Banks and the Bomb

Andrea Berger 0:02

We already counter proliferation finance because it's our policy that if we were to look at a bill of lading and there would be a nuclear weapon written on the bill of lading, we would not process a transaction.

Tom Keatinge 0:13

Well done.

Andrea 0:19

You're listening to the Arms Control Wong podcast, the leading podcast on arms control, disarmament and non-proliferation. My name is Andrea Berger. I'm a senior research associate at the Middlebury Institute of International Studies. And I'm joined today by my former colleague, Tom Keatinge, who's the director of the Center for Financial Crime and Security Studies at the Royal United Services Institute in London.

And we're going to be talking proliferation finance. Tom, thanks for joining.

Tom 0:45

Thank you. Thanks for having me.

Andrea 0:47

So your background from your, as you say, previous life is as an investment banker at J.P. Morgan. And you kind of transitioned out of that in order to take a look at how banks and the public sector could come together to solve and work to further some of the counter financial crime objectives that they jointly share. How does proliferation fit into all of that for you?

Tom 1:16

Yeah, that's right. So I did a master's in intelligence and international security. And one of the things that I looked at and found very interesting was the way in which finance can be used as a security tool. We're used to things like sanctions. We're used to kind of kinetic types of security. But what I thought was worth looking at is the lever that finance offers people, offers governments as a security tool.

And obviously that covers issues like terrorist financing, that covers issues like looking at the finance behind certain forms of organized crime like human trafficking and wildlife trafficking. And then something which, frankly, I hadn't really thought about until you and I met, which was the finance related to proliferation. You need money to buy the stuff to run a proliferation program, a WMD program.

And that was something that banks could potentially assist with. And that was really, I guess, as much as I knew and as much as we knew when we first looked at this topic almost three years ago.

Andrea 2:17

Why do you think it was that there was an emerging expectation that banks get involved in this? Why should it be the business at all of banks, whether or not North Korea and anyone else is trying to work to build a nuclear weapons program or a ballistic missile program?

Tom 2:33

So without dwelling too much on history, I think we have to remember that prior to the financial crisis in 2008, banks did pretty much what they wanted to. And in fact, one of the reasons I left banking was because people suddenly introduced regulations which got in the way of doing business. But following the financial crisis, following the enforcement action taken against banks like HSBC and Standard Chartered and others, expensive enforcement actions, it became clear that banks needed to do more than just make money for their shareholders.

They had a Societal responsibility to block money laundering attempts, to block bad money in general. And so we had this sort of moment in time, I suppose, where banks started to try and burnish their reputations by taking greater responsibility for the money they moved around and looked at a number of different threats, threats which are determined by the international community, And at that same time, and we're talking about sort of 2012, 2013, we had the focus on Iran and sanctions there, which obviously banks were critical to enforcing.

And so it became clear that banks, it became clear in boardrooms that banks ought to be doing more to support international security endeavors with their financial influence. And proliferation finance in 2012 was added to the Financial Action Task Force's List of responsibilities and so there was an opportunity and I think which we identified and perhaps we can talk about in a minute there was an opportunity to look at the issue of proliferation finance from the perspective of well what are banks doing what are they actually doing to contribute to the disruption of the financing of WMD programs

Andrea 4:19

That moment in time, actually, the 2012 period, I think, is a really important one. There had been a discussion about proliferation finance before that, and there was some interesting cables in WikiLeaks, for example, looking at the intergovernmental discussion that was happening behind the scenes over where we could house a proliferation finance. Or countering proliferation finance initiative, if you will, in the international space?

Was it something that should go in the proliferation security initiative? Was it something that should go elsewhere? And it seems like governments gradually came to the conclusion that the best place for it was, as you say, the Financial Action Task Force, which is the global standard setter, if you will, for counterfinancial crime and works with governments Its member states to try to improve their national efforts to implement programs to counter financial crime.

And proliferation finance became one of those financial crime issues.

Tom 5:19

Correct. I think it's worth spending a moment on the Financial Action Task Force, FATF. So this is a body set up in 1989 initially with the view of promoting financial integrity to tackle money laundering of the narcotics industry out of Latin America. So if you want to understand If you like, the origins of FATF, then watch the Netflix series Narcos, because that's what this is all about.

