1. Introduction

Illicit financial flows (IFFs) are a major obstacle to development and have become an increasing source of concern for developing countries.df87e48b2bfd Every year, a massive volume of capital is illegally or illicitly transported out of developing countries and into tax havens and the financial centres of the world.139fe85ff4ae Simultaneously, large amounts of IFFs are transferred within the same country. IFFs drain capital and tax revenue from developing countries. Moving capital out of the country illicitly enables tax evaders, corrupt officials, businesspeople, and criminals to better protect their funds from seizure.

IFFs threaten fundamental aspects of development, such as the rule of law, the quality and accountability of democratic institutions and, some argue, affect broader social trust.61e9f692fac5 These illicit outflows largely exceed aid funds and a great proportion of the flows are likely to stem from corruption.1c7661ffa13f These funds could otherwise be used to finance education, infrastructure, health care, and other vital elements of sustainable development. By reducing IFFs, governments will have more public funds available to invest in the development of their countries. Strengthening the rule of law and effectively prosecuting offenders could, in addition to significantly reducing IFFs, increase citizens’ trust in state institutions and, in turn, contribute to stability.

In the last ten to fifteen years, governments and international organisations have paid increasing attention to IFFs.d5b2039b89b7 More recently, the World Bank and the International Monetary Fund (IMF) have placed increased emphasis on corruption and addressing tax havens.6048ad20f48a Additionally, Goal 16 of the 2030 Sustainable Development Goals (SDGs) addresses corruption, and Target 16.4 specifically concerns IFFs: ‘By 2030, significantly reduce illicit financial flows and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organized crime.’ Achieving the SDGs will require considerably more resources than can be afforded by public finance. By curbing IFFs and recovering stolen assets, governments have the opportunity to unlock much needed resources to close the financial gap to achieve the SDGs.1b58a1d0dee2 Moreover, combating IFFs is an important element of tackling the crime, corruption, and violent extremism that threaten stability and economic development. However, the scale of donor support for tackling IFFs is relatively modest.a53a39dc3ce5

Development practitioners located in developing country offices and/or embassies of bilateral donors tend to be familiar with domestic anti-corruption structures and actors in the countries where they work. They are often less familiar with the dynamics of domestic corruption that create transnational dimensions and effects, and the importance of international bodies, processes, and assistance programmes that are seeking to address these aspects. In cases where these issues are understood, it is often difficult to see how to tie national-level anti-corruption efforts to internationalised corruption and the international mechanisms designed to counter it. This U4 Issue highlights important information regarding IFFs and the international bodies and processes designed to reduce them, and illustrates how development practitioners can make use of that information when addressing IFFs at country level. Moreover, this paper will provide an introduction to IFFs generally and address the relationship between corruption and IFFs specifically.

1.1 Methodology

We undertook a targeted literature review of the international dimensions of corruption and IFFs based on existing published research. This is presented throughout the paper and informs our analysis. In addition, we conducted semi-structured telephone interviews with development practitioners to identify how IFFs are addressed at country level. We chose this approach in order to evaluate the strengths and weaknesses of existing programmes and the usefulness of international legal, policy, and operational bodies, and the processes and initiatives which country-level practitioners might engage with.

As a case study throughout this paper, we have highlighted the German Development Agency’s (GIZ) global programme ‘Combating Illicit Financial Flows’, which was implemented by GIZ in East Africa, South America, the Western Balkans, and Germany. There were several reasons for selecting this programme. First, it has a wide geographical spread, including an important component linked to financial hubs in Germany and the Global West, which indicates a growing realisation that IFFs are not purely a ‘developing country problem’ but an international one tied to challenges in the global financial system. Second, this programme sought to strengthen the links of Germany and partner countries with regional and international bodies and support their efforts to address the international effects of IFFs. Finally, while it has recently been extended for an additional three years, it has run for several years and programme managers have therefore had time to reflect on its strengths and weaknesses.

2. Main issues to understand in IFFs

2.1. Definitions

In the literature on IFFs, there is no general agreement of a precise definition of the term. There are two main ways of defining IFFs. The first relies on the dictionary definition of ‘illicit’ as ‘forbidden by law, rules or custom.‘ When illicit is defined in this way, IFFs include ‘illegal’ in addition to the ‘socially unacceptable.‘ This definition poses several problems. For example, different political or financial actors may consider corporate tax avoidance by multinationals corporations as either socially acceptable or unacceptable, whereas transfers of funds that come from crime such as corruption are clearly illegal. Determining whether or not an international transfer whose purpose is to minimise tax payments is ‘illicit’ is difficult. Most tax planning is legal and considered by many to be legitimate. Yet there is substantial disagreement at the point when aggressive corporate tax planning becomes tax avoidance and undermines the social responsibility of corporations to pay taxes.34b5d751897d

The second way of defining IFFs is to equate ‘illicit’ with ‘illegal.‘ This is the most common definition, and is used by the World Bank and Global Financial Integrity (GFI): ‘Funds illegally earned, transferred or utilised that cross borders.’ Fontana and Hearson.0192d2be94eb argue that IFFs can be illicit for two overlapping reasons. In the first case, the money involved comes from the proceeds of crime, such as corruption or drug smuggling, so the transfers of funds are clearly illegal. In the second case, it is the process of transferring the money that is illegal and illegitimate, even when the funds come from legal and legitimate sources. The latter is most often done to escape taxes. Aggressive tax planning often uses loopholes in countries’ legal systems to hide away assets, hence defeating the legislative intent of the law without violating the law itself.41ace4e5d33d This type of aggressive tax planning poses a grey area between the legal and illegal, and the flow of money will be regarded as an IFF as per the dictionary definition,212be2f42c90 but not when illicit is equated with illegal. Moreover, definitions of IFFs often include a third component that addresses funds which are utilised illegally or illicitly, thus including terrorist financing in the definition.91ee2bfa365a

