Blockchain is not the answer to money laundering… yet
Blockchain technology has the potential to have a huge global impact on financial transactions.
Governments all over the world are exploring how the technology that underpins cryptocurrencies such as bitcoin can be developed and utilised to streamline compliance and bolster their arsenal in the fight against financial crime.
Current laws aimed at tackling financial crime, such as anti-money laundering (AML) regulations, are often complex and cumbersome, and compliance can be a costly business. But blockchain, or distributed ledger technology, could hold the solution.
One area being explored is the creation of ledgers that will store pre-verified customer information. This will enable businesses to identify clients and assess the risk of money laundering without the need for multiple AML checks.
For financial institutions, this would provide a safe place to access customer due diligence that will be both transparent and uneditable.
However, there are problems with this approach. Current legislation is frustrating efforts to develop blockchain, which means it might not be the answer just yet.
For instance, under GDPR, the European Union regulation that covers data protection for individuals, the right to be forgotten is at odds with blockchain, which by its very nature is permanent and unalterable.
Government agencies will need to address how a permanent log of personal information, which may be public, can work alongside this legislation. This could result in amendments being made to GDPR or creating workarounds that permit a degree of flexibility for compliance.
Another option may be to store personal data off the blockchain in a separate database, but this will probably limit the technology’s effectiveness.
Current anti-money laundering regulations are also an issue. Third-party reliance provisions allow a person (or company) to rely on third-party customer due diligence to satisfy their own regulatory obligations. But this is not a simple process.
It requires third parties to hand over all the due diligence information they have gathered to anyone looking to rely on it, and for the parties to retain copies of the data for at least five years. In addition, anyone relying on the due diligence remains liable for any regulatory failures made by the third party.
This level of accountability creates an administrative nightmare for financial institutions. It is unlikely that companies will be willing to accept this degree of liability.
This regulatory burden will result in even more cumbersome AML compliance procedures. As long as this remains, it seems unlikely that blockchain will be able to offer financial institutions the streamlined process they desire.
The Financial Conduct Authority, the UK regulator, accepts that changes to the anti-money laundering regime need exploring to allow new technologies to develop. Under normal circumstances one would expect the UK to work alongside the EU to research how blockchain could be deployed effectively to combat financial crime.
But the government and the EU, no doubt distracted by the fact that the UK is due to leave the EU by March 2019, have been slow to respond.
Given the global reach of organised crime, one would expect to see discussions on how to utilise blockchain technology in crime prevention at an international level. The foundations are in place, but it seems that many countries, including the UK, are waiting for someone else to take the lead.
This is a golden opportunity for the UK to reassert its position as one of the world’s leading financial centres and it would be foolish not to take a more proactive role.
There is no reason existing regulations should stifle the progress of blockchain in this area. If regulators can create shared platforms, then they could dramatically improve AML measures for financial services while reducing the cost of compliance.
It may even result in an internationally recognised digital client-identity forum. But clearly there is work to be done.
Kyle Phillips is a senior associate at Howard Kennedy, and a Young Fraud Lawyers Association committee member. For further information on the content above please contact Kyle Phillips.