The sanctions imposed on Russia by the West are tightening every day as the brutal war on Ukrainian soil continues.

We recently wrote about Russian sanctions and global supply chains. Financial institutions and suppliers are grappling to keep up to date with new regulations and what these might mean for their organisation.

In such uncertain times, illion’s Head of AML, Gihan Wijesundara, says it’s important for risk professionals to revisit proliferation financing, the freezing of assets – and potential impacts outside of Europe.

What is proliferation financing? 

As a start, it is worth reviewing the United Nations Security Council Resolutions (UNSCRs) relating to the prevention of weapons of mass destruction (WMD) proliferation. UNSCR 1540 was passed unanimously on April 28, 2004 against the proliferation of WMD. This resolution addresses the full range of WMD proliferation activities, which includes the acquisition of WMD by non-state actors and support for proliferators.

Who are these non-state actors? Non-state actors are an ‘individual or entity, not acting under the lawful authority of any State in conducting activities, which come within the scope of the resolution’. UNSCR 1540 not only focuses on terrorists, but on a broader concept of non-state actors. This is what we call the global approach for non-proliferation.

The other approach is called the country-specific approach and is focused on UNSCR 1718 and its successor resolution designed around the Democratic People’s Republic of Korea (DPRK) and the UNSCR 2231 on Iran. A country-specific resolution extends activity-based financial prohibitions, requiring countries to prohibit or prevent certain financial activities within the DPRK and Iran.
Countries are further required to exercise vigilance and prevent the procurement of items, materials, goods and technology by the DPRK and prohibit the trade of certain types of materials or goods that could contribute to a WMD.

The Financial Action Task Force (FATF) Recommendation 7 on ‘targeted financial sanctions related to proliferation’ further requires countries to meet international obligations to counter financing of proliferation. As per the FATF Recommendation 7, all the countries are required to implement Targeted Financial Sanctions (TFS) to comply with United Nations Security Council resolutions relating to the prevention, suppression and disruption of proliferation of WMD and its financing.

Further, these resolutions require countries to freeze, without delay, the funds or assets of, and to ensure that no funds and other assets are made available, directly or indirectly, to or for the benefit of any person or entity designated by, or under the authority of, the United Nations Security Council under Chapter VII of the Charter of the United Nations.

It should be also noted that the revised FATF Recommendation 1, set out in October 2020, requires financial institutions, designated non-financial businesses and professions (DNFBPs), and virtual asset service providers (VASPs) to have in place processes and procedures to identify, assess, monitor, manage and mitigate proliferation financing risks.

What are weapons of mass destruction?

WMD refers to nuclear, chemical and biological weapons and their means of delivery which poses a threat to international peace and security. The UNSCR 1540 requires all States to ‘adopt and enforce appropriate effective laws that prohibit any non-State actor to manufacture, acquire, possess, develop, transport, transfer or use nuclear, chemical or biological weapons and their means of delivery, in particular for terrorist purposes, as well as attempts to engage in any of the foregoing activities, participate in them as an accomplice, assist or finance them’.

What are proliferation financing risks and how do we mitigate against them?

Let’s explore the following risks mentioned in the FATF guidance:

1. Risk of a potential breach or non-implementation of targeted financial sanctions

If the designated persons and entities gain access to financial service, funds, assets or other economic resources, this risk will materialise. If the financial institutions, DNFBPs and VASPs fail to adopt adequate policies and procedures to mitigate proliferation risks, it can also
contribute to exacerbate risks. For instance, weak customer onboarding procedures, inadequate ongoing customer due diligence programs, absence or lack of proper screening solutions and overall deficiencies in risk management and compliance functions are the main culprits.

2. Risk of evasion of targeted financial sanctions

The designated persons and entities may take evasive action to avoid sanctions by using methods such as shell companies, complex ownership structures, proliferation networks and obscuring beneficial ownership.

Some of the risk mitigation measures to counter proliferation financing risks are:

• Improved onboarding processes for customers (including beneficial owners).
• Enhanced customer due diligence procedures.
• Effective maintenance of customer master data.
• Regular controls to ensure effectiveness of procedures for sanctions screening.
• Leveraging the existing compliance programs (including internal controls) to identify potential sanctions evasion.

When should you screen your customers?

As evident from above, countering the proliferation financing of WMD is complicated. If you are exporting any military goods or dual-use goods (items which have both military and civil application), you need to ensure that end users do not use or sell on these items to sanctioned parties. As a financial institution, DNFBP, or VASP, you need to ensure that your customer as well as any beneficiaries of transactions who are non-customers are not sanctioned.

To simplify when you need to screen your customers for such sanctions, we can revert back to the circumstances in which financial institutions, DNFBPs, and VASPs are supposed to conduct customer due diligence.

FATF Recommendations 6, 7, 10, 15, 16 and 22, suggest that the following criteria must be highlighted when onboarding a customer and when screening to counter proliferation financing.

1. During the establishment of the customer relationship (prior to onboarding of the customer, not after).
2. When the designated list has been updated (new entries have been added, current entries have been modified, or additional information has been added).
3. When customer information is updated (name changes, address changes, etc.).
4. When conducting transactions for occasional customers.
5. When conducting wire transfers.
6. When conducting virtual asset activities and the activities or operations of VASPs.

