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EU Financial Legislation, Hawala Banking and the Migrant Crisis: Developments and Implications

January 9, 2017 editor’s note: while world media have covered in depth the European Union’s approach to the migrant crisis, little attention has been paid to ongoing financial-sector EU legislation, and its ability – or lack thereof – to control possibly illicit international transactions, using alternative methods such as the Hawala system, favored by many Muslim migrants. (A basic explanation of how the system operates is available here on Wikipedia).

In the following analysis, Bulgarian banking expert Gergana Yordanova explains the relevant EU legislation and the discrepancies with the Hawala system- as well as the implications could have for EU security and financial policing.

By Dr. Gergana Yordanova, PhD.

Today’s historic migrant crisis is creating new risks and threats to the EU, and not only in terms of security and social services. They also include risks to the economic and financial security systems of the migrant-hosting states. In many states, this has involved the ‘net settlement’ of funds via the ‘Hawala’ system of informal Islamic banking. Despite cumulative volumes and financial scale, these settlement operations remain out of the scope of the EU’s new regulatory framework on payment and remittance systems infrastructure. This framework was created after the adoption of the 4th Anti-Money Laundering Directive and the Regulation on information accompanying transfers of funds in 2015.

There is thus a significant new security threat involving latent potential for money laundering and terrorist financing activities, on both the national and cross-border levels. The latter requires an active reframing process of the remittance systems mechanisms, and a holistic, risk-based approach in order to protect society from crime, and to ensure the proper functioning of the EU financial system when confronted with threats like money laundering and terrorist financing.

The New EU Financial Legislation in Context

In 2015, the European Council adopted two key points of legislation: a Directive regarding money laundering and terrorism financing; and a Regulation on information accompanying transfers of funds.

The first is officially known as Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the usage of the financial system for the purposes of money laundering or terrorist financing amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC. The official text is available here.

The second is known as Regulation (EU) 2015/847 of the European Parliament and of the Council of 20 May 2015 on information accompanying transfers of funds and repealing Regulation (EC) No 1781/2006. The official text is available here.

The approach of the new Directive (also known as the Fourth Anti-Money Laundering Directive) was based to a greater extent on risk analysis over measures for anti-money laundering activities and the prevention of terrorist financing. It established stronger requirements for customer due diligence checks. This was done to ensure that certain customer and transaction categories would not be exempt from the requirements for enhanced customer due diligence measures. The obliged entities would also have to apply a risk assessment level before deciding whether customer due diligence checks would be required.

The new Regulation is also closely related to the objectives of the Directive. It strengthens the existing legal requirements and obligations related to combating money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction, in terms of value transfers and remittance systems related to it. These provisions also take into account the standards developed in the field (the revised Recommendation No 16, former SRVII) on Wire Transfers, and the revised interpretative note for its implementation of the revised Financial Action Task Force – FATF Recommendations).

This refers to the 2012 FATF Recommendations and International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation. The official text is available here.

It also includes requirement for increasing the full traceability of funds and payments transfers. It does this by obliging payment/funds transfer service providers to supply the competent national authorities with information, both on the payer and the payee.

The new legislative aspects of this EU regulatory framework provide an instrument ensuring that the competent national authorities have effective tools in combating money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction. In particular, it concentrates on the misuse of the financial system by criminals who act as money launders and their associates.

These changes and reforms are considered by the EU as proper and effective results of a long-term process of identifying various weaknesses in the European financial and banking system.

The Migrant Crisis and Hawala Banking as a Challenge to the New EU Regulatory Framework

The development of a dynamic situation involving a large-scale migrant influx, however, shows that by 2016 – only a year after the adoption of the new regulatory framework, and a year before its entering into force (the new regulatory framework shall apply from 27 June 2017) – these measures had already risked becoming irrelevant. This was due to the sudden increase in persons with experience, and preferences, for informal alternative remittance systems, such as the Hawala system.

This risk is partly due to the fact that the new Regulation does not apply to transfers under 1,000 euros. Also, EU Member States should be able to apply lower thresholds as well as additional general limitations on the use of cash and other stricter provisions by law. This is subject to Article 2 (4) (5) of Directive (EU) 2015/849 and Article 2 (5) |c| of Regulation (EU) No 2015/847).

