What you should know
Proliferation finance in its current form is a relatively new topic. For example, the Financial Action Task Force (FATF) added proliferation finance to its recommendations (along with countering terrorist financing and money laundering) in 2012. [https://www.fatf-gafi.org/about/historyofthefatf/]. The issue of how proliferation is financed predates this development and is broader in conception than FATF's approach, which is relatively narrowly focused on designated entities. The UN Security Council has adopted financial and sectoral sanctions on North Korea and Iran in response to the proliferation programs of those countries that are broader in scope than FATF's measures. Given this, the topic of countering proliferation finance is a composite one in which states must meet the requirements of FATF while also implementing the requirements of UNSCRs. At heart, the goal is to prevent countries such as North Korea and Iran misusing the global financial system to further their programs.
The main actors related to proliferation finance are as follows:
At the international level, the FATF and the UN Security Council are the principal standard setting bodies related to proliferation finance. In the international system, individual countries remain responsible for implementation of international standards, and this remains true in relation to proliferation finance.
At the national level, there are generally several types of governmental entities involved in implementation. This typically involves financial sector supervisors and financial intelligence units which are often in treasury departments or financial oversight bodies. National crime or security services are often involved in implementation. Export licensing and customs agencies are typically indirectly associated with proliferation finance control implementation in cases where transactions relate to controlled goods and technology.
Individual banks and financial institutes are responsible for implementation in practice, which includes designated entity screening and customer due diligence.
As currently conceived, proliferation finance has a number of definitions which do not perfectly align together. This discord is driven in part by the actors involved in regulating proliferation finance, as set out below. A starting point for defining proliferation finance can be to consider what proliferators need from the financial system. In theory, FATF defines proliferation finance as follows:
In practice, FATF has decided to focus its requirements relating to proliferation finance on three key areas:
Implementation of UN targeted financial sanctions against entities involved in proliferation (this relates to FATF's recommendation 8)
Maintenance of an intergovernmental process and cooperation with industry
National risk assessments—a new requirement which requires governments to assess proliferation finance risks in their own national context.
UN sanctions, on the other hand, are broader in specific program contexts such as in relation to North Korea and Iran. Sanctions extend to sectoral activities such as oil and gas restrictions, maritime controls, and seafood sales. These are relevant to proliferation finance to the extent they are a means to raise funds by countries to use for proliferation-related purposes and because the sanctions were adopted to incentivize the target countries to end their proliferation-related activities. However, the scope of UN sanctions is clearly broader than the narrower approach taken by the Financial Action Task Force.
It has long been recognized that funding is a necessary element of a proliferation program. In many countries that seek nuclear weapons, funds are scarce, meaning that funds must be diverted from other purposes to support the proliferation program. It is in this context that Pakistan's President Zulfikar Ali Bhutto famously said that Pakistan would “eat grass” to get nuclear weapons if India did so.
The origin of current approaches to proliferation finance are twofold. First, the AQ Khan proliferation network (see box) saw non-state actors involved in state proliferation. The UN Security Council adopted resolution 1540 in 2004 which, among other items, requires states to take action to prevent non-state actors’ involvement in proliferation, including through the provision of funds. Second, in the mid 2000s, the UN Security Council began to use targeted sanctions to address proliferation concerns. In addition to designating individuals and entities, this included the freezing of their assets and blocking their transactions.
FATF took up the issue of proliferation finance after the UN Security Council had adopted these seminal resolutions. FATF is a member based organization that operates by consensus and which has included Russia as a member since 2003 [https://www.fatf-gafi.org/countries/#Russian%20Federation] and China as a member since 2007. [https://www.fatf-gafi.org/countries/#China] Russia and China traditionally take a conservative approach to the imposition of international or multilateral controls. In this context, FATF has taken a narrow approach to proliferation finance focusing specifically on the issue of UN designated entities. Even though early FATF documents have taken a broader (working) definition of proliferation finance, FATF's requirements related to proliferation finance are narrowly focused.
States and financial institutes need to keep in mind that, beyond the FATF's recommendations, the requirements of UN sanctions resolutions impose many additional requirements particularly in the context of Iran and North Korea. However, the overall effect of FATF's narrow approach to proliferation finance is that there is a lack of clear guidance from international authorities about what financial institutes must do to address proliferation finance risks. The development of proliferation finance typologies has helped in solidifying understandings of what proliferation finance can look like in practice. [https://www.fatf-gafi.org/publications/methodsandtrends/documents/typologiesreportonproliferationfinancing.html#:~:text=The%20Proliferation%20Finance%20Typology%20Project,measures%20to%20counter%20proliferation%20financing]
In this context, FATF recently required states to undertake proliferation finance risk assessments which helps states identify their exposure to proliferation finance risks.[ https://www.fatf-gafi.org/publications/financingofproliferation/documents/proliferation-financing-risk-assessment-mitigation.html] States will typically undertake risk assessments on a broader framing of proliferation finance rather than the more limited FATF framing.
At the national level, states must implement both the requirements of UNSCRs, FATF recommendations, and export controls. This requires a legal basis for each item, implementing regulations (where appropriate), the designation of agencies and the provision of resources and staff to these agencies, and engagement with the private sector. While the legal basis and designation of agencies is important, perhaps the main element of an effective national approach is effective interdepartmental cooperation so that relevant departments can leverage their resources, information, staff, and authorities to combat proliferation. Proliferation finance cases are invariably complex in nature and require broad and sustained cooperation to disrupt.
In Financial Institutes, proliferation finance requirements include the following:
Implementation of a sanctions screening process that also addresses ownership and control of parties to a transaction
“Know your customer” and client due diligence measures to understand exposure to proliferation finance risks, including geographical areas of operation, business lines, and business nature. This due diligence process should identify any connections to North Korea or Iran and connections with sectors affected by sanctions. It should also include measures to identify clients involved in sensitive or strategic sectors (i.e. that may hold export controlled technologies) and to ensure that such clients have in place appropriate internal compliance systems.
Undertaking broader analysis of the financial institute's business lines and geographical area to ensure that compliance resources are aligned to proliferation finance risks. This equates to a financial institute proliferation finance risk assessment.
Submitting suspicious activity reports or suspicious transaction reports when required or when concerns are identified. Where possible, categorizing any proliferation finance concerns (or concerns related to Iran, North Korea, or any other proliferating state) to aid Financial Intelligence Unit (FIU) staff in analyzing the data.
Proliferators should not be able to leverage the international financial system. UN sanctions and FATF recommendations seek to address this possibility.
FATF recommendations focus on ensuring that transactions do not relate to designated entities and interagency cooperation with the private sector.
FATF also now requires countries to undertake proliferation finance risk assessments.
Financial Institutes must implement compliance and due diligence measures and should undertake risk assessments of their own to ensure proliferation finance risks are identified and that resources are appropriately invested on this topic.