The Financial Action Task Force and its Recommendations

What this chapter covers

Chapter 8 carries 6 marks out of 50 — 12% of the paper.

Learning Objective- After studying this chapter, you should know about: Purpose of formation of FATF and initiatives taken by it to protect the global financial system from being exploited for illicit activities · The concept, process and preventive measures to be taken for Trade-based Money Laundering.

8.1 Introduction to FATF

The Financial Action Task Force (FATF) leads global action to tackle money laundering, terrorist and proliferation financing. The 40-member body sets international standards to ensure national authorities can effectively go after illicit funds linked to drugs trafficking, the illicit arms trade, cyber fraud and other serious crimes.

Forty members — and coincidentally forty Recommendations. Keep the two figures apart.

Its three functions: the FATF researches how money is laundered and terrorism is funded, promotes global standards to mitigate the risks, and assesses whether countries are taking effective action.

Reach: in total, more than 200 countries and jurisdictions have committed to implement the FATF's Standards as part of a co-ordinated global response to preventing organised crime, corruption and terrorism.

Who assesses: countries and jurisdictions are assessed with the help of nine FATF Associate Member organisations and other global partners, the IMF and World Bank.

Nine Associate Members — the FATF-Style Regional Bodies of section 8.4.

The decision-making body: the FATF's decision-making body, the FATF Plenary, meets three times per year and holds countries to account if they do not comply with the Standards.

And the consequence of persistent failure: if a country repeatedly fails to implement FATF Standards then it can be named a Jurisdiction under Increased Monitoring or a High Risk Jurisdiction. These are often externally referred to as "the grey and black lists".

The two lists

Grey List- When the FATF places a jurisdiction under increased monitoring, it means the country has committed to resolve swiftly the identified strategic deficiencies within agreed timeframes and is subject to increased monitoring. This list is often externally referred to as the "grey list".

Note what grey listing signifies — a commitment to fix the problem, with monitoring, not a call for sanctions.

Black List- For all countries identified as high-risk by FATF, the FATF calls on all members and urges all jurisdictions to apply enhanced due diligence, and, in the most serious cases, countries are called upon to apply counter-measures to protect the international financial system from the money laundering, terrorist financing, and proliferation financing (ML/TF/PF) risks emanating from the country. This list is often externally referred to as the "black list".

Two levels of response there — enhanced due diligence generally, and counter-measures in the most serious cases.

In plain words: a grey-listed country has promised to fix its gaps and is being watched. A black-listed country is high risk, so everyone dealing with it must take extra care.

These lists are what the earlier chapters refer to. Chapter 6 lists as a high-risk factor jurisdictions with relatively high levels of corruption, organized crime or inadequate AML/CFT measures, as identified by the FATF; Chapter 5 requires caution with respondent banks in jurisdictions which have strategic deficiencies or have not made sufficient progress in implementation of FATF Recommendations; and Chapter 2 records that the IFSCA exemption for a group service provider applies only where it is not in FATF high-risk jurisdictions.

8.1.1 The FATF President

The FATF President is a senior official appointed by the FATF Plenary from among its members. In April 2019, the revised Mandate extended the terms of the FATF Presidency to a two-year period.

The term of the President begins on 1 July and ends on 30 June two years after assuming office.

Duties: the President convenes and chairs the meetings of the FATF Plenary and the Steering Group. The FATF Executive Secretary and FATF Secretariat staff are responsible to and act under the instructions of the President... The President is the principal spokesperson for the FATF and represents the FATF externally.

Elisa de Anda Madrazo of Mexico is the FATF President from 1 July 2024 to 30 June 2026. She succeeded Mr. T. Raja Kumar of Singapore.

The FATF Vice-President, is appointed by the Plenary from among its members and assists the President in carrying out his/her responsibilities. Giles Thomson of the United Kingdom assumed his role as Vice-President of the FATF on July 1, 2025.

8.1.2 The mandate

Money laundering, terrorist financing and the financing of weapons of mass destruction are enduring concerns for the integrity of the financial system. They require a sustained political commitment to fight these threats.

This is why, in 2019, FATF Ministers gave the FATF an open-ended mandate after three decades of operation under a time-bound mandate. In 2001, the FATF expanded its mandate to also combat terrorist financing.

