When It Comes To Money Laundering, Cayman Is Not The Problem

Cayman also has extremely high know your customer (KYC) standards, including a verified registry of beneficial owners. And it has been at the forefront of cooperation in combatting international financial crime, signing a Mutual Legal Assistance Treaty with the US as far back as 1986.[ii] So, it came as something of a surprise when in February last year the FATF put Cayman on its AML “grey list”. Insult was then added to injury in February this year, when the EU put Cayman on its AML blacklist. What is going on?

The Financial Action Task Force (FATF) was established by the G7 in 1989 with the aim of reducing the problem of money laundering.[iii] The following year, the FATF issued 40 Recommendations, which became the core anti-money laundering (AML) standards.[iv]  The FATF made major revisions to these Recommendations in 1996, 2003, and 2012, as well as numerous minor adjustments. Among the most important changes were the addition, in 2003, of Recommendations relating to terrorism and proliferation financing, and, in 2012, of 11 “effectiveness” criteria.[v]

The primary means by which the FATF enforces its standards is through the production of mutual evaluation reports (MERs). Undertaken by representatives of regional FATF bodies, these are then reviewed and adopted during the Plenary meetings of the full FATF, which consists of 37 individual members and two regional members.[vi] New MERs have been undertaken each time the FATF has made major revisions to its Recommendations. Jurisdictions are thus on their Fourth Round of MERs. The most recent methodology for assessing compliance with the standards was finalised in 2013 but has been subject to numerous minor updates since.[vii]

Cayman’s initial Fourth Round MER, based on fieldwork undertaken in December 2017 by the Caribbean Financial Action Task Force (CFATF), was completed during 2018.[viii] In that MER, published in March 2019, the CFATF concluded that Cayman was Compliant or Largely Compliant with 27 of the 40 technical Recommendations but only Partially Compliant with the remaining 13 Recommendations. The CFATF also concluded that Cayman achieved a “Moderate” rating on six effectiveness criteria and “Low” on the other five. In the Executive Summary, the CFATF noted:

“The Cayman Islands has a high level of commitment to ensuring their AML/CFT framework is robust and capable of safeguarding the integrity of the jurisdiction’s financial sector. The jurisdiction’s AML/CFT regime is complemented by a well developed legal and institutional framework.”[ix]

However, it followed this immediately with the claim that “As a major international financial centre, the Cayman Islands is confronted with inherent ML/TF risks, threats and associated vulnerabilities emanating from domestic and foreign criminal activities (e.g. tax evasion, fraud, drug trafficking).”[x] And later, it asserted, ominously:

“Recognising the role of the financial sector as well as the interconnectedness to the global market, more analysis of the jurisdiction’s vulnerabilities to potential for complex ML/TF/PF schemes is required. Ultimately, significant efforts are required by the jurisdiction to ensure that it is capable of mitigating these vulnerabilities.”[xi]

Following the publication of the MER, the FATF automatically placed Cayman under “enhanced follow-up” because it was both Non-Compliant or Partially Compliant on eight or more of the Recommendations and had Low or Moderate effectiveness for seven or more of the effectiveness criteria.[xii] This led to a series of follow-up reports (FURs), the first published in November 2019 and the second in February 2021. Both reports focused exclusively on the 40 technical Recommendations. By February 2021, Cayman was deemed to be Compliant or Largely Compliant with 39 of the 40 Recommendations.[xiii]

The one Recommendation on which Cayman was only Partially Compliant was number 15 (R. 15), which pertains to risks from new technologies. At first sight, this seems odd because Cayman had been deemed Largely Compliant on R.15 in the 2019 MER. But the FATF changed the criteria for R. 15 in October 2018, after the completion of CFATF’s site visit to Cayman, adding in an obligation to establish a regime for regulating “Virtual Asset Service Providers” (VASPs).[xiv] Ironically, Cayman had passed its VASP law in October 2020, but that was after the February 2021 assessment was completed.[xv] Regardless, by February 2021, Cayman had fewer technical deficiencies than almost any other FATF-regulated jurisdiction.[xvi]

In spite of the FURs focusing exclusively on the 40 technical Recommendations and in spite of Cayman essentially acing the second FUR, successfully addressing 60 of the 63 deficiencies identified by the CFATF, when the FATF came to assess the report during the Plenary meeting in February 2021, it decided to place Cayman on its list of jurisdictions under increased monitoring. The reason? Cayman’s poor showing on the effectiveness criteria, which had last been evaluated during a site visit in December 2017—more than three years’ previously—and which accounted for the three remaining deficiencies.

