Utrecht School of Economics Tackling Money Laundering – Conference Rule-Based vs. Risk-Based approaches to control. The third EU AML/CFT Directive. Paolo Costanzo European Commission Utrecht, 3 November 2007

RULE – BASED VS. RISK - BASED The two approaches to AML implementation and compliance confront each other in the international scenario. This could favour: Discrepancies in the regulatory framework Difficulties in cross-border situations (for covered entities; for competent authorities) Which of the two approaches is more cost-effective?

Rule – based approach. The features Relevant measures or behaviours are pre-determined by rules given the same “triggering events” (e.g. transactions over a threshold), the same behaviours apply in all situations Compliance is achieved when pre-determined behaviours are adopted, regardless of their suitability (“formal” component) No or little discretion in adapting the measures to the concrete case (equal treatment of different situations)

Risk – based approach. The features Behaviours differ from case to case, depending on the risk Given the same “triggering events”, situations may be treated differently (different treatments for different situations) Compliance means exercising discretion in determining the most appropriate measures in light of the risk Compliance is achieved when the risk is tackled appropriately; examples set out in the rules are not exhaustive (“substantial” component) “High-level” legislation; extensive scope for guidance

THE IMPLEMENTATION OF THE NEW AML SYSTEM From 2003: convergence toward the risk-based approach to anti-money laundering 2003 FATF revised Forty Recommendations EU third anti-money laundering Directive (2005/60/EC) However, the rule – based approach is not entirely ruled – out

THE STATE OF PLAY IN THE EU 19 EU Member States evaluated in the “third round” of mutual evaluations (10 by the FATF, 9 by MoneyVal) 15 December: deadline for the implementation of the third Directive Problematic areas include risk-based issues, like: Overall Customer Due Diligence regime Politically Exposed Persons Correspondent banking relationships

Cost-effectiveness. Elements for a comparison Rule – Based approach Risk – Based approach PROs CONs Certainty Allocation of resources Flexibility Complexity Easy compliance Deterrence and prevention Uncertainty Easy controls Rigidity Active participation of covered entities Variation in time and space

Cost – effectiveness. Elements for a comparison (2) Rule – Based approach Risk – Based approach Cost Effectiveness In the transitional period: Cost Effectiveness In the longer run: Cost Effectiveness

How to ensure effectiveness and measure it? EX ANTE: shaping an effective risk – based AML system Need for an overall risk/threat assessment (at the country level) Understanding the economics of money laundering is of particular importance EX POST: measuring the effectiveness of the system The “embedded” tool provided for by article 33 of the third Directive: maintaining statistics to review the effectiveness Understanding the economics of anti – money laundering is crucial to calculate costs and assess benefits with appropriate methodologies

Conclusions The change over to a risk-based approach is expected to improve the effectiveness proportionally more than the costs The risk – based anti – money laundering system requires: To be shaped appropriately taking accounts of relevant threats To be assessed in its effectiveness on a continuous basis Appropriate tools should be identified to fulfil these tasks Understanding the economics of money laundering and assessing the cost of compliance with AML/CFT measures are key

Thank you for your attention. paolo.costanzo@ec.europa.eu