Financial and supervisory policy
Resilience
In the meantime, the UK should intensify work to make the supervision of its financial sector and DNFBPs more effective. Beside adding to the costs incurred by the Russian state and elite groups entwined with it, the objectives would be to improve the resilience of UK institutions and to reduce reputational damage to the UK. The aim would not be specifically to uncover and seize large amounts of money. As one expert has pointed out, ‘the dirty money has mixed into the economy beyond recognition and separation’.62
By world standards, the UK has public and private institutions with strong legal foundations. It does well in indices of rule of law and corruption, for example ranking 11th out of 113 countries in the most recent edition of the World Justice Project’s Rule of Law Index; 63 and joint 8th (with Canada, Luxembourg and the Netherlands) out of 180 countries and territories assessed for Transparency International’s latest Corruption Perceptions Index.64 Yet the UK’s financial sector and DNFBPs face significant challenges linked with corruption and money laundering. The 2017 National Risk Assessment of Money Laundering and Terrorist Financing (NRA) identified four areas that were at least partly at ‘high risk’ from money laundering:
- Financial services: The 2017 NRA argued that risk associated with the UK banking sector overall ‘is not judged to have shifted substantially’ since the first assessment in 2015. Retail banking, wholesale banking, capital markets, wealth management and private banking were all assessed to be exposed to ‘high’ money laundering risks. The 2017 NRA also described the Tier I Investor visa scheme as ‘a potential avenue for the laundering of the proceeds of corruption’.
- Accountancy services: The 2017 NRA judged accountancy services, overall, to be at ‘high’ risk of exposure to money laundering. It identified the creation and operation of companies, the facilitation of financial transactions and tax evasion as the areas ‘at highest risk of being exploited for money laundering’.
- Legal services: The 2017 NRA found that ‘there is still assessed to be a high risk associated with abuse of legal services in money laundering’. It pointed to the formation of trusts and companies on behalf of clients as the area at greatest potential risk.
- Trusts and corporate structures: The NRA noted that these are used ‘in almost all high-end money laundering cases, including to launder the proceeds of corruption’. Assessing UK trusts as ‘low risk’, it attached ‘significantly higher risks’ to overseas trusts. It judged corporate structures in the UK and overseas territories, particularly limited partnerships, as being at a ‘high’ risk of exposure to money laundering.65
Moreover, doubts surround aspects of the UK’s supervisory framework. The UK appears to be in reasonable shape as regards technical compliance with the requirements of the Financial Action Task Force (FATF), the independent intergovernmental body that sets standards for combating money laundering and terrorist financing. (The FATF carried out the latest mutual evaluation of the UK’s supervisory system earlier in 2018, and is scheduled to publish its findings in December.) However, serious questions have been raised about the effectiveness of the UK’s supervisory regime, the assessment of risk by financial institutions and DNFBPs and the resourcing of public-sector supervisory agencies.66
Apart from the negative economic effects of exposure to large-scale suspect financial flows from Russia (and elsewhere), for example on the UK’s housing market, the impact on the integrity and the workings of public and private institutions can be substantial. As well as potentially compromising individuals in sensitive positions and causing reputational harm or leaving them vulnerable to pressure, the corruption that goes hand in hand with illicit finance – and the widespread perception of it – can erode public trust in institutions. By sowing suspicion, cynicism and alienation, over time it can jeopardize the functioning of democratic and law-based systems. For these reasons, supervision of the financial sector and DNFBPs has a clear national security dimension.
The following are four examples of how vast amounts of potentially illicit money have entered the UK financial system from Russia:
- The ‘Global Laundromat’: The alleged laundering of over $20 billion from Russia via banks in Eastern Europe and from there to a network of companies – including entities incorporated in the UK.67
- ‘Mirror trading’ by Deutsche Bank: Related corporate structures in Moscow and London bought and sold the same quantities of the same stock, worth an estimated $10 billion, via Deutsche Bank’s Russia-based subsidiary.68
- The ‘Azerbaijan Laundromat’: Between 2012 and 2014 four UK-registered companies were part of a network of vehicles that processed an estimated $2.9 billion of suspect finance. Among those involved were senior figures in Azerbaijan’s elite and Russian entities, including Rosoboroneksport, Russia’s state-owned arms-export corporation, which is subject to US sanctions.69
- Property transactions: In written evidence submitted to the House of Commons FAC in April 2018, Transparency International UK stated that UK properties with a combined estimated value of some £4.4 billion had been ‘bought by those representing a high money laundering risk’. Of this total, an estimated £940 million was related to Russian individuals.70
The UK overseas territories pose an even bigger challenge. According to one estimate, from 2007 to 2016 over seven times as much Russian money entered them (£68.4 billion) as entered the UK (£9 billion). The overseas territories accounted for 12.4 per cent of Russian money invested outside Russia, compared with 2.6 per cent in the UK. The British Virgin Islands were the second most popular destination (after Cyprus) for financial flows from Russia (£56.3 billion), and the third most popular location (after Cyprus and the Netherlands) for Russian investment (£33.7 billion).71 A prime attraction of the UK overseas territories is secrecy, particularly as regards the incorporation of anonymously owned companies. Not all Russian money entering the overseas territories is derived from corruption and money laundering, but a large proportion of it almost certainly is.