And then really FATF sort of bumbled along in the background until 9-11. And as we all remember, a focus on al-Qaeda's funding was a major element of George W. Bush's war on terror. And so FATF was thought to be the right body to throw the terrorist finance ball to in 9-11, after 9-11. And that's a whole other story.

But then fast forward, as you say, to 2008, 2009, that sort of period, people started thinking, well, what more can we do to use finance as a tool of disruption? And as you rightly point out, by 2012, the decision was that FATF Should pick that up now FATF is a group of 30 odd countries mainly kind of OECD countries which develops policy which is then implemented by governments and their banking and financial sectors around the world It is, I think, many listeners will never have heard of FATF.

It is, I like to say, the most powerful body no one's ever heard of. Because finance gets into every nook and cranny around the world, FATF is tremendously influential. And it's that influence that the international community wanted to use to drive forward counterproliferation standards.

Andrea 7:10

So FATF eventually devised a definition for proliferation financing, which I think we should talk about for a second because it characterizes a little bit more concretely what exactly it is we're talking about. And the definition I came up with is the act of providing funds or financial services to Which are used in whole or in part for the manufacture, acquisition, possession, development, export, transshipment, brokering, transport, transfer, stockpiling, or use of nuclear, chemical, or biological weapons and their means of delivery.

They also include in that definition related materials, including both technologies and dual-use goods. And specifically, they refer to programs that are in contravention of national laws or Or where applicable international obligations. So in other words, they're talking basically about the financing of anything related to WMD programs or delivery vehicles that are illegal. So not funding of Los Alamos, if you will, or the atomic weapons establishment at Aldermaston.

They're talking about illicit programs like those of North Korea that's under UN Security Council sanctions. Interestingly, that definition has not been really thought about how to action in terms of delivery vehicles for chem or bio. That delivery vehicles in the definition tends in the operating assumption for most to be really just bio. Ballistic missiles and missile programs.

And the definition also doesn't include services, which I think is probably a growing problem, especially as North Korea sanctions regimes focus on Some attention on the provision of services because North Korea is known for doing that. It's known for going to Syria or Egypt or what have you to help them upgrade their own ballistic missile programs. And that is in the financing of that activity.

Paying for that would, in my mind, be proliferation financing.

Tom 9:19

So I just think on that, I think the assumption that one has to make is that any dollar that is earned around the world by the North Korean regime is probably related to their proliferation program. So you gave some examples there. You've obviously got examples of training of police forces in Africa and all that sort of stuff.

And I think one of the challenges that... Banks have had when confronted with what is you know a definition that required you to take sort of two breaths as you were reading it out is that where do you start where where do you start beyond simply saying well we're not going to do anything that's related to North Korea but then in a way that's what sanctions are telling you already so what is the nuance between proliferation finance or a counter-proliferation finance program within a financial institution And a well-imposed sanctions regime.

And I think one of the risks that we've identified in the research that we've done together is that banks might say, well, I'm being a good global citizen as it relates to DPRK sanctions, ergo, I am dealing with proliferation finance. But actually, the two don't necessarily overlap entirely. And I think what the international bodies did a very poor job of doing after 2012 was actually explaining to people what it is or explaining to financial institutions and their regulatory authorities and their governments what it is they're actually meant to be doing.

And the way I like to think about it is that The sort of the proliferation finance argument was sort of marched to the top of the hill by you know a number of countries within the FATF body and everyone was so exhausted they went home and thought well you know that's the end of it and then as we identified when we first met in summer 2014 what we identified was that in the in the the title of our the first report we worked on together The issue was out of sight, out of mind.

There'd been a big noise about it, 2008 to 2012, and then suddenly tumbleweed. And how can you expect countries around the world to take an issue seriously on the basis of a recommendation in the FATF policy? Guidelines which of course is not a great recommendation anyway as perhaps we will discuss so you know an A for effort an E for execution I guess is what we identified in our work

Andrea 11:52

Yeah, and as you say, it seems like one of the approaches that's just been taken to this is rather than trying to identify what proliferation finance is and looks like specifically for the most part, people just assume that you can counter proliferation finance by not going anywhere near proliferators, so not touching Iran or Iran. Or North Korea, or any business that looks like it might be connected to them.

So there's that confusion. Where do you draw the line in what proliferation finance is in practice? Is it just non-North Korean finance or countering Iranian finance, if you will? That's, I think, been a real practical issue that we can dig into more.