Including such grey areas in the definition of IFFs is attractive for several reasons. For example, it allows an opening for an important debate on what constitutes the social responsibility of corporations. Nevertheless, it defies operationalisation. It is difficult to stop something that is not illegal per se. The operationalisation, upon which the literature on IFFs is built, relies on the illegal component of the definition: ‘Funds illegally earned, transferred or utilised‘.24248dfa63b0

Most of the definitions of IFFs refer to illicit funds that cross borders. However, some definitions also include funds that are illicitly earned, transferred, or used within the same country.f79c9a6334e2 In their programme, ‘Combating Illicit Financial Flows’, GIZ argues that domestic IFFs are equally important to address in a development perspective. They define IFFs as ‘… all movements of capital or other assets which are illegal by virtue of their origin (e.g. criminal activity, tax evasion, corruption), the target/purpose (e.g. terrorist financing), or due to the modalities of their transfer (e.g. violation of sanctions or avoidance of oversight mechanisms).’ In order to tackle IFFs within and between states, both the measures at domestic level (to tackle purely domestic IFFs) and those at the international level (to tackle cross-border IFFs) must be applied.406ae08481b3

2.2. Scale

Research on IFFs poses methodological challenges because IFFs are hidden. Most of the existing estimates4fe327c04a37 are largely based on analysis of mismatches in official statistics. In other words, checking whether exports reported from country A to country B match reported imports. The IMF, which publishes some of the underlying macroeconomic statistics, specifically warns against using their data in this way, stating that the data cannot be used to estimate trade misinvoicing. There are two reasons why it is problematic to use the data in this way. First, not all trade misinvoicing shows up as mismatches in the trade data, and not all mismatches are evidence of trade misinvoicing. Second, large and seemingly detailed estimates may divert attention away from other areas of illicit flows, where such estimates do not exist. Relying on bad numbers debases the political debate and leads to weak policy analysis and ineffective action.930e8012c450

Moreover, estimates of IFFs provide few details as to their composition or the factors affecting variations across countries and over time. In 2005, GFI estimated that approximately 5% of global IFFs came from corruption, and most stemmed from commercial and criminal activities. The United Nations Economic Commission for Africa’s (UNECA) High Level Panel on Illicit Financial Flows from Africa also estimated that 5% of African IFFs came from corruption, and most came from corporate activities.c5a86ab51376 Despite the critiques of the global estimates on IFFs, there is widespread consensus among scholars, politicians, and policymakers that their scale is huge, and that they pose a major obstacle to development.c52d8044ca56 Estimates on how much developing countries lose through IFFs on an annual basis are important for raising the issue up the political agenda. No matter how the numbers are estimated, they are severe. We will never have accurate data on IFFs, just as we will never have entirely accurate data on corruption, drug trade, or human trafficking. Nevertheless, it is vital that IFFs are addressed and reduced.d6969de0cd44

Regardless of the methodological challenges in measuring the scale of IFFs, all existing estimates on the volume indicate that IFFs are a massive phenomenon in both developing and developed countries. In a 2017 report on IFFs5b4985453abb to and from developing countries between 2005 and 2014, GFI finds that IFFs likely accounted for between 14.1% and 24.0% of total developing country trade, on average, in this period. In the most conservative calculations, GFI estimates that illicit outflows from developing countries ranged from USD 620 billion to USD 970 billion in 2014.70abfffec3ed By comparison, the total official development assistance (ODA) from the OECD’s Development Assistance Committee (DAC) member countries totalled USD 137.2 billion that same year.c2850c24c803 Hence, even the most conservative estimates on the volume of IFFs largely exceed the amount of DAC aid that developing countries receive. Moreover, the GFI estimates are based on data on trade misinvoicing0456aa20f37d and therefore do not count all types of IFFs. The GFI estimates do not include cash movements, most criminal activities, misinvoicing of intangibles and services for which there are no data, and certain other invisible forms of trade anomalies. If these data were available, the estimates would be considerably higher.b2be0353407d

IFFs into developing countries are also huge. GFI estimates that the total inflows range between USD 1.4 trillion and 2.6 trillion in 2014,55fea7279056 making them much higher than the total outflows. GFI President Raymond Bakere21855ebd28b argues that the difference in numbers suggest that the outflows may well be understated. According to several customs officials in African countries: ‘No one in the business sector brings illicit money in without a parallel means of taking it out’.cc7bbff57af5

Measured against the level of trade, Africa ranked the highest in illicit outflows, ranging from 5.3% to 9.9% in 2014, while Asia ranked the lowest of the major regions, ranking from 3.9% to 5.6% of total trade in 2014.e3b626ece450 IFFs are damaging to all countries. However, they have more damaging consequences in developing countries because of their limited resource base and their smaller and less stable markets. UNECA’s High Level Panel on Illicit Financial Flows has estimated that IFFs from Africa could amount to USD 50 billion per year.2ad0e9ce205a

2.3. Impact on developing countries

‘The poor of the world cannot wait for perfection of the data’ – Tom Cardamone before a World Bank audience.afe769a67a22

Every year, developing countries lose a massive volume of wealth to corruption, tax evasion, and money laundering enabled by IFFs. These funds could help to fill the gap for funding sustainable development. The consequences of IFFs can be devastating for several reasons. IFFs enable corrupt politicians, public officials, and economic elites to hide their proceeds of corruption. When IFFs are sent overseas, they are likely to reduce the elites’ support for the development of the state because less of their wealth is dependent upon the domestic economy.44f4d781dd97

Further, reduced tax earnings have a direct negative effect on public and private investment as well as the provision of public services. The result is fewer schools, hospitals, jobs, and infrastructure projects, and weaker social protection for the citizens in these countries. IFFs place skewed tax burdens on poor citizens and honest businesses.a5d4916da8da Many of the effects of IFFs are circular. For example, if money laundering enables corrupt politicians to safely hide the proceeds of corruption, this will help them to retain power by shielding them from proper accountability, which may further enable them to corrupt the institutions responsible for detecting money laundering and crime.732bf044ffe2 When weaknesses in the financial system are not regulated effectively, organised crime and illegal economies can thrive.

