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Considerations for Legal Practitioners on De-risking in the Caribbean

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Paper by S. Nicole Liverpool Jordan, Deputy General Counsel, Caribbean Development Bank, delivered at the 16th Annual Caribbean Commercial Law Workshop: Hemispheric Change & Caribbean Commercial Law hosted by the Faculty of Law, University of the West Indies, Cave Hill Campus from July 23-25, 2017 in Miami, Florida.

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Considerations for Legal Practitioners on De-risking in the Caribbean

  1. 1. 1 | P a g e Considerations for Legal Practitioners on De-Risking in the Caribbean S. Nicole Liverpool Jordan Deputy General Counsel Caribbean Development Bank Background There has been a recent trend for large international correspondent banks to restrict or terminate their correspondent banking relationships (CBRs) with certain regional respondent banks1 , to “avoid, rather than manage, risk in line with the risk-based approach”2 . This is known as “de-risking”. As a result, stricter conditions have been required by regional commercial banks for basic banking services, such as opening and maintaining accounts, payment services and collections. This has affected local companies and individuals as well as companies in the international business and financial services sector, leaving them unable to honour their financial obligations or to obtain financial benefits. The effect of de-risking on the Caribbean region has been severe, with 89% of countries in the Caribbean reporting significant declines in CBRs.3 Among the members of the Caribbean Association of Banks, 55% have lost at least one CBR.4 Correspondent banks view the Region as a risky place to do business, susceptible to money laundering, tax evasion and the proceeds of crime from illegal drug trafficking. In addition, conducting business with respondent banks located in Caribbean countries is seen as unprofitable due to their small populations and economies, when compared to the severe penalties which have been imposed on the correspondent banks and the high due diligence costs. Concurrent with the de-risking trend there has been an increasing number of studies and other fora where views on de-risking have been examined by stakeholders in the financial sector. Several potential solutions have emerged from those discussions to address the withdrawal of CBRs. These solutions may once again offer individuals and businesses in the Region greater access to financial services and set the Caribbean on the path to achieving the United Nations’ Sustainable Development Goals through financial inclusion. This Paper will review, analyse and comment on the most viable and feasible solutions to address the de-risking challenge from a legal perspective. 1 Recent banking research from Accuity (May 2017) - between 2009 and 2016 CBRs have reduced globally by 25%. 2 Financial Action Task Force (FATF). 3 World Bank (November 2015), Withdrawal from Correspondent Banking: Where, Why, and What to do about it. 4 Caribbean Association of Banks (October 2016), Summary of Findings: Correspondent Banking Survey.
  2. 2. 2 | P a g e What are CBRs? CBRs in the Caribbean region facilitate the secure movement of money between countries where regional banks lack the capability to transfer funds across international borders. Correspondent banks facilitate wire transfers, conduct business transactions, accept deposits and gather documents on behalf of domestic respondent banks that do not have a physical presence in a foreign country. CBRs are therefore critical to Caribbean economies and their commercial trading relationships. Many of the Caribbean’s poor and vulnerable citizens are also dependent on CBRs for private remittances from both within and outside of the Region. Why now? As a result of the 2008 financial crisis, regulators have imposed requirements for greater transparency, introduced higher liquidity thresholds and increased enforcement actions for anti-money laundering (AML) breaches.5 Recently, large fines have been levied by regulatory bodies for violations of AML and combating the financing of terrorism (CFT) rules, which have had dire consequences for the non-compliant correspondent banks.6 Other factors responsible for CBRs being terminated or restricted are the perceived risks of reputational loss based on the jurisdiction in which the respondent bank is located; the type of services or industry which the respondent bank’s end-customer takes part in (for example, casino gambling and e-gaming); and lack of information about the respondent bank’s end-customer. CBRs may also be terminated for economic reasons, where the services provided to the respondent bank simply do not meet the correspondent bank’s cost-benefit tests given the realities of AML/CFT and increased compliance costs.7 The negative perception of the Region which has led to de-risking is unfortunate, since none of the Caribbean countries appears on the FATF and OECD8 lists for being non-cooperative in the fight against 5 Boston Consulting Group, Global Risk 2017: Staying the Course in Banking (March 2017) - the number of individual regulatory changes that banks must track on a global scale has more than tripled since 2011. 6 Accuity (May 2017) - in 2014 AML penalties peaked at United States dollar (USD) 10 billion. In 2012, HSBC paid a record USD 1.9 billion fine to settle money laundering accusations related to its Mexico operations; and Standard Chartered agreed to pay USD667 million to settle accusations of violating US sanctions against Iran and conducting money laundering activities for residents of Iran. 7 HSBC is reported to have spent USD290 million on improving its systems to try to avoid repeating the activity. Deutsche Bank recently unveiled a drive to add 400 people to its AML unit in 2017, which would boost the staff level by about 50%. 8 Organisation for Economic Cooperation and Development.
