Understanding the three main stages of how money launderers introduce illegally obtained illicit funds into the financial system is a must for anti-money laundering (AML) officers if they are to be effective in the fight against financial crime.
According to Europol’s “Decoding the EU’s Most Threatening Criminal Networks” report, half of the most threatening criminal networks in EU are involved in drug trafficking as their main criminal activity.
In most cases, the sale of drugs is conducted in cash. And, if the activity goes unnoticed, the drug traffickers can acquire a large amount of cash money. But what happens next?
They cannot simply deposit all the cash at once to the ATM machine or local bank branch. Because the existing Know Your Customer (KYC) regulations would rapidly flag such deposits as suspicious activity. And even more – they could freeze the funds, or even report such activity to the local authorities. This is where the Money Laundering process comes into the picture.
Understanding Predicate Offences
A predicate offence – or predicate crime – is an offence that is part of a larger offence. In a financial context, a predicate offence would be any crime that generates the proceeds of crime. The 6th EU Anti-Money Laundering Directive (6AMLD) describes 22 predicate offences that constitute money laundering. It includes certain tax offences, drug trafficking, environmental crime and cybercrime.
Drug trafficking clearly stands out as a key activity in the “Decoding the EU’s Most Threatening Criminal Networks” report. Accordig the report, 50% of the most threatening criminal networks are involved in drug trafficking. Either as a stand-alone activity or as part of a portfolio of activities, while 36% of them have a unique focus on drug trafficking.
How does this information help AML professionals? It doesn’t, until you start looking deeper. For example, drug trafficking is a very broad term and much more accurate information can be found by looking at how different drugs, such as cannabis or cocaine, enter the market. Most drugs enter the EU from the Netherlands and Belgium, why? Because these two countries have the largest ports in the EU.
Drug trafficking routes
Looking at the pictures below, it is clear that most cannabis comes from North Africa and cocaine from Latin America. So it is likely that different methods and techniques are used to launder the illicit funds. In general, the products go one way and the funds for the organized crime groups go the other.
3 stages of money laundering
Every AML professional knows and can quote the exact definition of money laundering. The description itself can vary from jurisdiction to jurisdiction. But the generally accepted definition remains that it is “the process of disguising the origin of money obtained illegally so that it appears to come from legitimate sources”. The process typically involves 3 main stages (or so called steps/phases of money laundering): placement, layering and integration.
While the term is quite simple, the money laundering process is a complex task. And in order to be successful in this criminal world, they must not attract the attention of law enforcement or other audits (e.g. tax audit).
Let’s take a closer look at all three stages of money laundering (also known as the 3 steps or 3 phases of money laundering in the AML/CFT literature).
Stage 1: Placement
The placement stage is crucial because it transforms physical cash, which is more difficult to handle and trace. It transforms it into forms that can be more easily manipulated and concealed in the subsequent stages of money laundering.
Some reports suggest that it is at this stage that financial institutions and designated non-financial businesses and professions (DNFBPs) are most likely to detect the illicit funds. There are several techniques to do this:
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Cash-based transactions
Large amounts of cash can be deposited into bank accounts. Or into money transfer companies in a manner designed to avoid detection. This method may involve structuring (smurfing), where large sums of money are broken down into smaller, less conspicuous amounts. And deposited into multiple accounts to avoid reporting requirements. If the amounts are small, even insurance companies could be vulnerable, as new contracts can be paid for in cash at physical locations. These contracts usually have a cancellation period after which the funds can be returned to a bank account.
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Bulk cash smuggling
Physically transporting large amounts of cash across borders to be deposited in foreign banks or to purchase valuable assets. This situation can occur when illicit funds are earned in countries that are becoming “cashless societies”, such as the Nordic countries (e.g. Sweden), and the funds are then moved south, where the cash is still relevant. According to EUROPL, regular large-scale cash seizures from cash couriers throughout the EU indicate that cash smuggling is still widespread. The amounts of cash seized at land borders are generally larger, while seizures at EU airports are more frequent.