To an outsider, this all seems very peculiar. If the FATF’s technical criteria serve any purpose, they must, surely, have a bearing on the effectiveness of a jurisdiction’s AML/CFT regime. So, why would the FATF choose to sanction a jurisdiction after it had already made significant improvements in meeting the technical criteria, especially given that the FURs did not look at effectiveness? How did the FATF even know whether or not Cayman’s AML/CFT was (still) deficient in effectiveness?

As noted, unlike most jurisdictions, Cayman’s AML/CFT framework requires service providers to verify the beneficial owners of Cayman entities. They must also verify the source of funds used in financial transactions. Failure to comply with these obligations are criminal offences punishable with fines and custodial sentences. Together, these measures are highly effective at discouraging potential money launderers from using Cayman.^[xvii] In other words, the low rate of prosecution of money laundering in Cayman can be explained by Cayman’s tough and rigorously applied KYC/AML/CFT laws, which encourage money launderers to go elsewhere.

The point being that the FATF’s measures of effectiveness are misplaced, at least for a jurisdiction such as Cayman whose very high standards act as an effective deterrent to financial malfeasance. An analogy with mosquito control is apposite. Until the 1950s, mosquitos were so prevalent in Cayman that in summer people rarely ventured out after dark and there were reports of animals suffocating from inhaling them. Then, starting in the 1960s, Cayman invested heavily in mosquito control. As a result, mosquitos are now a minor nuisance in Cayman, leaving humans and animals free to breathe the night air. The lesson is clear: if you reduce the source of a problem, there will be fewer problems to solve.

Perhaps one can forgive the FATF for misunderstanding Cayman’s approach to AML/CFT. After all, few of the 37 individual member jurisdictions of the FATF come close to meeting all the FATF’s technical Recommendations; indeed, several would seem to meet the criteria for being subject to enhanced monitoring but somehow have avoided such a fate. Even fewer have a system of verified beneficial ownership—which goes beyond the FATF’s Recommendations and is arguably far better at deterring criminal activity. Nonetheless, it does seem rather odd that the FATF would effectively impose a stricter penalty on Cayman after it had demonstrably improved its compliance than before.

Worse than the FATF’s decision to grey list Cayman have been the responses by other FATF members, several of which have imposed enhanced customer due diligence (ECDD), even though the FATF explicitly states that this is not necessary.

Then there is the decision by the European Union to place Cayman on its list of High Risk Third Countries – aka its AML Blacklist.[xviii] While this decision was essentially automatic given the EU’s methodology for adding jurisdictions to its blacklist,[xix] it was nonetheless undesirable for several reasons.

First, Cayman arguably has higher AML/CFT standards than many EU jurisdictions, so to the extent that the blacklisting caused EU-based persons to use EU-based structures rather than Cayman structures, it may have made it more difficult to identify instances of money laundering and terrorism financing. (Don’t even mention Wirecard.[xx])

Second, after the FATF put Cayman on its grey list, the EU introduced changes to its rules regarding securitisation special purpose entities (SSPEs), specifying that they cannot be established in jurisdictions on the list of high-risk third countries.[xxi] Firms specialising in the structuring of SSPEs have been shifting Cayman SSPEs, such as collateralised loan obligations issued by US corporations and seeking EU-domiciled investors, to other jurisdictions, such as Jersey.[xxii] Since there is no evidence that Cayman SSPEs present any greater ML/TF threat compared with Jersey SSPEs, this simply represents an additional cost with no benefits.

Third, Cayman facilitates hundreds of billions of Euros of investment into the EU by pooling assets in a tax neutral manner from investors in multiple jurisdictions.[xxiii] These investments improve the lives of tens of millions of EU citizens and generate billions of Euros in revenue to member state governments.[xxiv] The AML blacklist complicates such investments unnecessarily, adding costs to the transaction process. While the blacklist is unlikely to diminish Cayman’s role as a tax neutral jurisdiction for such funds, by adding costs it will reduce the benefits of such investments to the people of the EU.

Fourth, the EU listing came a year after the FATF listing, by which time at least one of the three alleged “effectiveness” issues that motivated the FATF listing had already been addressed and it seems likely the Cayman will be removed from the FATF grey list by October 2022. Unfortunately, while an EU blacklisting is an almost automatic consequence of an FATF grey listing, removal from the FATF grey list does not guarantee removal from the EU blacklist.

