Virtual assets – Red flag indicators

On 14 September 2020, the Financial Action Task Force (FATF) published the report “Virtual Assets – Red Flag Indicators of Money Laundering and Terrorist Financing”. The report aims to assist reporting entities (such as financial institutions, designated non-financial businesses and professions and Virtual Asset Service Providers) in both identifying and reporting potential money laundering (ML) and terrorist financing (TF) activity involving virtual assets and developing those entities’ application of a risk-based approach to their Customer Due Diligence (CDD) requirements. Regulators may also find the indicators useful when preparing suspicious transaction reports and monitoring reporting entities’ compliance with local AML/CFT controls.

The freestanding red flags identified in the report are drawn from over 100 case studies collected since 2017 from FATF jurisdictions, literature reviews, and open source research.

The FATF notes that “virtual assets and related services have the potential to spur financial innovation and efficiency, but their distinct features also create new opportunities for money launderers, terrorist financiers and other criminals to launder their proceeds or finance their illicit activities.” In line with this overall perspective, the FATF emphasises throughout the report that the mere presence of a red flag indicator is not in and of itself necessarily a basis for a suspicion of ML or TF. While a red flag may prompt further monitoring and examination, a client may be able to explain the red flag itself, or that the red flag is part of a transaction with a legitimate business or economic purpose.

The red flag indicators span the following categories. While some of the red flags are specific to virtual assets, the FATF notes that suspicious activities involving the use of virtual assets may also share similar traits with ML/TF activities involving the use of more traditional financial systems involving fiat currency or other kinds of assets:

• Transactions - including size and frequency of transactions with no logical business explanation and irregular, unusual or uncommon transaction patterns
• Anonymity - such as the use of peer-to-peer exchanges websites, mixing or tumbling services or unusual patterns involving anonymity-enhanced cryptocurrencies
• Senders or recipients – such as irregularities observed during account creation or the CDD process and customer profiles
• Source of funds or wealth – such as transactions originating from or destined to online gambling services, lack of transparency or insufficient information on the origin and owners of the funds, or a customer’s source of wealth primarily deriving from investments in virtual assets and ICOs (both legitimate and fraudulent)
• Geographical risks - criminals can exploit countries with weak, or absent, national AML/CFT measures for virtual assets
• Sender or recipient profiles - unusual behaviour can suggest criminal activity
• Source of funds or wealth - which can relate to criminal activity

The FATF indicates that a risk-based approach implemented with a regular and dynamic two-way dialogue between the public and private sectors would no doubt enhance the effectiveness of the report. The FATF therefore encourages competent authorities to disseminate the report to reporting entities and to conduct engagement and awareness-raising sessions with them to promote their understanding of the report.

This report complements the FATF guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (issued in June 2019) which explains how to understand the money laundering and terrorist financing risks of virtual assets; how to license and register the sector; what actions sectors need to take, to know information about their customers; how to store this information securely; and how to detect and report suspicious transactions.

We observe that the report provides helpful examples of red flags relating to virtual assets which will help reporting entities (VASPs in particular) and their compliance service providers fortify their AML/CFT policies specific to virtual assets. That said, many of the transaction patterns and examples of suspicious activity are no different to those which may raise concerns and prompt further action for reporting entities transacting in other asset classes. Regardless of asset class novelty, there is no substitute for a VASP implementing appropriate risk-based AML/CFT policies which are rigorously applied by well-trained and vigilant personnel. Strong AML/CFT policies combined with efficient onboarding and ongoing monitoring will also provide comfort to customers that a VASP has the procedures in place to identify, manage and mitigate the money laundering and terrorist financing risks that may be faced by VASPs and their customers.

FATF’s Report can be found here.

FATF’s press release can be found here.