AML and ESG: Enhancing ethics and efficiency

Compliance professionals have long recognised the interconnectedness of risk and compliance. For them, ESG represents a formalisation of what they consider everyday; although a business relationship may be low risk financially, it can carry a high risk from a broader ESG perspective.

As businesses navigate an increasingly complex regulatory environment and issues related to climate change, human rights and social responsibility gain commercial significance. Environmental, Social and Governance (ESG) has emerged as a crucial framework for comprehensive risk and ethics management. 

But given current economic instability, businesses are also tempering ‘doing the right thing’ with commercial imperatives. In this article we argue that integrating ESG and Anti Money Laundering (AML) compliance not only aligns with the growing demands for responsible and sustainable business practices, but also creates substantial and sustainable operational efficiencies.

The growing importance of ESG 

ESG has been labelled as ‘woke’, a passing trend or more specifically, as collated by McKinsey, a distraction from making money, hard to implement, difficult to measure and a mere correlation to positive financial performance, not the cause.

We live in a highly connected world where even a hint of scandal from a supplier or customer has the power to severely taint or even destroy a business. 

But in reality, ESG represents a logical progression from the 2000s concept of corporate social responsibility (CSR). While CSR focused on ‘feel good factors’ such as corporate philanthropy and ethical practices, ESG is an approach for the times. It takes a broader and more measurable approach to all types of risks and responsibilities, allowing businesses to align with customer values, avoid media sagas, deliver sustainable financial results and most importantly, be held accountable.

Whether the promoters or detractors are right is a moot point. We live in a highly connected world where even a hint of scandal from a supplier or customer has the power to severely taint or even destroy a business. Just look at JP Morgan and Jeffrey Epstein. 

The case for AML and ESG

Because of this interconnectivity, a direct line can be drawn between AML and ESG. HLB, a global network of independent advisory and accounting firms eloquently describes the link.

Environmental and AML

Environmental crimes, such as illegal logging, mining, and waste trafficking, generate significant unlawful gains, amounting to approximately $281 billion per year. The Financial Action Task Force (FATF) considers these environmental crimes as predicate offences for money laundering, attracting increased regulatory attention. However, tracking and prosecuting these offences remain challenging due to the blending of legal and illegally-obtained assets across supply chains and difficulties in cross-border enforcement.

Social and AML

The social component of ESG focuses on how companies treat people, encompassing employee rights, human rights, and consumer protection. An area of overlap between ESG and AML is human trafficking, a form of modern-day slavery that generates approximately $150 billion annually. Human trafficking affects nearly 50 million people worldwide and exists in almost every country.

Compliance professionals have long recognised the potential impact on brand and sales when engaging with customers or suppliers who may be low risk financially but carry high risk from a broader ESG perspective.

Governance and AML

In the governance component, the fight against corruption is a common area of overlap between ESG and AML. Corruption, including bribery and embezzlement, significantly impacts our ability to achieve sustainable development goals. Enhancing governance standards and combating corruption are crucial in promoting ethical practices and achieving sustainable outcomes.

AML has been ESG since forever 

Interconnected risk vectors

For compliance professionals, ESG represents a formalisation of what they have intuitively practised throughout their careers. When assessing the risk profiles of customers and evaluating whether to establish business relationships, compliance professionals already consider more than just financial indicators such as sources of wealth or funds. They also take into account additional factors like politically exposed persons (PEPs), sanctions, and adverse media status.

This holistic approach is essential because it acknowledges that risks extend beyond financial aspects alone. Organisations must also consider the potential impact on brand and sales when engaging with customers or suppliers who may be low risk financially but carry high risk from a broader ESG perspective: Jeffrey Epstein, Harvey Weinstein, The Crown Casino, Everton Football Club, Alisher Usmanoz… the list goes on.  

Active protection

By incorporating ESG principles into the assessment of a customer's risk profile, compliance professionals proactively safeguard their organisations. They recognise that their duty extends beyond mere financial due diligence – they must genuinely "Know Your Customer" (KYC) and evaluate how past activities may impact current and future business dealings. 

Taming the time and cost of compliance

A meeting of minds

The integration of AML into ESG compliance represents a strategic alignment of risk mitigation and ethical business practices. By aligning AML and ESG approaches, organisations ensure business relationships meet their ethical standards, contribute to responsible growth, and address the growing demands of stakeholders, including consumers, investors, employees, and the media.

By aligning KYC and ESG, organisations strengthen their risk posture while also allowing for operational efficiencies.

From this perspective, AML and its core component of KYC, becomes an integral component of a company's broader ESG strategy. It provides organisations with a useful framework to evaluate customers' and suppliers’ compliance with ESG principles, thereby enabling the inclusion of non-financial performance indicators within their business strategies.

Strength and efficiencies 

By aligning KYC and ESG, organisations strengthen their risk posture while also allowing for operational efficiencies through three key areas:

1. The sharing of skills, technologies, resources and knowledge. 
2. The creation of a tighter compliance mesh across the organisation, minimising risk exposure points. 
3. Presenting a united front to the market, helping attract like-minded talent, investment and customers. 

Operationalising the AML / ESG alignment

PwC have a comprehensive framework in which to approach the alignment of ESG and KYC. The key strategies include:

Broader information gathering

Beyond traditional KYC factors, businesses should expand their data collection to encompass ESG considerations. This approach enables a more comprehensive assessment of potential risks and ethical concerns associated with customers and suppliers. It also allows for a smoother customer experience by consolidating the number of information collection points.

Timing ESG reviews with KYC/CDD processes

By synchronising ESG reviews with predefined KYC reviews and audits, businesses can ensure a holistic evaluation of all relevant factors. This integration prevents potential gaps in risk assessment and enhances compliance efforts.

Amending acceptable risk criteria 

Acceptable risk parameters should be broadened to include ESG factors. For instance, even if a potential client passes a traditional risk assessment, an updated evaluation considering ESG factors may reveal their involvement as an ultimate beneficial owner (UBO) of an oil company, prompting a different risk profile. Adverse media checks can also uncover high-profile individuals involved in scandals, highlighting the significance of ESG considerations.

Know Your Supplier (KYS)

Businesses must evaluate the compliance and ethical practices of their suppliers. Conducting due diligence on suppliers and their practices mitigates potential risks associated with lax compliance or unethical behaviour.

Technology for the win

As compliance becomes more exacting and transparency more important, human effort alone is not enough. Instead, in both AML and ESG there has been an explosion of technology to help save time, money and effort, but also enhance accuracy.

On the AML side there’s watch lists, screening tools, storage repositories, reporting, transaction monitoring, case management tools and risk scoring. While for ESG it’s about collection, integration, consolidation, interpretation and reporting.

By approaching technology with a broader view of risk, companies can streamline workflows, reduce task duplication, consolidate data systems, prioritise APIs and focus on cross-business risk KPI reporting.

Conclusion

The alignment of AML and ESG represents a logical progression in the corporate responsibility journey. Boards and C-suites who embrace this approach recognise that AML is not merely a regulatory requirement but an opportunity to build trust, ensure ethical business practices, and align with the evolving demands of stakeholders. 

By aligning AML and ESG companies can effectively build a more comprehensive risk and ethics management strategy, fostering resilience, reputation preservation, and value delivery. Moreover, this approach can streamline processes, maximise resources, and create efficiencies that enhance overall business operations.