Jurisdiction Risk

Jurisdiction risk is a risk that happens when you borrow money to do business in a foreign country. Such risk can cause price volatility. It shows the jurisdictions where money laundering, terrorist funding, and proliferation financing create a major financial threat.

Jurisdiction Risk

What Is Jurisdiction Risk?

The term “jurisdiction risk” refers to the dangers encountered when conducting business in another nation or jurisdiction. Simply conducting business in a foreign nation or lending or borrowing money in that jurisdiction exposes one to these dangers. In many nations or locations, risks may also originate from the interaction of legal systems, regulatory frameworks, and political systems.

In recent years, jurisdiction risk has increasingly centred on banks and other financial institutions. This is because these organizations are vulnerable to the possibility that some of the countries in which they operate pose a high risk for money laundering and the financing of terrorism.

Operating in a foreign nation or territory brings with it the danger of being subject to the laws of that nation or region. When an investor is exposed to unanticipated changes in the laws, this is another instance in which the term “jurisdiction risk” might be utilized.

Note: To identify potentially dangerous jurisdictions with lax procedures to combat money laundering and terrorism financing, the United States government recommends that financial institutions use the most recent updates provided by the Financial Action Task Force (FATF).

How does Jurisdiction Risk work?

Any additional risk associated with borrowing, lending, or conducting business in a foreign country is “jurisdiction risk.” An investor’s exposure to a particular sector may be jeopardized if rules governing that sector are suddenly altered.

  • It’s not uncommon for this sort of risk to result in additional price volatility. As a result, investors seek larger returns to compensate for the increased risk.

  • Political risk is when an investment’s returns might be adversely affected by political changes or instability in a country.

  • Changes in government, legislative bodies, other foreign officials, or military power can all cause instability that impacts investment returns.

  • Lawsuits, exchange rate volatility, and even geopolitical unrest are dangers that financial institutions and corporations confront when dealing with jurisdiction risk.

  • There has recently been a correlation between jurisdiction risk and significant money laundering and terrorist activity.

  • The Financial Action Task Force (FATF) and the United States have branded some nations as “non-cooperative” because of the prevalence of these practices.

  • Money laundering or corruption issues necessitate particular Treasury actions.

Summary

It is common for financial institutions to have mechanisms in place to assess and reduce jurisdiction risk because of the severe fines and penalties that may be imposed on any financial institution found to be involved in money laundering or funding terrorism.

About Financial Action Task Force

Name Financial Action Task Force
Abbreviation FATF
Formation 1989; 33 years ago
Type Intergovernmental organization
Region served Europe
Purpose Combat money laundering and terrorism financing
Membership 39
Official language English, French
President Marcus Pleyer
Headquarters Paris, France

FATF, also known as Financial Action Task Force, is an intergovernmental organization created in 1989 by the G7 to combat money laundering. In 2001, its scope included terrorism financing.

FATF sets guidelines and promotes the smooth legal work, regulatory, and operational measures to combat money laundering, terrorism financing, and other risks to the international financial system. FATF is a “policy-making body” that promotes national legislative and regulatory changes. FATF oversees the implementation of its Recommendations through “peer reviews.”

The 1989 G7 Summit in Paris founded FATF to tackle money laundering. The task group studied money laundering trends, monitored national and international legislative, financial, and law enforcement operations, reported on compliance, and issued suggestions and guidelines to combat money laundering.

Note: Since 2000, FATF has maintained a blacklist and greylist (formally called the “Other monitored jurisdictions”). Financial institutions have shifted resources away from blacklisted companies. The listed nations’ domestic economic and political forces have pushed for FATF-compliant policies.

Things To Consider About Jurisdiction Risk

  • Since its inception in 2000, the FATF has made two documents publicly available three times a year.

  • The FATF has deemed several countries to have insufficient measures to address money laundering and terrorism funding in these reports. Non-Cooperative Countries or Territories are the names given to these countries (NCCTs).

  • The 22 nations classified as monitored jurisdictions by the FATF in June 2021 are Albania, Barbados, Cambodia, Cayman Islands, Haiti, Mauritius, Pakistan, Morocco, Myanmar, Nicaragua, Panama, Philippines, Senegal, South Sudan, Syria, Uganda, Yemen, and Zimbabwe.

  • These NCCTs do not have adequate anti-money laundering measures, nor do they recognize or combat terrorism funding as a problem. However, they have agreed to cooperate with the FATF to fix the issues.

