As the regulatory landscape around Environmental, Social, and Governance (ESG) evolves and money laundering techniques involving environmental crimes and socially impactful crimes like sexual exploitation become more prevalent, the need for businesses to integrate ESG criteria into their Customer Due Diligence (CDD) processes for anti-money laundering and countering the financing of terrorism (AML/CFT) has becoming more crucial. In this article, these developments and strategies for aligning AML practices with the emerging ESG considerations are examined.

This article was written by Nicky Goes([email protected]) and Sefa Gecikli ([email protected]), who are part of RSM Strategy team with a strong expertise in financial regulations.

AML x ESG

There's a growing focus on not just who the customers are, but also how their actions impact society and the environment. This approach combines environmental and social values with financial security checks and it is becoming more important in the fight against money laundering.

The Financial Action Task Force (FATF)’s report on money laundering from environmental crime highlights an important reality: environmental crime is now a preferred avenue for illicit financial activities due to its perceived 'low risk, high reward' nature. This underscores the growing importance of integrating ESG criteria into financial crime prevention measures. Furthermore, human trafficking, whether for forced labour or sexual exploitation is estimated to be one of the most profitable proceeds generating crime globally. The FATF and the Asia/Pacific Group’s joint study indicates that the proceeds from each type of exploitation are realized differently, requiring distinct money laundering mechanisms.

In response to these challenges, AML/CFT compliance standards are being enhanced across the EU, notably with the 6th EU Anti-Money Laundering Directive (AMLD). This directive broadens the scope of predicate offenses to include these topics such as “environmental crimes”, and “sexual exploitation, including of children”, among a total of 22 crimes established within the directive.

Banks and other financial institutions are required to carry out investigation on their clients, also known as Know Your Client (KYC) or Customer Due Diligence (CDD) especially for AML/CFT purposes. While ESG concerns are already a component of the KYC/CDD processes at many institutions to some extent, their role is set to become even more integral with the evolving regulatory landscape. The EU’s Corporate Sustainability Reporting Directive (CSRD) now mandates that entities within its scope must report on ESG dimensions. This regulation marks a significant change where the paths of CDD/KYC and ESG intersect since the application of CSRD requires companies to carefully examine their business partners. This serves not only to ensure that they meet ESG criteria, but also to prevent financial crime. 

Implications for Business: Adapting to ESG-Integrated CDD

With the growing prevalence of environmental crimes and human trafficking as common sources of illicit funds, it's essential to adapt your AML strategies to include ESG considerations. This means incorporating a more holistic view of your customers, not just verifying their identities and financial profiles, but also understanding their impact on society and the environment.

Several suspicious financial activities, or behaviours, as well as patterns could be associated with several types of ESG-related risks. The existence of a single indicator in relation to a customer or transaction may not alone warrant suspicion of a crime, but it should prompt further monitoring and examination. 

Checking out the indicators analyzed by FATF in terms of environmental issues, companies in the raw material industries making unusual money moves to distant financial centers or withdrawing large sums in areas known for illegal operations should be approach carefully. Also, it's a red flag when there are random deposits and transfers from different places, or when money quickly disappears in regions known for gold smuggling. The extractive industry also falls under scrutiny, especially with odd payments to companies that don't seem to fit their usual business profile. New entrants in the raw materials market also merit investigation in their swift and high-value transactions. Customers displaying unusually high wealth levels, particularly those involved in managing natural resources, raise concerns about potential illicit activities. 

Money laundering indicators linked to human trafficking reveal a complex pattern of financial activities. Suspicious signs include unusually high expenses at transport hubs or overseas, inconsistent with the customer's known activities. Payments for travel-related services, like airlines or car rentals, that don’t match up with the customer’s usual activities are also a red flag. Unusual banking behaviors, like multiple accounts transferring funds to the same third party or identical addresses reported by unrelated individuals, are warning signs too. In cases of human trafficking for forced labour, payments to labour agencies or recruiters, especially overseas, or repeated fund transfers to the same third party, indicate possible forced labour scenarios.

Getting inspired by OECD Due Diligence Guidance For Responsible Business Conduct, organizations are encouraged to thoroughly evaluate various aspects of their business partnerships:

Moreover, from a practical standpoint, incorporating key ESG-related terms into adverse media screenings can enhance the effectiveness while  checking an individual or a company against news sources to identify any negative reports. Some example keywords might include "environmental violation," "deforestation," "wildlife trafficking," "human rights abuse," and "labour violations."

Forward thinking: 

No longer CDD is just about knowing your customer; it's also about understanding their impact on the world. This evolution brings new challenges to the forefront. Obliged entities must now navigate this complex field, where integrating ESG criteria into their AML strategies is not just a regulatory requirement but an important aspect for business reputation. With the EU's CSRD and new AML Directive reinforcing this integration, entities are compelled to adopt a more comprehensive approach to CDD. Moving forward, the strategic landscape for obliged entities will increasingly involve the innovative use of technology to intertwine ESG considerations with AML compliance. Entities will need to adopt predictive analytics and machine learning to proactively identify and mitigate ESG-related risks before they escalate. This proactive stance on CDD will not only ensure compliance with evolving regulations but also position businesses as leaders in ethical finance, attracting socially conscious investors and customers. As we look to the future, the ability to effectively integrate these considerations into business strategies will become a key competitive advantage in an increasingly conscientious market.

At RSM, we possess extensive expertise that spans AML to ESG considerations, qualifying us to guide businesses, particularly medium-sized enterprises and family businesses, through these challenges. By understanding the unique requirements and regulatory landscapes our clients face, both locally and internationally, we tailor our services to address their specific needs with utmost attention and care.