The Use of “Politically Exposed Persons” in Campaigns

Environmental Governance in the Alternate (Investment) Universe: Knowing Your (Politically Exposed) Customer

By Stephanie Fried, Ph.D., Environmental Defense Fund

This article is an excerpt from the Briefing Paper “Alternative Investments and Secrecy Jurisdictions: Environmental, Social and Governance Issues in the Context of the Financial Crises” (pdf) by Stephanie Fried, Ph.D.


To offset [our] carbon footprint, we are continually planning and implementing environmentally friendly practices… as well as supporting external causes.(1)

-- Website of prominent international law firm and secrecy provider with offices throughout secrecy jurisdictions.

“When you get the property in South Cambodia which will be the next tourist destination, you plow your money in there. Your investor wants to get money out, but he is locked in until the project is completed. If they want to pull out, you can offer them land - which is worthless.”

“Let’s take a rainforest in Cambodia.  You need to chop down trees, and you need $2 million to do that. If you have fund of $100 million, you don’t want that sitting in the bank so you set up a commitment and call structure. The investor commits to provide $20 million. When you’re taking the stumps out of the ground, you ask for the money. The money gets sent, the investor is comfortable.  You have to give the investor an idea of when you will call them.”

 -- Partner in the above prominent international law firm, teaching a training session for hedge fund managers, 2007.

It is well known that illegal logging has played a devastating role in the forests of Cambodia, Indonesia and elsewhere in tropical Southeast Asia and that political elites and armed forces are often involved in such logging. Recent reports by the Center for International Forestry Research (CIFOR) have underscored the intersection between money laundering and various environmental crimes in the forestry sector.(2)

The CIFOR analyses underscore the fact that without bank financing, large-scale forest exploitation projects are simply not commercial feasible, given the cost of machinery, costs of harvest, processing, and transport. Increasingly, however, high-risk forest-based projects which, in countries with significant corruption and governance issues, often involve crimes such as illegal logging and air and water pollution, are now – as a result of relatively recent anti-money laundering statutes - leading to significant legal risks to investors.

In 2003, Indonesia passed landmark legislation making banks and other financial institutions responsible for transactions involving forestry and environmental crimes. The new legislation identifies illegal logging as a “predicate offence” for money laundering, meaning that money laundering charges and strict penalty schedules can now be applied to financial institutions engaged in projects that involve illegal timber harvesting. This approach seeks to prosecute the financial backers of illegal logging.

This section provides a brief overview of anti-money laundering statutes which may be triggered during the financing and implementation of mega-projects which involve the participation of prominent and politically connected individuals. It is important to note that, while the implementation by financial institutions of anti-money laundering (AML) due diligence requirements is often very weak, a focus by environmental and human rights activists on triggers for AML due diligence can result in queries by public authorities and relatively rapid action by financial institutions.(3)

In 1989, the Financial Action Task Force on Money Laundering (FATF) was founded at the G-7 Summit in Paris with a goal of promoting national and international policies to combat money laundering and terrorist financing.  The FATF meets several times per year and consists of legal, financial, law enforcement experts who monitor the status and progress of member countries, investigate money laundering, and promote the creation of appropriate global measures to combat money laundering.

FATF has identified a category of persons of concern, that is, Politically Exposed Persons (PEP). The PEP category is recognized by most governments and jurisdictions which identify Politically Exposed Persons as:

• individuals who are or have been entrusted with prominent public functions, for example current and former heads of state, senior politicians, senior government, judicial, military officials, senior executives of state-owned companies, major political party officials and their close associates and family members.

Regulations around the world now require banks and other financial institutions to “know their customer”, to understand their customer’s investment profile, patterns of transactions, and range of accounts owned. Most countries have adopted or are in process of adopting new Anti-Money Laundering (AML) transparency laws and a risk-based approach, as described in the Anti-Money Laundering Guidance Update issued by the Jersey Financial Services Commission in 2001.(4) Under this framework, financial institutions are obliged to implement customer due diligence proportionally to the risks involved in any given project or transaction.  There is a heightened focus on “Politically Exposed Persons” and “Politically Exposed Companies” with a focus on:

• Risk associated with providing financial and business services to government ministers or officials from countries with widely-known problems of bribery, corruption and financial irregularity;
  
  
• Cases where “those in power illegally amassed large fortunes by looting their country’s funds, diverting international aid payments, disproportionately benefiting from the proceeds of privatizations, or taking bribes in return for arranging favorable decisions, contracts or job appointments”;(5)  
  
  
• Tracking the proceeds of such corruption which are often transferred to other jurisdictions and concealed through companies, trusts or foundations or under the names of relatives or close associates.

Under the new laws, financial services businesses that handle the proceeds of corruption face the risk of severe reputational damage, criminal charges for having assisted in laundering the proceeds of crime, and lawsuits. The new laws mandate that, where it is known or suspected that a business relationship exists with a “politically exposed person,” detailed due diligence is required at outset of the business relationship and on an ongoing basis.  Financial services businesses must also assess which countries are most vulnerable to corruption (use of the Transparency International corruption list is advised) and must be most vigilant where customers are involved in businesses which appear to be vulnerable to corruption.