IFFs do not have only economic consequences; they can also affect other fundamental aspects of development that cannot be captured solely by numbers. First, the rule of law is partly dependent on the support of economic and political elites. If elites can shelter much of their wealth outside the country, they have a lesser stake in the development of, for example, property rights, which is an important aspect of the rule of law. IFFs, can therefore have a negative effect on good governance. Second, IFFs can have a negative effect on broader social trust in a society and trust in the government.01d276c2e2cb Bo Rothstein1e8617786af1 argues that the elites’ use of secrecy jurisdictions to hide away their wealth and avoid taxes can have serious consequences for citizens’ trust in institutions:

‘If the political, economic, social and maybe also the artistic elites behave in the way we have now seen in the Panama money laundering scandal, people will not only lose trust in these elites and the institutions they represent. There is also an additional cost to society that in the long run may have even graver consequences, namely that the basic fabric of social trust is eroded. And trust is a delicate thing, because once lost it is hard to regain. The implication is that we have to account for the existence of a double negative effect from scandals like this’.76b9183fac2c

2.4. IFFs and corruption

There is a close relationship between IFFs and corruption since the former is often a result of the latter. The literature on IFFs and corruption tends to show that there is a reciprocal causality between IFFs and corruption. Corruption is a source of IFFs and an enabler of money laundering, and money laundering allows for the proceeds of corruption to be hidden away and used. The possibility of moving capital illicitly makes corruption easier to engage in. Moreover, IFFs disproportionally damage state institutions in developing countries, by limiting the provision of public goods and undermining the stability and legitimacy of institutions.1a8b2ea15f22

Corruption and IFFs can be linked in several ways. Corruption can be the source of funds (bribes) that constitute illicit funds to be laundered. Illicit funds from corruption can be channelled to a bank account in a foreign country, typically to secrecy jurisdictions, and laundered abroad. Tackling IFFs has the potential to deal with high-level corruption of this kind. Moreover, corruption can be the means of facilitating the creation of IFFs, for example through corrupt tax administrators who ignore illegal tax evasion and other financial obligations. Examples of such corruption can be tax officials who make ‘favourable’ interpretations of tax regulations to lower a company’s tax burden, or tax officials turning a blind eye to tax evasion. Further, corruption can be a means for enabling an IFF via corruption in the institutions with obligations to report on IFFs. For example, when a bank official does not notify suspicious transactions to the relevant authorities because they have received a bribe.bc20c7e7ed1a

Secrecy jurisdictions

Secrecy jurisdictions,e66926e68ff1 including but not limited to tax havens, facilitate IFFs, harmful tax competition, money laundering, grand corruption, and economic crime. Tax havens are jurisdictions that offer low tax rates for foreign individuals and companies, (non-resident) limited regulations, and extreme secrecy about the ownership of registered corporations and individuals. The secrecy is a result of national laws that prevent the sharing, or even the collection, of information regarding the ultimate beneficial owner of bank accounts, legal persons, or other corporate vehicles.

Hiding away wealth, income, and company ownership in secret bank accounts and shell companies1f510c62cff6 encourages individuals and enterprises to evade tax. As such, the secrecy industry represents the supply side of corruption, while corrupt individuals and enterprises represent the demand side.c27c07f35d9d Secrecy jurisdictions are especially damaging to developing countries where financial regulation is weak, as they undermine rule of law in the countries of origins of the non-residents, and where money from taxpayers is desperately needed. An estimated USD 21 trillion to USD 32 trillion of private financial wealth is located in secrecy jurisdictions around the world.8cff1febb5b3 As much as 2.7% of global GDP is laundered worldwide in connection with criminal activities, and according to the World Bank, over 70% of large-scale corruption cases involve anonymous companies.00b7d48988c1

One of the most damaging aspects of secrecy jurisdictions is that they hide public money stolen by corrupt government officials from other countries. There are countless cases of politicians moving public money out of the country and into private accounts and shell companies in tax havens. However, only a handful of corrupt leaders have ever been held accountable for their actions, and seen their stolen assets returned.b22351f61581

3. Assessment of existing responses

3.1 Existing policies and the international architecture for tackling IFFs

Policies aimed at tackling IFFs are more useful to prevent grand corruption where relatively large amounts of money are involved. Petty bribery is much less likely to be detectable as IFFs, unless, for example, a politician receives many smaller bribes that need to be laundered. This is because policies designed to tackle IFFs have to target transactions of a certain size. Smaller bribes are more likely to be given and received in the form of cash outside the formal banking system.a184dbc478d9

Efforts to address IFFs differ depending on the country context and the underlying activities that result in their outflows. A number of policies have been introduced at national, regional, and international levels to prevent IFFs within and from developing countries. At national level, the main focus is on curbing corruption as a source of IFFs as well as on tackling money laundering related to different kinds of crime, including corruption. At international level, the initiatives aim at strengthening the integrity of the global financial system, a higher level of transparency, and addressing international corruption as well as the cross-border movement of illicit funds and recovering stolen assets.3f1f794e13b2

National efforts are important to curb IFFs, but on their own, they are not sufficient because of the global nature of the problem. The case of tax havens illustrates this very well. Offshore financial activity is a result of other states offering tax breaks to attract business into their jurisdictions and, as such, it is impossible to prevent this without an agreement on tax regimes.9709a775bd6d Moreover, national efforts to hinder domestic corruption must address IFFs in order to be successful. As such, any counter-IFF measures depend on both intra-state and inter-state cooperation.36f88f9f7add

