Adding Pakistan To 'Gray List' Has Important Consequences.

Legal News & Analysis - Asia Pacific - Pakistan - Regulatory & Compliance

6 June, 2018

 

At its February 2018 plenary meeting, the Financial Action Task Force members voted to place Pakistan on to its so-called “gray list” due to the country’s failure to adequately address terrorist financing activities within its borders. This listing has significant legal, economic and reputational implications for Pakistan. In addition, FATF’s action could result in western financial institutions and companies re-evaluating their business dealings in Pakistan and with Pakistani banks and counterparties.

 

FATF Background

 

Established in 1989, FATF is an intergovernmental body tasked with setting standards and promoting the effective implementation of legal, regulatory and operational measures to combat money laundering, terrorist financing and other related threats to the international financial system. FATF sets out a framework of measures — known as the recommendations — that set the prevailing international standards for anti-money laundering, or AML, and counterterrorist financing, or CFT, legal regimes.

 

The recommendations focus on steps countries should take to identify risks, develop policies, apply preventative measures, support transparency and aid international cooperation with respect to AML and CFT. FATF does not have the authority to force states to enact domestic legislation, but rather functions as a policymaking body that exerts pressure on member states to bring about legislative and regulatory reforms that conform to the recommendations.

 

FATF monitors the progress of its member countries in implementing the recommendations. FATF’s primary mechanism for monitoring member countries is the mutual evaluation process, which involves a team of experts visiting a member state and evaluating its AML and CFT regimes.[1] The experts assess whether a particular jurisdiction’s legal system comports with FATF’s recommendations and prepare a report documenting their findings. If the experts conclude that a member state’s legal regime has deficiencies, FATF’s International Cooperation Review Group, or ICRG, considers the report as well as comments from the member state at issue. If the ICRG confirms the findings of the report, FATF will subject that jurisdiction to higher levels of monitoring.

 

Member states deemed to fall significantly below the standards set forth in the recommendations can be included on FATF’s gray list or black list. The so-called gray list comprises jurisdictions that have strategic deficiencies or weaknesses in their domestic AML and/or CFT legal regimes, but have agreed to an action plan with FATF to address those deficiencies. The nine countries currently included on the gray list are Ethiopia, Tunisia, Serbia, Iraq, Yemen, Syria, Trinidad and Tobago, Sri Lanka, and Vanuatu. By contrast, the so-called black list (officially known as the “Non-Cooperative Countries or Terrorist” list) includes countries that FATF deems to be noncooperative in AML and/or CFT initiatives and that have not formed an action plan with FATF to address their deficiencies. Iran and North Korea currently are the only black-listed countries.

 

Pakistan and FATF

 

Pakistan’s Gray Listing in 2012

 

In 2012, FATF concluded that Pakistan had strategic deficiencies with respect to its AML and CFT program and added it to the gray list. FATF specifically recommended that Pakistan (1) promulgate legislation to ensure that it met FATF standards with respect to stopping terrorist financing, and (2) develop domestic programs to identify, freeze and confiscate terrorist assets.

 

Subsequent Removal From Gray List in 2015

 

Following its listing, Pakistan made substantial progress in enhancing its AML and CFT framework. Most significantly, the Pakistani government amended its domestic anti-terrorism legislation to bring it into line with the international standards mandated by FATF and the United Nations. In addition, Pakistan committed to act against the financing of certain organizations designated by the United Nations as terrorist organisations and increased monitoring of nonprofit organizations. Finally, Pakistan devoted additional resources to government authorities vested with enforcement responsibilities and increased enforcement against various terrorist organisations.

 

By 2015, FATF concluded that Pakistan had taken substantial measures to address its AML and CFT deficiencies and removed it from the gray list. FATF’s removal of Pakistan from the gray list was widely viewed as a positive development for the country’s economy.

 

Events of 2017

 

Throughout 2017, FATF member states repeatedly raised concerns regarding Pakistan’s failure to honor its commitment to strengthen its CFT program. In response, FATF requested that Pakistan take further actions to freeze the assets of terrorist organisations controlled by Hafiz Saeed, including Lashkar-e-Taiba and Jamaat-ud-Dawa, which are subject to economic sanctions by United States. The U.S. Department of the Treasury and India allege that Saeed was responsible for the November 2008 terrorist attacks in Mumbai that killed 164 people.

 

Pakistan’s Addition to the Gray List in 2018

 

On Jan. 20, 2018, the United States initiated a motion to add Pakistan to the gray list because of its CFT deficiencies. The United Kingdom, France and Germany announced their support for Pakistan’s gray listing shortly thereafter.

