Chapter 5: Anti-Money Laundering Regime and Its Challenge to National Sovereignty

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Chapter 5: Anti-Money Laundering Regime and Its Challenge to National Sovereignty


Part III

Anti-Money Laundering Regime: Examining the Challenge to Sovereignty, Jurisdiction and Law Enforcement


In this Part, the development of anti-money laundering regime (hereinafter: the AML regime) and the legal effects of such development that challenge to the principles of sovereignty, jurisdiction, and law enforcement will be analyzed. The core problem that is presented in this part asks how these challenges have originated and how it affects the existing rules of sovereignty, jurisdiction, and law enforcement. Regarding the challenge to sovereignty, this study examines the implementation of the AML regime from the standpoint of national sovereignty. Regarding the challenge to jurisdiction, this study analyzes the dynamics of jurisdictional theory in facing transnational money laundering practices. Finally, in relation to the challenge to law enforcement, this study exposes the changing character of law enforcement from a domestic level to an international sphere.

Chapter 5

Anti-Money Laundering Regime and Its

Challenge to National Sovereignty


5.1. Introduction

This chapter will analyze the implementation of the AML regime and the legal effects that challenge to national sovereignty. Whether the implementation of the AML regime curtails the sovereignty of a state is the central question of this chapter. First of all, a look into the relationship between globalization, global governance, and international standards will be taken. International standards have been emerging due to the process of globalization and the development of global governance in all aspect of life, including the prevention and eradication of money laundering practices. After discussing the relationship, this chapter elaborates on the issue of the AML regime as an international standard. This will be followed by an examination on how and why states comply with these international standards despite being voluntary rules and despite the states in question not being involved in the legislative-process of these standards. The last section will analyze the implementation of the AML regime as international standards from the standpoint of national sovereignty, focusing on the principles of sovereign equality and of non-interference. In this section, the experience of Indonesia in implementing the AML regime during and after blacklisting and the problems faced will be discussed.

5.2. Mapping the Relationship between Globalization, Global Governance, International Standards, and Anti-Money Laundering Regime
5.2.1. Globalization, Global Governance, and the Emergence of International Standards
Globalization can mean many different things in different contexts.1 However, scholars and policy makers tried to explain the evolving meaning of globalization by emphasizing on the key concepts referring to certain phenomena. Heba Shams, for example, defines globalization as a process of social change, which underlines the change in terms of geographic and political dimensions.2 Geographic dimensions refer to the direct effect of globalization that expands beyond an individual state, while political dimensions refer to the partial loss of state power in favor of the roles of other actors.3

As for the implications of globalization on society, it is widely acknowledged that globalization has both positive and negative impacts.4 One such positive impact is ease of access worldwide.5 On the other hand, one negative effect would include the expansion and spread of crimes into worldwide operations, such as the acts of money laundering. This type of crime is committed across the boundaries of multiple jurisdictions in which criminals, proceeds, and documentary evidence can easily move from one jurisdiction to another. By using the development of technology6 which facilitates the method of transferring illicit funds across-borders, criminals utilize them to make money laundering easier to accomplish and harder to detect.7 Money laundering in this context can be characterized as a transnational crime8 that raises worldwide problems. The characteristics of such a crime cannot be solved by an individual country, but requires multilateral efforts at an international level.9 Here in this context, domestic measures are not enough in countering money laundering, making international cooperation extremely important in addressing the problem.10

It is at this point that collaboration and cooperation between or among countries are of paramount importance for combating money laundering. Rules, principles, and procedures above the level of a nation state need to be created. This phenomenon leads to the establishment of global governance as a response to the globalization in which it manages. Global governance11 in this sense refers to how international affairs are governed in the current age of globalization.12 In such a context, global governance refers to the collective efforts to address worldwide problems that go beyond the capacity of individual states to solve.13

In terms of its actions, global governance established international standards14 which are then used in governing and guiding the conduct and behavior of states and non-state actors in solving their problems.15 A standard could be understood as a guide, setting rules for people to follow; they could also be understood as universal rules, defined by a rule-maker, that address public policy issues.16 In this setting, it could be argued that the concept of ‘international standard’ is intended to regulate the general acceptance of how states, corporations, or individuals behave. Here in this context, international standards address to voluntary guidelines or best practices for reducing the global threat of money laundering practices.17 In the context of money laundering, the Stockholm School Theories gave an example of international standards from the FATF forty-recommendations.18 These standards are not binding rules, meaning that no sanction can be imposed on states, corporations, or individuals that fail to comply with them. However, the question of how policies, procedures, and processes of ‘international standards’ impact on the anti-money laundering regime remains. This issue will be addressed in the following sub-section.