  • The organization added North Korea and Iran to the FATF’s “call-to-action” list. The FATF says that North Korea’s lack of commitment and inadequacies in the previously mentioned categories continue to represent a significant risk to international financing.

  • Moreover, the FATF expressed its worry over the country’s weapons of mass destruction proliferation. As stated by the FATF, Iran pledged its support for the organization but failed to put its words into action.

The Importance of Jurisdictional Risk

To effectively manage risk at the corporate level and when examining the risks associated with specific business relationships, it is critical to identify areas that may provide a greater inherent risk of money laundering.

Customer due diligence efforts (CDD), even those implemented after a commercial connection is established, may be inadequate if the risk classification of nations is erroneous. This might make it more difficult to spot questionable or odd transactions, which could increase the amount of money that is laundered.

Basel AML Index is an example of a rating that uses a composite score. Companies using more complex jurisdiction risk assessment models can better identify the risks associated with a certain business connection.

Firms can miscalculate their risk exposure and not consider the specifics of a given connection by using a simple model, such as relying on one source for an overall score.

Summary

Firms often utilize a variety of sources to identify high-risk jurisdictions. The Financial Action Task Force (FATF) and the European Commission publish lists of nations with strategic money laundering deficiencies, as do the countries that score highly on the Corruption Perception Index.

Identifying and Managing Jurisdictional Risk

Four areas of good practice are provided below to assist companies in building effective tools to detect and manage the jurisdiction risk when interacting with MSBs:

  • Companies should use various sources, and the information they give should be relevant to the risks connected with the types of relationships and services they provide.

  • Additional due diligence measures, such as requiring the customer to provide an independent assessment of their anti-money laundering systems and controls or conducting an on-site inspection.

  • Transaction monitoring should be set up to allow the company to detect and evaluate transactions not subject to CDD. For example, certain transactions might be excluded from the contract with the consumer in severe instances.

  • As part of their training, workers involved in risk assessment and client onboarding, transaction monitoring and sanctions screening should be aware of the dangers posed by variances in AML laws between jurisdictions.

Keep in mind: A company’s risk appetite should be routinely assessed to monitor its jurisdictional risk exposure. One source may not give enough information to assess the number of due diligence processes necessary for jurisdiction.

Frequently Asked Questions - FAQs

People asked many questions about jurisdiction risk. We discussed a few of them below:

1 - What are FATF high-risk jurisdictions?

Albania, Barbados; Burkina Faso; Cayman Islands; Jamaica; Malta; Morocco; Myanmar; Pakistan; Philippines; Senegal; South Sudan; Uganda; and Zimbabwe had their progress assessed by the FATF in October 2021.

2 - What is a risk assessment for jurisdictions?

The jurisdictional risk assessment is an essential but underutilized part of emergency management (JRA). It is the evaluation of historic, present and prospective threats to the health, safety, and property of the residents of that jurisdiction.

3 - Which jurisdictions require enhanced due diligence?

The European Commission still requires EDD for countries on its list of high-risk third nations. Albania, The Bahamas, Barbados, Botswana, Cambodia, Ghana, Iceland, Jamaica, Mauritius, Mongolia, Myanmar, Nicaragua, Pakistan, Panama, Syria, Yemen, and Zimbabwe are included on the greylist.

4 - What is the purpose of the FATF?

Increased monitoring by the FATF indicates that the jurisdiction has quickly remedied the identified strategic shortcomings within specified deadlines and is subject to further monitoring. The “grey list” is another name for this list.

5 - Is India a high-risk jurisdiction?

According to our research, significant money laundering jurisdictions include Afghanistan, India and Pakistan. They also referred to these nations as “high-risk.” Human trafficking is a major problem in the region, particularly in Afghanistan.

6 - What is the grey list, and why is Pakistan on it?

If a nation is grey-listed by the FATF, that signifies that the organization has enhanced the surveillance of its efforts to combat money laundering and terrorism funding measures. Also known as the “enhanced surveillance list,” the “grey list” serves as an umbrella term for several related concepts.

7 - What is distribution risk?

Independent risks must be pooled to invoke the actuarial law of large numbers, which is commonly utilized in tax deductibility arguments.

8 - Is Pakistan a member of FATF?

