Tracking Illicit Russian Financial Flows
Trillions of dollars in capital flows into the United States annually, and trillions of dollars in payments are cleared through New York daily. No one knows exactly whom the funds belong to, where they are held, or how they are deployed. No one knows because the U.S. government does not track the money — but it could if it wanted to. What is known is that Russia, other countries of the Commonwealth of Independent States, and China are the primary drivers of non-transparent capital flows worldwide.
Beginning next month, U.S. financial institutions will be required to identify the “beneficial owners” of new accounts under the Customer Due Diligence Rule. In other words, when a private company or other legal entity becomes the client of a bank, the bank needs to determine which people actually own or control the company. The rule is a major achievement for financial transparency, and it will go a long way to help understand how much money from Russia — both legitimate and illicit — is held in the United States. However, it addresses only one dimension of the multi-faceted ways in which illicit funds can travel to or through the United States opaquely. Painting a complete picture will require a comprehensive approach to mapping flows across bank deposits, portfolio investments, foreign direct investment, and real estate purchases.
Why Russian Financial Flows Matter
Tracking funds entering the United States from Russia —from the government, oligarchs, and organized criminal groups, in particular — is important because Russia produces extremely large opaque financial flows, and because a significant portion of the money is likely illicit in nature or origin. Economists have been able to approximate the scale of the phenomenon using two methods. The first method analyzes “net errors and omissions” in balance of payments figures (statistics that aggregate trade and investment between countries). The second locates mismatches in governments’ reports of their respective “international investment positions,” which record how many financial assets a given country holds in other nations, and conversely how many liabilities foreign nations hold in that country. By calculating discrepancies among numbers reported by various governments using both methods, it becomes clear that Russia has consistently produced huge unreported outflows of money.
Global Financial Integrity, an organization that specializes in this field, estimated that around $12 billion in illicit money has flowed out of Russia each year, a swift current in an even larger river of unrecorded outflows that may or may not be licit. Economists at Deutsche Bank found that net errors and omissions in British balance of payments data — about $100 billion from 2006 to 2015 – correlated closely with estimated capital flight from Russia, meaning the errors are likely derived from unreported capital inflows from Russia to the United Kingdom. Research by Gabriel Zucman and colleagues has concluded that up to 60 percent of Russian wealth is held offshore. Given the extreme inequality in the Russian economy, that means that wealthy Russians keep as many assets offshore as the rest of the Russian population holds in Russia itself.
Large-scale opaque financial flows out of Russia, then, are corrosive to Russia and the United States alike. In Russia, these hidden flows rob the country of needed investment, feed extreme inequality, and facilitate corruption and organized crime. In the United States, the flows threaten to undermine the rule of law and compromise important institutions. Given the opacity of these flows, there is also the risk that they will be used to evade sanctions, inappropriately fund the U.S. political process, or facilitate other malign Russian government activity.
Start with the Basics
The Customer Due Diligence Rule accomplishes one third of what is necessary to bring transparency to beneficial ownership in the United States. The rule will require beneficial ownership reporting for bank accounts held here, but it does nothing to ascertain who owns companies established in this country, companies which may or may not open a U.S. bank account. To address this issue, Congress needs to pass a law requiring beneficial ownership reporting at the time of company formation. The Treasury Department came out in support of a beneficial ownership registry in 2016. A recent House bill to require newly formed companies to report beneficial ownership information directly to Treasury appears to stand a good chance of passage and, importantly, enjoys the support of the financial services industry. The European Union is ahead of the United States, having issued a directive in 2015 mandating that member states maintain beneficial ownership registries.
The third and final piece of the beneficial ownership puzzle is preventing the anonymous purchase of real estate. Foreign buyers may purchase a house, condo, or commercial property in the United States without forming a U.S. company or opening a U.S. bank account. A New York Times investigation in 2015 highlighted the prominence of the Russian elite among anonymous purchasers of luxury Manhattan properties. A temporary Treasury Department order has required purchasers of high-end residential real estate in select cities to report identifying information and has revealed a startling degree of potentially suspicious activity. A permanent, nation-wide program would be appropriate.
Toward Meaningful Transparency
While the United States works to assemble a beneficial ownership regime, it should also turn to more sophisticated approaches to tracking how much Russian money moves through the United States and where it goes.
The single most effective tool to understand Russian financial flows — and to understand what portion may be illicit — would be the creation of a centralized database of all international funds transfers that transit the United States. Large New York banks that clear dollars for international payments would report the data on a near real-time basis. The reporting streams could then be combined, providing a complete view of U.S. dollar transactional activity. The idea has been studied by the Treasury Department but never finalized, although Canada and Australia collect this type of information. While international funds transfer records are available on an ad hoc basis, only a centralized database would drive the type of powerful analysis that is necessary. With a central repository in place, the U.S. government can ask questions like, “How much money flows between banks in Cyprus, Latvia, and Russia? Has there been a shift in the pattern in past months?” If a small bank suddenly and rapidly increases its level of dollar clearing out of proportion to the business profile of its customers, the shift will set off an immediate red flag. And the government will have more granular information about how much money moves from Russian banks to U.S. banks, or vice versa, than is currently available in Bureau of Economic Analysis or Bank for International Settlements data.
The second critical tool to better understand Russian financial flows is the formulation of anti-money laundering compliance obligations for managers of limited partnership investment vehicles like hedge funds and private equity firms. This idea, too, has been studied but never finalized. The industry manages trillions of dollars in assets in the United States, but the underlying investors are not generally disclosed. It is difficult for regulators, law enforcement agencies, or other financial institutions to assess the risk or legality of a transaction when the actor is itself a black box — often acting on behalf of others — without any obligation to detect and prevent illicit activity.
The third tool is an enhanced process to scrutinize foreign investments that pose a potential national security risk. The Committee on Foreign Investment in the United States already reviews such transactions. A bill making its way through Congress would make important improvements. Under the proposal, the committee would receive increased resources; would be able to review transactions involving certain types of foreign acquisitions for national security risk even if they did not result in foreign control of a U.S. business; and would be able require that certain transactions be submitted to it for review prior to completion (submission prior to completion is currently voluntary).
Knowledge is Power
Even if all of these measures are implemented, gaps will remain. For example, standards governing the transmission of wire transfer data don’t explicitly require that banks obtain all relevant information about the ultimate remitter and beneficiary of each transaction. And securities markets will continue to function with a degree of ambiguity, as institutions executing trades or custodying stocks or bonds generally know the identity of their immediate counterparty, but not necessarily the underlying client ordering the activity.
None of these reforms is a panacea, and bad actors will find ways to evade all of them. People will, without a doubt, lie, dissemble, and falsify documentation. They will find cut-outs to stand in for them. Some will steal the identities of innocents and impersonate strangers. Acknowledging the inevitability that oversight will always remain imperfect, the United States must strive to achieve enough transparency that illicit activity becomes difficult, not impossible. Armed with knowledge, we can begin to assess more fully the true extent of the problem.
 The rule requires the reporting of all beneficial owners who hold an equity stake of 25 percent or more, plus the name of one person in a “control” position. It remains to be seen whether illicit actors will attempt to evade meaningful reporting by structuring ownership stakes just below the 25 percent threshold or naming “control” persons who lack real decision-making authority. The Treasury Department’s Financial Crimes Enforcement Network, which issued the rule, and the Federal functional regulators, who will examine financial institutions for compliance, will likely be on the lookout for widespread evasion.
 Although the directive was issued in 2015, not all member states have fully implemented it at the national level.
The views expressed in GMF publications and commentary are the views of the author alone.