ESG Investing and AML Compliance: Environmental Crimes
In this third part of our series on the intersection of ESG investing and AML compliance, we explore the important issue of environmental, or ‘green’, crimes.
Dec 20, 2021
We'll cover the scope of criminal activities related to the environment, the challenges of uncovering them, and how to monitor which countries are most at risk. We’ll also talk about how we at CountryRisk.io are incorporating information about environmental risks into our country risk ratings.
In November 2021, the Financial Crimes Enforcement Network (FinCEN) released a statement on environmental crimes to every financial institution in the US, encouraging them to provide structured and detailed information on suspicious activities that may be related to such crimes as part of their subject access request (SAR) filings. Likewise, environmental crimes have been a priority area for the Financial Action Task Force (FATF) since 2019. And very recently, the European Commission released a proposal for a new EU Directive to strengthen the protection of the environment through criminal law.
What are environmental crimes?
While there is no standard definition of environmental crime, the term typically captures activities like:
- Wildlife trafficking: Illegal trade of protected animals or animal parts.
- Illegal logging: Unlawful harvesting, processing, and trading of trees. This includes protected trees, as well as the logging of trees without the right licenses.
- Illegal fishing: Fishing that violates national or international law.
- Illegal mining: Unlawful extraction and trading of commodities.
- Waste trafficking: The illegal dumping or exporting of waste.
In 2018, INTERPOL and other organisations estimated that such activities generate USD 110 – 281 billion in illegal profits every year, two-thirds of which come from unlawful logging, mining, and waste trafficking. That this estimate range is so wide reflects the data challenge in this area. Environmental crimes are often described as ‘low risk, high reward’ as they are difficult to identify and, even if they are prosecuted, the fines or legal consequences tend to be relatively small in proportion to the potential profits.
While the estimated illegal profits of environmental crime amount to just 0.3% of global GDP, that figure is likely to be under-reported. And, more importantly, it doesn’t account for the cost of environmental damage, such as the forest system degradation, loss of biodiversity, displacement of people, and contribution to climate change that comes from illegal logging. Since, according to the World Economic Forum, over half of global GDP is moderately or highly dependent on nature and its services, that cost is likely to be significant. Meanwhile, the negative consequences for nature itself are likely far greater than the scale of any illegal profits would suggest.
Environmental crimes are often related to other criminal activities and perpetrated by organised crime networks. The international nature of such crimes as the illegal exporting of waste from Europe to Africa, or wildlife trafficking from Africa to Asia, means they can only be carried out by sophisticated organisations. Meanwhile, labour-intensive crimes like illegal logging often go hand-in-hand with human trafficking and child labour. Corruption is often another related activity that enables many environmental crimes, such as through the falsification of documents or bribing officials for the purchase of mining rights.
What are the key challenges?
- Co-mingling of legal and illegal goods: Environmental crimes are often difficult to uncover once the goods concerned (e.g. precious stones, wood, or waste) have been moved across borders or up the value chain, as they can be easily co-mingled with legally sourced goods early in the supply chain—trees from faraway Russian forests look the same regardless of their legal status. As such, exposing such co-mingling is only possible through highly transparent supply chains and sophisticated tracking techniques.
- Dual criminality: Often, cross-border cooperation by enforcement agencies, such as the exchange of information, is only possible when the activity is criminalised under the laws of each relevant country. In many cases, a country might not even have laws for such activities because the industry in question simply doesn’t exist there. And in other cases, enforcement or fines related to environmental crimes are so weak that they contribute to the ‘low risk, high reward’ incentive for criminals.
- Cross-border activities: Many of these crimes involve multiple countries. Therefore, prosecution requires international & inter-organisational collaboration and standardised information exchange.
What are the best sources of country-level data?
At CountryRisk.io, we help organisations identify various country risk factors as part of their due diligence process. We do this by providing data, research, and quantitative models.
