Banks must focus on ESG issues to win the money-laundering fight

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The financial landscape may seem like a battlefield, with the war against cybercrime, money laundering and identity theft fiercer than ever as both sides deploy new tactics. Criminals are now increasingly exploiting environmental, social and governance vulnerabilities to launder money and finance illicit activities. This presents a significant threat to financial institutions and their bottom line.

From hefty fines to reputational damage, the costs can be staggering. For example, an Australian bank paid a $920 million settlement for inadequately implementing transaction monitoring to identify transfers related to child exploitation.

In 2023, the U.S. Office of Foreign Assets Control, or OFAC, sanctioned a company for running diamond mines in the Central African Republic — contributing to environmental degradation and human rights abuses — that circumvented the Kimberley Process and used the illicit funds to support ongoing military operations.

In October 2024, one of the 10 largest U.S. banks made headlines by pleading guilty to Bank Secrecy Act program failures linked to drug trafficking.

These incidents raise an important question for anti-money-laundering efforts: Are banks taking ESG data seriously enough?

As domestic and transnational financial crimes become increasingly intricate, more regulatory bodies are supporting preventative programs. In June 2021, the U.S. Financial Crimes Enforcement Network, or Fincen, introduced its first set of government-wide priorities focused on AML risks, which financial institutions must build into their AML control systems. Those included ESG factors such as human trafficking.

Established AML teams already have well-founded know-your-customer and screening programs, along with expert analysts. But as the above instances suggest, some banks might have a blind spot when it comes to integrating ESG-related screening of related entities within existing AML programs. Coupled with expanding regulatory requirements and limited resources, this has led to risks and a lack of defense against illicit activity.

Some financial institutions are responding with swift action. A recent conversation with a compliance executive at a global bank highlighted that more firms are building ESG safeguards using adverse media searches that employ unstructured ESG data, such as content from litigation records, shareholder proposals or public records and documents during customer refresh processes. Another leader shared that their bank rejected clients after learning that the boards of directors did not act in a manner consistent with good ESG practices.

Environmental crime attracts lawbreakers because of high profits and low conviction rates. A 2021 Financial Action Task Force, or FATF, report found that global environmental crime generates $110 billion to $281 billion annually. Yet despite the overlap of ecological crimes (wildlife trafficking, illegal waste disposal) with social (drug trafficking, human trafficking) and governance (corruption and bribery) pillars, OFAC and other groups tend to focus on national security and organized crime.

AML

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There is a need for clearer regulatory guidance and standardized approaches for ESG-related crimes, as standard AML screening processes alone are insufficient. Case in point: In environmental crime money-laundering cases, investigators often deal with legal commodities, like timber, gold or diamonds, which have legitimate markets. Although the commodity itself isn't outright prohibited, how it's sourced and traded determines its legality.

Double laundering adds another layer of complexity that is common with environmental crime. First, criminals falsify documents or bribe officials to make illegally sourced commodities appear to be from legitimate origins. The second element of laundering occurs when the illicit proceeds are made to appear as lawful earnings.

Front, shell and shelf companies can hide an enterprise's ultimate beneficial owners, or UBO. It's a critical element of the AML and know-your-customer process to determine who actually holds a stake in the entity. In 2023, Italian and German authorities uncovered an illicit waste-trafficking scheme transferring cash through fictitious companies in other countries; some profits were laundered through legitimate business activities, including the purchase of an Italian soccer team.

Financial institutions undergo constant pressure to remain vigilant in their financial crime compliance activities. Fincen has repeatedly reminded financial institutions to identify and report suspicious activity related to environmental crimes.

Consider a company that owns farms, which might otherwise not seem high risk, until you recognize that the agricultural sector is a prime arena for facilitating human trafficking. By incorporating ESG considerations more fully into the know-your-customer process, banks can potentially assign a higher risk rating for this type of industry.

In a recent report, Earth League International suggests, "transnational environmental crime networks are extremely resourceful and adaptable, capable of moving their money, illegal goods, and people across borders and continents as they please." While the industry routinely refines and reviews red flags and builds new keywords and typologies into know-your-customer systems, too often this falls only on the primary entity. There is a need to extend the scope of negative screening beyond just the primary entity and its web of related entities. As a result, investigators can follow the money.

I've heard it said that financial institutions are the first line of defense in the fight against financial crime. The benefits of integrating ESG factors into these efforts are far-reaching for financial institutions. Firms can develop a comprehensive view of their risk exposure, enhance their ability to predict criminal activities and strengthen compliance measures. With mounting calls for accountability and transparency, the argument is compelling to adopt an advanced defense strategy to tackle advanced threats.