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The term transaction monitoring does not require explanation. The purpose of this process is also quite obvious.
There is no doubt that transaction monitoring is essential to prevent money laundering. However nowadays we should look at this topic more broadly.
Illicit funds can be obtained as a result of predicate crimes such as fraudand used to satisfy gambling habits, a lavish life, or even payments for a mortgage…pretty much anything... The illicit funds are not always laundered.
Some criminals skip the classic three stages of money laundering, and go straight for the integration phase. Despite this it is still an obligation to identify and report such behaviour.
Also not necessarily illicit funds per se, but funds used subsequently for predicate offences might be detected as a part of transaction monitoring focused on cyber risk.
Detecting illegal funds is not the only part of this “puzzle”. Obliged entities have to comply with various sanction regimes and make sure that they will not allow the transfer of funds to and from sanctioned entities or regions. Sanctions checks are also part of transaction monitoring.
Therefore, it is crucial to comprehend the broader transaction monitoring picture - being a response to AML risks (money laundering, terrorist financing and human trafficking), fraud risk, cyber risk and sanction risk.
Transaction monitoring is an ongoing battle waged on multiple fronts. A battle which can make a difference.
How it all started
In 1988 the United Nations held a convention in Vienna, against Illicit Traffic in Narcotic Drugs and Psychotropic Substances. Although the main goal was to tackle the growing problem of illicit substance abuse, the convention also became a cornerstone for modern monitoring of movement of proceeds of crime, not only drug trafficking but also other crimes.
In the beginning of the 90’s two important definitions were forged and became the drive for the first EU AML Directive of 1991: money laundering and predicate offence - “mean any criminal offence as a result of which proceeds were generated that may become the subject of the offence” (from Convention of Council of Europe in Strasbourg in 1990).
Although the 1st AMLD was initially limited to drugs offenses, it set up a course to define a broader range of predicate offenses and international cooperation to fight against money laundering and terrorist financing. Over the years the definitions were expanded, and with the new technologies emerging, some new ones were created. 2nd AMLD extended the scope of 1st AMLD in relation to the range of professions obliged to comply with the AML laws. 3rd AMLD, based on the revised FATF recommendations, covered terrorist financing and introduced enhanced due diligence.
With the fast pacing growth of electronic means of money transfer and years of observations and practice into suspicious activity monitoring, 4th AMLD was introduced in 2015 (in force up to 2020), and it again covered emerging risks - use of gambling sector services to launder the proceeds of crime and use of electronic money. Next, 5th and 6th AMLDs were introduced with implementation deadlines in 2020 and 2021, each identifying new threats and expanding the scope of the Directive into new market participants.
The 6th AML Directive is a continuation of previous directives, and again it points out the importance of awareness of the financial institutions regarding broadening of money laundering predicate offences. The directive includes a list of 22 specific predicate offences for money laundering, which must be followed and considered during compliance performance.1
On the below chart, 22 predicate offences were presented in more detail:
Why is transaction monitoring so important?
Over the years the Directives put more and more emphasis on the crucial aspect of monitoring a customer’s behaviour. In parallel, the secrecy havens are shrinking and becoming less available and AML laws becoming more rigorous.
The law imposes an obligation on financial institutions and other market participants to not only know who their customers are, but also untangle complex beneficial ownerships, and most importantly, understand the source of the funds on the customer’s accounts, and reasons for their transactional behaviours.
Having knowledge of their customers was recognised as a powerful weapon to fight criminality. Worth noting, that this knowledge is crucial to addressing various risks - AML risk (money laundering and terrorist financing) prevention, but also fraud and cyber-risk prevention and sanction regimes compliance.
Although it might seem that the 21st century is the time where all the information is available and within hand’s reach (or chatGPT reach), this is not entirely the truth.
Information Noise and Case Study
While we indeed can easily access multiple data sources, the interconnectedness and complexity of the information, as well as ‘information noise’ of false or outdated information makes it close to impossible to fish out relevant pieces of intel. AML experts need to obtain sophisticated skills to be able to recognise and name suspicious activity and predicate offences.
It will not always be possible to know what kind of illicit activity is underlying the observed suspicious payments pattern, however cooperation between FIs and law enforcement enables the prosecutors to uncover crimes by following the breadcrumbs.
One of the good examples of the cooperation between the FIs and law enforcement was the 2017 human trafficking case in the United States. Knowledge about the patterns, expected behaviours and predicate offences allowed to comprehend large organised crime and stop human exploitation.
21 people were arrested in 2017 in Minnesota District, all accused of sex trafficking of women from Thailand to the United States and laundering the money proceedings. Criminals were using funnel accounts, a known money laundering method, which is related to depositing illegal sources into financial institutions at one geographic location and allowing funds to be rapidly withdrawn at a different location. During these proceedings funds were withdrawn in the United States and then transported as cash or mailed to Thailand.
The prosecution involved predicate crimes including sex trafficking, fraud, human trafficking, threats of force, and money laundering.2 Offenders were equipping their victims with fraudulent visas and other fictitious documents. Criminals forced women to open bank accounts in their own names. Money mules were hired to transport cash from the US to Thailand.3
Example above shows how important monitoring of transactions and customer’s behaviour is to detect a wide spectrum of predicate offences.
Such monitoring is usually performed post factum. However, it might help to identify crime and punish it, as well as to prevent its repetition in the future. In order to complement the review of customer’s activity it is crucial to monitor transactions in real time against sanctions lists. These restrictive measures are necessary to stop transactions from being performed by the entities violating the principles and norms of international law.
Significance of this topic is also highlighted by the recent changes in payments format implemented by the Society for Worldwide Interbank Financial Telecommunication (SWIFT). In March 2023 SWIFT introduced a new format of cross-border payments ISO 20022 messages.4 With ISO 20022, data will become more structured and standardised. New format should help in reducing the number of false positive hits which is a big step towards more efficient monitoring.
Predicate offences, money laundering, sanctions - the list of battles to fight is quite long. The transaction monitoring is essential no matter how broad we look at this process.
However, there is another component that comes in handy to effectively combat crimes - knowledge.
To be aware means to be able to act.
Enjoying this article?
Check out other publications in the “Transaction Monitoring” series:
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Partner, Financial Crime Unit, PwC Poland
Director, Financial Crime Unit, PwC Poland
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