Tom 12:33

That's a very great danger because, as we discovered, banks are lulled into a false sense of security when they say, well, I'm a bank sitting in the UK and I don't do anything with North Korea. So proliferation finance is not a problem for me. And by the way, I wasn't doing business with Iran either. So not a topic.

I'm fine. And then you look at a UN panel report and you see that bits of a missile that was – Dredged out of the sea that was fired by North Korea came from the United Kingdom. So, you know, there are intersections with bits of the financial community which, on the face of it, feel utterly immune from the topic.

And that sort of education and awareness building and thinking just simply wasn't done after 2012. So inevitably... When we've done the interviews we've done together, we basically identify that five years of progress was lost. There was no progress over five years.

Andrea 13:32

It was interesting, I thought, as well, when we got the Joint Comprehensive Plan of Action with Iran, because you would think that that would have meant that there was an opportunity for people to come together to look at the lessons of finding illicit Iranian finance, including proliferation finance, or in the case of Iran specifically, procurement for their nuclear and missile programs, and some kind of sharing of Of experiences and lessons learned would happen after the JCPOA that would allow us to have a more concrete conversation about countering proliferation finance.

And actually, it sort of seemed to create just a renewed apathy, if you will, towards the proliferation finance issue for a little bit. Because people thought – and when I say people, I mean much of the financial community thought, well, the proliferation issue with Iran is – there's a lid on it for now. There's been progress made.

U.S. State Department under the Obama administration was going around and telling everyone, do business with Iran again, and while they may have been reluctant – You know, the threat, if you will, of proliferation finance didn't seem to be particularly acute. And most people thought they didn't have risk from North Korea anyways at that time. Now we're in a different situation because of just the, you know, extreme public attention to the North Korean proliferation threat and the Trump administration's especially approach to If you will, tackling the foreign facilitators of North Korean business, including financial institutions.

So we're starting to see some action against Chinese banks. We're starting to see fines being levied for specifically this issue. And that has really woken the financial community up again to the fact that there are pool of freighters still out there and they may be touching their books.

Tom 15:32

That's very clear. And I suppose for cheerleaders of counterproliferation finance, the activity of the DPRK in recent months is a good thing because suddenly if you're a bank sitting anywhere in the world, you are on notice that DPRK is a risk. But again, we have to distinguish between Implementing sanctions which generally speaking because they're issued by the UN and they go on to the various private sector databases it's very difficult for a financial institution to honestly say I didn't know that sanctions were in place.

Implementation may be poor but it's very difficult for them to argue that they didn't know. I think when it comes to proliferation finance, that requires going a considerable step further. It's not just simply, am I providing banking services to a sanctioned bank in Dandong? It is, what activities are my clients doing? What products do they produce that might be at risk of diversion in support of a proliferation program?

Do I provide banking services to DPRK diplomats In Southern Africa because we know that they are using the illicit ivory trade to raise money for the state. So if you want to take proliferation finance seriously, then you've got to do a whole load more work than simply screen your clients and transactions for sanctions compliance. And that's a big deal for a big global bank.

It's arguably an impossible deal for a regional bank based in some part of Southeast Asia or Africa or wherever it might be.

Andrea 17:12

That's a great subject that I think we should come back to in a second. And maybe let's kind of tackle this question from the top down. So the flow of expectations from the international to the national level. And we were speaking a little bit already about FATF and the fact that it creates recommendations that include proliferation finance.

What's the FATF recommendation on proliferation finance that states are meant to adopt here?

Tom 17:40

So the FATF recommendation on proliferation finance, if I was to be flippant, isn't really a recommendation on proliferation finance. It's a recommendation, recommendation seven, thou shalt implement targeted financial sanctions. So, OK, well, that's not really very exciting news because thou shalt have done that for a good many years when the sanctions are a function of international law issued by the United Nations Security Council.

Andrea 18:06

And it comes back to the point we were already just making about the blurring of the lines between what is proliferation finance.

Tom 18:21

They look at you and then you go, well, they'll say, does that mean imposing sanctions? And I think that recommendation doesn't help clarify the situation. So you've got that recommendation. You've then got, without being a fataf geek, you've got their immediate outcomes, which basically are meant to assess the extent to which Countries are effectively implementing the recommendations and your recommendation an immediate outcome 11 there are 11 of them the last one number 11 addresses proliferation finance but there are things in that actually which I think countries overlook because it does talk about you're needing to be developing programs to identify and disrupt proliferation finance or sort of words to that effect And countries aren't doing that.

