Buy now pay later in the regulator's sights

Buy now pay later in the regulator's sights

Why Folks like Afterpay and Affirm are now in the AML regulators sights

Technology and Law

Technology and law, will they ever be in synch? Technology moves at light-speed, particularity in Fintech, law, not so much. Almost every month we see new and disruptive technology being released, designed with mass market appeal, rapid uptake by consumers and business, and adoption trends skyrocketing. At the same time, most of our laws around financial services are still decades old, and are based on the traditional banking and finance models.

Uber, while not specifically a Fintech, is a famous example of how disruptive technology outstrips the ability of our legal system to keep pace with technological change. Taxi industries globally had long been regulated, the laws mature and robust, requiring only minor enhancements and updates from year to year. When Uber released its peer to peer platform as a service, it caused enormous disruption. When is a taxi service not a taxi service? And what exactly should the law look like for this new definition? Should it be based on the models of old? Could an update of the legislation support the changes required? Or would a completely new set of regulations be required to define firstly " a platform" and "as a service" and finally the specifics of a ride sharing service. Consideration of disruptive technology as it relates to preparing legislation is long and involved, even before it gets to the stage of bill drafting, let alone actual implementation as law.

Fintech is even more complex. What is a payment service? What is credit? What is defined as a contract? Once upon a time these were well defined terms, understood, and enshrined in law and practice. However, with every passing day the finance world is seeing change that drives us more into the gray, rather than black and white. And when you consider than many pieces of legislation rely on supporting legislation for definitions and precedents the whole thing can become rather messy.

So back to Afterpay and Affirm, and other buy now pay later services. Depending on country of operation, these services will be defined as the provision of credit, or at the least, provision of money transfer services. Both of which are defined services for most countries anti-money laundering laws. This presents a set of challenges in itself, as the pure play for fintech is speed and simplicity for the end consumer, again regardless of whether the consumer is an individual or a business. And real AML compliance is by definition not instant. It is certainly easier when the consumer is an individual, with modern technology allowing us to verify an identity document almost instantly, but the correlation of an legitimate identity document and the person claiming the identity is still to be perfect in terms of instantaneous, regardless of what many of the identity verification tool providers would have you believe. And this is the area that the regulators are now taking a very hard look at. 

Why do Regulators Care?

Why do the regulators care? Money laundering is a big deal. It is the most fundamental facilitator of organised crime, allowing the use of illegally obtained funds to be used in the real world. It's quite difficult to buy a new Ferrari or a house on the beach with a couple of suitcases of foreign currency. Organised crime at any level has a massive negative impact on our society, particularly the most vulnerable among us, which is why the governments of the world have such a focus on any method of reducing the ability of criminal to benefit from their nefarious endeavors. 

Stages of Money Laundering

Money laundering has three stages, Placement, layering, and integration.

Placement is the movement of cash from its source, the source typically being illegal activity. The source is disguised or misrepresented, which is then followed by placing it into circulation through financial institutions, casinos, shops, bureau de change and other businesses, both locally and internationally. 

The next step is layering. 

Layering – The purpose of this stage is to make it more difficult to detect and uncover the laundering activity. It is meant to make the trailing of illegal proceeds difficult for the law enforcement agencies, and typical methods include Cash converted into Monetary Instruments – Once the placement is successful within the financial system by way of a bank or financial institution, the proceeds can then be converted into monetary instruments, and material assets bought with cash and then sold – Assets that are bought through illicit funds can be resold locally or abroad and in such a case the assets become more difficult to trace and thus seize.

And finally we have Integration – This is the movement of previously laundered money into the economy mainly through the banking and money transfer systems to enable said monies appear to be normal business earnings. 

Buy Now Pay Later services provide a mechanism for both Placement and Layering. Electronic Money Laundering, known as Transaction Laundering, is the digital evolution of money laundering and has become one of the biggest challenges facing the Anti-Money Laundering (AML) regime today. Transaction Laundering occurs when an undisclosed business uses an approved merchant’s payment credentials to process payments for another undisclosed store selling unknown products and services. This advanced, merchant-based fraud scheme takes advantage of legitimate payment ecosystems by funneling unknown e-commerce transactions through legitimate merchant accounts. 

This problem is at the heart of the KYC process - Know Your Customer. Buy Know Pay Later services introduce a middle man to the traditional merchant consumer process, ultimately removing aspects of transparency along the way. All merchants need to be identified prior to accessing the service, and consumers need to be identities as they are effectively receiving credit. Credit is used for money laundering by allowing the smaller loan payments to be made with cash from illegal activities, flying under the radar of the cash reporting systems. While most would understand the value of this in large value transactions such as cars and houses, it is not always apparent why this is viable in the sub $1000 purchase category. The answer is scale. Organised crime is just that, well organised. Having hundreds, even thousands of mules involved in money laundering is not uncommon.

And with the ease of access to the Buy Now Pay Later systems, instant credit approval, and lax identity verification's, we just gave criminals a whole new platform as a service. Hence the interest from the AML regulators. 


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