Two dates: 2001 for terrorist financing, 2019 for the open-ended mandate. Chapter 1 supplies the third — FATF was founded in 1989 with the initiative of the 1989 G7 Summit in Paris.

8.2 The 40 Recommendations

The FATF Recommendations provide a comprehensive framework of measures to help countries tackle illicit financial flows. These include a robust framework of laws, regulations and operational measures to ensure national authorities can take effective action to detect and disrupt financial flows that fuel crime and terrorism, and punish those responsible for illegal activity.

The 40 Recommendations are divided into seven distinct areas:

• AML/CFT Policies and coordination.
• Money laundering and confiscation.
• Terrorist financing and financing of proliferation.
• Preventive measures.
• Transparency and beneficial ownership of legal persons and arrangements.
• Powers and responsibilities of competent authorities and other institutional measures.
• International cooperation.

Seven areas, labelled A to G.

A — AML/CFT policies and coordination

B — Money laundering and confiscation

C — Terrorist financing and financing of proliferation

D — Preventive measures

Recommendations 10 to 21 cover the same ground as much of Chapters 5 and 6. They deal with customer due diligence, record keeping, PEPs, correspondent banking, new technologies, third-party reliance, higher-risk countries, STR reporting and tipping-off, in that order.

E — Transparency and beneficial ownership

F — Powers and responsibilities of competent authorities

G — International cooperation

A note on the table: the 'old number' column refers to the corresponding 2003 FATF Recommendation. Version as adopted on 15 February 2012.

And on terminology: the FATF Recommendations are also often referred to as the FATF Standards, which comprise the Recommendations themselves and their Interpretive Notes, together with the applicable definitions in the Glossary.

Three components of the Standards — Recommendations, Interpretive Notes and Glossary.

Implementation is not uniform: as countries have diverse legal, administrative and operational frameworks and different financial systems, they should adapt the implementation of the Recommendations to their particular circumstances.

8.3 The IX Special Recommendations

Recognising the vital importance of taking action to combat the financing of terrorism, the FATF has agreed these Recommendations, which, when combined with the FATF Forty Recommendations on money laundering, set out the basic framework to detect, prevent and suppress the financing of terrorism and terrorist acts.

The 40+9 Recommendations, together with their interpretative notes, provide the international standards for combating money laundering (ML) and terrorist financing (TF).

The nine at a glance:

Links worth noticing.

• II asks that terrorist financing be a predicate offence. Compare paragraph 4 of Part A of India's Schedule, which lists UAPA offences (Chapter 4).
• III says freeze without delay. Compare Chapter 5's duty to block, reject or freeze assets of these terrorists or terrorist entities immediately.
• IV uses the words suspect or have reasonable grounds to suspect. The IFSCA Guidelines use the same test for internal reporting.
• VI brings informal money or value transfer systems under the same rules as banks.
• VII requires name, address and account number to travel with a transfer. Compare the wire transfer rules in Chapter 5 and the ban on stripping payment messages.
• VIII names three misuses of non-profit organisations — the front, the conduit and the diversion. Compare the separate NPO limb in Rule 3 and the DARPAN Portal of NITI Aayog registration.

A note on "8" and "IX". The workbook uses both numbers. Section 8.5 quotes FATF's move to extend the 8 Special Recommendations on terrorist financing to cover cash couriers. Section 8.3 lists IX Special Recommendations, the ninth being Cash Couriers. Learn the list as nine, with cash couriers as number IX.

And the unifying principle: the cornerstone of the FATF 40+9 Recommendations is the risk-based approach which emphasizes the need for countries to identify and understand the money laundering and terrorist financing risks they are exposed to. This ensures they can prioritise their resources to mitigate risks in the highest risk areas.

The risk-based approach is the cornerstone. Chapter 5 says something similar when it calls the RBA the primary thrust of these guidelines.

The FATF continuously monitors new and evolving threats to the financial system and regularly updates and refines its Recommendations, and to help countries implement its Standards, the FATF also creates guidance and best practice papers on range of issues.

8.4 FATF-Style Regional Bodies

Nine FATF-Style Regional Bodies have been established:

India is a member of two of these bodies — the APG, the Asia/Pacific Group, and the EAG, the Eurasian Group, as Chapter 1 records.