Some might object that Cayman deserves to be on both the FATF grey list and the EU blacklist because it will prevent some money laundering and terrorism financing, which, given the massive global scale of these problems, would be no bad thing. But this is almost certainly not true. Indeed, the opposite is more likely the case.

A careful recent analysis by AML expert Ronald Pol suggests that the current global AML regime, of which the FATF and EU regulations form core parts, does next to nothing to prevent money laundering.[xxv] Moreover, Pol notes that the massive cost of current AML efforts, which fall largely on consumers and borrowers in the form of higher costs of banking, vastly exceed the meagre benefits.

There is also an enormous opportunity cost to the current unwieldy, subjective, and inefficient global AML/CFT regime which unwittingly targets jurisdictions such as Cayman that have in place highly effective AML/CFT measures while giving a green light to many less salubrious jurisdictions. Given the limited resources available to address money laundering and terrorism financing, the focus of AML/CFT efforts on Cayman by the FATF and EU effectively enables more money laundering and terrorism financing to take place globally. It is time for regime change.

 

 

Footnotes:

[i] Julian Morris, Cayman: Engine of Growth and Good Governance, Cayman Finance, 2021. https://caymanfinance.ky/wp-content/uploads/2021/10/20211012_CF-MNE-CIV-confidential-FINAL-9534818.pdf   See also: https://databank.worldbank.org/source/worldwide-governance-indicators

[ii] Cayman signed the MLAT treaty in 1986 but the US Senate did not ratify it until October 1989; the US President then signed it into law on 2 January 1990, the UK ratified it one week later, and it entered into force in March 1990. See: https://www.congress.gov/treaty-document/100th-congress/8 and https://www.state.gov/90-319. See also Nathaniel C. Nash, U.S. and Caymans Sign Crime Pact, The New York Times, July 4, 1986. https://www.nytimes.com/1986/07/04/business/us-and-caymans-sign-crime-pact.html

[iii] https://www.fatf-gafi.org/about/historyofthefatf/

[iv] https://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/FATF%20Recommendations%201990.pdf

[v] Originally, the AFT criteria were separate “Special Recommendations” but were subsequently subsumed into the amended 40 Recommendations. The “effectiveness” criteria remain separate.

[vi] https://www.fatf-gafi.org/about/membersandobservers/

[vii] http://www.fatf-gafi.org/publications/mutualevaluations/documents/fatf-methodology.html

[viii] https://www.cfatf-gafic.org/documents/4th-round-meval-reports/11255-fourth-round-mutual-evaluation-report-for-cayman-islands/file

[ix] Ibid. at p. 5.

[x] Ibid.

[xi] Ibid. at p. 8.

[xii] https://www.fatf-gafi.org/media/fatf/FATF-Universal-Procedures.pdf at p. 8.

[xiii] https://www.fatf-gafi.org/media/fatf/documents/reports/fur/CFATF-2nd-Follow-Up-Report-Cayman-Islands.pdf

[xiv] https://www.fatf-gafi.org/publications/fatfrecommendations/documents/fatf-recommendations.html

[xv] https://www.collascrill.com/news-updates/articles/virtual-assets-service-providers-vasp-regime-commencement/#:~:text=The%20VASP%20Act%20requires%20all,under%20the%20VASP%20Act%3B%20or

[xvi] https://www.fatf-gafi.org/media/fatf/documents/4th-Round-Ratings.pdf

[xvii] Dorothy Scott, “Sharing Financial Information: The Cayman Story Worth Telling,” Mondaq Business Briefing, 14 March 2017

[xviii] https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32022R0229&qid=1645520532786&from=en

[xix] European Commission, Methodology for identifying high-risk third countries under Directive (EU) 2015/849, Commission Staff Working Document. SWD(2020) 99 final. Brussels, 7.5.2020. At p. 5.

[xx] https://www.moneylaunderingnews.com/2020/07/wirecard-a-scandal/

[xxi] https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32021R0557&from=EN

[xxii] https://maples.com/en/news/2022/3/maples-group-supports-first-clo-migrations-to-jersey

[xxiii] https://caymanfinance.ky/wp-content/uploads/2021/06/EU-EOV-Brochure-Digital.pdf

[xxiv] Morris, supra note 1.

[xxv] https://www.tandfonline.com/doi/full/10.1080/25741292.2020.1725366