 

The United States’ motion was tabled at FATF’s plenary meeting during the week of Feb. 20, 2018. Pakistan reportedly initially succeeded in persuading China, Turkey and Saudi Arabia to vote against the motion, which was significant because the motion could not pass without two of those countries’ support. However, before a final vote was taken, the United States ultimately secured China’s and Saudi Arabia’s support. Turkey continued to oppose the motion, but it was unable to block the gray listing alone. As a result, FATF voted to relist Pakistan, and Pakistan will be officially added back to the gray list in June 2018.

 

Key Implications and Takeaways

 

The United States Is Taking a Harder Line With Pakistan

 

The United States was the driving force behind FATF’s decision to relist Pakistan. This gray listing was one of several steps the United States has taken to encourage Pakistan to crack down on terrorism within its borders.

 

In January 2018, the U.S. Department of State announced that it was suspending hundreds of millions of dollars in military aid to Pakistan. The United States took this action because it concluded that the Pakistani government had not taken sufficient action to stop terrorist organizations from using the country as a safe haven. Similarly, the United States also stopped disbursements due to Pakistan under the Coalition Support Fund, which is a fund administered by the United States used to make payments to its allies, including Pakistan, for providing support to United States in conducting counterterrorism and military activities. More recently, in April 2018, the U.S. Department of the Treasury’s Office of Foreign Assets Control imposed list-based sanctions on Lashkar-e Taiba’s political party — Milli Muslim League — and seven MML officials.

 

FATF Is a Political Organization

 

Like all international organizations, politics play a key role at FATF. The United States initially sought to add Pakistan to the gray list, and then it waged a political campaign to garner support for its proposal among other FATF member states. For its part, Pakistan attempted to thwart the gray listing proposal in different ways. After the proposal was announced, Pakistan quickly strengthened its counterterrorist financing regime and cracked down on terrorist organizations operating within its borders. At the international level, Pakistan lobbied its allies to oppose the gray listing.

 

Pakistan’s efforts to oppose the gray listing were ultimately unsuccessful, and FATF elected to include Pakistan on its gray list. A variety of political, diplomatic and legal considerations undoubtedly contributed to the United States and other FATF member states deciding to take such action.

 

Pakistan’s Gray Listing Has Important Consequences

 

When a country is added to FATF’s gray list, members states are expected to implement enhanced due diligence measures aimed at addressing such country’s domestic AML and CFT deficiencies. FATF lacks the authority to require member states to take such domestic measures but some countries likely will elect to do so.

 

Apart from these legal consequences, Pakistan’s gray listing shows that FATF member states have significant concerns regarding Pakistan’s commitment to target illicit money laundering and terrorist financing activities. Indeed, Pakistan’s gray listing — which will occur only three years after it was removed from that list — illustrates that the international community views Pakistan as moving in the wrong direction with respect to money laundering and terrorist financing.

 

Pakistan Will Likely Incur Economic Costs From the Gray Listing

 

Increased Costs of Doing Business in Pakistan and Decrease in Foreign Direct Investment

 

Pakistan’s inclusion on the gray list will increase foreign companies’ and financial institutions’ perceived risk of doing business in Pakistan. In response to this heightened risk, some operating companies and banks might elect to pull out of Pakistan altogether, while others will strengthen their compliance safeguards. The increased safeguards, in turn, could result in higher costs to foreign companies transacting in the country.

 

Further, weaknesses in a country’s anti-money laundering and counterterrorist financing regimes can discourage foreign investment. With growing global legislative requirements and consumer-driven pressure related to terrorist financing and money laundering, companies that operate in Pakistan would face legal risks as well as negative press. FATF’s gray listing highlights Pakistan’s weaknesses in these areas, which could deter foreign businesses from doing business or making investments in Pakistan.

 

Borrowing Challenges

 

As perceived financial risk rises, Pakistani businesses could be subject to higher levels of scrutiny from international lenders, which in turn could make it harder for them to obtain financing from foreign counterparties. Along the same lines, such companies could face increased borrowing rates from the debt markets and international organizations, including the International Monetary Fund and the World Bank.[2]

 

Conclusion

 

FATF’s decision to gray list Pakistan for the second time in recent years is a notable development. By taking this action, the international community has clearly indicated that it expects Pakistan to strengthen its domestic laws related to AML and CFT. In addition, the gray listing could have significant economic repercussions for Pakistan.

 

[1] These experts comprise of representatives from FATF member states and from various international organisations.

 

[2] However, past experience suggests that these costs might be limited. When Pakistan was gray listed between 2012 and 2015, the Pakistani government and businesses were able to access international capital markets and their borrowing costs did not rise materially. See Tariq Ahmed Saeedi, Moody’s warns Pakistan on downgrade risks amid political uncertainty, The News, March 22, 2018.

 

 

For further information, please contact:

 

Michael S. Casey, Partner, Kirkland & Ellis

michael.casey@kirkland.com