General restrictions on capital flows

IFFs can occur through black markets and illegal cash transfers. However, the mainstream financial system is where the majority of IFFs take place. The main objective of, for example, money laundering is to enable the funds involved to move into the financial system without raising suspicion. The system has several features that enable and even encourage IFFs, particularly where funds can be moved across borders anonymously and legally, quickly, and with few bureaucratic restrictions.a034c847e043

Massae775abf93d57 argues that the domestic financial system in many African countries is characterised by a number of features that may facilitate IFFs. These characteristics are related to ‘the structure and functioning of the financial sector, the scope and effectiveness of financial regulation and supervision, the linkages between the domestic financial system and global financial system, as well as to progress in financial innovation.’ Moreover, many features of the global financial system, such as banking secrecy, secrecy jurisdictions, and financial innovation (for example, new payment methods, virtual assets, and speedy transactions), may also facilitate IFFs. General restrictions on and greater transparency in financial markets are two ways of reducing the space for IFFs.

Good governance and strong institutions

In general terms, strong, capable, and well-respected government institutions create a hostile environment for IFFs. Such government institutions are more effective in combating IFFs, and a well-respected and legitimate system fosters a culture which discourages some illegal activities.ce04d49022a3 Rigorous tax authorities are critical in this regard. Ineffective tax authorities are one of the main constraints on the ability of states to collect revenue in general, and can enable tax evasion.

Good governance beyond government institutions is also important. A strong civil society and independent media are key to holding elected leaders and government institutions to account.42d71b8d8a83 Donor support to civil society and media can help national actors to investigate illegal activities and advocate reforms. Moreover, legal professionals and accountants are also explicit in facilitating IFFs, as seen in the Panama Papers and Paradise Papers. In the ongoing GIZ global programme, ‘Combating Illicit Financial Flows’, the Germans work with civil society in the Western Balkans to raise public awareness on the money laundering and IFF risks that are specific to the area; assist investigative journalists in the MENA region in financial investigations; and provide support to tax authorities with regard to politically exposed persons (PEPs).

Anti-money laundering measures and financial intelligence units

Efforts to combat money laundering are essential to tackling IFFs. Anti-money laundering laws and programmes attempt to prevent offenders from turning illegally earned money into legal funds that can be used for investment or consumption. Moreover, they aim at apprehending and punishing offenders, including those professionals who help primary offenders move, conceal, or transform proceeds of crime.8eb354aa0f53 All countries should comply with the Financial Action Task Force (FATF) recommendations to combat money laundering and terrorist financing. Stopping money laundering comes down to prevention and law enforcement. If countries do not possess the necessary legal framework and are not enforcing the laws and regulations already in place, it is not possible to stop money laundering.ab9ab4f35574 This is why FATF introduced the concept of effectiveness of AML/CTF regimes, in addition to technical requirements, in its revised standards of 2012.1e759db07dfe

Financial intelligence units (FIUs) are central bodies for receiving and analysing reports from the financial sector, as well as the non-financial sector, regarding activities that are suspected of constituting money laundering, and for distributing the results to the relevant authorities. FIUs can play a leading role in preventing institutional corruption and IFFs. When money is involved in crime, countries need institutions capable of investigation.acf19bc44492 Establishing FIUs and equipping them with the necessary capacities is required by the FATF standards,acfde93b32a9 and is mentioned in the subsections of the other FATF recommendations.a7b606cfd6c5 Most countries establish FIUs in compliance with the FATF recommendations.

Asset recovery

Stolen assets are the proceeds of corruption, such as money, properties, or other assets, amassed through corrupt acts.ec762df94788 The process of identifying, restraining, seizing, and repatriating stolen assets hidden abroad is a crucial part of curbing IFFs, and one of the greatest challenges for the global anti-corruption movement.389b7e35128b Countries around the world face legal constraints when dealing with stolen assets, especially developing countries that lack the resources needed to match the skills and creativity of criminals. Finding and holding stolen assets is a lengthy process full of legal and practical constraints because stolen assets are often held in secret corporate structures in multiple jurisdictions.74b24286b772 Gaps in the legal frameworks create opportunities for criminals. At the same time, globalisation, digital communication tools, and easy mobility of assets and funds allow individuals to transfer illegal funds with ease, making it very difficult to trace and recover funds and other property.0c185f192352 Up until today, only a small fraction of stolen assets have been returned to the country of origin.6802ed7ee4ee

Addis Tax Initiative

The Addis Tax Initiative (ATI) is a non-binding agreement reached in 2015 to address IFFs. The ATI is important for practitioners because it is relevant in some of the countries in which they work. The ATI emerged from the government negotiations in Addis Ababa on how to finance the SDGs. The initiative directly links IFFs to domestic resource mobilisation and, in turn, to sustainable development.