Measuring the country risk associated with environmental crime is challenging. The scoring of countries based on the prevalence of environmental crime is often hampered by the lack of reliable and consistent data. In addition, measuring the prevalence of environmental crime requires enforcement and quality institutions, which are often lacking in the very countries where such crimes are common. In turn, this can introduce a bias in scoring the environmental crime risks of these countries. To make a solid country risk assessment, then, the prevalence of a predicate offence (i.e. environmental crime) needs to be evaluated against the backdrop of the control environment and quality of enforcement. This calls for a qualitative approach when quantitative data is unavailable.
Here are some examples of data sources that can be useful:
- United Nations Office on Drugs and Crime: One of the key sources of data on various crimes is the United Nations Office on Drugs and Crime, which we used for a blog post on wildlife trafficking. However, in our view, the data quality—especially in terms of country coverage and timeliness—isn’t good enough to enable the purely quantitative scoring of countries.
- Wildlife Trafficking Report by the US Department of State: A welcome source for country assessments is the report to Congress on the ‘Eliminate, Neutralize, and Disrupt Wildlife Trafficking Act of 2016’, which lists Focus Countries and Countries of Concern. As part of its annual reporting, the State Department pools knowledge from various US agencies to identify those countries where wildlife trafficking is an issue. The latest report highlights the following countries: Bangladesh, Brazil, Burma, Cambodia*, Cameroon*, Democratic Republic of the Congo*, Gabon, Hong Kong, India, Indonesia, Kenya, Laos*, Madagascar*, Malaysia, Mexico, Mozambique, Nigeria*, People’s Republic of China, Philippines, Republic of the Congo, South Africa, Tanzania, Thailand, Togo, Uganda, United Arab Emirates, Vietnam, and Zimbabwe (* indicates countries of concern). The inclusion of Hong Kong and the UAE also underscores the importance of trading hubs.
- Organized Crime Index: Another great resource is the Organized Crime Index 2021 (OCI), which provides information on 190 countries in respect to flora, fauna, and non-renewable resource crimes alongside other predicate offences, such as human trafficking and drug trade. Based on the OCI, the highest risk countries are: Democratic Republic of the Congo, Colombia, Myanmar, Mexico, Nigeria, Iran, Afghanistan, Iraq, Central African Republic, Honduras.
- INTERPOL and EUROPOL: For individual country reports, we also recommend INTERPOL and EUROPOL. Their reports are especially useful for learning more about individual criminal activities.
- Global Environmental Tracker: The Environmental Investigation Agency’s Global Environmental Tracker is also a useful resource.
- World Bank and International Monetary Fund (IMF): Finally, we also recommend publications by the World Bank or IMF for a detailed understanding of money laundering risks, environmental crimes, and the quality of regulation and enforcement.
Relevance for ESG investing and AML compliance
The relevance of environmental crimes for anti-money laundering (AML) is clear, as the profits from such activities are often laundered through the international financial system. As a result, financial institutions need to assess the source of funds and report suspicious activities, as the recent guidance from the Financial Crimes Enforcement Network (FinCEN) highlights. Information about the source country its environmental crime prevalence can help when combined with data on the individual or corporation linked to the funds.
In turn, heightened awareness of the risks associated with environmental crimes can also reduce reputational risks, and is increasingly seen as a competitive advantage for multinational companies.
When it comes to environmental, social, and governance (ESG) investing in corporate bonds or equities, the goal is the same as with AML compliance: do not invest in companies that engage in environmental crimes. While the AML compliance office is often close to the individual financial transaction, the portfolio manager is far removed from the operational activities of the company. As such, even more than on the compliance officer, the portfolio manager must rely on available certifications and corporate transparency reports.
At a country level, investors can incentivise countries to address environmental crime by excluding from their investable universe those where such crimes are rampant. Theoretically, exclusion by a significant enough proportion of investors should lead to higher financing costs for these countries. An even better approach would be to engage with sovereigns by actively working with governments to address environmental crime through increased funding for enforcement agencies, legal changes (e.g. higher fines, easier information exchange with other countries), or the ratification of international treaties.
How we incorporate environmental crime data at CountryRisk.io
We plan to integrate some of the available environmental crime data and visualisations into our platform to help AML country analysts better understand where dirty money might be coming from. Similarly, we are considering adding an indicator to the ESG sovereign risk rating model regarding a country’s strength of enforcement of international environmental conventions.