The APG, in conjunction with the FATF and the other eight regional bodies, constitute a global network to combat money laundering, the financing of terrorism and the financing of proliferation of weapons of mass destruction. The FATF's 40 recommendations are the principal standards to combat these crimes.

And the summary: FATF promotes sharing of best practices, guides reforms in member and non-member states, and updates standards to address risks from emerging threats such as cryptocurrencies and proliferation financing. FATF's framework is widely adopted, boosting the transparency of financial systems, making it harder for criminals and terrorists to move, hide, or use funds undetected.

8.5 Trade-based money laundering

Trade-based money laundering is defined as the process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimise their illicit origins.

The first sample question asks for this by name.

There are three main methods by which criminal organisations and terrorist financiers move money for the purpose of disguising its origins and integrating it into the formal economy.

Three channels — the financial system, physical cash, and trade documents.

Each of these methods involves the movement of enormous volumes of funds and can operate at a domestic or international level. In recent years, the Financial Action Task Force has focused considerable attention on the first two of these methods. By comparison, the scope for abuse of the international trade system has received relatively little attention.

The history: in 2003, the FATF significantly toughened the standards that apply to the financial system and various non-financial intermediaries. Two years later, it extended these standards to cover the activities of cash couriers. To date, however, limited attention has been focused on trade-related activities.

And the consequence of tightening two channels but not the third: research has shown that when governments take action against certain methods of money laundering or terrorist financing, criminal activities tend to migrate to other methods. In part, this reflects the fact that more aggressive policy actions and enforcement measures increase the risk of detection and therefore raise the economic cost of using these methods.

This suggests that the FATF's recent actions to revise the 40 Recommendations on money laundering and extend the 8 Special Recommendations on terrorist financing to cover cash couriers, as well as the ongoing efforts of countries to implement these stricter standards, may have the unintended effect of increasing the attractiveness of the international trade system for money laundering and terrorist financing activities.

Displacement, not elimination. Squeeze two channels and the third grows.

8.6 The international trade system

The international trade system is subject to a wide range of risks and vulnerabilities, which provide criminal organisations with the opportunity to launder the proceeds of crime and provide funding to terrorist organisations, with a relatively low risk of detection.

The relative attractiveness of the international trade system is associated with:

In plain words: trade is huge, complicated, mixed with honest business, poorly shared between countries, and thinly checked.

Five reasons. The second sample question is built directly on them — the correct answer being the limited resources available for detection of illegal trades, while the distractors invert the others.

On the last point: research suggests that most customs agencies inspect less than 5 percent of all cargo shipments entering or leaving their jurisdictions. In addition, most custom agencies are able to direct relatively limited analytical resources to improved targeting and identification of suspicious trade transactions.

Less than 5 per cent inspected.

The scale: in recent decades, international trade has grown significantly: global merchandise trade now exceeds US$9 trillion a year and global trade in services accounts for a further US$2 trillion. Much of this trade is associated with the financial system, as a significant amount of goods and services are financed by banks and other financial institutions.

US$9 trillion in goods, US$2 trillion in services.

In industrial countries the growth of trade has significantly exceeded the growth of gross domestic product, while in developing countries it has increased even faster. In addition, virtually all economies have become more open to trade. This has placed increasing pressure on the limited resources that most countries, especially developing countries, have available to scrutinise these activities.

8.6.1 Abuse of the trade system — three related activities

The third sample question tests this definition — capital flight.

c) Trade-Based Money Laundering — unlike tax avoidance and capital flight, which usually involve the transfer of legitimately earned funds across borders, capital movements relating to money laundering – or trade-based money laundering – involve the proceeds of crime, which are more difficult to track.

The distinguishing feature is the source of the money. Tax avoidance and capital flight move legitimately earned funds. Trade-based money laundering moves the proceeds of crime.

A number of studies have analyzed techniques to establish whether reported import and export prices reflect fair market values. One of the methods currently being explored involves the use of statistical techniques to detect discrepancies in the information provided on shipping documents.

8.6.2 The four basic techniques

The basic techniques of trade-based money laundering include: over- and under-invoicing of goods and services; multiple invoicing of goods and services; over- and under-shipments of goods and services; and falsely described goods and services.

