Most people who have worked in the compliance industry over the years have probably noticed a sudden increase in the use of one particular term that is becoming more and more commonplace – proliferation financing.
But what exactly does this phrase mean and how does this impact the compliance industry?
In this article, we will not only take a closer look at this specific typology, but we will also look at some risk factors that may soon be useful to your organization.
What is proliferation financing?
The definition of proliferation financing has evolved over the years.
Back in 2010, the FATF defined it as “the act of providing funds or financial services used, in whole or in part, for the manufacture, acquisition, possession, development, export, transhipment, brokering, transport, transfer, stockpiling or use of nuclear, chemical or biological weapons and their means of delivery and related materials (including both technologies and dual-use items used for non-legitimate purposes), in contravention of national laws or, where applicable, international obligations.”
Today, the FATF defines proliferation financing as “the manufacture, acquisition, possession, development, export, trans-shipment, brokering, transport, transfer, stockpiling or use of nuclear, chemical or biological weapons and their means of delivery and related materials (including both dual-use technologies and dual-use goods used for non-legitimate purposes)”. It is also important to note that the FATF Recommendations on PF only take into account the UN Security Council Resolutions (UNSCRs), which are limited to the implementation of the UN sanctions regimes on DPRK and Iran, and therefore other high-risk jurisdictions may not receive the necessary attention.
As a result, when (properly) assessing PF risks, the FATF Guidance on PF Risk Assessment recommends considering two risks and definitions that are interconnected and equally important to address in efforts to prevent the global threat of weapons of mass destruction (WMD):
- the risk of WMD proliferation, and
- the risk of the underlying financing for the WMD proliferation
The key terms
To fully understand the complexities of proliferation financing and the regulatory measures designed to combat it, it’s valuable to review some key terms.
Weapons of Mass Destruction (WMD)
The term WMD refers to a biological, chemical, radiological, nuclear, or other weapon that can kill or seriously injure many people or cause great damage, but no weapon has received more recent attention than nuclear weapons.
In the aftermath of the September 11 attacks, the fear of unconventional weapons and asymmetric warfare became so widespread in many countries that it became the word of the year in 2002. So which countries should we be worried about?
The Treaty on the Non-Proliferation of Nuclear Weapons (NPT), established in 1968, is a cornerstone of global efforts to prevent the spread of nuclear weapons, promote the peaceful use of nuclear energy, and achieve disarmament. The NPT recognizes five nuclear-weapon states-the United States, Russia, China, France, and the United Kingdom-that possessed nuclear weapons before the treaty’s entry into force.
These countries are obligated to reduce their arsenals over time and not to transfer nuclear weapons to non-nuclear states. However, several nations operate outside the NPT’s regulations. India, Pakistan, and Israel have developed nuclear weapons without joining the treaty, while North Korea withdrew in 2003 and has pursued a robust nuclear program in defiance of international sanctions.
Countries with nuclear and biological weapons
Countries such as Iran are NPT signatories but face allegations of noncompliance, with concerns that their enrichment activities could lead to weaponization, and are sanctioned along with North Korea. Meanwhile, most states, including Germany and Japan, abide by NPT rules and maintain robust civilian nuclear programs under the supervision of the International Atomic Energy Agency (IAEA) without developing weapons capabilities. So is it really that complicated?
According to the Federation of American Scientists, there will be a total of nine countries with nuclear weapons in 2023: Russia, the United States, China, France, the United Kingdom, Pakistan, India, Israel, and North Korea. We have 1 country that is sanctioned (plus Iran, which is not listed in the chart below), 3 countries that do not promote the peaceful use of nuclear energy, and 5 countries that are part of the NPT, but 2 of them are ruled by de facto leaders who could abuse this power.
The exact number of warheads possessed by each country is secret, and estimates are based on publicly available information, historical records, and occasional leaks, but the chart below shows that while most countries have dozens or a few hundred warheads, Russia and the United States have the largest number of warheads. As a result, Russia’s geopolitical strategies, centralization of power under Vladimir Putin, and evasion of international agreements and legal norms make it a significant proliferation finance threat. Targeted sanctions on Russia’s military-industrial complex have sought to limit its ability to develop and export advanced weapons, but loopholes and covert financial networks continue to undermine these efforts.
Estimated nuclear warhead inventories, 2023
Sources: Federation of American Scientists / Our world in data
If we add the countries that have possessed or used biological and chemical weapons, we would have a good picture of the key countries that could be potential perpetrators.