  3. 3. 3 | P a g e AML/CFT and the majority of countries in the Region have signed inter-governmental agreements with the United States of America (US) to give effect to FATCA.9 The Caribbean region no doubt has suffered based on its proximity to neighbouring countries in South and Central America, which have received failing grades for prevention of money laundering. However, since 2015 there has been renewed regulatory focus on the Region when thousands of offshore companies registered in at least 18 Caribbean jurisdictions10 were named in the leak of the Panama Papers.11 In 2016 the US State Department listed several Caribbean countries12 as jurisdictions of “primary concern” for money laundering.13 De-risking has not only affected the traditional “offshore” jurisdictions in the Caribbean, but other countries in the Region have clearly been significantly impacted, with 89% of Caribbean countries reporting significant declines in CBRs, as previously stated. Impact of de-risking on Caribbean economies Caribbean economies are small and vulnerable and operating in a turbulent global economic arena has weakened their already limited economic growth capacity. The stripping away of trade protections has severely affected domestic enterprises operating in traditional industries. Therefore, to address these challenges, the Caribbean, as a bloc, has been looking to enter into new reciprocal trade arrangements and to diversify away from agriculture and manufacturing. De-risking, brought on by concerns of regulatory pressure, “reputational risks” and profitability, has presented new challenges to the Region’s ability to successfully carry out cross-border transactions. Many of the new industries earmarked to generate growth in the economies of the Region have had to operate in an increasingly uncertain business environment. In Belize, for example, it has been reported that businesses have had to set aside weeks to make routine payments to suppliers abroad that previously used to take moments.14 In Barbados, international business companies (IBCs) have been experiencing delayed transactions, bank accounts being withdrawn and some existing and new IBCs have been unable to open bank accounts. 9 US Foreign Account Tax Compliance Act. 10 Anguilla, Antigua and Barbuda, Bahamas, Barbados, Belize, British Virgin Islands, Cayman Islands, Dominica, Grenada, Guyana, Haiti, Jamaica, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines, Suriname, Trinidad and Tobago and Turks and Caicos Islands. 11 The International Consortium of Investigative Journalists. 12 Antigua and Barbuda, The Bahamas, Belize, British Virgin Islands, Cayman Islands and Haiti. 13 2016 International Narcotics Control Strategy Report (INCSR), Vol II. 14 Y. Torbati, Caribbean countries caught in crossfire of U.S. crackdown on illicit money flow (Reuters, July 2016).
  4. 4. 4 | P a g e Banks in the Caribbean which have international affiliations, are largely unaffected by the recent de-risking trend, as they can use those affiliations to clear US dollar transactions. However, indigenous Caribbean banks and money transfer operators depend on CBRs.15 Without CBRs, the Region would find it difficult, at best, to engage in international trade, effectively being cut off from the global financial system, and to receive remittances from abroad, putting the Caribbean’s economic and social development at risk since its citizens depend on remittances for food, housing, health care, school fees and other basic necessities. In Jamaica the total amount of remittances in 2015 was USD2.23bn, the equivalent of a ratio of remittances to GDP of 16%. With no clarity about why their CBRs were being severed, some indigenous respondent banks began their own de-risking campaign – closing accounts for remittance services catering to people with little access to traditional banks. To get around the de-risking problem, an increasing number of legitimate financial transactions have been carried out at higher costs in riskier environments outside the regulated financial system, while illicit activity has been pushed even further underground. Belizean business persons have had to routinely fly to neighbouring countries to withdraw US dollar cash in order to repay loans in Belize because they could no longer send a wire.16 Ironically, this prevents financial intelligence units from receiving and analysing information on the very transactions they wish to regulate. The President of the Caribbean Development Bank (CDB), Dr Warren Smith, speaking to reporters at the end of the recently concluded 47th annual meeting of the Bank's board of governors, said that from CDB’s perspective de-risking “is one of the biggest dangers to our growth and development that we have faced in recent times.” Addressing Regulatory Concerns Regional governments and respondent banks are making efforts to manage AML/CFT risks and raise their AML/CFT frameworks to international standards. The Eastern Caribbean Currency Union countries have decided to consolidate their national AML/CFT work into one regional operation under the responsibility of the Eastern Caribbean Central Bank. This should lead to more effective implementation and enforcement of regulations. 15 In Belize only two banks, each of which have international affiliations, maintain CBRs with US banks. 16 Y. Torbati, (Reuters, July 2016).
