AML and ESG analysis — more in common than meets the eye
We explore the similarities between the worlds of anti-money laundering compliance and ESG investing.
Oct 30, 2020
The former appears to be a dry, process-driven domain. The latter is faster-evolving, more fashionable — even ‘sexy’.
But that point of view does not stand up to scrutiny, and was largely based on ignorance about AML: as an economist and investment strategist, I had had limited interaction with AML compliance, and was happy to keep it that way. However, in my role as managing partner at CountryRisk.io, where we help organisations make better decisions regarding country risk, I find that the two worlds have more in common than it seems — and, crucially, AML analysis could inform sovereign ESG scoring.
Let me share some thoughts about similarities and synergies:
Making the world a better place: ESG investing is clearly about improving the world we are living in (at the same time as generating investment returns), whether by addressing climate change, protecting biodiversity or reducing social inequality. But AML, too, has a higher purpose — preventing money laundering stops criminals from benefitting from illegal activities.
Overlapping focus areas: ESG risk factors are constantly evolving and expanding. A few years ago, ESG investing was synonymous with climate change. Now, partly due to agreement in 2015 of the UN Sustainable Development Goals, we have substantially broadened the ESG horizon to incorporate other environmental aspects such as nature conservation and social factors such as inequality or human rights violations.
For AML, analysis focuses on so-called predicate offences: the criminal activities that are the sources of dirty money. While drugs are an obvious source of ill-gotten gains, there are many more, and a number of these overlap with the concerns of ESG investors. The 6th EU Anti-Money Laundering Directive defines 21 predicate offences that range from human slavery (clearly a social factor in the ESG world), corruption (a classic governance concern) and environmental crimes such as the illegal export of waste or wildlife trafficking.
Lack of assessment standards: There is no agreed ‘best practice’ when it comes to assessing ESG or AML country risk factors. On both sides, initiatives are underway to find consensus on such standards. IOSCO, the international body for securities regulators is looking to harmonise ESG disclosure standards for companies, for example, while the European Commission is working on overhauling rules relating to AML and counter-terrorism financing within the EU. However, we are clearly still some way away from agreed international rules.
Greenwashing and checkbox exercises: Both realms are vulnerable to poor practice, whether ‘greenwashing’ in ESG or check-box exercises in AML. In the ESG area, too many practitioners add a third-party ESG risk score to conventional analysis and claim to be practicing ‘ESG integration’. In AML, too often institutions blindly rely on some third-party risk classification without understanding the underlying complexities.
Dogged by poor data: Both areas are enormously data-intensive — but, again, lack of standards and harmonisation make much of this data less useful than it should be. This makes analysis of sovereigns’ ESG and AML positions challenging, to say the least.
However, there is one clear difference between the two fields. ESG is clearly high on the agenda for many organisations. Investment managers, in particular, appear to have substantial budgets to increase their capacity and product offerings regarding ESG. AML, in contrast, tends to be less well resourced. AML functions are typically seen as cost centres rather than a source of profitability and business growth — indeed, too often AML requirements can create (often entirely justifiable) barriers to new business initiatives.
Synergies at play
However, this is where synergies exist, and where the two areas could find mutual advantage. Given the overlap between AML and ESG concerns, AML data, whether at the corporate or sovereign level, could generate additional insights that ESG analysts might find helpful. I believe that ESG analysts could learn from talking to their AML counterparts.
And here, again, is another point of commonality between the two disciplines. They are both complex, nuanced and require credible data and hard-earned insights. Relying on third-party scores, generated within black-box systems, will not be equal to the challenges presented by both ESG analysis and effective AML practice.