is available from the Finance for Biodiversity website: www.f4b-initiative.net.