However, it may be noted that all of these techniques are not necessarily in use in every country.

a) Over- and Under-Invoicing. Money laundering through the over- and under-invoicing of goods and services, which is one of the oldest methods of fraudulently transferring value across borders, remains a common practice today. The key element of this technique is the misrepresentation of the price of the good or service in order to transfer additional value between the importer and exporter.

Which direction the value moves depends on which way the price is wrong:

Under-invoice to move value to the importer; over-invoice to move value to the exporter.

b) Multiple Invoicing. Another technique used to launder funds involves issuing more than one invoice for the same international trade transaction. By invoicing the same good or service more than once, a money launderer or terrorist financier is able to justify multiple payments for the same shipment of goods or delivery of services. Employing a number of different financial institutions to make these additional payments can further increase the level of complexity surrounding such transactions.

Note that no false pricing is needed — each invoice may be accurate. Only the repetition is wrong, and spreading the payments across banks hides it further.

c) Over- and Under-Shipments. A money launderer can overstate or understate the quantity of goods being shipped or services being provided. In the extreme, an exporter may not ship any goods at all, but simply collude with an importer to ensure that all shipping and customs documents associated with this so called "phantom shipment" are routinely processed. Banks and other financial institutions may unknowingly be involved in the provision of trade financing for these phantom shipments.

The phantom shipment — documents without goods, and a bank financing nothing at all.

d) Falsely Described Goods and Services. A money launderer can misrepresent the quality or type of a good or service. For example, an exporter may ship a relatively inexpensive good and falsely invoice it as a more expensive item or an entirely different item. This creates a discrepancy between what appears on the shipping and customs documents and what is actually shipped.

And services are harder still: the use of false descriptions can also be used in the trade in services, such as financial advice, consulting services and market research. In practice, the fair market value of these services can present additional valuation difficulties.

A consultancy fee has no market price to compare against.

8.6.3 Complex techniques

In practice, strategies to launder money usually combine several different techniques. Often these involve abuse of both the financial and international trade systems.

Black market peso exchange arrangements is one such Complex Trade-based Money Laundering technique that provides a useful illustration of how a number of different money laundering techniques can be combined into a single criminal operation. These transactions combine a number of different illegal activities, such as drug smuggling, money laundering through the financial system and trade-based money laundering.

What makes it different: unlike the basic trade-based money laundering techniques discussed above, there is also no need for the importer and exporter to collude in a fraudulent transaction for the black market peso exchange arrangement to work. Instead, the prices and quantities of the goods can be correctly reported to customs agencies and value can still be transferred across borders.

No collusion, no false documents — and value still crosses the border. That is what makes it hard to detect through document checks alone.

Although the term "black market peso exchange" refers to a money laundering technique that was originally associated with Colombian narcotics trafficking, these arrangements are widely used in many countries to repatriate the proceeds of various types of crimes.

8.6.4 Current practices and the way forward

To examine the capacity of national authorities to combat trade-based money laundering, the FATF project team has made use of a detailed questionnaire to survey current practices in a range of countries. This questionnaire focuses on the ability of various government agencies to identify suspicious activities related to trade transactions, to share this information with domestic and foreign partner agencies, and to act on this information.

Five kinds of agency were studied: customs agencies, law enforcement agencies, financial intelligence units, tax authorities and banking supervisors.

Three practical steps follow:

In plain words: train people, share what is already known at home, and build channels to share trade data with other countries.

The fourth sample question is built on this paragraph — the effective measure is establishing clear information-sharing gateways through MOUs, Mutual Legal Assistance Treaties, and customs-to-customs cooperation for exchange of trade data.

Note why the distractors fail. Raising customs duties does nothing about document fraud. Investigating alone is the opposite of cooperation. And limiting reporting to domestic institutions ignores that the value crosses borders.

Additional reading listed by the workbook

• Frequently Asked Questions (FAQs) on International Financial Services Centres Authority (Anti Money Laundering, Counter-Terrorist Financing and Know Your Customer) Guidelines, 2022.
• UAPA Order - Gazette Notification 4391(E) dated October 10, 2024.
• UBO Identification dated September 08, 2023.