The initiative was set up with the support of 40 countries and organisations. The participants pledged to collectively double their technical cooperation in the area of domestic revenue mobilisation and taxation by 2020. Tanzania, Ethiopia, the Philippines, and Indonesia are among the developing countries that have signed the agreement and have said that they will strive to curb their losses in revenue due to IFFs.492dcb66794b One of ATI’s aims is to facilitate donor coordination and share information. International organisations and ‘lead’ donors active in partner countries are encouraged to use the ATI network to seek the participation of other donors for elements of domestic resource mobilisation programmes.2cee78006c54

Exchange of information in tax matters

To tackle the negative consequences of tax havens and find out where residents are hiding their money, authorities in one country need to obtain information from financial institutions or commercial registers in other countries. However, tax authorities cannot simply request information from these institutions in another country. A legal framework for the exchange of information must be in place. There are three methods for exchange of information.1f45ee2b8675

1. Upon request: Under this standard, a jurisdiction must first make a formal and specific request to receive information from a state abroad. Because it is very easy for tax evaders to hide their assets and identity in tax havens, it can be time- and resource-demanding for the requestor to collect the necessary information about the taxpayer being investigated before the request can be made. Furthermore, after that information is gathered by the jurisdiction, the state can still reject the request, if it does not meet the criteria of the applicable agreement. Even when the information is exchanged, by the time the jurisdiction received the evidence, the individual may already have moved the assets.
2. Spontaneous: This standard allows jurisdictions to exchange information with each other whenever they come into possession of any data which may be relevant for the other jurisdictions.
3. Automatic Exchange of Information (AEOI): This standard supposes the periodic exchange of information without the need to request it.

AEOI is the preferred way of exchanging information between jurisdictions. The OECD regards cooperation between tax authorities through AEOI as crucial in bringing national tax administration in line with a globalised economy. Over the past 20 years, the OECD has designed and updated standards for exchange of information and, in 2014, released the Common Reporting Standards for AEOI. They also developed the OECD Automatic Exchange Portal for the implementation of AEOI in tax matters. This online support contains information about AEOI and an overview of all bilateral relationships that are currently in place for AEOI under the OECD framework and other bilateral agreements.12b184512f5c Moreover, it is important to mention the Global Forum on Transparency and Exchange of Information for Tax Purposes, which offers technical assistance activities to support its member jurisdictions in effectively implementing the international standards on transparency and exchange of information, and ensuring that exchanges between members’ tax authorities are efficient and of high quality.f10598f88881

Base erosion and profit shifting, and country-by-country reporting

Base erosion and profit shifting (BEPS) refers to tax avoidance strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low- or non-tax locations. The BEPS initiative seeks to address these international tax standards that have become open to exploitation by multinational firms. The OECD has, together with the BEPS Associates in its Inclusive Framework on BEPS Format, initiated an implementation package under Action 13 of the BEPS project on transfer pricing documentation and country-by-country reporting. Country-by-country reporting requires certain multinational companies to report to the tax authorities for risk assessment purposes their revenues, profits before income tax, tax paid and accrued, numbers of employees, stated capital, retained earnings and tangible assets in each tax jurisdiction, and staff levels on a country-by-country basis. This can be used to detect and deter abusive tax avoidance practices. The implementation strategy foresees that tax authorities will automatically exchange these key indicators of multinational enterprises with each other, thereby allowing tax authorities to make risk assessments as to the transfer pricing arrangements and BEPSrelated risks, which may then serve as a basis for initiating tax audits.1748c62e55b9

Beneficial ownership transparency

Beneficial owners (BO) are the true human owner(s) of a company or other legal entities. BO secrecy helps to feed corruption and tax evasion, as it enables criminals and corrupt individuals to hide their assets in secrecy jurisdictions by a chain of unaccountable corporate entities. Publishing the real owners of companies can help ensure that there is a level playing field for all companies to know who they are doing business with, and for law enforcement and tax authorities to find the companies that are related to a specific individual.

The benefits of BO transparency are numerous. It can help improve investment climate, reduce reputational and financial risks, prevent corruption and IFFs, strengthen the rule of law, increase trust and accountability, and enhance revenue collection. Since 2013, the fight against secret company ownership has gained great momentum. The G8 and G20 have made BO transparency one of their priorities, and the European Union (EU) has required member states to establish registers. In addition, several countries have passed national legislation and are working towards public registers. However, as it is a relatively recent development, there is little BO information available to date.190d67ead2ed

The Extractive Industries Transparency Initiative (EITI), which works on greater transparency in the extractive industries, is one of the few organisations that have delivered practical results through annual collection and publication of BO information in EITI Reports. By early 2017, 45 EITI countries have published BO roadmaps which outline how they are going to reach public BO goals.e124feb3f7c3

3.2 Engaging with IFFs at country and regional level: Lessons from GIZ’s global programme

One of the key challenges for development practitioners is how to address the problem of IFFs in partner countries and regions. Particularly, how to relate to the international frameworks discussed above. In this section we present an overview of our findings focusing on the example of the German global programme, ‘Combating Illicit Financial Flows’, implemented by GIZ on behalf of the Federal Ministry for Economic Cooperation and Development (BMZ). Specific insights related to the GIZ global programme can be found in this section. Whereas generalanalysis of this and other policies and practices can be found in section 3.3 below and recommendations for donors and practitioners wishing to engage in addressing IFFs appear in section 4.

GIZ global programme: ‘Combating Illicit Financial Flows’

This global programme was initiated in May 2015 and aims to improve the inter-sectorial, inter-state, and inter-regional fight against IFFs.At the end of 2018, it was recommissioned for another three years. The objective for the new period is to strengthen ‘the system used in the cross-sectorial fight against illicit financial flows at national, regional and international level’, and the current programme has four fields of intervention:

1. The prevention of IFFs
2. Cross-institutional investigations
3. Asset recovery
4. Inter-ministerial cooperation

The project is implemented in four hubs: Latin America (Peru), Eastern Africa (Kenya),96bccbc5ae06 the Western Balkans (Macedonia), and global (headquarter level in Germany). In Latin America, the main emphasis of the programme is on the implementation of international standards against money laundering and the financing of terrorism. More specifically, it focuses on implementing the FATF standards through a close cooperation with national authorities, mainly in Peru, as well as with the FATF-style regional body GAFILAT. The programme seeks to link national-level efforts to regional and global processes against IFFs. In Kenya, the aim of the project is to reduce the volume of IFFs transferred into, through, and out of Kenya. At micro level, the Kenya programme focuses on human capacity development; at meso level, the intervention aims to develop key institutional players combating IFFs;6d6819d1321c and, at the regional macro level, it focuses on networking and knowledge-sharing in the areas of asset tracing, recovery, and mutual legal assistance.f6fbaf93980b The regional cooperation is centred upon FSRBSAAMLG.42179db2e097 In the Western Balkans, the project aims to reduce the volume of IFFs which are transferred into, out of, and through the region. As of November 2017, the project implemented in Macedonia has centred on developing capacities in techniques to investigate IFFs tailored to the specific needs of the region. To this end, the programme has been working with public prosecutors on the necessary techniques and standards to combat money laundering and transnational bribery.