They are basically at best encouraging their financial sector to implement sanctions per Recommendation 7, tick in the box, and nothing more. And so immediately, the objective of disrupting proliferation finance is... Is derailed because people say, well, we're addressing targeted financial sanctions per Recommendation 7. So there's kind of a disconnect right from the very start. And as you and I have discovered, that disconnect is real because it means that the messaging going out from governments to their financial sectors in vulnerable parts of the world is about sanctions.

It's not about proliferation finance.

Andrea 19:51

I was looking through the FATF mutual evaluation reports because countries get evaluated against what they're doing on their recommendations and specifically some of these sort of general frameworks that FATF has outlined. And in those mutual evaluation reports, it is astonishingly clear that there are A number of countries that have done literally nothing on proliferation finance. And those that get good marks, it's interesting to see the variation between the types of things they do and still get kind of top marks for countering proliferation finance.

It's a fairly basic approach that even the most sophisticated, if you will, countries encountering proliferation finance are taking.

Tom 20:41

You and I have met with Ministry of Finance, Treasury officials and the like around the world and sometimes they genuinely think, no, no, no, we're doing absolutely what we're meant to do and then you ask them to describe it and it's hard not to say, well, you're actually not doing what you're meant to do. You're meant to do.

And of course, as with many different forms of sort of financial crime and enforcement of responses to those, the onus is put by the state onto the financial sector to deal with this challenge. And if that can't be communicated clearly, then you're frankly never going to have a robust system for identifying and disrupting proliferation finance.

Andrea 21:26

The good news is, and to be fair, I do see partly as a result of the attention to the North Korea issue, more countries Focusing on creating national frameworks for countering proliferation finance. You know, there's a greater number of countries that are now trying to implement counterproliferation finance legislation, which is good to be able to create the interagency frameworks to take action if you wanted to seize a bank account or funds in a bank account on this basis.

There is improvement.

Tom 21:59

I think that's true. That's definitely true. But it's spotty and it's regional. So, for example, again, not to turn this into a masterclass on the Financial Action Task Force, but the FATF has mini-me's around the world in different parts of the world. So there is an Asia-Pacific group. There is an East and Southern Africa group, etc., etc., And in some parts of the world where, if you like, the awareness of proliferation is very visible because missiles are flying over your country, there is a real drive to educate governments and their financial systems.

So the Asia-Pacific group should be commended for the awareness bill that it's done. You know, we've worked together on model laws in that region and so on. So I think, you know, there is, as you say, there is an awareness. On the flip side, you know, I've visited these mini-me's in other places around the world in regions that shouldn't be worried about proliferation finance.

You know, and it's just not an agenda item at all. Right.

Andrea 23:02

Yeah, you're absolutely right. And when I was talking about the flip through I did of the evaluation reports, it's clear that the ones that are making most progress are in Asia and to an extent Europe, of course, that you would expect that just because of heightened attention to counter financial crime generally. And in Latin America and Africa, the picture is totally different.

Your Zimbabwe's and Uganda's have done nothing on this.

Tom 23:26

And there's an important point which is worth reiterating, which is absolutely the belligerence of North Korea has made sure that this topic is getting some profile. It isn't necessarily just about North Korea and sanctions on North Korea. It's a much broader, there's a penumbra around the sanctions which matters, and that's the proliferation finance bit, and it's important to make that distinction, I think.

Andrea 23:57

Agreed. And that distinction, I think, is something particularly difficult for financial institutions to kind of understand and interpret, right? So in your view, why is this so hard for banks? Because every time we speak to banks, you get the reaction, okay, well, we've thought about this a little bit. More banks are saying that now. The extent to which they have thought about it, I'm not entirely clear on, especially in recent months with all the North Korea attention.

But everyone you meet Wants to emphasize how difficult this is. And why is that?

Tom 24:37

I think that's right. So it's difficult for a number of sort of practical and I suppose philosophical reasons. The practical reasons are that banks are required by international law or by their national laws to know their customer, KYC, and to conduct due diligence on their customers. So I'm sure we've all had the experience when you want to open a bank account, You have to provide all sorts of evidence of who you are and what's your income and all that sort of stuff because the bank wants to learn about you and then it wants to monitor whether your activity deviates from the expectation and that would then cause perhaps a further investigation.