The above criteria are only relevant to mitigating proliferation financing risks. However, the screening of customers should extend beyond that to mitigate risks. This includes PEPs, other sanction lists, adverse media, warnings, fit and propriety, criminal history, watchlists, jurisdiction,
etc. In such instances, the following criteria should also be considered for screening.

1. Regular screening of the customer base following a risk-based approach.
2. When there are changes to the risk profile of the customers (e.g. types and nature of transactions conducted, business, source of funds, purpose and intended nature of the business relationship, etc.).
3. Conducting ongoing customer due diligence to review customer profiles.

It should be noted that the above list is not exhaustive, but does provide some insights into screening obligations.

Why a robust KYC and ongoing customer due diligence program is essential for effective sanctions screening

It is a common misconception that KYC sanctions screening is set and forget, it’s not. If the KYC information is incorrect, obsolete, or incomplete, it will start causing problems for your business sooner or later.

For the best results, customers need to perform their own due diligence which works hand in hand with sanctions screening. If the KYC information entered into the software solution is incorrect, obsolete, or incomplete, a positive match is less likely. Even if a positive is achieved with bad data, a business will not know if the regulation applies to the individual or the whole entity. This level of
detail is needed when dealing with sanctions and has the potential to cause more problems and aggravate the issue rather than solving it.

If the KYC information is up to date, accurate, and complete, and is supported by a robust ongoing customer due diligence process, it will provide the assurance needed for the compliance and risk-management teams to set greater confidence thresholds in matching.

illion is uniquely positioned to transform the processes of an institution meeting AML/CTF obligations, while providing a smooth customer experience. Accurate and up-to-date customer information from illion enables you to meet AML/CTF obligations in relation to customer
onboarding, as well as ongoing customer due diligence.

Unveiling ultimate beneficial ownership is another challenging area where illion’s products and expertise can greatly assist to mitigate risks. illion pulls data from independent and reliable sources, which is critical to meet safe AML standards.

When should you freeze assets?

In order to understand the expectations on freezing assets, it is important to note the term ‘without delay’ which is repeatedly mentioned across FATF documents and reports. Below is the definition.

‘The phrase without delay means, ideally, within a matter of hours of a designation by the United Nations Security Council or its relevant Sanctions Committee (e.g. the 1267 Committee, the 1988 Committee, the 1718 Sanctions Committee). For the purposes of S/RES/1373(2001), the phrase without delay means upon having reasonable grounds, or a reasonable basis, to suspect or believe that a person or entity is a terrorist, one who finances terrorism or a terrorist organisation. In both cases, the phrase without delay should be interpreted in the context of the need to prevent the flight or dissipation of funds or other assets which are linked to terrorists, terrorist organisations, those who finance terrorism,
and to the financing of proliferation of weapons of mass destruction, and the need for global, concerted action to interdict and disrupt their flow swiftly.’

As you can see, it mentions ‘ideally, within a matter of hours of a designation’, which is the level of compliance standard that must be upheld. When a designation list is updated, sanctions screening should be carried out immediately and measures should be taken to freeze any assets that are flagged. At first, this may seem like a daunting task.

illion has partnered with leading sanctions screening solutions providers to uplift the compliance capabilities of financial institutions, DNFBPs, and VASPs. These solutions can be customised to meet the requirements of reporting institutions. Whether it is a one-off search, list-based search, or the entire customer base, illion can cater to the requirements.

Challenges in freezing assets

We should be mindful that designated lists are public documents. The designated persons and entities will take all possible measures to evade sanctions. Many of them hide behind complex corporate structures to obscure beneficial ownership. This is why it is important to understand the
corporate structures, controlling ownerships, beneficial ownership and ultimate beneficial ownership, persons, or entities acting on behalf of such designated persons or entities and representative offices. To infiltrate these proliferation networks, it is essential to conduct customer
due diligence including identifying beneficial ownership, control structures, and to have proper tools such as screening solutions.

In conclusion, a good start would be to first review your current proliferation financing risk assessment and then contact an illion solutions specialist who can show you how our AML/KYC solutions can help protect your business.

For more information please fill in the form at the bottom of the page.

Disclaimer

The views expressed herein are of the author and not of illion.

References

1. FATF (2012-2022), International Standards on Combating Money Laundering and the
   Financing of Terrorism & Proliferation, FATF, Paris, France, www.fatfgafi.org/recommendations.html
2. FATF (2013-2021), Methodology for Assessing Compliance with the FATF Recommendations
   and the Effectiveness of AML/CFT Systems, updated October 2021, FATF, Paris, France,
3. FATF (2018), Guidance on Counter Proliferation Financing – The Implementation of Financial
   Provisions of United Nations Security Council Resolutions to Counter the Proliferation of Weapons of Mass Destruction, FATF, Paris www.fatfgafi.org/publications/fatfrecommendations/documents/guidance-counter-proliferationfinancing.html 
4. FATF (2021), Guidance on Proliferation Financing Risk Assessment and Mitigation, FATF,
   Paris, France, https://www.fatf-gafi.org/publications/financingofproliferation/documents/proliferation-financing-risk-assessment-mitigation.html
5. https://www.un.org/disarmament/wmd/sc1540/
6. https://www.un.org/securitycouncil/sanctions/1718#current%20sanction%20measures
7. https://www.un.org/disarmament/wmd/
8. https://www.un.org/en/sc/1540/faq.shtml

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