Illicit financial flows definitions — crucial questions

Putting the IFF agenda in action at the country level. Part 1 of 9

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Insights from U4 Anti-Corruption Resource Centre

11 min readOct 5, 2017

Global Financial Integrity — the leading advocacy organisation on IFFs — defines an IFF simply as “funds [that] are illegally earned, transferred, and/or utilized.” Photo: Christine Roy

Some claim that an estimated US$ 1 trillion in illicit financial flows (IFF) left developing countries in 2013. With such volumes, it is no surprise that IFF is an international policy concern. The 2015 Sustainable Development Goals expressly address IFF in goal 16.

Nevertheless, many anti-IFF policies still need to be put into action. At the country level, this is not as easy as it might seem. Anti-IFF policies often leave unanswered questions. This blog series outlines some critical questions for country level work on countering IFF. Policymakers, development agencies and practitioners need to consider these questions if anti-IFF efforts are to succeed. Hopefully, this discussion will spark dialogue that can help advance anti-IFF efforts at country level.

This first post discusses why we need to better define “illicit financial flows.” The definition has important policy implications, especially at the country level.

Fredrik Eriksson is a lawyer with extensive experience from private sector research, policy analysis, evaluations, strategy development, and consultancy work — mostly on anti-corruption and governance issues. He leads the U4 Innovation Lab and private sector research.

Kinds of cross-border transfers

A first difference concerns the kind of cross-border transfer that can qualify as IFF. The GFI definition refers to funds, meaning money. The OECD definition on the other hand refers to financial capital, which is a broad term that can refer to anything with money value used in the pursuit of future revenue. Clearly, that is a wider term than funds as it can cover loans, equity, financial instruments, or possibly even physical assets if used in the pursuit of future revenue. The difference in the practical implications of these definitions is striking. Identifying cross-border money flows is one thing. Identifying private contracts that transfer a loan from a person in country A to a person in country B is quite another thing. When each party has a contract identifying the transfer of the loan to a new loan taker or a new lender in another country, does that mean that a cross-border flow has taken place due to that change in legal status? It would certainly fit with the term ‘financial capital’, but is it a cross-border flow? Or are there other criteria which require a cross-border flow of money rather than a transfer of legal status across borders?

Neither definition is clear on what components of the definition need to be illegal…

Illegal this, illegal that?

The common denominator in both definitions is that they refer to illegality. Neither definition is clear on what components of the definition need to be illegal for a flow of funds or financial capital that crosses a border to be qualified as IFF. The OECD definition is partly clear on one component that must be illegal, notably criminal offences, which are always illegal.

The OECD definition is also much narrower in terms of where the financial capital must come from (the source). It states that the activities must be “aiming to transfer financial capital out of a country”. Activities that lack that aim do not qualify as a source for IFF under the OECD definition. And for activities that are not criminal, there is no clear requirement that they must be illegal.

…that extra and incredible practical difficulty in establishing its volume is not needed if the OECD definition is used.

Does the use of transfers matter?

Another difference between the two definitions concerns the component in the GFI definition which refers to the use of the transferred illicit funds. The OECD definition does not mention that financial capital transferred across a border can qualify as IFF based on how it is used. That difference represents two very different practical implications. Following the GFI definition, use does matter. Establishing its extent ought to require that researchers try to identify what cross-border transfers have been used illegally. Such data cannot be collected in one country only, nor could we ever expect any precision in such data as only a very small proportion of illegal use can possibly be identified. Whatever data that is eventually collected on illegal use and linked to a cross-border transfer would need to inform an estimate. On the other hand, that extra and incredible practical difficulty in establishing its volume is not needed if the OECD definition is used.

…the GFI definition does not state what law that defines when the source, the transfer mechanism or the use are illegal.

How to know what is illegal?

Finally, contrary to the OECD definition, the GFI definition does not state what law that defines when the source, the transfer mechanism or the use are illegal. Also, it is not clear if the OECD definition refers to an international law that the country has ratified, or if illegality defined by international law should be understood as a universal norm. If so, established legal principles in international law and the need for a national ratification are ignored.

The table below summarises these observations.