Historical biological weapons activity
Source: Our world in data
Historical chemical weapons activity
Source: Our world in data
Dual-use goods and technologies
In politics, diplomacy and export control, dual-use items refer to goods, software and technology that can be used for both civilian and military applications (more than one purpose at a time).
While some items, such as missiles, can be easily identified as military weapons, other items and technologies, such as drones, night vision, and thermal imaging, require a more detailed assessment of their civilian and military uses.
The “dual-use dilemma” was first noted with the discovery of the process for synthesizing and mass-producing ammonia, which revolutionized agriculture with modern fertilizers, but also led to the creation of chemical weapons during World War I. With the development of Graphic Process Units (GPUs), products such as game consoles can be classified as dual-use technologies due to the GPU’s ability to process high quality images at high speed, a feature shared with missile guidance systems (real case example – military fears over PlayStation2).
Source: Mercedes-Benz Group AG
The history of proliferation financing
Proliferation financing is not a newly invented term, but it gained more attention in the early 2000s after the September 11 terrorist attack.
In the 20th century, post-Cold War nuclear de-escalation marked a significant shift toward reducing the global nuclear threat, leading to agreements such as the Strategic Arms Reduction Treaty (START) and initiatives such as the Nuclear Non-Proliferation Treaty (NPT) and the establishment of the International Atomic Energy Agency (IAEA), which promote disarmament, prevent proliferation, and ensure the peaceful use of nuclear technology. It is important because if a country illegally develops weapons of mass destruction (WMD), concerns arise about the serious threat to global peace, security and stability, as the development of WMD by one country can trigger arms races or conflicts, destabilize entire regions and undermine these international security frameworks.
A good example is Pakistan and Abdul Qadeer Khan, one of the most controversial figures in nuclear history, hailed in his homeland as the father of Pakistan’s nuclear arsenal. He was also labeled a dangerous renegade and the most notorious proliferator of nuclear weapons after smuggling nuclear technology secrets to “rogue” states such as North Korea, Libya and Iran.
In 2004, the United Nations Security Council adopted Resolution 1540, which requires states to take a number of measures to prevent the proliferation of nuclear, chemical and biological weapons. Subsequently, in 2007, the FATF began to address the threats posed by the financing of proliferation and its links to terrorism and terrorist financing, as proliferation financing in practice often uses the same channels as terrorist financing.
This was reiterated in the UN Security Council’s targeted sanctions resolutions 1718 (2006) and 1737 (2006) against the Democratic People’s Republic of Korea and the Islamic Republic of Iran, respectively. In reality, it is a mixture of terrorist financing and sanctions typologies.
Obligations for FATF members
As of November 2020, FATF member states are required to conduct national PF risk assessments (RAs).
Financial Institutions (FIs) and Designated Non-Financial Businesses and Professionals (DNFBPs) are also required to conduct such assessments at the institutional level in order to “identify, assess and take effective measures to mitigate their risks of money laundering, terrorist financing and proliferation financing”.
In addition, this requirement is reiterated in the FATF’s 2021 Guidance on Proliferation Financing Risk Assessment and Mitigation and will be assessed in the next round of mutual evaluations once the previous round has been completed.
The Conundrum of Proliferation Financing
Proliferation financing presents a complex challenge as countries navigate different political, economic, and security interests. This issue stems from the need to prevent the proliferation of weapons of mass destruction while recognizing that nations vary widely in their approach to international agreements, sanctions enforcement, and financial regulations.
Some countries actively adhere to frameworks such as the Nuclear Non-Proliferation Treaty (NPT), the Chemical Weapons Convention (CWC), and the Biological Weapons Convention (BWC), demonstrating their commitment to global nonproliferation norms. These nations often implement strict financial controls, enforce United Nations Security Council sanctions, and cooperate with international bodies such as the Financial Action Task Force (FATF) to disrupt proliferation financing networks.
Conversely, other states deviate from these obligations. For example, Russia has been accused of violating the CWC through its alleged use of banned chemical agents, such as Novichok, in high-profile poisonings. Russia has also been criticized for providing material or financial support to sanctioned entities, such as supporting North Korea’s nuclear program through illicit trade networks that evade international sanctions. Moreover, Moscow’s arms sales to states with weak export controls, such as Iran, further complicate efforts to curb proliferation financing. Similarly, North Korea continues its nuclear and ballistic missile programs in defiance of international sanctions, often supported by covert financial networks that exploit loopholes in global financial systems. Meanwhile, some states prioritize strategic or economic interests over nonproliferation commitments, allowing for ambiguous enforcement or tacit support of these programs.
