Table of Contents
Chapter 8: Financial Action Task Force and Its Recommendations on AML and CFT
The Financial Action Task Force (FATF) is the premier global intergovernmental organization dedicated to setting international standards and promoting the effective implementation of legal, regulatory, and operational measures for combating money laundering, terrorist financing, and proliferation financing (ML/TF/PF).
GENESIS AND EXPANSION OF FATF MANDATE
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[ 1989 G7 Paris Summit ]: Established to counter drug-trafficking money laundering
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[ 1990 ]: Formulated the original FATF 40 Recommendations
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[ 2001 (Post 9/11) ]: Expanded mandate to include Counter-Terrorist Financing (8 Special Recs)
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[ 2004 ]: Added 9th Special Recommendation on Cash Couriers (40 + 9 Recommendations)
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[ 2012 Revision ]: Comprehensive overhaul integrating 40 Recommendations; added Proliferation
Financing of Weapons of Mass Destruction (WMD)
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[ 2019 Ministers' Meeting ]: Granted open-ended, permanent mandate (replacing time-bound renewals)
Institutional Structure of the FATF
- The FATF Plenary: The supreme decision-making body of the FATF. It convenes three times a year (typically in February, June, and October) to review mutual evaluation reports, update standards, review emerging typologies, and issue public listings of high-risk jurisdictions.
- FATF Presidency: The FATF President is a senior official appointed by the Plenary from among its member states for a two-year term (commencing on July 1 and ending on June 30 two years later). The President chairs the Plenary and Steering Group and acts as the principal global spokesperson. Elisa de Anda Madrazo of Mexico assumed the FATF Presidency for the term July 1, 2024 to June 30, 2026, succeeding T. Raja Kumar of Singapore. Giles Thomson of the United Kingdom serves as Vice-President.
- Global Network & FSRBs: The FATF comprises 40 member jurisdictions (including India, which joined as a full member in 2010). However, its global reach extends across more than 200 jurisdictions through nine FATF-Style Regional Bodies (FSRBs):
- Asia/Pacific Group on Money Laundering (APG) - India is a member
- Caribbean Financial Action Task Force (CFATF)
- Council of Europe Committee of Experts on the Evaluation of Anti-Money Laundering Measures (MONEYVAL)
- Eurasian Group (EAG) - India is a member
- Eastern and Southern Africa Anti-Money Laundering Group (ESAAMLG)
- Financial Action Task Force of Latin America (GAFILAT)
- Inter-Governmental Action Group against Money Laundering in West Africa (GIABA)
- Middle East and North Africa Financial Action Task Force (MENAFATF)
- Task Force on Money Laundering in Central Africa (GABAC).
FATF GLOBAL PUBLIC LISTINGS
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┌────────────────────────────────┴────────────────────────────────┐
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[ Jurisdictions under Increased Monitoring ] [ High-Risk Jurisdictions Subject to a Call ]
("GREY LIST") ("BLACK LIST")
- Strategic deficiencies identified in AML/CFT - Substantial strategic deficiencies in AML/CFT/PF
- Country has committed to an Action Plan with FATF - High threat to international financial integrity
- Subject to heightened monitoring and progress audits - FATF calls on all nations to apply:
- Examples: Jurisdictions working through action plans 1. Enhanced Due Diligence (EDD)
2. Countermeasures (sanctions, transaction bans)
- Standard Jurisdictions: DPRK, Iran, Myanmar
The Dual Public Sanction Lists: Grey List vs. Black List
- Jurisdictions under Increased Monitoring (The Grey List):
- When the FATF places a jurisdiction on this list, it signifies that the country has formally committed to resolve identified strategic deficiencies within agreed timeframes under active FATF monitoring.
- Impact on IFSC Intermediaries: Transactions involving banks or counterparties in grey-listed jurisdictions must automatically be assigned an elevated risk rating, triggering enhanced transaction scrutiny and verification of source of funds.
- High-Risk Jurisdictions Subject to a Call for Action (The Black List):
- Reserved for countries with catastrophic, systemic deficiencies in their AML/CFT/PF regimes that present a direct hazard to the international financial system.
- For black-listed states (e.g., Democratic People's Republic of Korea, Iran, Myanmar), the FATF calls upon all member states to apply Enhanced Due Diligence and, in extreme scenarios, targeted countermeasures (such as prohibiting financial institutions from opening branches in those states, limiting correspondent banking relationships, and barring cross-border fund transfers).
The FATF 40 Recommendations constitute the universally recognized international benchmark for anti-money laundering and counter-terrorist financing legislation. National governments and financial sector regulators—including the Ministry of Finance, SEBI, RBI, and IFSCA—draft their domestic statutes and guidelines to align directly with these recommendations.