  5. 5. 5 | P a g e CDB has contributed USD 250,000 towards a project aimed at increasing financial transparency and helping limit the loss of CBRs in the Region. The project addresses 3 components: (1) Strengthening the implementation of, and compliance with, international financial integrity standards by governments in the Region, including updating laws and regulations, as required; (2) Increasing the technical capacity of banks and credit unions in the Region to conduct customer due diligence and adopt AML best practices, including training for staff at respondent banks; and (3) Improving public-private sector coordination with regulators to more effectively address de-risking and develop a mechanism for ongoing dialogue between this group and external regulators and foreign banks. The project will be implemented over 3 years in partnership with the Multilateral Investment Fund, a member of the Inter-American Development Bank Group. Coordination with regulators has started and is already reaping results. A high-level advocacy group led by the Prime Minister of Antigua and Barbuda has been responsible for a robust campaign to represent the interests of the Region, including approaching the United Nations (UN) and the World Trade Organisation to create greater awareness of the issues facing Caribbean countries and to spell out the efforts being made by regional governments and respondent banks. A few months ago this group announced that it would employ the services of a lobbyist to help tackle the issue of de-risking. Country groups and lobbyists have encouraged regulators to be clearer with US correspondent banks about their expectations. This has successfully led to the US Treasury Department issuing guidelines explaining that there is no expectation for correspondent banks to vet individual customers of foreign respondent banks with whom they have correspondent banking relationships (Know Your Customer’s Customer); there is not a zero tolerance expectation that mandates the strict imposition of formal enforcement action regardless of the facts and circumstances of the situation; and many fines were applied in cases of deliberate wrongdoing.17 US regulators have in turn encouraged correspondent banks to conduct full due diligence checks on respondent banks instead of avoiding the responsibility by refusing to grant CBR services. In light of this, US regulators should create a safe harbour that protects correspondent banks from punishment if they conduct due diligence on customers and follow certain rules for preventing AML breaches, for example, checking all wire-transfer information against relevant governmental and UN watch lists of criminals and suspected terrorists. Adopting this or a similar type of safe harbour would give US correspondent banks confidence that they can do business with the specific respondent banks in “high-risk” regions that genuinely try to identify criminal actors. 17 U.S. Department of the Treasury and Federal Banking Agencies Joint Fact Sheet on Foreign Correspondent Banking: Approach to BSA/AML and OFAC Sanctions Supervision and Enforcement (August 2016).
