Pakistan on FATF’s grey list: what, why, and why now?

The grey listing should be placed in the larger picture of US-Pakistan relations that have had many ups and downs.
Published July 5, 2018

The international watchdog against money laundering and financing of terrorism, the Financial Action Task Force (FATF), has put Pakistan on a list of “jurisdictions with strategic deficiencies”, also known as the grey list.

FATF’s reasoning is Pakistan’s “structural deficiencies” in anti-money laundering (AML) and combating financing of terrorism (CFT).

The other countries on the list, in alphabetical order, are Ethiopia, Serbia, Sri Lanka, Syria, Trinidad and Tobago, Tunisia and Yemen.

This is not the first time Pakistan has found itself on one of FATF’s list of not-so-good guys; the country was there in 2008 and from 2012 to 2015.

Editorial: FATF’s unwelcome action

But Pakistan stands out as the most significant name on the list with the largest population and the largest economy, not to forget the largest military.

Pakistan now has 15 months to implement an action plan to be able to negotiate an exit from the grey list.

Entry and exit from FATF’s grey list is an ongoing exercise. In the past, some countries perceived to be particularly weak in money laundering and financing of terrorism, such as Panama, Kenya and Nigeria, have been able to find an exit from the grey list.

Here we break down Pakistan’s placement on FATF’s grey list by answering a set of questions.

What does FATF mean by money laundering and financing of terrorism?

Both are financial crimes. In simple terms, money laundering pertains to disguising money earned from a crime as money earned through legitimate sources.

The crime could be corruption, drug trafficking, fraud or tax evasion. Terrorist financing involves collection of funds to support acts of terror or terrorist organisations.

A key difference between the two is that, in money laundering, the source of funds has to be a crime.

In the financing of terrorism, funds may come from perfectly legitimate sources, such as donations from ordinary citizens, but the purpose has to be a crime.

What is FATF looking for in AML and CFT?

FATF has formulated a set of 40 recommendations which have become international standards on AML and CFT

Over time, these recommendations have been and will continue to be updated. The recommendations list out the essential measures that countries should have in place to:

  • identify the risks, and develop policies and domestic coordination;
  • pursue money laundering, terrorist financing and the financing of proliferation;
  • apply preventive measures for the financial sector and other designated sectors;
  • establish powers and responsibilities for the competent authorities (e.g., investigative, law enforcement and supervisory authorities) and other institutional measures;
  • enhance the transparency and availability of beneficial ownership information of legal persons and arrangements; and facilitate international cooperation.

FATF evaluates a country’s performance based on its assessment methodology that covers:

  1. technical compliance, which is about legal and institutional framework and the powers and procedures of the competent authorities, and
  2. effectiveness assessment, which is about the extent to which the legal and institutional framework is producing the expected results.

A lot of these recommendations and methodology are nothing but the dry financial jargon that is characteristic of multilateral bodies and compliance professionals, such as a “risk based approach”, “structural deficiencies”, “materiality”, “customer due diligence”, “suspicious transaction report” etc.

Is Pakistan really one of the worst performers on money laundering and financing of terrorism?

Money launderers and terrorists do not report their crimes. It is very difficult, if not impossible, to measure these crimes directly.

FATF and others try to take an indirect route to measure the vulnerability of a country to these crimes by evaluating laws and their implementation.

Pakistan’s assessment by different entities is not going to be the same.

Take for instance the ranking of Pakistan by the Basel Anti-Money Laundering Index. This index seeks to measure the risk of money laundering and terrorist financing.

It uses 14 indicators dealing with regulations, corruption, financial standards, political disclosure and the rule of law, which are aggregated into one overall risk score.

Op-ed: Between FATF and GSP Plus

This index currently ranks Pakistan 46 out of 146 countries in 2017, better than Tajikistan (4), Mali (7), Kenya (11), Sierra Leone (26), and Panama (30) — all of which are currently not on FATF’s monitoring list.

This index is developed by the Basel Institute on Governance that describes itself as “an independent not-for-profit competence centre” that is associated with Basel University.

Chances are that it is far less political in nature than FATF. However, this index is also partially based on FATF. Now that FATF has placed Pakistan on the grey list, it would affect Pakistan’s ranking on this index as well.

Regarding terrorism, many in Pakistan disagree with FATF and see the country as a victim of terrorism that has already suffered and sacrificed much.