The programme in the Western Balkans collaborates with other countries in the region, such as institutions in Kosovo, Serbia, and Montenegro. The relationship with these countries is not as developed as in Latin America and Eastern Africa; however, it addresses the aspect of inter-agency cooperation in the whole region.

At headquarter level in Germany, GIZ supports the inter-ministerial coordination on IFFs among BMZ, the Federal Ministry of Finance (MoF), the Federal Ministry of Interior including the Federal Police Office, the Federal Ministry of Justice, the Federal Ministry of Economic Affairs and Energy, and the Federal Foreign Office. This coordination is of utmost importance to ensure that Germany adopts a uniform position in the international processes and partnerships set up to combat IFFs. Furthermore, the involvement of these bodies opens up additional channels for efficient cooperation of the global programme with international organisations such as FATF, OECD, the UN-System, and the World Bank.665796b60dc0

A third advantage is the fact that the programme can advise the German ministries on the effect of their policies in developing countries . One example of this is the case of FATF. Money laundering in general and FATF in particular are often not looked at primarily from a development perspective. However, in Germany the MoF heads the German delegation to FATF – and not BMZ.3f601fcefa44 The MoF’s decision-making focuses on the effects of FATF processes in Germany and on the global AML system, even though their institutional setup is not designed to automatically look at the effects in developing countries. As such, the programme assesses the (potential) effects of decisions made by FATF on the unique situation of developing countries and translates it into advice for BMZ and German practitioners. This ensures that the development perspective is considered in the process and reflected in Germany’s positioning on FATF matters.ede05b4e4bc2

Key insights from the programme

The GIZ global programme follows a holistic approach that comprises the entire value chain to combat IFFs: from prevention through detection and investigation to asset recovery and mutual legal assistance. Project activities are tailored to the specific national or regional context, and target necessities regarding human capacities, organisational development, cooperation systems, and regulatory frameworks. Those activities are then based on country priorities stipulated in national policies and strategies, identified in national and sectorial risk analyses, and highlighted by international assessments such as the FATF mutual evaluations.

Our interviews identified FATF compliance as a key entry point for reform at national level. Many of those interviewed expressed their surprise that there was not more interest from donors to support FATF compliance, despite a strong desire from partner countries to meet FATF standards. Our contact from GIZ headquarters remarked that countries have a national interest to meet FATF standards. This is because FATF compliance is taken into consideration when ranking a country’s credit-worthiness, and that country’s risk according to FATF mutual evaluations has implications for foreign direct investment (FDI). A country’s desire to attain a high level of FATF compliance can provide a good entry point for building partnership agreements that address IFFs and financial crime.

In Macedonia it was discovered that while criminal investigations tended to be well run, authorities neglected financial investigations, which which led to fewer prosecutions relating to financial crime. The focus of GIZ’s activities in the country was to strengthen the ability of its authorities to conduct financial investigations. The programme identified several capacity gaps, such as the inability to tackle illegal cash movements and process them with financial investigations.

Another structural weakness leading to the neglect of financial investigations was the failure of different government agencies to share information. GIZ established a multiagency working group which included members from customs authorities, financial police, FIU, and public prosecution, and engaged with individuals at different levels of those agencies in order to ensure a wider buy-in to the idea of joint investigations and information and data sharing.

The FATF standards recommend that countries develop a risk-based strategy to tackle money laundering and the financing of terrorism. That is why GIZ supported Peru in analysing money laundering and terrorism financing risks in important sectors such as the financial, mining, fisheries, and timber sectors.342e3406f8c1 Moreover the programme advised Peru on the development of the long-term policy and the medium-term national plan to combat these crimes.7264e8c93785

In addition to this in-country work, the global programme also strengthened existing regional networks and organisations. For example, the hubs in Africa and Latin America support the regional asset recovery inter-agency networks as well as the FATF-style regional bodies (FSRB).

It was noted that some standard anti-corruption measures can actually weaken the effectiveness of programmes aimed at reinforcing financial investigations. For example, in Peru there is an anti-corruption measure that requires all police personnel to rotate positions every three years. This led to significant difficulties in creating a cadre of staff specialised in financial investigations.

One of the key insights from our research was that, while it had a global approach, the programme paid a lot of attention to the local context. For example, in Peru the National Risk Analysis regarding money laundering assumed that IFFs would be a major issue in the timber sector, as it is in neighbouring Brazil. However, after examining that sector the programme realised that, despite the high extent of illegal activities, there were no signs of major IFFs. Similarly, in the Balkans it was assumed that electronic transfers of IFFs would have been a significant issue; yet after assessing the situation it was realised that illegal cash transfers were also an issue and they adapted the programme accordingly.

3.3. Evaluation of existing policy responses

Despite the many initiatives to curb IFFs, the existing initiatives and policy responses face several challenges. In many developing countries, there is very low compliance with FATF standards and there are very few cases of successful asset recovery.ea63dd35f452

There are a number of possible explanations for the ongoing challenges in preventing IFFs in developing countries. First, there is a lack of political will. In many cases, corrupt officials tend to protect their own interests by remaining passive to the mechanisms that are essential to combat IFFs and to promote asset recovery. In cases where the necessary initiatives have been adapted, there is often a lack of implementation of laws and policies. This may be due to lack of will, resources, or expertise.