This disparity creates a conundrum: global nonproliferation efforts depend on universal compliance, but inconsistent enforcement undermines that framework. Russia’s actions, coupled with similar behavior by other nations, underscore the critical need for greater multilateral cooperation, enhanced financial oversight, and mechanisms to address noncompliance. Closing financial loopholes and maintaining pressure on violators remain critical to reducing the risks of proliferation financing in a fragmented international environment. A good start in addressing this issue would be for countries to prepare a National Risk Assessment on Proliferation Financing (NRA on PF) that considers broader proliferation risks not covered by the updated FATF Recommendation 1, which refers to the risk of WMD proliferation and the risk of proliferation financing.
The role of financial institutions
Financial institutions play a critical role and must implement robust systems to meet the following requirements:
1) Implement effective international sanctions screening systems that collectively target entities involved in the proliferation of weapons of mass destruction (WMD) under United Nations sanctions;
2) perform comprehensive customer due diligence (CDD) to verify the identity and legitimacy of clients, alongside ongoing monitoring to detect suspicious activities;
3) monitor transactions that may indicate financing for the procurement of dual-use items. This could be a challenge arguable if it is the most difficult task for financial institutions to indicate because if the item is used forhas a nomenclature code with both civilian and military applications, the institution needs to understand the trading activities, supply channels and intended use of such goods.
Payment reference field screening could be seen as a potential solution to flag potential transactions involving the procurement of dual-use items. Few of the EU supervisors (Lithuania, Latvia, Estonia) support this measure, but there is no critical research nor feedback from these supervisors as to whether payment reference field screening is indeed an effective mechanism for preventing proliferation financing. this field, which is often included in wire transfers or payment instructions, rarely contains descriptive information about the purpose of the transaction needless to say that no one would voluntarily do so and can reveal such red flags, such as references to controlled or dual-use items (e.g., “precision instruments” or “chemical reagents”), “precision instruments” or “chemical reagents”) that can be used in weapons programs. That is why regulators supporting this measure are going further – requiring more comprehensive disclosure of transaction purposes in the payment reference field;
4) Use adverse media screening and OSINT tools as additional methods of gathering information when customers are suspected of being associated with potential proliferation financing.
How do you assess proliferation financing risk for your company?
Disclaimer: Please note that there is no single approach that will work ideally for every organization, so all will need to create their own frameworks.
While proliferation financing controls encompass a wide range of tools and methodologies, the starting point is always the same – prioritization. Or, in more familiar compliance terminology, a risk-based approach.
A robust risk-based approach that combines assessment and continuous monitoring is essential to mitigate the threat of proliferation financing and sanctions evasion. Any proper assessment begins with customer due diligence (CDD) and enhanced due diligence (EDD) for high-risk customers. The following factors should be considered when analyzing the customer profile:
- transactions involving dual-use goods
- links to high-risk jurisdictions
- unusual payment patterns
- frequent changes in transaction descriptions,
- the use of intermediaries
- attempts to obfuscate beneficial ownership
In terms of sanctions evasion, the following factors should be considered:
- customer uses aliases
- use of shell companies
- use of alternative payment systems.
When considering potential red scenarios and red flags, we highly recommend reading RUSI’s Institutional Proliferation Finance Risk Assessment Guide, which defines examples of factors that could increase risk and provides examples of how to apply a risk-based approach.
