‘Compliance of corporate, non-financial sector a weak link… In India, regulators working to bridge the gaps’: Mohamed Daoud

Under both the FATF recommendations and the PMLA, the directors, the shareholders and the owners of a company need to be screened to check if one of them is sanctioned or on a watchlist, what is their level of ownership? Is the owner foreign? Is he linked to any sanction party (corporate or individuals)? Is he linked to a sanctioned country? The checking of ownership is required for both the banking/financial sector as well the non-financial sector.

The newly added PMLA sectors are part of the non-financial sector called by the FATF as “Designated Non-Financial Business and Professions” (DNFBP) and include real estate, dealers in precious metals and stones, law/legal firms and other notaries which the PMLA is not targeting yet.

These requirements have been part of the FATF recommendations for the last 15- years, however, now that it is part of the local AML regulation, it will be subject to enforcement and supervision to make sure that organisations are looking for this type of information. There is a big concern in the region related to sanction evasion through shell companies created by foreign entities. For instance, I am coming from Dubai, so I know the problem: there are a lot of oligarchs and a lot of assets are linked with them. So, the local regulators and the international institutions are making sure that neither the banking systems nor the corporate sector are misused by shell companies for financial crime.

The banking and financial sector in India has a high maturity in compliance thanks to the Reserve Bank of India. In addition to the banking and financial sector, there are now increased requirements for the corporate sector to comply with the FATF recommendations. There will be a FATF evaluation of India, scheduled at the end of this year, the date is not yet confirmed but it will happen. From the recent evaluations of regional countries, the focus of the FATF evaluation assessment will be on the corporate and non-financial sectors.

The non-financial sectors, by nature, have serious weaknesses and misunderstandings of what is AML/CFT compliance and how to implement this regulation. They might be companies doing business with foreign owned third-parties without knowing that these third-parties’ companies are sanctioned, or are suspected of money laundering or other financial crime. Therefore, there is a huge pressure on the non-financial sector to start checking who are the directors and shareholders behind the companies they are dealing with. Where are these companies coming from, are they based in high-risk countries? Is one of the owners flagged in another country? For Indian companies, it is important to know if the beneficial owners are foreigners, which nationalities, and where they are operating from.

Q: Two things: one, you mentioned the directors of the companies might not be known and where the actual beneficial owners are not known, those companies are under the watch. There have been earlier instances for tax evasion, there have been cases of shell companies. So, why are you specifically concerned about the transactions from countries under sanctions?

A: A tax issue is a financial risk and is mainly an internal issue to a country. The AML/CFT regulation is related to international reputation risk. One very important rule to know is the regulation that will apply for transactions is not the countries where these transactions occurred but rather the regulation of the country of the used currency. If it is a USD (US dollar) transaction, then it is the US laws and regulations that prevail. If it is a GBP (Great British Pound) transaction, then it is the UK laws and regulations that will be applied. This means transactions in USD performed by Indian companies with any foreign corporates are under USA AML/CFT laws and regulations.

If a bank in India has been misused for USD cross-border transactions involving Russian sanction entities, then these transactions might be checked by the US correspondent bank which discovered that the ordering parties or the beneficiaries are on the US sanction list. This will seriously affect the trust and relations with the foreign US bank which might decide to close the USD account of the local bank in India. If a bank in India or anywhere in the world, has its USD account closed, then the bank will simply go bankrupt. the banks in India and elsewhere requires USD because 80% of the international trades and export/imports are made in this currency.

Regarding corporate sector compliance, most of the companies believe that they don’t need to comply with the AML/CFT regulation because their transactions are going through their respective banks thus the responsibility of compliance should be performed by the banks and the lenders. This is where the regulator is stepping in and saying no, as a company, if you are opening a business with an entity called XYZ, then you are responsible and liable for this partnership and you should check who this entity is.

If the money is originating from a high-risk country, the compliance rules for companies are similar to the ones in the banking sector. In the corporate sector, checks must be made about all their business relationships and third parties involved, in this case, this could include suppliers, agents, distributors, and subcontractors. The risk here is mainly related to the foreign entities as the payment between the two parties is going to involve one of the foreign currencies such as the USD. The problem, in this case, is when a company in India is doing business such as a supplier with a foreign company. that has different international shareholders and owners that might have been flagged in the recent US sanctions.

Q: So how much impact in terms of data might be in terms of losing revenues through such transactions?

A: The FATF recommendations are not focused on tax and related risks. The regulations related to anti-money laundering, and anti-terror financing, are purely regulatory and reputation risk. If a pharmaceutical group based in Germany, the US, or in the UK is sending medicine to India, they would like to have their distributors in India to share their values and principles regarding the fight against corruption, bribery, money laundering, and terrorist financing, thus to deploy the same international regulations.

Q: Ahead of the FATF assessment, a lot of these changes have been done in the money laundering rules. How do you see the effectiveness of these tweaks?

A: The changes require more effective compliance and more disclosures from sectors that were not initially concerned with financial sectors. The changes also include more enhanced due diligence and Know Your Business Partners and Know Your Suppliers (KYS) beside your customers. All the changes and tweaks are in anticipation of the FATF Assessment Review that is normally scheduled at the end of this year.

Q: When you say that India could get isolated, what is the risk that you are seeing?

A: The past FATF evaluations in the region over the last few years show that the corporate and non-financial sectors are the weak link in the country from an AML/CFT compliance point of view. If the upcoming FATF evaluation finds that the FATF recommendations compliance in the corporate sector is very weak, they might decide to include the country in the grey list. As an example, the European Union will consider the grey list country as high-risk jurisdiction with strategic deficiencies in AML/CFT that pose a significant threat to the financial system. The Economic Review Magazine published in January 2022 reported that according to the AMF research, an average FATF grey listing resulted in a decrease of the GDP capital Inflow by 7.6 and a decrease of foreign direct investment of 3% GDP which represented around 20 Billion USD for a country like Turkey.

Q: India’s review is happening after a long gap. So, what is the likelihood of India being in a grey list or staying outside the grey list

A: It is impossible to predict. But let me tell you, for example, the UAE may have never thought they would be in the grey list and they have been in the grey list later. The FATF mutual evaluation review analyses the implementation of the FATF recommendations in both the financial and non-financial sectors, but more over the effectiveness of the deployment. In recent regional FATF Mutual Evaluations, the corporate and non-financial sector level of compliance was not up to expectations. This has been seen in many emerging countries. But I am also seeing in India the regulators doing corrective actions and taking different new initiatives, laws, and enforcement to try to bridge the gaps, if any.