So your bank's Are good at understanding their clients. They also have to monitor and screen transactions. Are you suddenly making payments that you haven't made previously? What payments are people trying to make to perhaps terrorist-related countries around the world? So all of that sort of stuff can be automated. It involves a lot of human intervention as well.

But the bottom line is that sort of bread and butter business of a bank. So understanding, being sort of situationally aware, I guess, banks are good at doing. As soon as you move away from, if you like, sort of vanilla screening, sort of simple algorithmic things that banks can do, it becomes very, very difficult. And as soon as you're asking banks to opine on the activities of their clients and even to sort of...

Figure out whether what looks like legitimate activity is actually illegitimate activity, it gets very, very complicated. And that's particularly the case with proliferation finance because you're not just talking about the movement of money. You're also talking about the movement of goods. And trade finance is an important business for banks. So asking banks to understand what's in the box that they're financing that's moving around the world is extremely challenging.

And many of them would argue not their responsibility. That's the responsibility of banks. Of customs officers. So understanding their clients, yes. Understanding transactions, yes. But then the actual kind of activities that underlie the financing, well, that's a tough ask.

Andrea 26:48

That's maybe a good place where we can segue to the three general ways where you could theoretically, if you were a financial institution, pick up proliferation finance, the three ways you could do that. And the first I think you already indicated, which was you can identify entities and individuals that are involved in a WMD or ballistic missile program.

And with that, you know, you have sanctions lists in some cases that identify those entities and individuals, but really proliferating entities and individuals go far beyond what's in sanctions lists. The fact that if you look at the UN sanctions lists on North Korea, to take an example, and you... That the Chinese and the Russians make every effort to ensure those lists are shorter than they probably should be, then you realize that actually the sheer number of entities and individuals involved in proliferation-related activity to North Korea's Probably way beyond just what's on the list.

Tom 27:56

How many people are on those lists at the moment? I mean, roughly.

Andrea 27:58

That's a good question. They've expanded recently, so I imagine there's less, I think it's less than 100 still. In total between entities and companies. Yeah, probably, or maybe close to that. And, you know, of course, there's more than that that have in some way touched the North Korean nuclear missile programs.

Tom 28:17

And if you're on that list, you know you're on the list. So, you know, you're not going to do your banking in an overt way. Yeah. So... People figure out how to get around these things.

Andrea 28:27

So the point I'm trying to come to, I think, is that if you're a financial institution, you can't just rely on those lists that the US or UN or EU has given you of who's been involved in proliferation in the past in order to determine that you've screened out all the entities and individuals that are related to proliferation finance.

You've got to do a little more than that. And so that's maybe where we get into kind of network analysis, more of the... Potentially negative media stuff as the media pays more attention to proliferators and proliferation in North Korea or other places. And as well, looking at things like UN Panel of Experts reports, a lot of the entities and individuals mentioned in there do not make it into sanctions lists.

And For the most part when I've asked financial institutions if they have anyone who goes through those reports to pick out some of the details against which they could screen I've overwhelmingly heard no's and that consistently surprises me.

Tom 29:32

So we presented some of our findings to a group of banks in Singapore for example and there were about 30 banks in the room and Exactly ask that question. Who's read the March 2017 UN panel report? And two people put their hands up, which was interesting, but it turned out that that was a personal interest as opposed to a kind of corporate mandated responsibility.

So I think the point that you make is that If you want to do the right thing as it relates to counterproliferation finance, then as a bank, you need to go further than the kind of mandated steps you should be taking. And the question is, How do you know what further looks like? And I think that's why the work that we all do as a kind of think tank community on this topic, the work that investigative journalists do, is so sought after by financial institutions because they're kind of gagging for information that can help them feel smarter on this topic.

And that's not coming from governments, generally speaking.

Andrea 30:39

The other thing to note here is just how often third-party service providers get used to do screening. And that can be on not just sanctions lists, but also gray lists or negative media, right? There's companies like World Check, which is owned by Thomson Reuters that does a lot of this. That's right.