Policy consequences of different understandings

The following is an example of the consequences of different interpretations of what needs to be illegal in the GFI definition:

• An IFF exists when both the source and the transfer mechanism of a cross-border transfer are illegal.

• An IFF exists when either the source or the transfer mechanism of a cross-border transfer is illegal.

Why does this distinction matter for country policies? If the first definition applies, a criminal’s transfer of ill-gotten gains to another country would not be an IFF, so long as he or she used legal mechanisms to do so. A country that defines IFF this way would focus on policies preventing underlying illegal activities, crimes and illegal transfer mechanisms. It would not need to focus on legal transfer mechanisms.

If the second definition applies, a transfer would be an IFF if either it consisted of illegal or criminal proceeds, or were transferred using illegal mechanisms. A country that applies this definition must have a broader policy focus. It must focus not only on preventing illegal activities and transfers, but also on detecting cross-border transfers of ill-gotten gains through legal means.

Each alternative requires different policies, which also means different types and amounts of government resources.

This distinction is not merely academic. Each alternative requires different policies, which also means different types and amounts of government resources. Yet policy documents dealing with IFF provide little guidance about this distinction.

Implicitly comprehensive definitions?

The IFF definitions above only discuss transfers of “funds” (money) and “financial capital” (anything with money value used in the pursuit of future revenue). But what about other assets that are transferred and later converted to money? The definitions do not mention that although financial capital could potentially include it. Still, this calls into question whether the definitions are complete.

…what about other assets that are transferred and later converted to money?

If anti-IFF policies that build on the GFI definition only block illegal fund transfers, criminals could simply transfer something else of value across borders and then liquidate the asset. In other words, for the sake of coherence, it appears that the definitions need to encompass transfers of other mediums of value as well. That would result in more comprehensive anti-IFF policies, including trade-based money laundering, and illicit trade (incl. smuggling) (see Cassara, and OECD).

The contextual constraints of illegality

Since different countries treat fund transfers differently, identifying the actions that are unethical, illegal, or criminal is a common problem. The term “illicit financial flows” itself creates confusion. That something is illicit means that it is more than illegal as it also refers to the social norms of disapproval: “disapproved by society.” This suggests that some cross border flows may be a problem even if they are not technically illegal. For instance, if a kleptocrat follows the legal process to create a law that gives him or her access to the public coffer, there is still an abuse of political position (Bhorat et al.).

Flows of public funds that are legally extracted for the benefit of private or particularistic group interests by a government do not qualify as IFF.

However, a formal conviction in a court of law would be impossible, which means assets cannot be recovered through legal means. Similarly, AML measures will not stop cross-border transactions that are legal (see discussion above on what parts that need to be illegal for a flow to qualify as IFF). Public disapproval and political contestation may eventually be the only options for holding the government accountable. Events such as the Arab Spring suggest that if this does not work, citizens may attempt to effect change less peacefully (Idris). Still, despite the inclusion of the word “illicit” in IFF, the current definitions are clear: flows of public funds that are legally extracted for the benefit of private or particularistic group interests by a government do not qualify as IFF.

What transfer mechanisms are illegal?

Finally, when should a transfer mechanism be illegal? Some means of making legal cross-border transfers lack transparency. For example, many people around the world use so-called informal value transfer systems (IVTS, also known as hawala) to transfer funds through IVTS agents (see Passas). IVTS refers to any system, mechanism, or network of people that receives money for the purpose of making the funds or an equivalent value payable to a third party in another geographic location. The transfers generally take place outside of the conventional banking system through non-bank financial institutions. Those non-bank financial institutions may be business entities whose primary business activity is not the transmission of money (see FinCEN Advisory).

IVTS transfers are especially important in fragile countries that lack accessible financial institutions. Such transfer mechanisms are also important for the poor, as the costs for a customer are considerably lower than those made by formal financial institutions (see Passas).

…IVTS do not fit under the above definitions of IFF.

Often, these transfers are not prohibited or even regulated. They are legal. Thus, IVTS do not fit under the above definitions of IFF. Yet IVTS transfers can enable illegal acts, since they are not transparent, although clearly have the potential to be (see Passas). Advocates or practitioners who demand transparency might argue that they should become illegal. But should IVTS be considered when developing anti-IFF measures? Or should policies against IFF focus on transfers in developed contexts, where IVTS transfers are less important? Or is there another way that maintains the value of IVTS and improves transparency?