5.2.2. Anti-Money Laundering Regime as an International Standard
The term ‘standard’ can be described as ‘a guide for behavior and for judging behavior’.19 The term standard can also be described as a set of universal rules defined by a rule-maker that addresses public policy issues.20 Referring to the concept of ‘international standard’, this term attempts to convey generally accepted rules of behavior between governments, corporations, and individuals from two or more countries in conducting business and financial affairs.21 In this matter, ‘international standard’ can be manifested into recommendations, best practices, principles, code of conducts, or guidelines. In the context of anti-money laundering policy, ‘international standard’ is codified in the FATF forty-recommendations. As an international standard, the forty-recommendations function as ‘a blueprint’ for governments in creating money laundering laws and regulations.22

The first international standards were issued in 1990 and aimed at preventing the acts of money laundering particularly in the scope of financial systems. These standards cover the general framework,23 the improvements of national legal systems,24 the enhancement of the role of financial systems,25 and the strengthening of international cooperation.26 Due to the changes in money-laundering methods, techniques, and trends, these standards were revised for the first time in 1996 and took into account two factors: the vulnerabilities of technological advances and the profits derived from beyond drugs-related crimes.27 The emerging trends of money laundering around the world compelled the FATF to revise its recommendations for the second time in 2003.28

As an international standard, the forty-recommendations (2003) comprise of four sections. These involve the legal system;29 measures to be taken by financial institutions and non-financial businesses and professions to prevent money laundering and terrorist financing;30 institutional measures necessary for combating money laundering and terrorist financing;31 and international cooperation which involves mutual legal assistance and extradition.32

The first section relates to the legal system that provides the scope of money laundering, provisional measures, and confiscation. In this section, the FATF recommends its members to criminalize money laundering and apply this crime to the widest range of predicate offences.33 The FATF also recommends adopting measures to confiscate the proceeds of money laundering.34 In implementing its recommendations, the members should ensure that they are not inhibited by bank secrecy laws.35

The second section relates to the role of financial institutions, non-financial businesses and professions, and the role of countries in the prevention of money laundering and terrorist financing. The role of financial institutions is conducted through customer due diligence, record keeping, and the reporting of suspicious transactions.36 In contrast, the functions of countries are to provide sanctions who fail to comply with its requirements, to refuse the establishment with shell banks, to implement feasible measures to detect and monitor cross-border transportation of currency, and to apply its recommendations to businesses and professions.37

The third section concerns the institutional measures necessary in a system for combating money laundering and terrorist financing.38 Firstly, countries should ensure that their financial institutions are effectively implementing the forty-recommendations.39 Secondly, countries should ensure that effective, proportionate and dissuasive sanctions - whether criminal, civil or administrative - are available for natural and legal persons who fail to comply with anti-money laundering or terrorist financing requirements.40 Thirdly, countries should establish a Financial Intelligence Unit (FIU) in their territories.41 Fourthly, countries have to develop special investigation techniques suitable for the investigation and should provide their own competent authorities.42 Finally, countries should ensure that their policy makers, FIU, law enforcement, and supervisors have effective mechanisms that enable them to co-operate and co-ordinate domestically with each other to combat money laundering and terrorist financing.43

In the fourth section, the FATF encourages countries to conduct international cooperation by fully implementing all relevant international conventions.44 In this case, countries should provide the widest range of mutual legal assistance notwithstanding the absence of dual criminality.45 Also, countries should be able to take expeditious action in response to requests by foreign countries to identify, freeze, seize, and confiscate the property laundered, the proceeds, and the instrumentalities used in the commission of these offences.46 In relation to extradition, countries should recognize money laundering as an extraditable offence through either extraditing its own national or submitting the case to its competent authorities for the purpose of prosecution. Finally, countries should co-operate with each other, in particular, on procedural and evidentiary aspects to ensure the efficiency of such prosecutions.47

5.3. Analyzing the Implementation of the Anti-Money Laundering

Regime and the Compliance of States

The emergence of various laundering methods as described in the previous chapter48 has been responded by the anti-money laundering regime (AML regime) in preventing and controlling money laundering practices. Establishing international standards is one effort to internationalize the anti-money laundering policy. Its internationalization aims to raise the issue of money laundering into an international level. This then leads to the question of how far have countries complied with their obligations under the AML regime? Three subject matters that will be elaborated in this section are the meaning and theories of compliance, constructing state compliance with the AML regime, and assessing the compliance of states with the regime.