Tom 30:58

So if you go back to after the financial crisis and this kind of pressure on banks to be better global corporate citizens, that there is a neurosis that banks suffer from, which is to know everything about everybody all the time and as quickly and as swiftly as possible. And so the result is that private sector companies like Thomson Reuters, World Check and Dow Jones and LexisNexis, there's a sort of a mushrooming of these providers.

They tap into that neurosis by providing nicely packaged information. And back to something I said previously, that nicely packaged information is provided in a way that can be screened using the algorithms, the automatic algorithms and so on that... Banks are using. So if you were to do a sort of pie chart of where do banks get useful information from, actually sanctions lists and governments is a very small slice.

The vast majority comes from these private sector providers and investigative journalists and think tanks.

Andrea 32:05

Yeah, absolutely. So entities and individuals are route one to identifying proliferation finance in theory. Route two is activity, and this is really hard, and it's something that governments try to push a lot, especially you hear, for example, the United States advocating for an activity-based approach to countering proliferation finance. That, in my mind, is one of the most challenging ways to look at this because it requires you to – Figure out how proliferation finance as an activity looks different than other forms of financial crime and what distinct type of signatures you might pick up from proliferation that you wouldn't from terrorist finance or money laundering.

What's your view on how that could be done or can it be done?

Tom 32:56

Yeah, so I think my view on that has evolved over the course of the work that we've done together. And I think there's – across a range of types of financial crime, but very definitely in the proliferation finance space, there is a real risk that the authorities – Force banks to miss the wood for the trees. And by that I mean try so hard to spot, in this case, proliferation finance-related activity, that actually you end up missing a bigger picture.

And so I very strongly feel that having a good understanding of... Of what the risks are that are out there, what are the global priorities, what's normal activity for one of your clients. For example, the UN panel report talks about the North Korean regime training or refurbishing military kit in Sub-Saharan Africa. Well, you as a bank in Sub-Saharan Africa should be thinking about what exposure might I have to that business.

I mean, the other thing which when we talk about activity is, you know, there are companies that are shipping goods around the world and so on, and you know, they, they, the shipping companies don't have any responsibility normally for what's in the boxes that they're moving around the world. you know, I'm sure listeners have looked at bills of lading before, but you know, they're not written for an observer who is a bank. They're written as a contract between, you know, the shipper and the recipient, and Understanding what that all means as a banker is extremely difficult.

If there is documentation, often there isn't. So I think if I was still working in the bank and somebody came in and said, well, you should be doing your activity-based analysis to disrupt proliferation finance, I would say, OK, sure, but help me do that because I I'm a banker of moving money around the world and, you know, I can do certain things.

But at some point there's a line beyond which I find it very difficult to go. And there is a for me, there's a big philosophical issue here, which is that at what point should governments take responsibility for these kinds of things and perhaps recognize that, you know, they shouldn't be putting it all on the all on the banks.

So I've sort of.

Andrea 35:16

Let's come back to that on the goods point, because I think that's a particularly interesting debate as it relates to goods. On the activity front, when we did our first major report on this, we took a look at the red flags and indicators that the Financial Action Task Force, that governments had put out on proliferation finance. And on other forms of financial crime.

And when we compared those, what we saw was that of, I think, the 25 FATF red flags for proliferation finance, so the indicators, if you will, of what they believe is characteristic of proliferation finance, of the 25, all but one were also encompassed in red flag and indicator lists for completely different forms of financial crime.

Tom 36:07

Yeah.

Andrea 36:09

But also things like the illegal diamond trade and whatnot. And the one that was different was that the good being shipped was out of the technical potential of the sending or receiving country. And I thought that was fascinating because if I were a bank, I wouldn't know how to get my head around that as the one thing that we've identified being different for proliferation than other forms of financial crime and how you would implement that.

You would have to have such a detailed technical knowledge of what the capabilities of the Iranians are as it relates to detailed control lists even. It's so hard.

Tom 36:55

I've learned from you over these last years. You don't necessarily need to be procuring the state-of-the-art tech to build the kinds of weapons that... That the likes of North Korea wants to get their hands on. So you might try and screen against dual-use goods lists, and you and I have interviewed people who spend all their time trying to look through all these lists that are produced by Vassana and all these other organizations.

It's very, very difficult, and even then you might not spot the stuff that matters. I think it's a big challenge. And absent having an HSBC customs officer on the dock in Singapore or whatever, I think banks will find it very difficult ever to really get their arms around this topic. And why I think more and more what banks should be doing is...