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Casinos & junket operators
Criminals can simply go to casinos, buy chips with cash (e.g. 1 000 euro), put the chips in a slot machine, use it once for 1 euro and then cash out 999 euro as “winnings”. In less strict casinos, they may not even have to pretend that gambling is taking place. In addition, recent investigations show that junket operators, who work with casinos to attract high net worth individuals to gamble in the casino, pose significant money laundering risks. Because they may be part of a larger network providing underground banking services to various criminal enterprises requiring money laundering or money transfer services.
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Purchase of items
Buying goods that contain larger value (such as cars, jewelry, precious metals, art) that can be easily resold. These items serve as a means of converting illicit cash. Converting into assets that can later be transported to other countries and liquidated relatively quickly.
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Cash-intensive businesses
Cash-intensive businesses can be easily misused for money laundering as they provide ample opportunities to mix licit and illicit proceeds. A high volume of small transactions, the use of high denominations and the variety of regulations governing the use of cash payments are all factors that can be exploited by criminals. According to EUROPOL, the businesses most at risk of money laundering are: bars, restaurants, pizzerias, grocery stores, construction companies, car dealers, car washes, art and antique dealers, auction houses, pawn shops, jewelers, textile retailers, liquor and tobacco stores, retail/nightclubs, gambling services, strip clubs and massage parlors.
Stage 2: Layering
The primary objective of layering as one of the 3 steps of money laundering is to separate illicit money from its source. And to do so by creating complex layers of financial transactions. This process makes it difficult for the authorities to trace the money back to the original illegal activity. In short, the more layers that are created, the more difficult it becomes to identify the source and ultimate owner of the funds.
Money launderers use a variety of techniques to layer funds:
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Wire transfers
Moving money through a series of accounts at different banks, especially in different jurisdictions, to disguise its origin. For retail customers, this activity may be combined with money mule activity involving many counterparties. While for corporate customers, this method is usually combined with the use of shell companies or offshore accounts to disguise ownership.
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Brokerages & Exchanges
Buying and selling stocks, bonds, commodities, exchanging fiat currency or other financial instruments through brokerages and exchanges. This process can create a complex web of transactions, as the illicit funds can be converted into securities and foreign currency, which can then be transferred between different brokerages. Cryptocurrency exchanges play an important role by facilitating the exchange between fiat and cryptocurrency. During the layering phase, illicit funds are separated from their original source by exchanging primary coins for other coins. This process, also known as ‘chain hopping’, moves money from one cryptocurrency to another, across poorly regulated exchanges and jurisdictions, creating a money trail that is difficult to trace.
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Use of shell companies and trusts
Creating shell companies and trusts in different jurisdictions to hold assets or conduct transactions, often using nominee directors and shareholders to hide the true beneficiaries.
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Trade-based money laundering (TBML)
Over- or under-invoicing, false declarations and other trade-related methods to move money across borders. This can include the use of fictitious trade documents or over/undervaluation of goods and services, double payments for the same invoice, etc. While this technique is more common in international trade, it can also be used in domestic trade. The most commonly traded goods include second hand vehicles, metals, clothing, construction equipment, medical devices, fish products, real estate, watches, high value goods, gold, clothing, art, artefacts and antiques, non-fungible tokens (NFTs) and even animals such as horses.
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Money Mules
Individuals who have been recruited, often unknowingly, to act as money laundering intermediaries for criminals. They transfer illicit funds between accounts, often in different countries, on behalf of others, using personal and/or corporate bank accounts. According to Europol, money mules are often part of a larger money laundering scheme, increasing the distance between operations, goods or victims and criminals. Like cash couriers, money mules mainly offer their services for a fee rather than being involved in the predicate offence. Their accounts are sometimes opened through impersonation or identity theft. Investigations reveal the recruitment of students, migrants and vulnerable people in financial need. Mules are heavily recruited through social media, particularly in fraud schemes.
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Digital assets
In many countries, illicit funds have been channeled into cryptocurrency trading platforms. And police have seized crypto accounts, cards, or applications on cryptocurrency exchanges as proceeds of crime. However, the global nature, speed and commingling of cryptocurrency transactions pose significant challenges to law enforcement investigations. It is also difficult to trace and freeze crypto assets and convert them into fiat currency. Therefore, criminals have partly shifted to DeFi, cryptocurrency mixers, NFTs, peer-to-peer marketplaces and more privacy-oriented cryptocurrencies, such as privacy coins. Criminals are also using stable coins to avoid fluctuations in the value of cryptocurrencies; they have started to use them not only to move value, but also to store value in wallets beyond the reach of law enforcement.