  6. 6. 6 | P a g e The Second Payment Services Directive of the European Union (EU)18 imposes a requirement on EU member states to ensure that payment institutions have access to credit institutions’ payment accounts services, i.e. CBRs, on an “objective, non-discriminatory and proportionate basis” and to provide the reasons for rejection of any access to the regulator.19 The UK Treasury’s interpretation of the Directive20 is that correspondent banks will need to put criteria in place for assessing applications for CBRs by respondent banks. Then, if the correspondent bank rejects an application or withdraws a service, it will be required to give notice to the regulator with reasons, to enable the regulator to monitor compliance with the Directive. Lobbyists on behalf of the Region’s respondent banks should, when in discussions with US regulators, suggest a legislated response similar to that of the EU. Pooling of Resources There have been suggestions that information sharing and increased collaboration among the correspondent and respondent banks will make due diligence easier and reduce the costs of compliance. Banks have been signing up in large numbers21 for an information-sharing service established in December 2014 by SWIFT22 that reduces the cost of researching potential customers. SWIFT’s registry allows banks to contribute data verified by the organisation and then shared with selected other banks in the network, instead of one bank obtaining data from another every time that bank provides CBR services for the other bank. However, the sharing of information among banks may fall afoul of local privacy laws. For the SWIFT registry, the banks are responsible for ensuring that they can contribute the data in compliance with their local applicable law. Where required, this includes ensuring that their local applicable law provides a legal basis to process such data for customer onboarding and regulatory compliance purposes. Faced with US banks terminating their CBRs with Mexican banks of various sizes, in 2015 Mexico made changes in its bank-secrecy laws allowing its banks to share information about clients’ risk profiles. Seemingly, the Cayman Islands has learned from the Mexican experience. In 2015, Cayman was the only Caribbean country listed among the top 10 countries that most actively promote secrecy in global finance23 . However, it has since done two things to improve its ‘secrecy score’. Cayman was one of only 14 ‘first mover’ jurisdictions to ratify the multilateral agreement for the OECD’s Common Reporting Standards and 18 EU Directive rules become effective in January 2018. 19 Article 36 of the Directive. 20 Minutes of the meeting of the Payment Services Stakeholder Liaison Group (October 2016). 21 Over 3,000 banks in over 175 countries are already using it to exchange their KYC data, SWIFT.com/KYC Registry. 22 Society for Worldwide Interbank Financial Telecommunication. 23 Tax Justice Network (November 2015) – Financial Secrecy Index
  7. 7. 7 | P a g e agree to start exchanging information by 2018 with select jurisdictions. After a number of years of consultation, in July 2016, Cayman enacted the Confidential Information Disclosure Law (CIDL) to dispel the idea that the Cayman Islands is a secrecy jurisdiction. The CIDL repealed the Confidential Relationships (Preservation) Law which had been in force since 1976 and which attached criminal sanctions not just for revealing confidential information, but merely for asking for it. All other jurisdictions would have to consider how they might allow for exchange of information without breaching data protection and privacy laws. There has been some discussion of Caribbean countries coming together to establish a commercial bank in the US to provide CBR services to banks in the Region. Transactions of the regional respondent banks would then be consolidated and channelled through this bank. However, the consolidated traffic may still be regarded as high-risk and the US-based bank would still be subject to the same regulatory rules as any other US-based bank providing CBR services. Another suggestion has been to set up a bank in the Caribbean as a hub for the consolidated transactions and this bank could nest transactions with those of an intermediary bank that continues to have CBRs. However, again, the consolidated traffic may still be regarded as high-risk leading to increased scrutiny of the intermediary bank’s relationship with the correspondent bank. These solutions do not appear to bring any cost or time savings to the customers. Bolstering Data It has become equally important, as a solution to the de-risking trend, that the tools used for due diligence are strengthened. The use of data analytics to monitor for potential criminal behaviour has been proposed to make correspondent banking less risky and more commercially viable, alleviating the cost benefit analysis of correspondent banks.24 One option is for banks to make more widespread use of the Legal Entity Identifier (LEI), a universal system or standard to identify corporate customers. The LEI is designed specifically to help the authorities around the world clearly identify the entities that transact across markets, products and regions, thus making it easier to recognise trends and risks and take appropriate corrective action. For individuals, the use of biometrics is suggested. Biometrics are specific measurements related to human or biological characteristics that are used to identify individuals. For example, fingerprints and voice recognition can be adopted for Know Your Customer (KYC) processes as a method to recognise customers 24 PwC (September 2015), Charting a future for US-dollar clearing and correspondent banking through analytics.