Understanding the normal activity of their clients and querying deviations from that. And that, I think, is probably where the focus should lie.

Andrea 38:07

You picked up there on Avenue 3. So if Avenue 1 is entities and individuals, Avenue 2 is activity-based counterproliferation finance, and Avenue 3 is goods-based screening, you'd, I think, very clearly painted some of the problems with Or challenges in doing goods-based screening if you're a financial institution because you lack a full picture of the information necessary to determine whether a good is something you should query or not, whether it's controlled or not, whether it is going to a prohibited end use.

And when we went around and talked to financial institutions, it was fascinating to hear people Some of the misperceptions that financial institutions have about what the goods element of proliferation looks like, just the very, very basics of proliferation, because you had these quotes, and this is my favorite, and I, I still can't believe, I know what you're going to say, and I still can't believe someone said that, but you should go ahead and say it. I was wonderful. I can't even off the top of my head. I can't even remember Which region it was that this came from.

I actually think it was Europe. And one of the banks we interviewed said, well, we already counter proliferation finance because it's our policy that if we were to look at a bill of lading and there would be a nuclear weapon written on the bill of lading, we would not process a transaction. And I had to contain myself because...

Anyone who looks at proliferation realizes that's just not the way things are done in modern proliferation. You are not having a fully assembled weapon. In all likelihood, put on a container somewhere and where someone would declare that in a way that a bank would see. You're dealing with dual-use goods. You're dealing even with components that are broken down to such a level that they may not be on a control list.

They might be caught by catch-all controls, but if a small component goes into a missile or is destined for a missile program, it should be controlled and

Tom 40:20

So I think there are two important points to bring out on the goods topic. The first one is that there is this assumption that banks know what goods they are financing. So within banks, you have departments that deal with trade finance. And these guys are steeped in the trade business. They're trade people first and foremost rather than necessarily finance people.

But it's worth, and so there'll be letters of credit and all that sort of stuff that support the trade. But it's worth remembering that 80% of global trade is done by what's called open account. So if I want to send a box from London to Singapore, then money just goes into accounts. There's no underlying documentation. There's no letter of credit.

So all the bank sees is the movement of money from London to Singapore. It doesn't see any supporting documentation. So even if the supporting documentation to look at... That's quite complex. It's not written for the banker's eyes. And in most cases, there isn't any documentation anyway.

Andrea 41:25

Particularly in Asia, which uses more open account, more Andrea Berger just sending direct payments to Tom Keatinge than providing the documentation with it.

Tom 41:36

And as you rightly said just now, we saw all sorts of, those that sort of felt they should be taking this issue seriously were tying themselves into tremendous knots trying to analyze HS codes, and as I said before, Vassinalis, dual-use goods, export control. I mean, they were really trying hard, but I don't think they were being effective.

Without a question, they weren't being effective.

Andrea 42:03

So that's something that I believe this community has to work on more because banks do obviously feel that they have to screen for dual-use goods, not only for the counterproliferation finance, but also just trade-based money laundering activities, misvaluing of goods, et cetera. And we could probably help.

Tom 42:26

Try to at least refine what's happening or focus efforts on where they're more likely to be effective, rather than the areas in which they're really unlikely to be helping. I mean, I, you know, I, I see how help can work in, in other sort of financial crime arenas. I look at the work the banking sector and governments are doing on topics like human trafficking. I mean When the two sides come together in a productive partnership, it's remarkably powerful.

But if you leave the bank to sit there and try and figure something out on their own without that kind of input from experts who understand these topics, we'll make no progress at all. And that's the mistake we've made in recent years. We just left the banks to get on with proliferation finance. And generally speaking, they didn't.

Andrea 43:13

One of the things we have to talk about, which we haven't yet, but it's a major issue that crosses into this space, but other forms of financial crime as well, is the challenge that financial institutions have of getting a good picture of what's going on of a financial flow because of correspondent banking. And what... Listeners might not realize is that when we worked together, you were basically like my personal investopedia where I'd come to you and basically be like, Tom, explain these basic banking concepts to me.

And correspondent banking in the early days when we were working on this was one that you helped me get my head around.