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Legal Business Structures (LBS)
Criminals tend to hide the identity of beneficial owners (or simply be a minor shareholder to avoid standard KYC practices). They mask it by layers of corporate structures that spread across multiple jurisdictions, often offshore. In addition, these structures can be used to exploit the weaknesses of national tax regimes.
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Online casinos and poker rooms
Criminals can place a series of bets, often on games such as poker, slots or sports betting. The aim is not necessarily to win large sums of money. The goal is to move the money around and mix it with other players’ legitimate funds.
Stage 3: Integration
At this step of money laundering, the illicit funds have been successfully laundered and appear to be legitimate. The integration phase of money laundering involves the re-entry of these ‘clean’ funds into the mainstream economy. It is often done through legal channels, making it extremely difficult to distinguish them from legitimate wealth. Some examples are
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Investment in real estate
One of the most common methods of integrating laundered funds is through real estate transactions. The launderer can buy property, often at inflated prices, and invest in development projects that can later be rented out. The complexity of the property market and the ability to transfer ownership can obscure the origin of the funds.
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Business investment and acquisition
Criminals may invest in or acquire businesses using laundered funds as capital. This not only integrates the funds, but can also generate legitimate income through salaries or dividends. Businesses in cash-intensive industries, such as restaurants or entertainment, are particularly attractive. Because they can blend illicit funds with legitimate cash flows.
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Luxury goods and art
Purchasing high-value items such as luxury cars, yachts, jewellery and art is another method. These items can later be sold, providing a seemingly legitimate source of income. Such items can also be transported to other countries and liquidated relatively quickly if necessary.
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Securities and financial instruments
Investing in stocks, bonds and other financial instruments allows launderers to generate returns and integrate funds into the financial system. These instruments can be used to receive interest and dividends. And it can make it difficult to trace the origin of the money.
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Fictitious loans and mortgages
The creation of fictitious loans or mortgages allows funds to appear as legitimate debt repayments. This method can involve complex schemes where money is lent and then repaid, creating a trail that looks legitimate.
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Shell companies and trusts
The use of shell companies and trusts to hold and store assets can further obscure the link between the funds and their illicit origins. These entities can also be used to invest in other businesses or properties, providing an additional layer of separation.
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Bribery and corruption
Europol states that 60% of criminal networks operating in the EU use corrupt methods to achieve their illegal objectives. They do so by gaining unfair advantages and expanding their criminal empires. Networks of corrupt individuals operate across multiple organisations and geographical locations. In some cases, corruption is facilitated by independent intermediaries acting as service providers. Individuals are targeted for corruption either because of their position of power (e.g. prosecutors, judges, etc.) or because they possess relevant information.
Underground banking
Europol’s report “The Other Side of the Coin” also highlights that almost 70% of criminal networks operating in the EU use basic money laundering techniques. They involve the main gatekeepers and about 30% use professional money laundering networks and/or underground banking.
The Informal Value Transfer System (IVTS) is a mechanism or network of people who receive money in order to make the funds or an equivalent payable to a third party in another geographical location, operating outside the regulatory oversight of the legitimate banking sector.
It is also known as underground banking. The implementation of stricter anti-money laundering regulations in mainstream financial institutions has made IVTS increasingly attractive to criminals and criminal networks. And they are often used to move the proceeds of migrant smuggling, organised property crime, human trafficking and drug trafficking. Hawala is one example of how IVTS can be used to move and launder the proceeds of crime, with hawaladars (those who operate hawala) often running separate parallel businesses, particularly currency exchanges, travel agencies or telephone shops.
Connecting the dots
People (even the most sophisticated money launderers) are not perfect and make mistakes that can be detected by AML professionals.
Therefore, understanding 3 steps of money laundering and how money launderers operate, not only locally but internationally, is critical. Because today’s world requires close cooperation between the public and private sectors. This is crucial to protect the reputations of all parties involved in this fight.