5.3.1. The Meaning and Theories of State Compliance
Theories of compliance are useful for understanding the compliance-related behavior and the reasons behind the behavior. There are various theoretical definitions and multiple meanings of ‘compliance’. In a broader context, the term ‘compliance’ which can be described through synonyms such as obedience and willingness, requires a wish, a request, a demand, or command.49 Compliance can also be defined by observing the conformity of a behavior to a specific set of rules50; or by observing the implementation of regulation by a country that adhere to the agreed upon set of provisions.51 Taking state behavior into consideration, compliance may refer to the application of international standards or agreements. This means that compliance points to a state fulfilling its obligations under international standards or agreements.

Whichever definitions are formulated, compliance comprises three basic elements: ‘actor’, ‘behavior’, and ‘norm’. ‘Actor’ refers to the states or non-state entities that conclude international agreements and then implement and enforce them in their actual behavior. ‘Behavior’ refers to the action of the actor undertaken to conform to the international obligation on the domestic level. ‘Norm’ refers to the standard or specification to which the actor has to comply. Norms in this context point to the international and domestic compliance. The international compliance is about the behavior of state; about how and why they comply with the norms. The domestic compliance, in the mean time, focuses on the behavioral of corporations and individuals under the supervision of any state. The question is when the compliance takes place and the reasons why states comply or not with their obligations.

Oran Young in his book ‘Compliance and Public Authority’ points out that ‘compliance occurs when the actual behavior of a given subject conforms to prescribed behavior; and non-compliance or violation occurs when actual behavior significantly differs from prescribed behavior’.52 In the meantime, Shihata distinguished two categories of compliance, namely, formal compliance and substantive compliance.53 According to him, formal compliance occurs when states enter into an international agreement, while substantive compliance takes place when any state adopts the international agreements and implements them in its domestic legal system.54

From the essential question as to why states comply or not with international obligations in some cases and not in others, some basic models of state compliance arise. Waltz55, for example, proposes three kinds of theories, namely, the realist theory, institutionalist theory, and normative theory. In the realist theory, it is claimed that any state obeys international law only when it serves its own self-interest. It is the interest of a state that is the main aspect and the principal reason for considering the compliance of international obligations.56 As apposite, any state will violate the law if the law is contrary to its interests. In this case, a state acting based on what Hulsse and Kerwer call the logic of consequences in which they expect costs and benefits of compliance with any rules.57 This theory argues that power rather than law is the primary determinant in interstate relations.58 The institutionalist theory asserts that compliance can be reached effectively by establishing an international institution whereby legitimate standards of state behavior are created.59 The normative theory, finally, argues that moral and ethical obligations deriving from natural law form behavioral guidance for states to obey or not with international obligations.60 The approach of this theory focuses on the force of ideas, beliefs and standards of appropriate behaviors as a major influence on government willingness to comply with international agreements.61 This theory argues that states behave according to the logic of appropriateness in which they have a tendency to follow the rules.62 This theory tends to use a cooperative approach and moral force in obtaining compliance.63

Other opinions regarding the causes and reasons as to why states comply or not with international law have been proposed by Abram Chayes and Antonio Handler Chayes64, Thomas M. Frank65, and Harold Honju Koh66. Chayes & Chayes point to the ‘managerial approach’ in promoting compliance with treaty norms. The ultimate impetus of compliance, according to this model does not stem from the fear of sanctions, but rather the lost of reputation and avoidance of isolation from the international community.67 In addition, they suggest that non-governmental and inter-governmental institutions play significant roles in using the above tools for managing and leading to a satisfactory level of compliance.68 As opposed to the ‘managerial model’, Chayes & Chayes refuse elements of the ‘enforcement model’ such as military, economic, membership or unilateral sanctions. The reason to refuse it, according to them, is due to high-costs and the legitimacy problems.69

Still another case was argued by Thomas Frank. He proposes the ‘fairness approach’ in which legitimacy and distributive justice function as the central causes and reasons of state compliance. In this matter, Frank argues that countries will obey international rules if they consider that the rules are fair and in accordance with the right process.70 Finally, Koh proposes ‘transnational legal processes’ in analyzing state compliance with international law. Koh argues that as transnational actors – including both state and non-state actors – interact, patterns of behavior and norms emerge which are internalized. This model internalized them into the domestic institutions, politics, and legal systems, which in turn leads to compliance.71

5.3.2. Constructing State Compliance with the AML Regime Compliance Mechanisms
The compliance mechanisms in the work of the FATF to member and non-member countries involve three models, namely, self-assessment, mutual evaluation, and Non Cooperative Countries and Territories (NCCT). The first two mechanisms are for the FATF’s members and the third one is for non-members.

