In one of our previous episodes, we discussed aligning AML practices with ESG criteria. As stated, no longer CDD is just about knowing your customers, it is also about understanding their impact on the world. 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. Financial institutions 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. The question then arises, how do you incorporate ESG related integrity risks into your CDD investigation. In this article, the strategies for aligning AML practices with ESG considerations will be further explored.     

This article was written by Nicky Goes and Kristi Rutgers. Nicky ([email protected]) and Kristi ([email protected]) are part of RSM Netherlands Business Consulting Services with a focus on financial regulations.     

Environmental crime thrives as one of the most profitable criminal activities primarily due to the lack of public awareness and consideration. With minimal awareness and consideration, the risk of detection remains low, while the potential rewards for engaging in environmental crimes are substantial. The convergence of minimal consequences associated with environmental crime and the allure of high rewards incentivizes criminal behavior. Consequently, the combination of these factors elevates the opportunity for criminals to commit environmental crimes. As environmental crimes are being considered as money laundering within the 6th AMLD, financial institutions should integrate ESG integrity risks into the CDD investigations. By integrating ESG integrity risks into CDD processes, entities can enhance their ability to identify, address and prevent environmental crime. In order to do so, the Financial Action Task Force (FATF) published a report regarding money laundering from environmental crime, emphasizing the ‘low risk, high reward’ nature of environmental crime. This report provides guidance to financial institutions, by addressing red flags helping institutions to identify environmental integrity risks.

Potential risks indicators related to money laundering from environmental crimes

The report of FATF specifies the risk indicators and red flags that should be considered during CDD investigations. Risk indicators serve as signals that suggest the likelihood of unusual or suspicious activities. The existence of a single indicator may not definitely indicate criminal activity, but it should result in further monitoring and examination. For instance, the FATF highlights the issue of deforestation for mining purposes, which leads to catastrophic damage to ecosystems and poses significant health and safety risks for workers under unregulated conditions. The FATF noted the risk indicator of front companies to blend proceeds from illegal mining, logging, and waste trafficking into their legitimate business accounts, along with the use of shell companies to hide beneficial owners. One specific red flag highlighted by the FATF pertains to the intermediaries such as timber processing facilities, sawmills and metal refineries, which serve as chokepoints for the entry of illegally extracted natural resources into the supply chain. Indicators of suspicious activity include the apparent mingling of income from various sources linked to the mining or logging sectors. Moreover, sawmills or gold refineries may exhibit distinctive identifier data (such as bank account details, transaction records, company information, tax codes, or specialized equipment) which can be merged with other red flags to highlight suspicious activities.

What do entities need to do to counter Environmental Crime?     

Although the FATF acknowledges the existence of risk indicators and red flags associated with environmental crimes in their report, it had not yet published a specific strategy for combating these offenses. No longer only obtaining a corporate social responsibility policy is enough, it is expected to dive deeper into the environmental strategies of your client. It is expected that companies will take detailed measures in order to combat environmental crimes within their supply chain. The OECD has released a comprehensive guideline, which includes a specific strategy addressing a particular typology of environmental crime: deforestation. This guideline sets an useful example for companies of how to address ESG risks, such as deforestation, by providing a 5-step strategy to implement into the practices of companies.     

The first step includes establishing a policy on deforestation and strong management systems by setting up clear targets for reducing deforestation and acceptable risk levels within operations, supply chains and business relationships. These targets may align for example with collective agreements or investor expectations. Policies should prioritize addressing the most significant risks and impacts first, considering factors such as likelihood, scale, scope, and irreversibility of impact. Regular review and adaptation of policies are essential to reflect changes in sourcing areas, shifting patterns of deforestation, and evolving knowledge about deforestation risks.
The second step is about identifying, assessing and prioritizing deforestation risks in the supply chain and involved mapping the supply chain to identify various actors within the supply chain. This step is crucial for understanding the risks associated with deforestation in the production and sourcing of commodities and products covered by the enterprise's deforestation policy. Mapping the supply chain includes identifying the source of commodities, the country of production, source area, and, where applicable, the plot of land of production. Red flags such as protected areas, areas with high levels of rural poverty, weak governance, and conflicts are considered during this stage.

The third step includes the design an implementation of a strategy to respond to deforestation. This plan should include measures for transparency improvement, engagement with suppliers, specification of actions, response to adverse impacts, promotion of forest-positive outcomes, and support for international initiatives. It serves as a roadmap for mitigating risks and promoting positive outcomes for forests and communities.

The fourth step is establishing systems to track and monitor due diligence accounts to make dure they are effective. Monitoring involves assessing deforestation levels and risks in sourcing areas over time, using various sources of information. Verification includes reviewing documents, conducting audits, using satellite data, and engaging with stakeholders to ensure compliance with due diligence procedures. Results from monitoring and verification should inform improvements to the due diligence system, which should be dynamic and responsive to changes in risks. Internal control mechanisms should also be monitored to ensure effectiveness. Collaboration with external stakeholders is essential for unbiased verification and problem identification.

The fifth step is about reporting publicly on company efforts to implement due diligence. This reporting should be regular and transparent, balancing the need for information dissemination with concerns about business confidentiality and competition. Reports should include qualitative information on system design as well as quantitative data on performance. Key elements to be included in these reports are the enterprise's commitments regarding deforestation, the percentage of production volume considered deforestation-free, summaries of risk analysis and mitigation systems, information on compliance with legislative requirements and international standards, and details of cooperation with stakeholders. Reports can be disseminated through various channels such as annual reports, sustainability reports, or specific forest impact reports, and should be accessible and understandable to stakeholders. Additionally, enterprises should use clear and consistent metrics to facilitate monitoring and analysis, aligning their reporting with international standards such as those of the Global Reporting Initiative (GRI).

While the FATF did not publish a specific strategy for combating environmental crime, it is evident that merely obtaining a corporate social responsibility policy is no longer sufficient. There is a growing expectation for companies to delve deeper into their environmental strategies. The OECD's comprehensive guideline serves as a valuable resource, offering a 5-step strategy to address ESG risks. By following these steps, companies can not only mitigate risks, but also enhance transparency and accountability in their operations.

Forward thinking

In conclusion, financial institutions play a crucial role in driving sustainable development and mitigating environmental risks. By demanding concrete strategies from their clients as mitigating measure during the CDD investigation, in order to combat environmental crimes, financial institutions can uphold their commitment to responsible business practices while safeguarding against reputational, regulatory, and financial risks. It's time to elevate environmental due diligence to ensure a more sustainable and resilient future for all stakeholders. As shown, companies should incorporate various measures, variating from identification of risks within their supply chain, design strategies to respond to environmental crimes, very due diligence within the supply chain and develop policies and procedures to create a concrete strategy to combat environmental crimes. These measures encompass identifying risks within their supply chains, developing responsive strategies to combat environmental crimes, conducting thorough due diligence throughout the supply chain, and establishing robust policies and procedures for combating environmental offenses. These expectations offer valuable insights for financial institutions conducting CDD investigations. Simply assessing corporate responsibility practices is insufficient for mitigating environmental risks associated with client activities. Financial institutions must delve deeper, requesting clients' strategies for combating environmental crimes. This entails obtaining the outcomes of their supply chain due diligence efforts and understanding their proactive approaches to responding to environmental offenses. RSM is Thought Leader in the field of International Trade, Anti-money Laundering (AML) and regulatory compliance. We offer frequent insights through training and sharing of thought leadership that is based on a detailed knowledge of regulatory obligations and practical applications in working with our customers. If you want to know more, please reach out to one of our consultants.