Environmental, social and governance (ESG) considerations have become indispensable aspects of sustainable finance and responsible investing, generating a lot of attention and press coverage. Yet there is an important connection between ESG and financial crime which is seldom discussed. Particularly, the harmful activities of environmental crime, such as illegal deforestation, wildlife trafficking, waste trafficking, and illegal mining, reap globally-felt negative consequences, which has prompted regulators and financial institutions to take action. Some estimates state that ESG regulations have increased by an astounding 155% over the past decade. The European Union, for example, has mandated corporate sustainability disclosures for large and listed companies since January 2023. And in its most recent annual report, the European Banking Authority (EBA) highlighted the role of ESG risks in the prudential framework.
The three factors that comprise ESG are essential in assessing corporate reputation, investment risk, and sustainability. And both the undermining of ESG factors and the prevalence of financial crimes pose severe threats to firms and increase regulatory and financial risks. Additionally, as with all criminal activity, when ESG crimes occur, the proceeds must be laundered. This is where financial crime naturally overlaps with ESG. A closer look at this intersection can provide valuable insight into how anti-financial crime compliance can further ESG objectives.
This article examines the relationship between ESG and anti-financial crime and the benefits of their integration, and takes a future view of how ESG will continue influencing anti-financial crime priorities and efforts.
E - Environmental
As awareness and urgency to address climate change increase, harmful environmental practices have become more scrutinised. Climate action is no longer limited to individuals making voluntary eco-friendly choices but increasingly involves regulatory protections and legal requirements.
Environmental crime threatens entire ecosystems, human health, and industries. It also reaps massive profits for criminals, being one of the most profitable crimes in the world. The latest figures estimate environmental crime generates $110-281 billion annually. Despite its profitability, environmental crime is perceived as a ‘low risk, high reward’ activity. A recent report on wildlife trafficking in Europe highlighted that because financial institutions lack knowledge of timber and wildlife trafficking typologies, suspicious financial transactions often go unnoticed. These unlawful activities are often linked to organised crime, corruption, and other illicit activities (e.g. environmental crimes such as illegal logging or waste trafficking reportedly fund non-state armed groups and militias, and have links to human trafficking and slave labour).
In case you missed it, check out FINTRAIL’s article on environmental crime, where we examine illegal waste trafficking, deforestation and logging. We explore how criminals typically launder the proceeds of these specific crimes and what financial institutions should do to respond.
Environmental crime has been a predicate offence in Europe since the EU’s Sixth AML Directive came into effect in 2020. In the past few years, the global authority on anti-money laundering and counter-terrorism financing (AML/CTF), the Financial Action Task Force (FATF), has published various guidance papers on money laundering from environmental crime and the illegal wildlife trade, marking it as a new area of awareness for financial institutions. In the reports, the FATF draws attention to links to terrorist financing and other areas of criminality. National regulators have also released specific guidance, such as in Canada and the United States. And last year, for the first time, the Basel AML Index included environmental crime data in its methodology.
Along with a deeper analysis of environmental crime is the recognition that it undermines the sustainability goals set by the ESG framework. As illicit proceeds from environmental crime are laundered, financial institutions face reputational risk, regulatory risk, and financial risk — all of which directly concern ESG-focused investors and financial institutions.
S- Social
One of the key components of the ‘social’ pillar of ESG is human rights. Human trafficking, forced labour and modern slavery generate illicit revenue that finds its way into the legitimate financial system, directly impacting anti-financial crime programmes. Awareness of these crimes has gained significant traction in the past decade, with FATF guidance on topics such as migrant smuggling and money laundering, legislation such as the UK’s Modern Slavery Act of 2015, and frameworks for human-rights centred sanctions programmes such as the UK’s Global Human Rights Sanctions Regulation 2020.
ESG regulation relating to the ‘social’ pillar is also an important area of focus in the US, evidenced by the Uyghur Forced Labor Prevention Act, which prohibits the importation of goods that were produced by forced labour in the Xinjiang Uyghur Autonomous Region of China, and has serious implications on supply chains. While other jurisdictions have shied away from a total ban, there have been sanctions for human rights violations against the Uyghurs in places like the UK and Canada, with consequences for financial institutions’ screening programmes.
Such instances underscore the need for financial institutions to be alert to the regulatory and reputational risks associated with emerging social issues within ESG, emphasising the importance of understanding the risk a customer poses.
Case study: ESG ‘social’ pillar and anti-financial crime compliance
In 2020, the major Australian bank Westpac reached a settlement regarding more than 23 million breaches of AML laws, including failing to detect transfers involving child exploitation. The bank was fined AUD 1.3 billion ($922 million) by the regulator AUSTRAC - the biggest AML breach in Australia’s history. Among its failures, Westpac failed to implement adequate transaction monitoring scenarios to identify child exploitation risks, and to carry out appropriate monitoring and investigation of suspicious transactions.
G- Governance
Within the ESG framework, bribery and corruption are most clearly aligned with both the ‘governance’ pillar and anti-financial crime. Bribery and corruption have long been an area of focus for financial institutions in mitigating financial crime, evidenced by the need to employ special measures for managing politically exposed persons and treating them as higher risk customers.
In updated guidance on anti-bribery and corruption (ABC) compliance programmes, the Wolfsberg Group stated that financial institutions should consider aligning their ABC programmes with “aspects of bribery and corruption risk which are connected to human rights or ESG concerns”. There have been recent reports of firms already including ESG factors within their ABC and financial crime risk rating systems and vetting clients, suppliers, and third party entities in vulnerable industries.
Integrating ESG principles with anti-financial crime strategies
Overall, ESG is a high priority for regulators and will continue to gain significance with both official bodies and the general public. This means that financial institutions should actively consider ESG risks as part of their risk-based approach and within their anti-financial crime programmes.
Concretely, this can mean:
Conducting enhanced due diligence for individuals or businesses involved in industries with a higher ESG risk (e.g. forestry, animal-related businesses)
Updating policies and risk appetite statements to account for ESG, and including ESG risk as part of business and customer risk assessments
Including ESG risk triggers in adverse media screening
Enhancing training on ESG risks for compliance staff, including exploring its connections to other areas of financial crime
Conclusion
Integrating ESG considerations into anti-financial crime strategies will become increasingly important as regulatory and industry bodies, like the FATF, focus on the financial aspect of environmental crimes, and as jurisdictions continue to legislate the ESG space. The connection between ESG principles and financial crime has critical implications in areas like risk assessments, screening, and due diligence. Recognising these ESG risks can mitigate financial risks, ensure regulatory compliance, and contribute to global sustainability goals.
At FINTRAIL, we combine deep financial crime risk management with industry expertise to optimise your anti-financial crime programmes. We’re here to support you in creating robust policies and procedures; refining, enhancing or testing your systems and processes; and providing context-based training to your teams. Get in touch to find out how we can help you fortify your controls against ESG crimes and incorporate an ESG risk strategy in a practical and efficient way.