  1. Self-Assessment

The first mechanism is self-assessment exercise. It monitors annually the progress of the FATF members in implementing the forty-recommendations.72 In this exercise, each member provides information on the status of its implementation dealing with legal and financial aspects. Herein, each member is required to complete a standardized questionnaire, showing to what extent the recommendations have been implemented.73 The information is compiled and analyzed with the result presenting a view of the progress of the members in implementing the forty-recommendations.74 Based on the assessment, the FATF may offer suggestions for further enhancement of countries’ anti-money laundering systems.

  1. Mutual Evaluation

The second mechanism is the mutual evaluation process. It is a monitoring method that evaluates the performance of the AML systems of member countries based on the implementation of the forty-recommendations.75 Herein, it provides more detailed examinations of the measures to combat money laundering. This method is carried out by a Team, which consists of selected experts in the field of legal, financial, and law enforcement from different countries, performing an on-site examination.76 The Team analyzes data submitted by the governments and then verifies the data through on-site visits and interviews.77 Subsequently, the secretariat of the FATF issues a draft confidential report that the Team and the evaluated countries will discuss.78 The final report is a confidential opinion that will issue after discussing in the FATF plenary meeting.79 The report describes how well the member countries adhere to the recommendations and identifies areas for further enhancement.80

The mutual evaluation has had three rounds since 1992; every member was evaluated once in each round. The focus of each round differs depending on the targets that will be obtained. The first round was conducted between 1992 and 1995. It focused on monitoring the progress of the FATF members in implementing the forty-recommendations.81 The second round occurred between 1996 and 1999; its focus was on the effectiveness of each country’s anti-money laundering laws and systems.82 The third round of mutual evaluation was conducted between 2005 and 2008 and focused exclusively on the compliance of the revised recommendations, the areas of serious deficiencies identified in the second round, and the effectiveness of counter-measures.83 Here in the third round, the FATF evaluated its members based on the forty-recommendation 2003, the 9 Special Recommendations 2001, and the Anti-Money Laundering/Combating Terrorist Financing (AML/CFT) Methodology 2004.

  1. The Non Cooperative Countries or Territories

The third mechanism is a policy for assessing the implementation of anti-money laundering by non-member countries in order to achieve maximum compliance with the forty-recommendations.84 The FATF reviewed non-member countries by using twenty-five criteria for defining non-cooperative countries or territories. The objective of the initiative is to counter money laundering through having international standards implemented by all global financial centres.85 Non-member countries that do not comply with the forty-recommendations will be categorized as Non Cooperative Countries or Territories (NCCTs).86 Here in this context, the FATF adopted twenty-five criteria in defining the NCCTs. These criteria cover prevention, detection and penal provisions. 87 The rationale for this policy is to encourage countries and territories not only to implement anti-money laundering legislations, but also to improve existing countermeasures. This approach uses ‘peer pressure’ being based on ‘naming and shaming’ by blacklisting certain non-member countries that do not comply with the FATF standards. The countries which are categorized as an NCCT appear in the FATF’s blacklist. According to the FATF, the aim of this initiative is for all financial centres to adopt effective measures to prevent, detect, and repress money laundering in the world’s financial system.88 For non-member states, the forty-recommendations are put into effect when it is conceived that the launderers and traffickers are taking advantage of the weak or non-existent regulations regarding these matters.89

This is the reason why the FATF has obliged non-member states to implement the forty-recommendations. It has become evidence that even though the members have strengthened their systems, the criminals try to seek other jurisdictions that have weaknesses in their money laundering countermeasures. As a consequence, money laundering may affect not only non-members with weaknesses in their legislations but also the member states that have complete money laundering countermeasures. In the 2000 NCCT report, fifteen countries were identified as non-cooperative in the fight against money laundering. In 2001, the FATF added eight countries to the list including Egypt, Hungary, Indonesia, and Nigeria. The list changes each year based on countries compliance. Some countries are removed from the list, some remain, and new ones were added. The following figure displays the list of NCCTs process from 2000 to 2006.

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