Under new AML statutes, due diligence should include close scrutiny of any complex structures (companies, trusts, multiple jurisdictions) “bearing in mind that most legitimate political figures would expect their personal affairs to be undertaken in a more than usually open manner rather than the reverse.”(6)  Every effort must be made to establish the source of the wealth, including the economic activity that created the wealth, and to ensure that these are legitimate activities and sources, at beginning of the business relationship and on an on-going basis. It is expected that a financial services company would review, at a senior management or board level, the decision to commence such a business relationship and would regularly review the relationship, developing a profile of expected activity for the business relationship so as to provide a basis for future monitoring. The review would include close scrutiny of any unusual features such as very large transactions, the use of government or central bank accounts, particular demands for secrecy, the use of cash or bearer bonds or other instruments which break an audit trail, the use of small and unknown financial institutions in secrecy jurisdictions, and regular transactions involving sums just below a typical reporting amount.

The Case of United Fibre Systems Pulp and Chip Mills, Indonesia

Around the world increasing evidence is appearing of the use of alternative investment vehicles in infrastructure and mega-project finance.  One example is the recent attempt by a new Hong Kong-based hedge fund to provide substantial financial support for a controversial Indonesian paper and pulp project.

In its July 2007 debut, Abax Global Capital, claimed to be a one billion (U.S.) dollar hedge fund, the largest Asian fund ever launched outside of Japan.(7) Within weeks of its launch, the fund announced plans to invest $225 million in the controversial United Fibre Systems (UFS) pulp mill project in Kalimantan, Indonesia.  United Fibre Systems had been rejected, however, by most public and publicly-listed financial institutions as a result of the likelihood of tremendous environmental damage, illegal logging and climate impacts also leading to considerable financial risk.(8) In addition to environmental concerns, the UFS projects triggered international attention for the involvement of convicted felons, Suharto-era Indonesian generals and former Indonesian first family members – i.e. “politically exposed persons”  -- who appeared likely to generate heightened due diligence requirements under relatively new anti-money laundering laws.

Over the past five years, the troubled company sought finance from a wide range of public and private institutions.  An international coalition of over 100 organizations in close to 30 countries presented detailed environmental and social analyses of proposed UFS operations to the U.S. Treasury Department, European finance ministries, and Indonesian officials. Plans for support for the UFS project from the World Bank Group's Multilateral Investment Guarantee Agency (MIGA) were dropped. The World Bank's Indonesia Country Director announced that there would be no further plans for World Bank Group involvement in the project.  OECD-member export credit agencies, including Austria's OeKB, rejected the project. Deutsche Bank and JP Morgan withdrew support.  The planned entry of a newly-created and apparently highly-capitalized Hong Kong hedge fund into the project set off alarms throughout the conservation and finance communities because of the lack of a coherent methodology for influencing Hong Kong hedge funds and other such international investors in the alternative investment sector in a process of environmental due diligence and upward harmonization of environmental and social standards.

It turned out, however, that there were substantial links between the new hedge fund and major private sector financial institutions.(9) Prime brokers for Abax Global Capital were Merrill Lynch and Goldman Sachs. Morgan Stanley has a significant minority share in the management company. Abax is managed by former representatives of Citadel, DBS, Mellon HBV/Fursa Alternative, Standard Chartered Bank, Allianz Hedge Fund Partners (Allianz Global Investors Kapitalanlagegesellschaft) and Morgan Stanley. Both Morgan Stanley and Goldman Sachs have committed to widespread application of Equator Principles throughout their investment and advisory portfolios. Merrill Lynch has environmental standards. The UFS projects appear to violate the Equator Principles. In September 2007, the Financial Times published an article on Abax and its involvement in the controversial UFS project. The majority of the proposed Abax finance for the controversial Indonesian pulp mill -- $200 million of the proposed $225 million package – was never issued.  As of September 2008, financing for the mill has still not been finalized.


(1) The “environmentally friendly practices” advertised on the website of this company apparently include sponsorship of an essay competition for young environmentalists in the Cayman Islands and an “actively green day” where staff in one offshore domicile were asked to come to work in an environmentally friendly manner. Staff responded by pushing each other in a wheelbarrow and bouncing to work on large rubber balls. Other breakthroughs included the provision of recycling bins, a reduction in the number of phone books, and the use of one “green Christmas card” that all staff signed instead of sending individual cards.
(2) M. Spek, Financing Pulp Mills: An Appraisal of Risk Assessment and Safeguard Procedures, CIFOR, 2005
(3) The case of the controversial United Fibre Systems proposed pulp and wood chip mills in Kalimantan, Indonesia is a case in point. See below.
(4) The notes below are taken from  Jersey Financial Services Commission, “Anti-Money Laundering Guidance Update,” 2001
(5) Jersey Financial Services Commission, “Anti-Money Laundering Guidance Update,” 2001
(6) ibid
(7) Abax launches with demand of over $1 billion, Asianinvestor.net, 9 July 2007
(8) For example, see: Environmental Defense Fund, CAPPA, Walhi KalSel et al, “Memorandum on Environmental, Social, and Financial Risks Associated with the UFS pulp and wood chip mills and the proposed UFS acquisition of the Kiani Kertas mill,”  endorsed by 93 organizations in 27 countries, 2006
(9) United Fiber enters $225 million financing with Abax, Asianinvestor.com, 7/25/07