The use of alternative financial systems such as Hawala banking could thus become a potential threat to the economic and financial security of the EU, insofar as exclusion from the monitoring mechanism could damage the integrity, stability and reputation of the financial sector, its growth and market capitalization and threaten both the internal market and international development.

Directive (EU) 2015/849 : Risk Assessment Requirements

With the above-cited Directive, the EU acquis communautaire, the EU Commission must prepare a report identifying, analyzing and evaluating money laundering and terrorist financing risks that could affect the internal market, and also relate to cross-border activities. The imposed deadline for drawing up this report is 26 June 2017.

Thereafter, the Commission is required to update it every two years, or more frequently if appropriate; this is specified in Article 6 (1) of Directive (EU) 2015/849). The report would cover the areas of the internal market that are at greatest risk in terms of money laundering and terrorist financing. Risks assessed are associated with each relevant sector and based on the revised FATF Recommendation No 1 and the FATF Immediate Outcome 1.

This is also in accordance with Article 7 (2) of Directive (EU) 2015/849), as well as a list of the most common means by which criminals launder illicit proceeds.

It is clear that the settlement mechanisms for Hawala funds transfer should be added in the EC’s report, in the part related to the most common means of laundering illicit proceeds. This risk assessment should be conducted regardless of the scale and volume of funds thus transferred, without taking into account the benchmark subject to Article 2 (4) (5) of Directive (EU) 2015/849 and Article 2 (5) |c| of Regulation (EU) No 2015/847).

In broadening this implementation, an effort would be made to track all the financial flows generated by the migrant waves from the Middle East and North Africa. Moreover, it would preventively interrupt any potential schemes of money laundering or terrorist financing via the ancient informal Arabian alternative remittance system.

Customer Due Diligence

The new EU Directive also foresees the gradual elimination of secret banking, financial and credit arrangements, by establishing strict prohibition of anonymous accounts or passbooks for clients of credit and financial institutions. This is in accordance with Article 10 (1) of Directive (EU) 2015/849. This requires the execution of two types of customer due diligence: one simplified and the other, enhanced, in accordance with Article 13 of Directive (EU) 2015/849. The following measures are required:

  1. identifying the customer and verifying the customer`s identity based on documents, data or information obtained from a reliable and independent source;
  2. identifying the beneficial owner and taking reasonable measures to verify that person’s identity;
  3. assessing and, as appropriate, obtaining information on the purpose and intended nature of the business relationship;
  4. conducting ongoing monitoring of the business.relationship including scrutiny of transactions undertaken throughout the course of that relationship to ensure that the transactions being conducted are consistent with the obliged entity’s knowledge of the customer.

The identities of migrants and refugees in Europe could also hypothetically be identified by customer due diligence with the new Directive, though this is admittedly more difficult in the cases of many newcomers lacking documentation. Thus, a priori it would help to identify persons among the criminal contingent and their associates, as well as people against whom there have been charges or some reasonable assumptions have been made for acting as money laundering, terrorism financing and organized crime agents.

Beneficial Ownership Information

Customer due diligence is directly related to the new aspect in identifying the legal beneficial owners of corporations and other for-profit legal entities. Thus, the information regarding beneficial owners will be delivered by public central registers, in accordance with Article 30 (3) of Directive (EU) 2015/849 and Article 3 of Directive (EU) 2009/101.

The Register should ensure timely and unrestricted access by the competent financial intelligence authorities. Moreover, the information stored could help authorities in gaining a clearer picture of the scale and volumes of various “black and gray” business activities such as: Islamic Hawala finance (in case of any available book-entry transfer orders or payment and cash deposit statements as written evidences), various types of global offshore banking schemes, different clearing houses, central depositories/repositories or central counterparties, large fund transfers to countries or jurisdictions classified as tax havens, as well as political corruption. The last can include acts of nepotism, undue influence-peddling and business relations of politically exposed persons who entrust prominent public functions, their family members and persons known to be close associates. Among the above-mentioned activities and functions, possibilities exist for cases of money laundering, terrorist financing and the financing of proliferation of weapons of mass destruction.

