Financial regulation and the loss of sovereignty

A global phenomenon, nothing to do with Brexit

Right now in South Africa, President Zuma is being urged to refuse to sign the new Financial Intelligence Centre Amendment Act.

This act is part of ongoing global tightening of controls to reduce/eliminate money laundering and combat the financing of terrorism. There is plenty of freely available documentation to describe the aims – for example from the IMF and from the World Bank.

So these regulations are centrally imposed by global non-government organizations. Just like the Kyoto Protocol and the United Nations Declaration of the Rights of the Child, right?

Err ….. no. These regulations are different because they inhibit cross-border business if they are not ratified.

For example, many banks in other countries do not have to just implement AML (anti-money laundering) and CFT/CTF (combating the financing of terrorism / counter terrorist financing) rules. They also perform the role of correspondent banks and have to ensure that their respondent banks are also compliant. For example, the Wolfsberg Correspondent Banking Principles lay out best practices that have been adopted by many global banks, and the Financial Action Task Force (“FATF”) International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation recommendations have become de facto global rules even though every country enacts its own AML/CFT legislation.

Correspondent banking is the (usually cross-border) process whereby a correspondent bank administers a correspondent account for a respondent bank or other financial institution. Typically the correspondent bank is a large global bank whereas the respondent bank may be a very small domestic bank that uses the correspondent banking relationship to offer its customers foreign currency denominated services. For example, a small South African bank with no subsidiary and no banking license in the USA, could use a correspondent banking arrangement with a large USA-based global bank (such as JP Morgan) to offer South African businesses the ability to pay an overseas supplier in US dollars.

Correspondent banking present a significant compliance risk and an increasing cost of compliance. Due diligence on the respondent bank is required and often obtaining the necessary documentation is challenging. In particularly risky scenarios, due diligence on the respondent bank’s customer is also required (“KYCC” – know your customer’s customer).

A possible response is “de-risking” – withdrawing from providing correspondent banking services to some customers / geographies. When several large global banks all take the same decision, the impact on some parts of the world can be drastic.

This risk was articulated very recently by Christine Lagarde, Managing Director of the IMF, in a speech at the Federal Reserve Bank of New York.

In her speech, she referred to IMF staff discussion note (“sdn”) no. 16/6 The Withdrawal of Correspondent Banking Relationships : A Case for Policy Action which describes in detail how global banks are withdrawing from correspondent banking and how this is impacting smaller and developing economies.

The IMF sdn uses the example of Samoa where 20% of GDP is derived from remittances by its diaspora, particularly in Australia, New Zealand and the USA. The inability to remit forex clearly has the potential to severely impact the Samoan economy.

By preventing the effectuation of updated legislation, particularly in the light of the South African banks’ independent decisions to sever ties with the Guptas (potentially a significant KYCC issue for correspondent banks), President Zuma raises the risk profile of providing correspondent banking services to South African respondent banks, impacting international trade and remittances. Reliance on correspondent banking for remittances impacts rural poor disproportionately, exactly where President Zuma’s greatest support lies. Hence his filibuster can only weaken his support further.

But beyond exposing President Zuma’s ever increasing Putin-esque tendencies, this situation clearly shows how international payments are supra-national, meaning that no country can opt out of adherence to the rules (other than the USA, perhaps, where presidential candidate Donald Trump’s nationalist rhetoric is all the more frightening due to the US dollar’s reserve currency and main international trade currency status allowing the USA to refuse to adopt regulations that no other country can ignore).

In effect, we can clearly see that all other countries have lost their sovereignty in this domain. And there’s nothing that can be done about it. The British people recently voted for Brexit. But withdrawing from the European Union will not give Britain greater autonomy regarding AML/CFT compliance – not if it wants to maintain trade relations with the rest of the world.

Perhaps the USA has a bedfellow that can ignore the rules? North Korea.

One single comment

  1. Interesting commentary in the FT following Madam Lagarde’s speech – – which recognizes the potential for alternative payments infrastructures so emerge. Obviously a blockchain-based system is one option. The article also states that “The inference, we’d say, is that the global financial system is sitting at a critical juncture beyond which it could easily bifurcate into two competing networks: one transparent, one opaque.”

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