Finding the missing pieces of the puzzle: using regtech to combat illicit financial flows

Finding the missing pieces of the puzzle: using regtech to combat illicit financial flows

3 July, 2020    

Modern financial crime has evolved significantly over the last few decades. Detecting these global networks of sophisticated crime has become more complicated than solving a thousand-piece puzzle in minutes and with half the pieces missing; humanly impossible.

This is the kind of complexity that faces the authorities and institutions at the forefront of fighting illicit financial flows (IFFs) – defined as capital, financial and resource flows that are transferred, handled or used illegally (GFI, 2019; Cenfri, 2018). The consequences of ineffective action against these crimes are severe, particularly on the poorest countries. IFFs are estimated to be as large as USD 80 billion annually in Africa alone (UNECA, 2017), and were as large as 18% of total trade in 2015 (GFI, 2019). Accordingly, they are prioritised in the SDGs, specifically SDG 16.4.

So, what can be done to prevent IFFs and unlock the development potential of Africa? Cenfri is exploring various strategies for reducing IFFs, one of which is the role of indicators in helping to address IFFs. Tracking and measuring information through indicators is a necessary first step, but the time has come to change emphasis to proactive enforcement and one of the better options is through use of regtech (regulation technology), particularly its increasing ability to overcome some of the key gaps in actively combatting IFFs.

Illicit financial flows – a complex puzzle without all the pieces

Just like an incomplete puzzle, IFFs and their criminal networks are difficult to solve because they involve complex transactions that are specifically designed by some of the brightest professional minds to be obscure. There are typically several different institutions and individuals involved in an IFFs network, and uncovering the crime requires a precise understanding of all the moving parts. However, it is difficult to see the full picture because the various pieces of information that complete the picture are in different places, separate from one another, and are difficult to make sense of in isolation. The authorities responsible for combatting IFFs tend to only have certain pieces of information and as such, they may be sitting on incredibly useful information without having any idea. The pieces of information in plain sight, when skilfully analysed alongside other data, unveils a complex network of IFFs. What’s more, the various different data are typically stored in different formats and states (for example structured versus unstructured data). Without advanced artificial intelligence machine learning (AI-ML) systems, these data can’t be compared and are effectively useless.

Africa needs solutions that facilitate access to key local and global data and the analytical power to turn innocuous data into actionable systemic insights that reveal ecosystems of criminal networks. Currently, there are some initiatives at the global and regional levels that do this to some extent. For example, automatic exchange of information (AEOI) facilitates exchange of information between countries without having to request it. This helps to track cross country-tax evasion. There is also the country-by-country initiative that requires multinationals to disclose the tax they pay in each country of operation. These initiatives help for their intended purposes, but they are not geared to tackling IFFs and particularly not in relation to the specific challenges present in African countries. Moreover, there are deficiencies in the way the data is handled and processed. For example, the data requested and shared often comes in different/incompatible formats, there is limited capacity to curate and analyse data, there is limited clarity in terms of which data to request and when to request it, and there are different laws, regulations and reporting standards that present barriers to effective sharing. These data, therefore, should form part of a much broader, systemic AI-ML approach.

Adaptive smart solutions to find the pieces and put them together in real-time

What is needed are advanced solutions that can facilitate such information sharing and complex multi-layered analytics in real-time. This is where regtech comes in. Regtech is essentially the use of technology, either by a regulator or the supervised institution, to enhance regulatory risk and business processes. In the case of IFFs, advanced data analytics systems (regtech) can potentially be used to promote the sharing of vital IFF network information and can analyse this information from a global criminal network perspective. These advanced systems link various connections of isolated, rarely utilised and often inaccessible data, effectively making these databases interoperable (including structured, unstructured and non-integral data in different forms). For example, they can track disguised beneficial ownership, identify and monitor mis-invoicing and misdeclarations, comparing this against tax-related and other linked data in real-time. Depending on how regtech is applied, the systems can also be used to detect, link and verify unique identities, even without any link to foundational ID or even without any names.  With the use of artificial intelligence (AI), data analytics systems can further improve over time, detecting and monitoring the changing criminal modalities and ultimately enhancing the capacity for combatting IFFs. Basically, regtech brings all the puzzle pieces together in one place and connects them in real-time far better than any human-driven system can.

Implementation can be a challenge, but the right approach can yield success

You might ask why countries are not doing this already if the solution is so clear? Firstly, it’s important to note that regtech forms part of a host of different approaches that need to be put in place to combat IFFs. Secondly, these solutions need to be implemented in an appropriate way with sustainable business cases across government and industry sectors. Although a number of primary benefits flow back to regulatory institutions and sector, a significant number of the benefits flow into the economy in general through increased liquidity, lower risks, and more buoyant markets with less risks of countries losing access to international financial markets.

Achieving the SDGs is the end goal

While regtech cannot defeat IFFs on its own, it is a vital part of the defence structure. Without leveraging technology, countries are essentially trying to map out a puzzle without all the pieces, while blindfolded. Regtech can connect the dots and free up space for authorities to focus on other areas, such as governance, social welfare and development. The implications of winning the fight against IFFs are significant, as they would free up billions of dollars that governments and industry could use for infrastructure development, investment opportunities, health, and social spending programmes. This could have a more substantial impact in achieving the SDGs than, for example, official development aid.

This work forms part of the Risk, Remittances and Integrity programme, a partnership between FSD Africa and Cenfri.

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