Practical implications

The open questions, uncertainties and inconsistencies in relation to the definition of IFF are many. Their consequences are very concrete for how to approach IFF at country level. In particular, the definition is directly relevant for assessing its volume (whether through direct measures or proxies that can inform an estimate), the extent of policy measures, and to be able to know whether anti-IFF measures have any effect on IFF.

Researchers, donors or practitioners who need to delineate relevant anti-IFF policies and measure their effectiveness must choose a definition and seek to fill in the blanks.

These are problems that are unlikely to be resolved through more country level research or ‘to just get on with it’ regardless. While country level experiences may indeed inform how many of the answers to these questions and uncertainties could be formulated, country level research on a topic that has no clear definition will need to rely on clarifying what IFF is and is not on its own. Researchers, donors or practitioners who need to delineate relevant anti-IFF policies and measure their effectiveness must choose a definition and seek to fill in the blanks. Alternatively, one can choose to focus on a more narrow type of transfer, source, mechanism or use that seems less ambiguous in relation to the uncertainties and blanks of the IFF definitions.

…options for how to measure IFF systematically, and for finding alternative ways to overcome the immense data problems at country level.

Researchers, donors or practitioners also need to find relevant and credible proxies to establish a volume baseline, or establish a baseline of contributing factors to a system believed to facilitate IFF (identified through systems mapping). Whatever the choice, that baseline is informed by the definition unless focus is on a more narrow intervention. Measuring change either in terms of volumes or in terms of system disruptions provide options for how to measure IFF systematically. To find alternative ways to overcome the immense data problems at country level is necessary. Still, despite eventual local creativeness at country level, it does not mean there is coherence in the definition, in policies or in how to measure it. At best, with the current situation, all we can hope for is fragmented but transparent and systematic approaches, spelling out definition choices as well as all the assumptions made.

…all we can hope for is fragmented but transparent and systematic approaches, spelling out definition choices as well as all the assumptions made.

What do you think?

How important is the definition of IFF? For whom does it really matter at country level? And how should policymakers and practioners relate to it?

References

Bhorat, H.; Buthelezi, M.; Chipkin, I.; Duma, S.; Mondi, L.; Peter, C.; Gobo, M.; Swilling, M. and Friedenstein, H., Betrayal of the Promise: How South Africa is Being Stolen (Johannesburg: Public Affairs Research Institute, 2017).

Cassara, J.A. Trade-Based Money Laundering: The Next Frontier in International Money Laundering Enforcement (Hoboken, NJ: John Wiley & Sons, 2015);

FinCEN Advisory, “Informal Value Transfer Systems”, Issue 33, March (Vienna, Virginia: Department of the Treasury, 2003)

GFI, “Illicit Financial Flows,” GFI website (2017)

High Level Panel on Illicit Flows from Africa, Track It! Stop It! Get It!. Report of the High Level Panel on Illicit Financial Flows from Africa, Commissioned by the AU/ECA Conference of Ministers of Finance, Planning and Economic Development (2015)

Idriss, I., “Analysis of the Arab Spring,” Helpdesk Research Report (GSDRC, 2016)

OECD, Illicit Financial Flows from Developing Countries: Measuring OECD Responses, at 16 (Paris: OECD, 2014)

OECD, Illicit Trade: Converging Criminal Networks (Paris: OECD, 2016)

Passas, N. “Financial Intermediaries: Anti-Money Laundering Allies in Cash-Based Societies?”, U4 Issue 2015:10 (Bergen: Chr. Michelsen Institute, 2015)

Ross, S., “What is the difference between financial capital and economic capital?”, Investopedia website (March 17, 2015)

World Bank, “Illicit Financial Flows (IFFs)”, World Bank Brief, 14 April (Washington DC: World Bank, 2016).

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The U4 Anti-Corruption Resource Centre at CMI works to identify and communicate informed approaches to partners for reducing the harmful impact of corruption on sustainable and inclusive development.

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All views expressed in this post are those of the author(s), and do not necessarily reflect the opinions of the U4 partner agencies, or CMI/U4.