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Money laundering is facing a major paradigm shift

Thanks to the rapid rise of crypto currencies, money laundering is facing a major paradigm shift. Will our regulators and supervisors be able to handle this?


While the latest revelations such as those by the ‘FinCEN Files’ point to bankers as essential partners for criminals and terrorists for laundering their illicit funds, the reality of the global financial system is changing rapidly. Already, criminals and terrorists are no longer fully relying on banks for their transactions. Evidence shows that money launderers are taking more than a keen interest in crypto currencies.


These virtual currencies have become much easier to use and make it impossible to detect who is behind the transactions. It makes them attractive to users, but high-risk for supervisors. And it’s not only bitcoin. There are now over 7000 different virtual currencies around, according to CoinMarketCap estimates, with more than $350 billion in capital value.



The popularity of these crypto currencies has become clearly visible in my home country, Estonia, which unfortunately already has a dubious reputation after the $230 billion Danske Bank and Swedbank scandals dating back a few years. The popularity of crypto in Estonia already is evident also on the streets of Tallinn. Crypto ATMs are not difficult to find.


Because of the bank scandals, Estonian banks now are expected to be more transparent and more diligent in discouraging black money. Banks indeed have become more cautious, prioritising risk management. However, the marked increase in virtual currency traders now has become the biggest risk.

The latest annual report by the RAB, our national financial intelligence unit, makes alarming reading. RAB has reported a tenfold (!) increase in requests for crypto licenses from foreign companies in 2018, to 1430 applications. And that number continued to rise in 2019, when 1690 applications were examined. Only 108 applications were received in 2017.


Most of these requests are from foreign companies whose ownership or ultimate beneficial owner are difficult to check. The licences are requested for exchanging virtual currencies for hard cash, and for the provision of digital wallet services.


To date, the total number of Estonian crypto licences is estimated at 3000, in a country with a population of 1.3 million people and a direct, 294-kilometer border with Russia. It makes Estonia an indisputable market leader worldwide in the crypto exchange market. No other country has so many virtual currency traders operating in its legal system.


According to the RAB the majority of license applicants are foreign members of a management body or beneficial owners. They do not have any substantial activity in Estonia. In other words, while their economic activities are registered here, operations and the substantive management of a company take place in other countries. This makes monitoring difficult, if not impossible.


Among these companies there are likely to be many shell companies, established specifically with the objective of laundering illicit funds. This week’s FinCEN revelations showed that, at the time of the Danske Bank and Swedbank scandals, secretive agencies were mass-producing U.K. shell companies that criminals and launderers could use for bank accounts in the Baltic states.


Could it be that the pattern is repeating itself? The sharp increase in the number of companies trading virtual currencies in Estonia already answers that question.

So, what is the government doing? In March Estonia partially transposed the European Union’s 5th Anti-Money Laundering Directive. The requirements for financial institutions now apply to virtual currency traders. In addition, the 5th Directive forces increased transparency upon virtual currency traders.


Because of this directive transactions between two virtual currency companies now are subject to regulation. The minimum share capital of a legal person was increased from EUR 2500 to EUR 12000. Any company wishing to engage in crypto trade now is obliged to have a bank account with a financial institution in the European Economic Area which officially provides a cross-border service and whose activities are registered with the Financial Supervision Authority. The company must also have a physical presence in Estonia: either a local representation or a local board member. The latter must be resident in Estonia.


Each crypto company in Estonia now is required to assign an anti-money laundering officer who must be physically located in Estonia. In addition, the due diligence requirements for the board member and the anti-money laundering contact point have been increased. They must have appropriate education and work experience and be of good repute. The know-your-customer requirements for crypto traders are now equivalent to those for financial institutions.


Virtual currency traders had just over three and a half months to bring their activities into line with these new requirements by 1 July. Not unexpectedly, this short deadline has triggered a high degree of confusion, especially when it concerns the use of fictitious resident shadow directors and the process of freezing permits. The latter will provide traders with a one-year extension to bring their activities into line with the new requirements.


So a considerable number of virtual-currency traders and their advisers are scrambling to comply, fearing that their license will be withdrawn. It clearly means that the increased administrative burden for Estonian supervisors is considerable, also given the legal challenges now be tabled.


The government, for example, has been asked to analyse the legality of the obligation of a board member to be resident in Estonia. There is confusion about the changes brought about by the recent decision of the government to move the RAB, which is currently an autonomous structural unit of Estonia’s Police and Border Guard, known as PPA, to the Ministry of Finance.


The current legal confusion in the wake of the introduction of AMLD5 also makes it difficult to effectively prosecute possible money launderers. A conviction for a money laundering requires indisputable proof during a criminal proceeding. Building such proof requires the close involvement of law enforcement authorities of the country where the offence has been committed. However, several cases have not even reached criminal proceedings. Cooperation with law enforcement authorities in other countries to investigate offences so far has simply not been successful.


Any judicial proceedings against crypto companies registered in Estonia and the administration of justice and criminal proceedings must take place in Estonia. But the reality is that the actual activities and operations of these companies take place outside the country. This means that it is often not possible to determine exactly where a criminal offence has been committed. It shows that the judiciary component also has to be adapted to the reality of a world with crypto currencies.


The steps being made at a European Union level are minimal. In September five EU Member States agreed a joint statement on the protection of consumers from traders in virtual property currencies. Germany, France, Spain, Italy and the Netherlands want to ban virtual currency traders in Europe until suitable regulations are in place. That’s easier said than done.


In Estonia, we can already use virtual currency machines. In the US it is already possible to make donations in virtual money for the presidential campaign. Christine Lagarde, President of the European Central Bank, also has acknowledged that regulation of virtual currencies in Europe is long overdue.

Freezing the market for virtual money by force is an illusion. Virtual currencies have come to stay. Nor should we assumed that all virtual currency traders have a criminal background or use it to move money with a criminal background.


And indeed: the innovation of decentralised blockchain software means that it is possible to enable all parties to follow the history of transactions from the beginning to the end. A crypto currency is protected against counterfeiting. Those that design the laws applicable to crypto currencies need to understand the power of blockchain, and leverage this in the interest of society.


The legal framework for crypto needs to adapt to this new reality as soon as possible. The longer we wait, the more likely it is that one day we will find ourselves in a situation where we have helped criminals to operate in a convenient and alternative system. The market for virtual currencies is indisputably attractive for them at this point in time. The law needs to catch up.


So, let’s make sure that we do not drive into the future while looking into the rear view mirror. Much of the data in the FinCEN Files is several years old, while criminals constantly update and finetune their methods. As the evidence from Estonia, crypto is the latest example. A future-proof AML/CFT framework for all countries in the European Union needs to make it impossible money-launders to use crypto currencies.


If this remains unaddressed, we will certainly face another series of embarrassing exposés in the coming years. Embarrassing not just for banks, but also for governments and the people that run them. And most of all, problematic for society because it means money from criminal activities - drugs trade, trafficking - that make people suffer, and from activities that undermine our democracy, will continue to distort our world.

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