Second, the existing international initiatives present a number of weaknesses. Many of the most important initiatives have not been integrated into developing countries’ legal frameworks. Few developing and emerging countries have been actively part of the development of such initiatives. The FATF recommendations, for example, to some degree fail to take into account specific characteristics of developing countries, such as the economy being largely cash based, the lack of financial inclusion that leads to the dependence on informal banking systems, and the use of informal value transfer methods. Another weakness with many international standards2cc5aa00d3c7 is that they lack a legal enforcement mechanism because they are soft laws. As a result, the initiatives can easily be watered-down at national level.0e69a217cc8b

Third, the existence of regulatory loopholes and weak governance in many developing countries, together with a low level of expertise and knowledge, constrains effective implementation of international standards. In the case of asset recovery, a country requesting the recovery of assets can be perceived as being highly corrupt, and the country receiving the request may refuse to participate in repatriation, due to the risk of the assets entering into dark channels again.

Fourth, tackling IFFs requires inter-institutional collaboration at the national level and across borders. For example, FIUs, prosecutors, and the judiciary have to work together effectively to tackle money laundering. However, there is often a lack of collaboration between authorities, locally as well as internationally, which limits the effectiveness of investigations of IFFs.8ddadf5fabe8

There are examples of successful cooperation and the return of stolen assets. In 2005, following a decision by the Federal Supreme Court of Switzerland, the governments of Nigeria and Switzerland agreed on a process to return USD 458 million stolen by the late military dictator General Abacha. The repatriation of these funds was one of the first cases of looted funds being returned.9bf1e194cf19 Moreover, in April 2019, ICIJ, the investigative journalists behind the Panama Papers, reported that more than USD1.2 billion has been publicly collected by governments after the 2016 investigation.d7d4b16564dd

The Financial Transparency Coalition (FTC4e8c04a694d2) questions the role of financial institutions in curbing IFFs. Conventional thinking holds that it is the country’s head of state, minister of finance, and other elected officials who set the rules of its financial system. However, this is not always the case. There are many international institutions that establish the standards and rules of financial systems. In many cases, elected officials have little or no say in these standards, but are obliged to follow them. Some of these institutions, mentioned by the FTC, are FATF, the Bank for International Settlements,a7051783f84d the Basel Committee on Banking Supervision,f44791e0a373 the Financial Stability Board,f92383a01cc3 International Accounting Standards Board,5bd633c59677 and the International Organization for Securities Commissions.1a192c14b695

FTC criticises these institutions for having significant influence, without enough transparency and accountability in how they operate. Moreover, these institutions may not be inclusive enough to address global IFFs, as the membership is often small and there are usually few seats at the table for developing countries. Many of their non-binding norms and standards are being implemented in developing countries in a one-size-fits-all approach without properly questioning their suitability at the local level.d75115a4ad87 FTC recommends that these institutions should increase their transparency and include non-government stakeholders in their processes to ensure accountability; that their decisions should be subject to healthy scrutiny; and that the membership needs to be globally representative and include middle- and low-income countries.bbfba8097345

Assessing the GIZ global programme

The programme is a well-developed one in that it recognises the fact that tangible activities, beyond data gathering and research activities, to address the problem of IFFs can be initiated at country, regional, and global levels. This is perhaps its biggest success given that much of the literature suggests that, in order to address the problem of IFFs, it is first necessary to document evidence and collect data. Certainly, as GIZ staff have acknowledged, data sharing is crucial to the success of the programme, but it also demonstrates that key activities which build institutional capacity to investigate and prosecute financial crime can be achievable at country level. It identifies a number of entry points for engaging development partners with the IFF agenda at country level – in particular, highlighting the relationship between FATF compliance and favourable credit and country-risk ratings. The legal and institutional reform needed at country level to meet FATF standards thus becomes an issue tied to national interests.

What is also promising about this programme is that it makes use of a broad definition of IFFs which is not limited to international flows but includes illegal domestic flows of capital. Its level of sophistication, particularly in how it coordinates activities at national, regional, and international levels and advances inter-regional cooperation, is to be celebrated. It was acknowledged that key regional locations, both in the Gulf and on the African continent, facilitate transnational money laundering. This illustrates the need to engage actors outside of the traditional framework of development assistance i.e. Gulf nations and sultanates.

That being said, any programme designed to address the issue of IFFs will be judged on its ability to produce tangible results beyond the activity level. Ultimately, its success will be dependent upon either a reduction in the levels of IFFs or a corresponding increase in the number of public prosecutions for financial crime related to illegal transfers, money laundering etc. At present, those types of figures, as GIZ staff have acknowledged, are not yet available. As a result, this programme, although extremely promising in its design and activities, is susceptible to the problems plaguing other types of anti-corruption reforms that see the problem of corruption in terms of institutional or capacity weakness, or as a deviation from law-abiding behaviour. Corrupt practices also need to be understood in relation to the structure of social relations within wider society, prevalent social behaviour and norms, and social status incentives tied to the accumulation of wealth. When IFFs are viewed as a technical problem, the solution to that problem also appears technical. Yet the mixed success of other anti-corruption initiatives necessitates an approach that also addresses the non-technical, social issues that enable corruption.