The 40 Recommendations are organized into 7 Core Thematic Pillars:
THE 7 THEMATIC PILLARS OF FATF 40 RECOMMENDATIONS
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┌──────────┬──────────┬──────────┬──────┴───┬──────────┬──────────┬──────────┐
▼ ▼ ▼ ▼ ▼ ▼ ▼ ▼
[ Pillar A ] [ Pillar B ] [ Pillar C ] [ Pillar D ] [ Pillar E ] [ Pillar F ] [ Pillar G ]
AML/CFT Money Terrorist Preventive Transpar- Powers of Interna-
Policies & Laundering Financing & Measures ency & UBO Competent tional
Coordina- & Confis- Prolifera- (CDD, PEPs, (Legal Authorities Coopera-
tion cation tion Recordkeep) Persons) (FIU, LEAs) tion
Pillar-by-Pillar Breakdown of Key Recommendations
Pillar A: AML/CFT Policies and Coordination (Rec 1 & 2)
- Recommendation 1 (Assessing risks & applying a risk-based approach): Mandates that countries and financial institutions identify, assess, and understand their ML/TF risks and apply resources proportionally to mitigate them.
- Recommendation 2 (National cooperation and coordination): Requires inter-agency mechanisms (e.g., between IFSCA, FIU-IND, ED, and SEBI) to coordinate AML policy formulation.
Pillar B: Money Laundering and Confiscation (Rec 3 & 4)
- Recommendation 3 (Money laundering offence): Mandates the criminalisation of money laundering on the basis of the Vienna and Palermo Conventions, applying it to all serious predicate offences.
- Recommendation 4 (Confiscation and provisional measures): Directs countries to enact legal mechanisms enabling the freezing, seizure, and confiscation of criminal proceeds without prejudicing the rights of bona fide third parties.
Pillar C: Terrorist Financing and Financing of Proliferation (Rec 5 to 8)
- Recommendation 5 (Terrorist financing offence): Criminalises the financing of terrorist acts, individual terrorists, and terrorist organisations, irrespective of whether funds are derived from legal or illegal sources.
- Recommendation 6 & 7 (Targeted financial sanctions): Obligates countries to implement targeted financial sanctions regimes to comply with UN Security Council resolutions relating to the prevention of terrorism (UNSCR 1267/1373) and the prevention of proliferation of weapons of mass destruction.
- Recommendation 8 (Non-profit organisations): Requires targeted oversight of NPOs vulnerable to terrorist financing abuse.
Pillar D: Preventive Measures for the Financial Sector (Rec 9 to 23)
- Recommendation 10 (Customer due diligence - CDD): Prohibits anonymous accounts; establishes CDD thresholds, identification of natural and legal persons, and Beneficial Ownership discovery.
- Recommendation 11 (Record-keeping): Requires financial institutions to maintain all transaction records for at least 5 years.
- Recommendation 12 (Politically exposed persons - PEPs): Mandates risk management systems to determine if a client is a PEP, requiring senior management approval and source of wealth verification.
- Recommendation 13 (Correspondent banking): Prohibits entering into correspondent relationships with shell banks; requires gathering sufficient information on respondent institutions.
- Recommendation 16 (Wire transfers - 'Travel Rule'): Requires ordering and beneficiary financial institutions to obtain, verify, and transmit accurate originator and beneficiary information alongside cross-border wire transfers.
- Recommendation 20 (Reporting of suspicious transactions): Mandates that financial institutions report suspicious transactions promptly to the national Financial Intelligence Unit (FIU).
- Recommendation 21 (Tipping-off and confidentiality): Legally shields institutions from liability when reporting in good faith, and strictly prohibits tipping off the client.
Pillar E: Transparency and Beneficial Ownership of Legal Persons (Rec 24 & 25)
- Recommendation 24 & 25: Requires countries to ensure that competent authorities have timely access to adequate, accurate, and up-to-date information on the beneficial ownership and control of companies, legal arrangements, and trusts.
Pillar F: Powers and Responsibilities of Competent Authorities (Rec 26 to 35)
- Recommendation 26 to 29: Mandates the establishment of an independent, operational Financial Intelligence Unit (FIU), adequate supervisory powers, and law enforcement investigative authority.
Pillar G: International Cooperation (Rec 36 to 40)
- Recommendation 36 to 40: Obligates countries to provide rapid, constructive, and effective mutual legal assistance (MLA), extradition, and regulatory information exchange.
As the global banking system implemented sophisticated automated transaction monitoring to detect wire transfer layering, criminal organizations increasingly shifted to the international merchandise trade system to disguise illicit wealth. Trade-Based Money Laundering (TBML) is defined by the FATF as the process of disguising the proceeds of crime and moving value across borders through the use of trade transactions in an attempt to legitimize their illicit origins.
The international trade ecosystem is uniquely vulnerable to exploitation due to:
- Enormous global trade volumes masking illicit flows;
- The complexity of multi-jurisdictional shipping logistics;
- The commingling of legitimate commercial trade financing with criminal proceeds; and
- Information asymmetries between customs agencies, tax authorities, and financial institutions.