| Risk Category | Risk Factors |
|---|---|
| Customer | Private customers: - Residence and nationality of a country sanctioned for proliferation of weapons of mass destruction (e.g., Iran or North Korea) or a country that is not a party to the NPT. - Customer is a Politically Exposed Person (PEP) from a higher risk country, or a customer's activities involve embassies from higher risk countries. - Adverse media associated with cybercrime groups (e.g., Lazarus Group, Anadriel, etc.) Business customers: - Complex ownership structures - Use of international corporate vehicles - Involvement of virtual currency providers - Companies with nominee shareholders - Money services businesses - Manufacturing (e.g., selling dual-use items to high-risk countries) - Agriculture (e.g., purchasing ammonia from a high-risk country) - Research organizations and certain universities (e.g., those involved in nuclear programs) - Suppliers, buyers, and trading partners in the WMD technology/dual-use goods/nuclear/defense industries - Maritime/shipping industries - Shadow banking providers - Money exchange businesses - Embassies and consulates - Corporate service providers and intermediaries |
| Geographic locations | - Jurisdictions known for diversion (e.g., Commonwealth of Independent States used as a diversion point for importing goods into Russia) or a major transit country. - High-risk jurisdictions and third countries (e.g., EU and FATF grey- and blacklisted countries) - Countries subject to sanctions or embargoes; countries identified as lacking adequate AML/CFT laws and regulations - Offshore financial centers and non-cooperative tax jurisdictions - Jurisdictions identified as having significant levels of corruption, organized crime, or other criminal activity - Jurisdictions identified as financing or supporting terrorist activities |
| Products & services | - Open account payments - Letters of credit - Cross-border payments - Correspondent banking - Foreign accounts - Provision of precious metals and stones services - Provision of marine insurance products - Provision of virtual asset trading |
| Delivery channel | - Face-to-face origination - Non-face-to-face origination |
What should be considered a prohibited, restricted, high or medium risk level when assessing geographic PF risks depends on each individual company and its risk appetite framework. However, based on our experience, there are certain risk factors (see table below) that companies should be aware of when structuring their geographic risk matrix and other situations, such as the following:
- a) There is no “one size fits all” approach when it comes to ML/TF and PF geographic risks. For example, there may be countries that are exposed to higher PF risks even though they are neither on the FATF lists nor subject to UN sanctions (take Russia as an example);
- b) It is clear that sanctions should be respected, but does this mean that an individual of Iranian nationality residing in the EU should be prohibited from accessing financial services in the EU? Probably not, but an entity registered in Iran and operating in the EU should receive heightened attention.
| Risk factors |
|---|
| Country is subject to UN sanctions (North Korea and Iran). - Intelligence suggests the country may be considering developing a nuclear capability through illicit procurement. - Country is subject to other sanctions (e.g., China, Syria, Russia, and Pakistan). - Country has a significant corporate/trade network of PF state/ties with sanctioned country/countries. - Country is on the FATF's high-risk country list, gray-list, or the EU's high-risk jurisdictions and high-risk third countries. - Known country of diversion, country with a low level of effectiveness in mutual evaluation reports, including on Immediate Outcome 11 - Geographic proximity to a proliferating country. - Country provides flags of convenience or passports of convenience to higher risk countries. - Country identified by UNPoE/Office of Foreign Assets Control/mainstream media as either trading with sanctioned states or lacking sufficient visibility/transparency on trade patterns. - Country does not respond to UNPoE inquiries. - Country is not a party to the Nuclear Non-Proliferation Treaty and/or country is maintaining or enhancing, or is expected to maintain or enhance, its nuclear capabilities. - Proliferating state has diplomatic presence in country. - Country neighbors a proliferating state. - Country has a large diaspora from a state of proliferation concern. - Country hosts a financial, trade, or transshipment center attractive to proliferation financiers. - The jurisdiction hosts a manufacturing sector that produces goods controlled by international WMD-related supplier regimes and/or their delivery vehicles. - The jurisdiction has weak controls and/or enforcement with respect to ML, TF, and PF. - Country has strong regulatory and enforcement mechanisms recognized by the FATF, and/or is not assessed in any of the risk category reports, and/or is not on the FATF lists. - Country has a robust system of business registration. - Country has conducted a National Risk Assessment (NRA) for ML/TF/PF (note that this is a FATF requirement and may be an indicator of low risk) and has identified and implemented mitigating controls to address high-risk issues identified in the NRA. |
AMLYZE approach
AMLYZE is an advanced anti-financial crime platform designed to address AML/CFT and other CFP-related risks. The platform not only enables a risk-based approach by providing comprehensive risk assessment tools, but also includes robust customer screening and payments screening capabilities such as sanctions and negative media screening. You can also review the capabilities of transaction monitoring and customer risk assessment products as complex tools against proliferation financing.
AMLYZE allows users to upload custom lists of suspicious keywords, including those that identify dual-use items. This feature is particularly useful for meeting compliance requirements in jurisdictions where regulators require payment purpose screening.
Transactions against these lists can be screened using fuzzy matching algorithms designed for effective payment data screening.
We believe that every financial institution should pay close attention to these issues and use technologies that address them to protect against hidden risks and comply with global regulations.
