The active enforcement of currency controls in Sri Lanka, amid a deepening economic crisis, has underscored the fluid operating environment for risk and compliance teams in the Asia-Pacific region.
The government crackdown on foreign exchange transactions and holdings comes as an estimated $50 billion has leaked from the country over the past decade, according to sources in Colombo. Global Financial Integrity, the Washington DC-based think tank, has estimated that at least $40 billion leaked from the country between 2009 and 2018 through a trade-based money laundering technique known as “mis-invoicing”.
Financial crime compliance specialists are warning anti-money laundering (AML) teams to pay attention to the changing risk landscape. They said that even if “breaching currency controls” is not a predicate laundering offence in their home jurisdiction, they may have exposure through overseas branches. In addition, there may be other linked offences that qualify in their own jurisdiction, such as tax evasion.
Consultants also warned that the reintroduction of currency controls in Sri Lanka could be a harbinger of things to come across the region, as countries respond to a more volatile economic environment.
The Sri Lankan central bank has initiated a stringent system of capital controls to try to stabilise the nation’s currency. Exporters have been ordered to repatriate foreign exchange earnings within 180 days of transactions amid a surge in capital outflows. Citizens and businesses have shifted to other currencies and overseas assets in response to a collapse in the currency throughout 2022. This capital flight has been procyclical and worsened the downward pressure on the Sri Lankan rupee (SLR).
At the same time, the country has been seeking international loans to pay for critical imports such as fuel, food, fertilisers and medicines.
Central bank steps in
The central bank has been responding to the economic crisis with a series of desperate measures that have angered some citizens and foreign lenders. The country defaulted on its debt in May 2022, the first such failure in the country’s history. The economic mismanagement led to a shortage of essential supplies and waves of political unrest, including the storming of the President’s Palace in July last year, which made headlines worldwide.
In response, the central bank’s interventions have included a mandatory currency conversion system for exporters of goods and services, requiring them to change their foreign exchange earnings back into Sri Lankan rupees. The central bank, which houses the country’s financial intelligence unit (FIU), has also vowed to crack down on illegal transactions.
“All licensed banks are required to strictly monitor receipts of goods to Sri Lanka,” the central bank said. The bank stressed that it “has the right to initiate action against non-compliance by any exporter or licensed banks”.
The return of capital controls was more likely in a period of economic instability and was a recognised tool in many countries a few decades ago, said Gavin Coles, principal at Kasker Consulting in Melbourne.
“The majority of the AML professional world is too young to remember when capital controls existed across much of the West,” Coles said.
“In the UK, from 1939 until Margaret Thatcher in 1979, everybody was limited to the cash they could take on holiday — £65. Everybody was aware you couldn’t move your own money across borders in any volume without real difficulties. Investments in assets and property overseas were restricted, making it difficult for the average Briton.”
Anti-money laundering teams would need to prepare for a more complex operating environment as more countries across the Asia-Pacific region consider capital controls to shore up their currencies, he said.
“With the increasing need to grow tax revenue and limit large capital flows, there’s a higher likelihood in almost every country of capital controls at some point. People say ‘it couldn’t happen here’ — I disagree strongly. In the global financial crisis, let’s not forget, we saw overnight restrictions on access to bank funds in multiple countries. There was suddenly no ability to move those funds out of the country — or even in some cases from one bank to another,” he said.
“Why is that important to financial crime professionals? Well, it is entirely likely that the AML programs set up to detect laundering and sanctions control evasion will be tasked with policing capital control oversight.”
Coles was recently in Sri Lanka as part of a capacity-building AML training program in conjunction with the central bank and the Asian Development Bank.
Strained negotiations
Sri Lanka is implementing a raft of austerity measures and attempting to restructure its debt as part of its efforts to secure an emergency $2.9 billion loan from the International Monetary Fund (IMF). As the negotiations continue to drag on, the country’s economy continues to suffer and the central bank has increased its resolve to reverse a wave of capital flight.