In its most recent plenary meeting, the global financial crime watchdog, the Financial Action Task Force (FATF), opted to keep Pakistan on its “grey list” for supporting terrorism. Watchdog for financial crimes, including money laundering and terrorist funding, the Financial Action Task Force (FATF) is an international organization.

9 - Is the UK a FATF country?

They are British overseas territories known as Crown Dependencies (a FATF Member). MONEYVAL began evaluating the Crown Dependencies of the United Kingdom in October 2012, along with the rest of the United Kingdom.

10 - Is the United States a member of the FATF?

FATF nations in North America include the United States, Canada, and Mexico. To name just a few of the European nations represented on FATF’s roster: Austria, Belgium, Denmark, Finland, Germany, France, Greece, Iceland, Ireland, Italy, Luxemburg, the Netherlands; Norway, Spain, Portugal, Switzerland, Sweden.

11 - Is Malaysia a high-risk Jurisdiction?

The US State Department has designated Malaysia as a Country/Jurisdiction of Particular Concern for Money Laundering and Other Financial Crimes. Malaysia’s open, middle-class economy faces a wide spectrum of money laundering risks.

12 - What is FATF and its purpose?

Global money laundering and terrorist funding watchdog, the Financial Action Task Force (FATF) International standards are established by the intergovernmental body to curtail illegal actions and the harm they cause.

13 - What is delivery channel risk?

How you provide your services might increase or decrease the firm’s risk. There is an increased danger of identity fraud when a customer is not met face-to-face.

14 - What is a FATF jurisdiction?

Increased monitoring by the FATF indicates that the jurisdiction has quickly remedied the identified strategic shortcomings within specified deadlines and is subject to further monitoring. The “grey list” is another name for this list.

15 - What makes a jurisdiction high risk?

The regulatory frameworks of high-risk countries suffer from substantial strategic flaws, making them less effective in preventing money laundering, financing terrorism, and financing proliferation.

Conclusion

Investing can expose investors to foreign exchange risk, another jurisdiction risk (also known as currency risk). Therefore, a global financial transaction could be affected by shifts in the value of one currency relative to another. A fall in an investment’s value is one possible consequence of this. Utilizing hedging tactics such as options and forward contracts is one way to protect oneself from the dangers associated with currency exchange.

Related Articles

Jurisdictions Risk Under Increased Monitoring

Increased-monitoring jurisdictions collaborate with the FATF to resolve strategic inadequacies in anti-money laundering, terrorist financing, and proliferation funding regimes. When the FATF places a jurisdiction under heightened monitoring, it implies the government has committed to resolving strategic shortcomings within established timelines. This list is called the “grey list.”

The FATF and FATF-style regional organizations (FSRBs) continue to engage with the below jurisdictions as they report on their strategic inadequacies. The FATF urges these nations to finish their action plans on schedule.

The FATF finds other states with strategic money laundering, terrorism, and proliferation financing weaknesses. The FATF or their FSRBs have not yet evaluated several jurisdictions.

Since the COVID-19 epidemic began, the FATF has voluntarily allowed countries without pressing deadlines to report progress. Albania, Burkina Faso, Barbados, Cambodia, Cayman Islands, Jamaica, Malta, Morocco, Pakistan, Panama, Philippines, Myanmar, Nicaragua, Senegal, South Sudan, Uganda, and Zimbabwe. Updated statements are below.

Jordan, Mali, Haiti, and Turkey were granted the chance to delay reporting; therefore, the June and October 2021 statements for these countries are included, but they may not reflect the most recent status of the AML/CFT regime. FATF now includes the UAE after evaluation.

Keep in mind: The FATF will monitor their development. The FATF does not require extra due diligence processes for these nations but urges its members and other governments to consider the information below in their risk assessments.

What is Jurisdiction Risk?

If a company does business in a foreign country, it is exposed to the possibility of legal action. This situation may emerge if a company has physical locations in another nation or does business there, such as lending money to borrowers in a different country.

A company’s business model may be impacted by a change in the legislation in one of these locations. Because of the severe penalties that may be levied on these institutions if they are found to be complicit in money laundering, they must put in place additional safeguards to protect themselves.

Because of the increased volatility of currency exchange rates, an organization’s investment in a particular nation may abruptly fall. This problem may be alleviated by implementing a sound hedging plan. Investors and lenders will expect a greater return rate before investing in a firm with a high level of jurisdiction risk.

Note: Money laundering and other illegal activities involving huge quantities of money are more likely to be connected with financial institutions that deal with significant sums of money.

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