Understanding proliferation financing: Key steps for compliance and risk management
Proliferation Financing (PF) is becoming an increasingly important aspect of the compliance landscape, akin to well-known areas like anti-money laundering (AML) and counter-terrorism financing (CTF). Recently, regulators, particularly in the UK, have begun implementing stricter measures to help businesses identify and mitigate PF risks.
This global shift towards enhanced regulatory measures suggests that other nations will soon adopt similar strategies. Many companies are in the early stages of understanding the risks associated with proliferation financing, but there are actionable steps they can take to minimize and evaluate their exposure.
What is Proliferation Financing?
Presently, there isn’t a universally accepted definition of PF. Broadly, it involves the provision of financial services or products that support the transfer or export of nuclear, chemical, or biological weapons, including their delivery systems and related materials. PF also encompasses financial or legal support for proliferation activities and the financing of trade in sensitive goods.
In September 2022, FATF introduced amended standards to identify, assess, and mitigate PF risks. These require financial institutions and certain non-financial businesses to conduct a PF risk assessment and make it available upon request.
Historically, PF hasn’t been a core element of enterprise-wide risk assessments (EWRA), unlike AML and CTF. However, the UK’s inaugural national risk assessment on PF has elevated it as a crucial component of an effective compliance program. PF is less understood than money laundering and counter-terrorism, making it more challenging for businesses to detect.
FATF defines PF risk as encompassing threat, vulnerability, and consequence, with businesses needing to identify, assess, and understand the risks related to breaches or evasion of targeted financial sanctions obligations. It involves inherent risks (risk level before control measures) and residual risks (risk level after mitigation).
Why Sanctions Screening Alone is Inadequate
Sanctions screening is vital for identifying PF risk by vetting businesses and individuals to safeguard against illegal activities and ensure compliance. However, this alone is insufficient for addressing PF risk. Proliferators often use tactics that evade traditional detection methods, such as employing seemingly legitimate actors not listed on sanctions.
Effective PF risk management requires thorough knowledge of customers. Implementing Know Your Customer (KYC) guidelines and carefully examining any unusual transactions can help uncover PF activities. Even minor inconsistencies, when scrutinized, can reveal potential PF activities.
Several indicators can signal PF activity, such as transactions involving dual-use goods or controlled commodities. Dual-use items, which serve both civilian and military purposes, pose a higher PF risk. Proliferation networks often acquire individual goods and components, making seemingly innocuous transactions in the supply chain or payment processing potential red flags for PF activities.