The central bank has raised interest rates by a record 950 basis points this year. The economic situation in the country is “stable … but at a very low point,” said P. Nandalal Weerasinghe, governor of the central bank.
Capital controls would stabilise the economy in the short term and would “limit capital outflows and reduce depreciatory pressure on the soft-pegged currency,” Fitch Solutions Sector Intelligence said.
Some of the measures include a suspension of remittance outflows from businesses’ foreign currency accounts and a freeze on overseas investment from residents, unless approval is granted from the central bank.
In July last year the government closed an amnesty period for Sri Lankan residents to “deposit or sell the foreign currency in [their] possession” to an approved bank. Under s 8 of the Foreign Exchange Act No. 12 of 2017 it is now an offence for Sri Lankans to hold foreign currency.
In addition, the central bank has banned money changers from offering higher exchange rates to customers than the exchange rates offered by licensed banks.
These types of laws posed challenges for AML compliance officers (AMLCOs) that work in organisations with a footprint across the region, Coles said. It also gave rise to situations where it was difficult to determine whether a suspicious activity report (SAR) needed to be filed outside Sri Lanka.
“At the moment, there’s no easy equivalent criminal offence, in many countries, for cases where a customer has evaded capital controls. Some AMLCOs believe this means no SAR can be submitted,” he said. “But there is almost always a possible associated offence that AML officers need to consider — for example, a tax evasion offence, fraud, or other offence. You have to be very clear, I think, around the wider requirements of what you should be reporting to the FIU.”
The profit motive
Another challenge for AML teams is the fact that capital controls immediately shift the profitability calculation of doing any economic activity. This can lead to changes in business activity that can make legitimate transactions look illegal — or vice versa.
“Capital controls change the way in which a particular asset movement or fund flow can become valuable for those that are trying to evade the capital controls. If you think your home currency is about to collapse 80%, a previously loss-making foreign transaction can become attractive,” Coles said.
“So, one of the typologies that AMLCOs should be looking for is a rapid change in the fund flow or trade flow that has come in close to the capital controls.”
Anti-money laundering teams also need to consider the transaction activity that may be linked to legitimate tax planning among customers. This can prevent the filing of erroneous or “defensive” SARs.
A capital idea
Large companies were willing to spend millions of dollars on tax advice to shift profits as tax regimes change, while the sudden increases in tax rates in countries such as Sri Lanka, as part of a raft of reforms driven by the International Monetary Fund (IMF), would also drive changes in tax planning and lawful profit-shifting strategies, Coles said.
“Capital controls will become part of that analysis, but it becomes a more complex conversation because you can’t just move the money from country A to country B as the tax rates change. There may be controls on doing that,” he said.
“So, it’s a crime discussion but also an economic discussion and a business planning discussion. In short, if your customer due diligence (CDD) does not explain your customer’s situation accurately, you won’t be able to spot outlier behaviour. This includes ensuring that your Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) controls are fit for purpose, to help identify customer connections to countries around the world which may become linked to capital controls.”
For AML teams, it is critical to consider that capital controls will drive legitimate customers into the black economy to move funds across borders. As authorities have seen with countries such as Vietnam and China, this creates a vast flow of money in which criminal funds can circulate. Authorities in Australia, for instance, have seen large volumes of cuckoo smurfing activity involving legitimate customers in Vietnam and China, which have capital controls.
Financial intelligence units and police will now have to add Sri Lanka to the list of countries that are highly likely to be linked to cuckoo smurfing.
“We know from capital flight from restricted economies such as China, that when people want to get around capital controls, they don’t care about losing 10%. They just want to get their money out. So, the profit margins for the criminals can be massive, and that can be invested in future criminal activity in other countries such as Australia. Legitimate wealth gets turned into a criminal threat,” Coles said.
This article first appeared on Thomson Reuters Regulatory Intelligence.
