Implementing sanctions screening and due diligence methods

Published on Apr 12, 2019

Banks and other financial firms the world over find they are faced with a fluid, fast-changing regime of sanctions programs, and hence they invest in skilled financial crime personnel and compliance solutions to help hedge them from regulatory breaches.

It is not uncommon for staff at financial institutions to feel that they are in a complex situation when it comes to keeping up and accurately dealing with sanctions programs administered by various authorities, including the US Office of Foreign Assets Control (OFAC), European Union and United Nations Security Council (UNSC).

Increasingly complex work

Financial firms are also grappling with big data revelations from major financial crime scandals such as the Panama Papers, which have ‘named and shamed’ entities and individuals deemed to be suspects of tax evasion and other unlawful financial activity.

Such data leaks have triggered newly-established ‘pseudo sanctions lists’ which have been adopted so far by many compliance vendors and have obliged banks to flag and investigate transactions whenever their screening engines intercept a matching hit.

This is definitely adding more complex and cumbersome grey areas to the compliance function which has gone far beyond what we had envisaged a decade ago.

Indeed, sanctions compliance and the fear of huge regulatory fines has become so serious that firms are increasingly establishing US-based sanctions compliance programs, with some relocating portions of their global sanctions-related compliance programs to the US to ensure better cooperation with the US Treasury Department.

When it comes to sanctions compliance, banks need to consider top anti-money laundering (AML) and counter-terrorist financing (CFT) due diligence measures and best practices that they can implement in order to keep on the right side of the law and avoid huge penalties.

An increasingly important area is how to mitigate sanctions risks linked to products and payment methods concerning trade finance and cross-border transactions.

Key aspects include dual-use goods, red flags and issues such as wire stripping.

Products: The dual-use factor

Regulators are supervising reporting entities more closely, and have realised that some banks are not taking adequate measures to mitigate the risks of money laundering and terrorist financing in their finance business, thus rendering their institutions more conducive to trade-based money laundering (TBML).

It is important to understand the link between trade finance and money laundering risks.

Goods shipped between nations are normally financed by banks with letters of credit (LCs).

Money can inadvertently be laundered through inaccurate representations of goods on these LCs; misrepresentation of the true value of goods shipped, such as over and under-invoicing; phantom shipments or shipping prohibited dual-use goods which may be difficult to identify.

A trade-based money laundering identification process needs to account for these different scenarios and hypotheses.

An important issue is that of dual-use goods, which are items or technology that can have both military as well as commercial applications.

For example, hydrogen peroxide can be used for paper bleach and missile propellant, while nickel aluminides can be used to manufacture household glass containers and aircraft engine blade coating.

On one level this can be evident in a country’s capacity to militarise, such as war planes or civilian nuclear power plants producing enriched uranium that can be weaponised.

At another level, this can become an issue of huge concern when terrorist groups smuggle chemical fertilisers such as ammonium nitrate to be used as explosives.

Hence, the same agricultural or industrial materials mentioned on a Swift MT 103 commercial payment can be used in biological or chemical weapons of mass destruction, making reporting entities more vulnerable in complying with the Financial Action Task Force (FATF) Recommendation 7, which addresses Proliferation Finance (PF) and other regulatory requirements within this scope.

How to treat red-flags

Given these examples of the real end-uses of dual-use technology, what comes next is the question of how reporting entities will proceed when alerted to the presence of these goods on a LC or commercial cross-border wire payment, and also how to treat red flags?

Red flags will require the bank to put on an investigator’s hat and carry out an enhanced due diligence process by asking the right questions, such as:

  • Does the client’s Know Your Customer (KYC) file have enough information about the entity’s main line of business and geographic location and whether there is any proximity or relation between this location and regulatory ‘hot spots’ like Iran or North Korea?
  •  Mere screening of Swift MT 103s and 700s used for LCs is no more a panacea. Is your compliance department checking whether underlying goods contained therein represent dual-use goods or not? The EU Commission and Singapore have developed a list of dual-use goods which banks can use in their search or screening process, whether they use simple processes such as the CTRL+F function or more advanced IT solutions.
  • If goods have been clearly identified as dual-use with the potential of violating embargoes, did the exporter secure the right customs documentation and export licenses from competent authorities?

For a while, trade finance was document-intensive and paper-based, and anchored to practices that proved their effectiveness and earned global trust over generations.

However, this is no longer the case.

Banks processing trade finance transactions should consider saying bid goodbye to a bygone age where they used to deal and examine documents only in accordance with ICC’s Uniform Customs and Practice-UCP and International Standard Banking Practice (ISBP).

Even strict conformity to these standards is no longer a guarantee that respondent banks will be shielded from possible sanctions violations, and can cost them dearly in terms of reputational and legal risks once a transaction falls under the compliance radar of their correspondent bank.

Payments: Methods and wire stripping

Although electronic fund transfers are a swift and efficient way to route payments globally, money launderers tend to use them as a quick conduit for shifting dirty cash between countries and bank accounts.

Illicit fund transfers are easily hidden among the millions of legitimate transfers that occur each day.

Clearing systems like Fedwire, TARGET2, SWIFT and CHIPS move millions of wires or transfer messages daily.

During the layering or EDD (Enable, Distance and Disguise) stage, money launderers also use money transfers to distance illicit proceeds from their original source, thus adding a layer of opacity to the audit trail.

The goal is to move the funds from one bank account to another, and from one jurisdiction to another, so that it becomes more difficult for law enforcement or investigative agencies to trace the origin of the funds.

While carrying out their correspondent banking services and daily payment operations, banks can get exposed to wire stripping and pseudo sanctions risks which in turn have an overarching impact on cross-border banking activity in today’s highly interconnected financial community.

Wire stripping occurs when a bank willfully decides to weed out, tamper, or even alter the payment details of a Swift message be it an MT 103, 202, or 700 especially, with regard to ordering/beneficiary client details (country, address, name), origin of goods and sea ports involved.

Such a premeditated practice is usually done to override sanctions filters and make a non-compliant payment look compliant so that it will not be rejected or flagged by the correspondent.

To identify those vulnerabilities, banks must compare the payment before it enters and after it leaves the bank’s Swift gateway.

Hash keys could be systematically generated and then compared for similarity if they do not match in a particular transaction.

By the same token, banks should compare key attributes of payment pairs like MT202COV accompanying a corresponding MT103.

Where payments are linked to other payments, discrepancies between these payment pairs may indicate that wire stripping has occurred.

About the author: Shawki Ahwash is the designated Money Laundering Reporting Officer (MLRO) and Head of AML/CFT and Sanctions Division at North Africa Commercial Bank sal, Beirut, Lebanon. He holds a Masters Degree from AUB,  Combating Financial Crime (CFC) certificate from CISI London and is a certified anti-money laundering specialist (CAMS). Shawki is also a university lecturer and speaker with the Union of Arab Banks (UAB), ACAMS, and other institutions. He has also been an AML/CFT trainer in several MENA compliance workshops.

This article is expressing personal opinions and is meant for information purposes only. The article does not intend to replace professional or legal advice. It is recommended that readers seek independent professional or legal advice, or speak to authorised persons/organisations.


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