The FinCEN Files: A reminder of the challenges for EM and ESG investors
The files are the latest illicit flows exposé following Luanda Leaks, Paradise Papers, Panama Papers, Swiss Leaks and Lux Leaks.
Cache leaked from US Treasury in mid-19
- Suspicious Activity Reports (SARs) are sent, confidentially, by banks globally to the US Financial Crimes Enforcement Network (FinCEN, which is part of the US Treasury).
- They are sent when banks have concerns about transactions conducted for their clients in US$ currency, regardless of where the transaction took place physically (eg SARs can be sent by “correspondent” banks based in the US that facilitate transfers in US$ for banks located outside the US).
- Their concerns are that the transaction in question may involve illicit activity such as money laundering, terror funding or violation of sanctions.
- SARs merely flag a suspicion; they do not constitute proof.
- The FinCEN Files refers to over 2,121 SARs, covering over US$2tn of transactions between banking clients in over 170 countries, between 1999 and 2017, which were leaked (from a whistleblower in the US Treasury) to Buzzfeed News and then shared globally (via, for example, the International Consortium of Investigative Journalists, ICIJ).
- This is likely a fraction of all SARs sent to FinCEN in this period; c2mn SARs are filed every year (FinCEN has a staff of merely 270).
BuzzFeed and ICIJ publish on 20 September 2020
After 16 months of analysis (eg the SARs are categorised and accessible on the ICIJ website) and further investigation (eg obtaining 17,600 other records from whistleblowers, court files and freedom of information requests), the ICIJ published its findings in a report on 20 September, and more are likely to follow from its global partners (in 88 countries).
The ICIJ argues that banks “continue to play a central role in moving money tied to corruption, fraud, organised crime and terrorism. According to the ICIJ, five banks that appear most often in the FinCEN Files (Deutsche Bank, Bank of New York Mellon, Standard Chartered, JPMorgan, HSBC) “repeatedly violated their official promises of good behavior”.
Implications for EM and ESG investors
We have written extensively on the subject of corruption for EM and ESG funds before and how it is ultimately very damaging for economic growth, social welfare and political sustainability but may, for significant periods of time, have little impact on economic growth or bond and equity market returns — see Corruption: The ugly truth for EM and ESG investors (July 2020).
There is a temptation to wonder at the salacious details of the FinCEN Files and then consign it to a list of leaks and investigations that have shed light on illicit financial flows without leading to regulatory action that eliminates them or lasting portfolio investment strategy implications: eg the Luanda Leaks, Paradise Papers, Panama Papers, Swiss Leaks and Lux Leaks.
The difference this time — the original documents in question emanate from a number of large global banks as opposed to one or two firms — may not be sufficient to change that.
There is likely little impact on immediate investment strategy (indeed, there is no significant incumbent government leader mentioned so far, in contrast to the prevailing leaders in, for example, Iceland and Pakistan, at the time of the Panama Leaks).
However, for long-term investors with either EM mandates or ESG guidelines, there are three implications worth highlighting.
1) US$ reserve status
The FinCEN in the US Treasury is a key regulator against money laundering and terror finance because of the global reserve currency role of the US$. That is a role played as much for the legitimate economy as the illicit one. If regulators and the media (with the help of whistleblowers) are emboldened by this sort of leak, it may be another reason why, in the long term, the owners of illicit wealth may increasingly opt for alternative currencies in which to store and transact that wealth outside the US$ (including unregulated cryptocurrencies). Given the scale of the illicit economy, any shift out of US$ assets would presumably have negative repercussions for the value of the US$.
2) Ethics in ESG factors (in EM and DM funds)
No one should be shocked that criminals seek to launder their money and that some banks reportedly systematically struggle to overcome an economic motivation that runs counter to their regulatory duty. However, how do funds that claim to adhere to ESG (environmental, social and governance) criteria and principles reconcile their ethical guidelines with continuing investment in countries from which and into which large illicit outflows continue to occur and continuing transactions (eg brokerage and custody services) with banks reportedly involved in facilitating those flows? Perhaps, this is just another selective, subjective omission from the ESG criteria that fund marketers like to claim are objectively determined.
3) EM retention of capital
Greater regulatory scrutiny of all fund flows out of EM and into developed markets may, over time, encourage more of that EM capital to stay at home and reinvest domestically. The loss of the uber-rich expatriate real estate markets, developed market bond and equity markets, international private bankers and art dealers, sports franchises in the developed markets may end up being the gain of EM equities, bonds, real estate and industrial assets. The level of real interest rates is a useful indicator of the incentive for local high-net-worth wealth to invest in domestic listed bond and equity markets — see EM central bank firepower (September 2020).
This article first appeared on Tellimer.com. To read more from our Head of Strategy & Equity Research, Hasnain Malik, go here.
