Blockchain is not the answer to money laundering … yet


Blockchain technology has the potential to have a huge global impact on financial transactions. Governments around the world are exploring how technology that supports cryptocurrencies like bitcoin can be developed and used to optimize compliance and strengthen its arsenal in the fight against financial crime.

Current laws aimed at combating financial crime, such as anti-money laundering legislation (AML), are often complex and cumbersome and compliance can be an expensive activity. But blockchain, or distributed ledger technology, could contain the solution.

An area explored is the creation of master books that will store the information of pre-verified customers. This will allow companies to identify customers and assess the risk of money laundering without the need for multiple AML checks.

For financial institutions, this would provide a safe place to access client due diligence that will be both transparent and non-modifiable.

However, there are problems with this approach. Current legislation is frustrating efforts to develop blockchain, which means it may not yet be the answer.

For example, according to the GDPR, the regulation of the European Union that covers data protection for individuals, the right to oblivion is in contrast to the blockchain, which by its nature is permanent and unalterable.

Government agencies will have to examine how a permanent record of personal information, which can be public, can work together with this legislation. This could result in changes to GDPR or the creation of alternative solutions that allow a degree of flexibility for compliance.

Another option would be to store personal data from the blockchain in a separate database, but this will probably limit the effectiveness of the technology.

Current anti-money laundering rules are also a problem. Third party trust provisions allow a person (or company) to rely on due diligence from third-party customers to meet their regulatory obligations. But this is not a simple process.

It requires third parties to deliver all due diligence information to anyone who wants to rely on it, and for the parties to keep copies of the data for at least five years. Furthermore, anyone who relies on due diligence remains responsible for any regulatory errors on the part of the third party.

This level of responsibility creates an administrative nightmare for financial institutions. It is unlikely that companies will be willing to accept this degree of responsibility.

This regulatory burden will result in even more cumbersome LR compliance procedures. As long as this remains, it seems unlikely that blockchain will be able to offer financial institutions the simplified process they desire.

The Financial Conduct Authority, the UK regulatory authority, agrees that changes to the anti-money laundering regime must be explored to enable the development of new technologies. Under normal circumstances one would expect the United Kingdom to work with the EU looking for how the blockchain can be used effectively to combat financial crime.

But the government and the EU, no doubt distracted by the fact that the United Kingdom will leave the EU by March 2019, have been slow to respond.

Given the global scale of organized crime, one would expect to see discussions on how to use blockchain technology to prevent crime internationally. The basics are fine, but it seems that many countries, including the United Kingdom, are waiting for someone else to take the initiative.

This is a gold opportunity for the United Kingdom to reaffirm its position as one of the world's leading financial centers and it would be foolish not to take a more proactive role.

There is no reason why the existing regulations should suffocate the progress of the blockchain in this area. If regulators can create shared platforms, they could significantly improve AML measures for financial services while reducing the cost of compliance.

It could also result in an internationally recognized digital identity-client forum. But clearly there is work to be done.

It is Kyle Phillips a senior associate with Howard Kennedy, the law firm and president of the Young Fraud Lawyers Association

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