More effective supervision of the financial industry and DNFBPs would be a welcome reassertion of the national interest over the interests of sectoral groups wanting to defend the status quo. At worst, these are what one scholar terms ‘the supply side of corruption’: the actors in the West ‘who benefit from the widespread practice of securing assets in special financial zones that provide secrecy and anonymity to their account holders’.72 Financial and non-financial service provision is a comparative advantage for the UK in its relations with Russia (and other countries). What is at issue is the weight that should be attached to it. The state’s duty to ensure the security of its citizens surely comes before the interests of a branch of the economy. Yet for too long official thinking about the place of financial sector supervision in the UK’s Russia policy has been shaped by deference towards sectoral concerns. This is a choice that successive UK governments have made; there is nothing inevitable about it. It is time to adjust the balance in favour of national security.
This is not to say that the UK has been inactive. Since the last FATF evaluation in 2007, it has transposed EU money laundering directives into national legislation. It has taken a lead at the international level, notably bringing together representatives from governments, businesses, civil society, law enforcement, sports committees and international organizations for its Anti-Corruption Summit in London in 2016.73 It now has a minister of state for security and economic crime; and it has created structures to improve co-ordination between official agencies as well as between the government and the private sector.74 The UK is, moreover, implementing meaningful reforms. In 2016 it became the first G20 country to establish a public register of beneficial owners.75 As previously noted, starting in 2021 it will require overseas companies buying or owning property in the UK to disclose information about the ultimate owners. In April 2018 it set out proposals for reform of limited partnerships and Scottish limited partnerships that would subject them to more rigorous checks.76 These steps are welcome. What is much less clear is whether they go far enough, whether they are being implemented quickly enough, and whether the machinery to supervise and enforce them is being properly resourced.
Reputation
The previous section included examples of financial scandals or allegations involving UK-based organisations or financial structures. No one should doubt the reputational damage inflicted by such cases, which feed the view that the UK is hypocritical in advocating legality, accountability and transparency, while applying laws and rules in ways that fall below those standards, sometimes by a wide margin. The extent to which this perception is merited is open to debate, but it is widely held. As a result, the UK leaves itself open to claims of disingenuousness when it urges action by others to combat corruption and money laundering. Besides being a source of embarrassment, even shame, the charge of double standards makes it harder for the UK to position itself as a persuasive proponent of reforms that would serve its own interests.
For the UK’s policymakers, dealing with Russia is inherently difficult primarily because political leaders in Moscow do not consider the UK to be their country’s equal in the global system.77 Allegations of UK hypocrisy make this task more difficult still. Charges of Western double standards have become clichés of Kremlin propaganda. Typically, they are salvoes of ‘whataboutery’ intended to deflect criticism of Russia, to cripple Western positions and initiatives and/or to provide a pretext for Russian actions that lack an obvious justification. For Russia’s leaders, as one expert has noted, an assessment of the national interest ‘far outweighs quasi-theoretical standards of acceptable international behavior’.78 Even so, accusations of hypocrisy needlessly damage the UK’s standing, making it harder for the UK government to be heard with respect and authority. And the UK’s failure to enforce its own financial-sector laws and regulations as effectively as it could and should has shaped a perception in Russia of an interlocutor that does not practise what it preaches.
In the words of one specialist, from 2014:
‘Why does a G8 country so easily welcome the money of our public officials?’ is probably one of the most popular questions asked about the UK amongst the Russian civic community and Russian anti-corruption NGOs.79
From there, it is not far to the judgment that the UK need not be taken seriously – the position that it ended up in following the publication of the Litvinenko inquiry report.
The UK’s mixed performance as regards financial sector supervision has other repercussions. For the UK, acting with partners and allies is always preferable to acting unilaterally, particularly when dealing with Russia. Yet the patchiness of the UK’s own supervisory performance makes it harder to persuade others to take concerted action in this field. Even if the UK is a leader in some areas, if it put its own house in better order its appeals to others would carry more weight. As things stand, it is unable to project the influence abroad that it could.
A related issue that injures the UK’s reputation is the phenomenon of institutional arbitrage. The financial sectors of the UK and other Western jurisdictions have helped to facilitate the authoritarianism and systemic corruption that blights Russia. This challenges the assumption, which guided Western policy for much of the post-Cold War period, that integration with the global economy would drive democratization in Russia by empowering the private sector and enabling it to assert itself in its relations with the authorities there. As one scholar has put it, ‘financial internationalisation evolved hand in hand with growing authoritarianism, an increasing use of repressive methods of control, and reduced liberties for the Russian population’.80 This is so because asset securitization overseas reduces the incentives for Russia’s elite to push for improved governance at home. Again, the implications for the UK’s much-prized reputation as a champion of democracy, human rights and rule of law are severe.