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January 22, 2018

A year after the ‘Panama Papers’ created ripples across the globe, the November 2017 ‘Paradise Papers’ data leak seems as if history is repeating itself. The Paradise Papers is a set of 13.4 million confidential electronic documents relating to offshore investments that were leaked to the German newspaper, Süddeutsche Zeitung. The documents originate from the offshore law firm Appleby and business registries in 19 tax jurisdictions, and indicate how politicians, multinationals, celebrities, and high-net-worth individuals the world over, have used complex structures to avoid taxes.

The Boston Consulting Group says $10 trillion is held offshore (as per the BBC Panorama report) which is about the equivalent of the combined GDP of the UK, Japan, and France!

In essence, the leaked documents show how global companies and wealthy individuals have strategically reduced their tax burden by stashing money in favorable tax jurisdictions available across the globe. According to the BBC Panorama Report, these jurisdictions are known as tax havens to the layman, and offshore financial centers (OFCs) to the industry. They are generally stable, secretive, and reliable, often small islands but not exclusively so, and can vary on how rigorously they carry out checks on issues of non-compliance.

The investments made in this regard are often considered illegal and may raise questions of business ethics and conduct, as the popular belief is that corporations and wealthy individuals use tax havens to minimize tax obligations. The high degree of secrecy associated with such investments raises their risk perception, thereby calling for strict vigilance from a financial institution perspective. Any negative observation can lead to major issues for financial institutions in the form of regulatory penalties, reputation risk, and so on. Given the criticality of the situation, the European Union in December 2017, published a tax havens’ blacklist; other countries across the globe may follow suit.

So, the key question in this scenario is, what should banks do to avoid being pulled into this net?

The answer is obvious – rigorous customer activity monitoring. But, is it that simple? No. It calls for a great deal of discretion at the banks’ end, a mere mention of a client (with reference to offshore investments) in data leaks such as the Paradise Papers may not warrant an investigation. A selective and risk-based investigation must be undertaken, as was highlighted by the ‘Panama Papers’ incident wherein investigations did not lead to any big arrests or undisclosed sums and resulted in very few actionable cases.

Financial institutions must devise foolproof mechanisms to identify the clients that must be closely scrutinized based on a well-defined risk matrix, which can help obviate the need to review everyone appearing on the list. Such a matrix can consider aspects like the level of information available in such publications, the amount involved, the tax haven jurisdiction involved, the type of client (for instance, legal firms and entities are supposedly at a higher risk level),  PEP status, the type of banking relationship (for instance, commercial banking and private banking relationships are typically regarded as high risk areas), and declared turnover or income vis-à-vis funds reported. In addition, the matrix must also take note of any adverse news about a client, past records of money laundering or other financial crime activities, and so on.

Analytics driven methods should be adopted for identifying the threshold values for the parameters and for risk weighting them rather than simple manual methods. A variety of advanced analytics techniques can be used to arrive at the exact and appropriate threshold values for the parameters identified based on review of the past data and money laundering trends applicable. Similarly, analytics can also help in identifying appropriate risk weightages for the identified parameters.

Further, the matrix can also have over-riding parameters or threshold values, which means, a hit on the same alone would make the customer high risk (regardless of the values for other parameters). For instance, previous SAR filing, undisclosed PEP status, and confirmed reports of financial crime or tax non-compliance, and so on, can be over-riding parameters. All such individuals and entities should be considered for detailed scrutiny; as deemed appropriate, such entities should be reported to the regulators and relationship should also be terminated.

Hence, a model of this nature can eliminate the need to review and scrutinize all the sundry names that would appear in publications such as the Paradise Papers. Not only will this improve your customer confidence and their perception of your brand (the ones who are not guilty), but it will also facilitate a timely AML review of the ‘real’ cases. What do you think? Please share your thoughts in the comments section below.

Govindaraja V is part of the Business Operations business unit at Tata Consultancy services (TCS), and heads the AML CoE for the group. He has over twenty years of experience and has worked in some of the leading banks in India, besides spending a decade at the Reserve Bank of India. He holds a Master's degree in Science from the Tamil Nadu Agricultural University, Coimbatore, India, and is a Certified Associate of the Indian Institute of Bankers.


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