4. Recommendations for development practitioners and donors

The principal aim of this paper is to offer operationally useful policy guidance to country-level development practitioners on how they might consider transnational corruption, specifically IFFs, as part of their strategic approach to in-country anti-corruption measures. We began this paper with a guide to the key issues needed to understand what IFFs are, how they relate to a country’s development, and the relationship between corruption and IFFs. This was followed by a survey of international instruments, agreements, and processes designed to address the problem of IFFs, including an assessment of existing policies. Assessment of those policies has been hampered by a lack of consistent and concrete evidence of their potential impact. In order to evaluate existing practice, we included an assessment of a GIZ global programme designed to link country-level activities to regional and international bodies. To conclude, we present both general and practical in-country recommendations based on the research. While the emphasis of these recommendations remains at the country level, we also include more general recommendations given the need for wider regional and international support to address the global dimensions of IFFs.

The general recommendations are largely at the national government level, illustrating how governments and donors can leverage their influence for change in existing laws, address the problem that tax havens pose, encourage transparent beneficial ownership, and press for domestic and international regulation of financial sectors. A key issue relevant to these recommendations is the role that supporting sectors play in enabling IFFs – particularly the role of accountancy firms, lawyers, notaries and so forth. This is especially important as often these sectors also play conflicting roles in the discovery of corruption. These issues point to the very general recommendation of encouraging greater transparency within the economy as a whole. Since the economic crisis of 2008, increased scrutiny of the financial sector has risen up the policy agenda and, subsequently, economic transparency has been embraced by the World Economic Forum and others. Registers of beneficial ownership are one such tool to increase the transparency of this sector. We also recommend that resources should be used to foster greater collaboration and inter-ministerial dialogue. These general recommendations help to build a wider approach towards controlling illicit flows.

4.1 General recommendations

Legal changes and improved regulation

Donors should use their influence to:

• Push for changes in existing laws in order to close current loopholes (for example, improving money laundering legislation to include the mainstream financial system),
• Urge governments both in home and host countries to regulate and control tax havens within their jurisdiction,
• Encourage beneficial ownership transparency (this can, for example, be achieved by compliance with FATF or EITI standards for beneficial ownership),
• Increase regulation and supervision of the financial as well as the non-financial sector (especially notaries, lawyers, accountants, luxury traders, and casinos), with new regulations to focus on how the domestic financial sector links with the wider global financial system, and
• Change legislation to encourage greater transparency within the economy.

Programme recommendations

• Donors should consider programmes that tie together activities at national, regional, and international (including home countries) levels.
• Governments should consider using their development aid budgets to support inter-ministerial dialogue on IFFs in their own countries. This approach is already in operation in the UK and Germany, and is being discussed in Switzerland.

4.2 Practical recommendations for the country level

Working at the country level poses several challenges and requires a thorough understanding of the local political and social contexts to assess which sectors are high risk for illicit flows. The following recommendations propose a number of approaches towards addressing in-country illicit flows as well as identifying key entry points for engagement on this issue with local and national governments and agencies. For example, many countries have a strong desire to meet FATF standards as compliance with them is a factor which influences their credit rating. Putting aside the question of how reliable those credit ratings actually are, the fact that they are often taken into consideration in relation to FDI decisions is a strong incentive towards FATF compliance.

Coordination is an important area both between donors but also at inter-ministerial and agency levels. By highlighting the GIZ programme, we have shown that successful collaboration between enforcement, legal, and financial agencies has led to a coordinated policy response to IFFs. Supporting civil society as partners can aid this approach – particularly when civil society organisations can present evidence to legal authorities to support those agencies’ work in detecting and prosecuting money laundering and corruption offences.

Strategy and entry points

• Follow a value chain approach from prevention through detection and investigation to asset recovery and sanctions.
• Prioritise activities according to national policies and strategies, national and sectorial risk analyses, and international assessments such as the FATF mutual evaluations.
• Use the strong desire of countries to meet FATF standards as an entry point for reform. Countries have a national interest to meet these standards as FATF compliance is taken into consideration when assigning a country’s credit rating, which has implications for FDI.
• Conduct national and sectorial risk analyses to identify areas or sectors most prone to IFFs. For example, training of border and customs officials to detect cash transfers was more important in Macedonia than initially thought.

Collaboration, coordination, and support

• Link with core in-country authorities and establish good relationships both between the donor agencies and the authorities but also among domestic authorities. The latter can be achieved by establishing joint working groups and providing platforms for dialogue and information sharing.

Creating inter-institutional cooperation is a challenge but it is necessary to overcome institutional silos in order to effectively tackle the problem of IFFs, which naturally cut across competences of different institutions.

• Use existing structures to create dialogue within the country, region, and among international development partners.
• Develop inter-regional cooperation and facilitation of information sharing.
• Have in mind the wider donor community in order to create strategic links with other donors and increase coordination towards strengthening the capacities of authorities to cope with increased demand for activities. Establish donor coordination committees to meet regularly every quarter to share information on their anti-IFF activities.
• Make use of FATF regional bodies and regional asset-recovery networks when developing interventions at country level. Building regional support through these bodies can strengthen their work as well as the impact of in-country activities.

Working with civil society

• Avoid the exclusion of civil society in donor-led programmes. Often the vital role that civil society can play is neglected in such programmes, yet its activities have had a significant impact on uncovering the size and scope of IFFs. For example, the Panama and Paradise Papers were brought to light by investigative journalists and Civil Society Organisations (CSOs).
• Work with journalists and non-governmental organisations to strengthen programmes focusing on institutions. For example, journalists can help government agencies in their investigations of illegal activities by providing much needed data.
• Donors should use existing contacts with CSOs from programmes engaged in social accountability work. This can help in creating advocacy platforms to push for legal and other reforms.
• Train investigative journalists on the topic of IFFs.

Donor flexibility

• Donors need to be aware that addressing the issue of IFFs takes time and needs to be reflected in project cycles, and monitoring, evaluation, and learning approaches.
• Donors should consider integrating IFF programmes into longer-term strategic plans for addressing in-country corruption.
• The donor community needs to be flexible in their programmes so that they are needs-driven and avoid replication of activities.