  8. 8. 8 | P a g e quickly and accurately. Proponents highlight the fact that biometrics are less vulnerable to fraud and forgery, unlike paper-based documents such as passports and national identity cards. Biometrics along with a paper-based process will lead to faster and more accurate verification of identities. Privacy issues also surround data obtained during the use of biometrics. To what extent has the individual consented for his or her biometric data to be used? Was consent given for the purposes of authenticating the individual only in the context of banking and financial services? Can the data be used for authenticating the individual for immigration purposes where the individual did not want to be identified? Can the data be used to disclose medical conditions? For example, some fingerprint patterns are related to chromosomal diseases. These questions need to be resolved before the widespread use of biometrics is implemented. Other Alternatives to Traditional CBRs Central banks in the Region may have to assume the role of counterparts to correspondent banks without putting their assets at risk, by processing foreign exchange transactions for respondent banks that no longer have CBRs. It has also been suggested that regional central banks can act as guarantors of regulatory observance and information integrity on behalf of domestic respondent banks. However, it should be noted that central banks are not immune from the loss of CBRs, as is the case in Belize where the central bank lost 2 of its CBRs25 due to the overall withdrawal from the country of certain correspondent banks. It has been suggested that there may be a trend to enter into non-USD CBRs.26 However, for the Caribbean, since most of the Region’s trade is conducted in USD, the currency of choice is still the USD. This solution therefore may not be feasible in all cases, but may be considered in situations in which business can be conducted in other currencies. In a recent report27 , the sub-regional headquarters of the Economic Commission for Latin America and the Caribbean (ECLAC) has declared that blockchain technology could be a solution to de-risking, since it stores and transmits data in a secure form, which would “enable the detection of illicit financial transfers and thereby decrease risk and associated compliance costs”. In addition, a blockchain-based network would allow Caribbean banks to “bypass correspondent banks altogether, thereby reducing transaction costs and increasing efficiency”. However, ECLAC sees blockchain as more of a long-term solution, declaring it not 25 IMF (June 2016), The Withdrawal of Correspondent Banking Relationships: A Case for Policy Action. 26 Accuity (May 2017) - the number of Chinese Renminbi CBRs has increased by 8% since 2014. 27 ECLAC (April 2017), Prospects for blockchain-based settlement frameworks as a resolution to the threat of de-risking to Caribbean financial systems
  9. 9. 9 | P a g e yet ready to fully deliver. This is mainly due to the fact that ownership remains anonymous in an ‘open’ model blockchain system, which runs counter to a regulatory regime which insists on banks KYC. Legal Considerations For lawyers practising in the offshore banking and international business sectors, it is imperative to comply with AML laws and to carry out thorough due diligence on all clients, even those introduced through intermediaries such as banks, other law firms and accountants. This will go a long way in assisting correspondent banks in knowing the origin of the funds that they are processing. Given the current operating environment, offshore legal practitioners should also manage their clients’ expectations regarding the ease of doing business in their respective jurisdictions with the delays in opening bank accounts and in completing financial transactions. Corporate lawyers would also have similar advice for their clients regarding ease of doing business. In addition, when negotiating contracts with their client’s suppliers, lawyers should ensure that there is adequate time built in for payment after presentation of an invoice and, be attentive to any ‘time is of the essence’ clauses in the contracts. For attorneys working in the legislative drafting units in solicitor or attorney general’s chambers, they will no doubt be called upon to draft robust updated AML laws and regulations designed to prevent terrorists, drug traffickers, tax evaders, and other criminals from misusing the financial system to commit their crimes. Ideally, those laws should be harmonised with other jurisdictions in the Caribbean, as that would lead to more efficient regulation of the banking industry. While there needs to be an effective partnership between the banking sector, the regulators and law enforcement, as a precursor draftspersons should concentrate on laws to bolster investigatory powers of law enforcement and intelligence agencies, so that banks can renew their focus on commercial, rather than regulatory, activities. We see from the Mexican and Cayman examples that bank secrecy and data privacy laws may also have to be revisited by Caribbean governments to create a legal mechanism by which respondent banks could share information about their customers and their transactions. In the interim, attorneys should be giving advice to respondent banks and to their customers on the extent to which customers’ data can be legally shared pursuant to any local freedom of information and data protection legislation. This advice would also extend to future situations where respondent banks in the Region introduce biometrics to identify their customers.
  10. 10. 10 | P a g e In-house counsel of respondent banks also have to consider negotiating new CBRs with, in some cases, smaller correspondent banks as well as CBRs in new currencies. There are, of course, also opportunities for lawyers who wish to move in-house to get specialist training and join the growing compliance departments of respondent banks. June 9, 2017

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