The Global Terrorism Index 2017 by Institute for Economics & Peace, which describes itself as “an independent, non-partisan, non-profit think tank”, ranks Pakistan as the fifth-most affected country from terrorism, behind Iraq, Afghanistan, Nigeria and Syria.

What are the implications for Pakistan?

FATF uses peer pressure through the age-old technique of name-and-shame. There are many factors at play and it remains unclear how negative Pakistan’s placement on the grey list will eventually turn out to be.

There is, however, no debate that it is indeed a negative. Here are some of the ways in which grey listing could affect Pakistan.

Pakistan’s banking channel could be adversely affected as it is inevitably linked with the international financial system.

The impact on Pakistan’s economy could be relatively wide, touching imports, exports, remittances and access to international lending.

Foreign financial institutions may carry out enhanced checking of transactions with Pakistan to avoid risk of violations pertaining to money laundering and financing of terrorism.

They may ask more questions and apply more checks. Some such institutions may also avoid dealing with Pakistan’s financial system altogether.

Cover story: Black into white — inside money laundering

Another affectee is the sentiment of foreign investors. That Pakistan has been placed on the grey list has been covered in international news media and the fact will not go unnoticed by potential investors. Stock prices at Pakistan Stock Exchange appear to have already felt this impact.

Perhaps the biggest threat from being placed on the grey list is Pakistan could be pushed further down to the black list.

This black list comprises Iran and North Korea, the two countries West loves to hate. But placing Pakistan on the black list is probably a step too far to be on the cards at this stage.

These potential implications of grey listing need to be balanced against past experience.

Pakistan was on FATF grey list from 2012 to 2015, when it completed an IMF programme and also raised funds from international bond markets.

The country has also survived far graver financial challenges, such as those posed by nuclear explosions in 1998.

Are FATF’s concerns regarding Pakistan about money laundering or financing of terrorism?

It seems FATF’s concerns are mainly regarding financing of terrorism.

The FATF’s public statement issued on 29 June, 2018 begins by saying, “In June 2018, Pakistan made a high-level political commitment” to “strengthen its AML/CFT regime and to address its strategic counter-terrorist financing-related deficiencies [emphasis added].”

This is also made clear when we look at the actions Pakistan is being asked to take to exit the list:

  1. terrorism financing risks are properly identified, assessed, and supervised;
  2. remedial actions and sanctions are applied in cases of money laundering and financing of terrorism violations;
  3. competent authorities are coordinating to identify and take enforcement action against illegal money or value transfer services;
  4. authorities are identifying cash couriers and enforcing controls on illicit movement of currency and understanding the risk of cash couriers being used for financing of terrorism;
  5. improving inter-agency coordination including between provincial and federal authorities on combating financing of terrorism risks;
  6. law enforcement agencies are identifying and investigating financing of terrorism and prosecuting related designated persons and entities;
  7. financing of terrorism prosecutions result in applicable sanctions and enhancing the capacity and support for prosecutors and the judiciary;
  8. effective implementation of targeted financial sanction against all designated terrorists;
  9. enforcement against financing of terrorism violations including administrative and criminal penalties and authorities cooperating on enforcement cases; and
  10. facilities and services owned or controlled by designated persons are deprived of their resources.

Is this a financial or a political issue?

If the commentary by international news media is any indicator, Pakistan’s placement on FATF’s grey list is far more political than financial in nature.

It is being seen as one of the several ways the US is attempting to pressure Pakistan to “do more” on issues related to terrorism.

The long-winded, jargon-filled recommendations and methodology used by FATF leave plenty of flexibility for the team of assessors to exercise their “informed judgement”.

That is, based on the same information, assessors could reach more than one judgement, including the one sought by the politically powerful.

By placing Pakistan on FATF’s grey list, US has indeed demonstrated its intent to turn up the pressure on Pakistan.

US is also a major financier of FATF and the current president of FATF is an Assistant Secretary from the US Department of the Treasury who heads the Office of Terrorist Financing and Financial Crimes.

If US can have Pakistan placed on the grey list, it may also make it difficult for Pakistan to exit the list.

Bottom line is that FATF’s grey listing of Pakistan should not be looked at in isolation but placed in the larger picture of US-Pakistan relations that have had many ups and downs.

Header illustration by Mushba Said