Tom 43:50

So, yeah. Okay, so the first thing that is important to understand is that, generally speaking, money, cash, does not move around the world through the banking system. What moves around the world are messages. And so a bank in London will say, you know, FYI, please credit the account of someone in Singapore with $500 because Tom Keatinge... In London wants that balance to go up by $500.

And then a series of messages get sent through a chain around the world because chances are my bank in London does not have an operation in Singapore. And those links in the chain are called correspondent banks. So the way to think about it is that there are bits of piping around the world Transmitting messages and often those bits of piping don't know the sender of the money nor do they know the recipient of the money they're just a bit of dumb piping in the middle and what has happened over the years is that banks have realized that being that dumb piping is a risk because if I don't know who's sending the money and I don't know who's receiving the money I could be you know Complicit in a financial crime without realizing.

And so what banks, what correspondent banks will do, and of course these tend to be the big global banks that are astride the globe with sort of financial superhighway, creating a financial superhighway. What those banks, correspondent banks do is they start to look and scrutinize those local banks who are the banks that hold the account of Tom Keatinge or the person receiving the money in Singapore.

And go, well, how good are your standards? Do I think that your due diligence standards, your compliance standards are high enough? And this is where we come to the kind of current hype around the DPRK sanctions, which is there are small banks in China, in regions of China that border North Korea. And if you are a big global bank in Hong Kong, you're going to look at your relationships with those banks and say, am I at risk of being involved in proliferation finance because you, Bank in Dandong, are handling illicit finance?

And I don't want to be responsible for allowing that money access to the financial superhighway. And so there's a lot of talk at the moment about sanctions should target Chinese banks and that sort of stuff. In a way, that's already happening because if you're a big global bank in Hong Kong, you've probably already removed all relationships with Chinese banks that you think might expose you to North Korea.

So the banking network plays a huge role in all of this. And I think it's something that people often kind of forget when they get lost in the weeds of proliferation finance or any other kind of financial crime threat.

Andrea 46:39

And the North Koreans are particularly good at manipulating the piping, if you will, because what they've realized is that they're likely to face blockages in the pipes if they try to have formal banking relations between North Korean banks and foreign banks, even Chinese banks at this stage. Those formal relationships are in fact now prohibited under sanctions. So one of the things they do instead is they send individual North Koreans overseas who are representatives of their banks, and those guys just set up a personal account in a foreign bank, let's say in China, and they use that account like you would a correspondent banking relationship.

And so the North Koreans are kind of... Trying to get around some of the issues in the piping to obscure the fact that the starting point for a transaction may have been North Korea.

Tom 47:29

Yeah, that's right. And I think the very visible examples of those are the way that North Korean diplomats use the fact that a North Korean diplomat walks into a bank in South Africa. If I'm a bank in London who is part of that international piping, And I'm asked to do a transaction from South Africa to Malaysia, let's say, well, on the face of it, that looks like just a normal transaction.

And there's no real sort of North Korea red flag in that, of course, unless the bank in South Africa is awake and alert and realizes that it's banking a North Korean diplomat, which it may not do. So, as you rightly say, it's not difficult, frankly, to circumvent these controls. And, you know, if you want to learn lessons on how to do it, then the North Koreans are masters.

Andrea 48:25

We're supposed to end podcasts on happy notes. Do you have a happy note on counterproliferation finance to end on? It's getting better. Can we end on that?

Tom 48:32

I have a happy note, which is that I think when you look at the interest that we – and I actually think together – We sort of entered a space that was empty. And of course, there are now plenty of people looking at it. I think there's much more awareness of this topic amongst governments, amongst banks, amongst sort of multilateral institutions.

But the bottom line is, you know, as the panel reports indicate, there's much more work to do. The good news is that there are more people interested in this topic who can do that work that needs to be done.

Andrea 49:11

That's right. And particularly in the think tank community, I think the non-proliferation group has woken up to this really as well. And there's a small but dedicated group of people, whether they're here at RUCI or at Middlebury where we are or at King's College London or the Center for New American Security or NYU. There's groups of really smart people that are working on this now.

And I think that's going to benefit us hugely.

Tom 49:37

And importantly, it's not just... The arms control wonks, it's also, that's true, it's just ex-Treasury people, it's ex-bankers, and that, I think, is the, is the great development of the last two or three years. Good happy note to end on. Thank you very much. Thanks, Tom, so much for joining me on the podcast. My pleasure.