New EU Obligations on Payment Systems Providers and the Hawala System

In relation to the information accompanying funds transfers, the new Regulation obliges the payment system provider in accordance with Article 3 (Definition 5) and Article 4 of Regulation (EU) No 2015/847.

This requirement is meant to ensure that funds transfers are accompanied by the information on the payer related, as follows: both the names of the payer and of the payee; their payment account numbers; address; official personal document number; customer identification number or date and place of birth for the payer. These conditions are specified in accordance with Article 3 (Definitions 3 and 4) and Article 4 of Regulation (EU) No 2015/847.

However, the Hawala system`s modus operandi precludes these obligations and requirements for informational and data provision of transfers of funds. In Hawala system settlements, the anonymity of both counterparties is its primary principle of not declaring any verified identity. Moreover, there are no payment or accounting documents (such as deposit and withdraw cash receipts, transfer orders, bills, statements etc.) for any Hawala transaction. Thus, no book-entry (de)materialized form is the second principle of Hawala Banking.

Under the new EU Directive, transfers that exceed 1,000 euros (whether within or outside the Union), require the payment system provider to make available at least the names of the counter-parties, their payment account numbers (in accordance with Article 3 (Definition 7) of Regulation (EU) No 2015/847) or the unique transaction identifier, if applicable (in case of Article 4 (3) of the Regulation, in accordance with Article 3 (Definition 11) of Regulation (EU) No 2015/847).

Notwithstanding these new regulatory requirements, it is obvious that they do not include the Hawala system’s transfers of funds and settlement of remittances. This Eastern transfer system is already very widespread among Muslim communities in Europe, and will continue to be illegal in terms of the new EU acquis communautaire until the adoption of a criteria and mechanisms for its monitoring by relevant national authorities.

Until that time, Hawala banking will remain a fast, convenient and reliable way of transferring funds the origins of which could be illegal and could generate a number of penalty provisions concerning money laundering activities, terrorism financing and the financing of proliferation of weapons of mass destruction. This means that to each payment service or related instruction/order for execution of a payment risk assessment and analysis would be required for signs of illicit activity for each payment transaction, under Article 9 of the Regulation. Any suspicious one would then have to be reported to the national or regional financial intelligence unit (in accordance with Article 9 of Regulation (EU) No 2015/847). However, given the nature of Hawala banking, this is clearly impracticable.

EU Obligations on Intermediary Payment Systems Providers regarding Transaction Data

A set of various effective risk-based procedures for determining information on the payer and the payee within the remittance, messaging or payment and settlement system used to affect the transfer of funds are necessary in order to execute it. Such an obligation on the intermediary payment systems provider is in accordance with Article 3 (Definition 6) of Regulation (EU) No 2015/847.

This requires the implementation of effective procedures. Where appropriate, these include ex-post monitoring or real-time monitoring to determine whether any of the information on the payer and the payee is missing.

These obligations are difficult to meet with the Hawala system. It does not allow delivery and record retention of payer and payee information. Therefore, to comply with the law, the intermediary payment systems provider would have to take into account the missing information and establish effective risk-based procedures for determining whether to execute, reject or suspend each Hawala transaction, and whether it is to be reported to the national or regional financial intelligence unit (in accordance with Article 9 of Regulation (EU) No 2015/847).

Conclusion: Challenges and Opportunities from the Hawala System

The European Union’s continuing reforms of financial transaction controls have overlapped with an unprecedented migrant crisis, one which has brought alternative payment and settlement methods into increasing use in Europe. While Hawala and other alternative payment schemes were in use in Europe for many years before the migrant crisis, and indeed before the legislative amendments of 2015, the difficulty of bringing them under the scope of the law is a systemic and probably impossible task.

As we expect the migrant economy’s use of Hawala banking to only increase in years ahead, this will pose new challenges for EU lawmakers, banking and financial officers- but also new opportunities for experts and firms specializing in analyzing and monitoring alternative payment methods in an increasingly globalized Europe.


Note: This analysis has been adapted from a conference paper, entitled Reframing of Remittance System Mechanism of the EU in Liaison with the Migration Flows: the Hawala System Case, which was initially presented by the author at the Cross-Border Cooperation and Development Policies on the Balkans Conference, held from 17-18 November 2016 at Ss. Cyril and Methodius University of Veliko Tarnovo, Bulgaria.

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