THE 4 CLASSIC TBML MODUS OPERANDI
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┌───────────────────┬─────────────┴─────────────┬───────────────────┐
▼ ▼ ▼ ▼
[ Over-Invoicing / [ Multiple Invoicing ] [ Over / Under- [ Falsely Described ]
Under-Invoicing ] Shipments ] [ Goods & Services ]
- Over-Invoicing: - Same shipment invoiced - Phantom Shipment: - Cheap goods billed
Goods priced above multiple times zero goods shipped, as luxury goods
fair market value - Justifies duplicate all paperwork - Intangible services
- Under-Invoicing: cross-border bank processed (consulting/IP)
Goods priced below remittances - Under-shipment: with zero market
fair market value less volume shipped benchmark
The 4 Primary Techniques of Trade-Based Money Laundering
1. Over-Invoicing and Under-Invoicing of Goods and Services
- Over-Invoicing: An exporter invoices goods at a price far higher than their fair market value. When the importer remits payment, excess value is transferred from the importer to the exporter.
- Example: Shipping industrial valves worth $10,000 but invoicing them at $100,000. The importer transfers $100,000, thereby transferring $90,000 of illicit capital across borders under the guise of genuine trade.
- Under-Invoicing: An exporter invoices goods at a price substantially lower than their fair market value. The importer subsequently sells the goods in the open market at real market value, realizing the difference.
- Example: Shipping luxury electronics worth $200,000 but invoicing them at $20,000. When the importer sells them for $200,000, the importer captures $180,000 in untainted commercial proceeds.
2. Multiple Invoicing of Goods and Services
A criminal syndicate issues multiple invoices for the exact same underlying shipment of goods. By using different banks or financing facilities across jurisdictions, the importer justifies multiple payments to the exporter for a single physical consignment.
3. Over- and Under-Shipment (Phantom Shipments)
- Over-Shipment: Shipping a larger quantity of goods than indicated on invoices.
- Under-Shipment / Phantom Shipments: The exporter bills for goods but ships a substantially lesser quantity, or in extreme cases, ships no goods at all (Phantom Shipment). The importer and exporter collude with corrupt logistics agents to generate fraudulent bills of lading, customs declarations, and certificates of origin to trigger trade finance payouts from unwitting commercial banks.
4. Falsely Described Goods and Services
Manipulating the description, grade, or quality of the goods. Inexpensive, low-grade merchandise is falsely declared as premium, high-value commodities (e.g., shipping low-grade scrap metal labeled as high-purity copper cathodes). This technique is also rampant in cross-border services (such as management consulting, software licensing, and market research), where objective market valuations are notoriously difficult to ascertain.
Complex TBML: The Black Market Peso Exchange (BMPE)
The Black Market Peso Exchange (BMPE) is a sophisticated, multi-layered TBML methodology originally developed by Colombian drug cartels, now replicated globally across diverse currencies.
BLACK MARKET PESO EXCHANGE (BMPE) MECHANISM
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[ Drug Cartel sells narcotics in Country A (e.g., US) for cash ]
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[ Cartel sells illicit cash at a discount to a Peso Broker ]
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┌───────────────────────┴───────────────────────┐
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[ Broker deposits cash into [ Legitimate Importer in Country B
financial system in smurfed wishes to buy goods from Country A ]
amounts / shell accounts ] │
│ ▼
│ [ Importer buys cheap dollars
│ from Broker in Country B ]
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└───────────────────────┬───────────────────────┘
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[ Broker pays Country A Exporter on behalf of Importer ]
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[ Exporter ships legitimate manufactured goods to Country B ]
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[ Importer sells goods in Country B and pays Broker in local currency ]
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[ Broker remits clean local currency to Drug Cartel ]
International Trade Compliance Controls for GIFT IFSC Entities
As GIFT IFSC develops into an international trade finance, aircraft/ship leasing, and bullion trading hub, Regulated Entities facilitating letters of credit (LCs), documentary collections, and trade loans must enforce stringent trade compliance controls:
- Unit Price Verification: Cross-referencing declared invoice unit prices against global commodity spot benchmarks (e.g., London Metal Exchange, Platts, ICIS) to flag significant pricing variances exceeding normal commercial tolerances (e.g., $\pm 10%-15%$).
- Dual-Use Goods Screening: Automated screening of cargo descriptions, Harmonized System (HS) codes, and end-users against export control lists for dual-use technologies capable of weapons proliferation.
- Vessel Tracking and Maritime Due Diligence: Utilizing automatic identification systems (AIS) to track shipping vessels, verifying that vessels did not execute covert ship-to-ship transfers, disable transponders, or make unscheduled port calls in sanctioned nations.
- Scrutiny of Third-Party Intermediaries: Investigating red flags such as payments originating from unknown third parties unassociated with the trade contract, letters of credit with frequently amended beneficiary details, or transshipment routes lacking economic justification.