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Keywords:

  • blacklist;
  • club organisation;
  • effectiveness;
  • legitimacy;
  • money laundering

Abstract

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

This article uses the case of anti-money laundering regulation to investigate international club organisations’ efforts to secure compliance with their rules. As these rules can hardly claim much legitimacy, one would expect that they are complied with only if the club organisation uses side-payments or coercion. Indeed, the Financial Action Task Force against Money-Laundering (FATF), the international standard setter in that field, has used blacklisting to force non-members into compliance. But although it had greatly improved compliance, the blacklist was suspended again after a short period of time. Why? This article argues that this was due to allegations of the blacklist being illegitimate. The FATF reacted by withdrawing the blacklist and also by engaging in various legitimatory practices, because even club organisations need legitimacy if they want to achieve results. Only if the rules are considered legitimate, will there be actual, and not just formal compliance. Hence this article denies the existence of a dilemma between legitimacy and effectiveness (the conventional view), suggesting that only legitimate rules can be effective.


Introduction

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

In June 2000, the Financial Action Task Force on Money Laundering (FATF), the international standard setter in that field, published a blacklist of countries it deemed “non-cooperative.” In reaction, most of the countries on the list quickly implemented anti-money laundering rules in line with the FATF’s standards, and the blacklist was judged a great success, not only by the FATF itself but also by scholars.1 Surprisingly, however, the FATF soon backed down from using this shaming technique. The blacklist was suspended in November 2002, and it was abandoned altogether in October 2006. This is puzzling: Why did the FATF give up such a successful measure? It has been argued that this was due to the blacklist’s lack of legitimacy. But why should a powerful club organisation like the FATF care so much about its legitimacy for it to wind down its most powerful regulatory instrument?

In Political Science and International Relations (IR), coercive measures are often regarded as a good way of securing compliance because they leave rule-takers little choice but to follow the rules.2 However, the downside of coercion is that it entails high costs. Therefore, regulators seek to legitimise their rules, and thereby secure voluntary compliance. In this light, the FATF must have called off its blacklist – and turned to legitimatory practices instead – out of cost considerations. The present article offers a different explanation. It argues that the main problem with coercive measures, blacklists included, is not their costs, but their limited problem solving effectiveness.3 Coercion is successful at securing formal compliance only. Such formal compliance alone has little effect on the problems that the rules are supposed to solve. The main advantage of legitimation, in comparison, is not just that it is relatively inexpensive, but that it is able to secure actual compliance. Rule-takers are more likely to actually adapt their practices (and not just their laws) to international rules, if they consider these rules legitimate. Only if the rules are actually complied with, and not just on paper, can they be effective. Hence international regulators seek legitimacy in order to enhance the effectiveness of their rules. From this perspective, the FATF could not ignore criticism of its blacklist being illegitimate, as this undermined the organisation’s ability to actually rule out money laundering. This argument turns the conventional wisdom about there being a trade-off between legitimacy and effectiveness on its head: Legitimacy does not reduce, but enhances effectiveness. Coercion, in contrast, is an obstacle rather than an instrument for effective problem solving, at least when it comes to global governance.

The remainder of this article is structured as follows. I begin with an overview of the empirical case, which is then followed by a discussion of why the FATF abandoned the blacklist despite its apparent success. The subsequent section analyses political reactions to the blacklist, showing that the practice was criticised for its lack of legitimacy. Next, I argue that even international club organisations have reasons to care about their legitimacy, as a lack of legitimacy threatens the organisation’s effectiveness. A further empirical section then shows that such considerations may well have brought about FATF’s decision. The final section discusses the very latest developments in the international anti-money laundering regime in the light of the argument developed here.

The fight against money laundering

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

The activity of disguising the illegal origin of money is an old practice. Yet the practice was not considered much of a problem until the 1980s, when the US criminalised money laundering in the context of its “war on drugs.” Aware of the international dimension of money laundering, the US pressured its G-7 partners to join the fight against it. Together, in 1989, they created the organisation that was to coordinate their efforts, the FATF. Officially only a task force, the FATF is effectively an intergovernmental organisation with a small secretariat (now at a record high with 15 members of staff) based in Paris. Its membership was initially very exclusive – restricted to the G-7 countries plus some other OECD members. The organisation’s club character (Drezner 2007) enabled the members to quickly agree on a set of common standards, the “Forty Recommendations,” which served as a benchmark for national anti-money laundering legislation. As recommendations, they are non-binding rules, that is, standards of behavior states can adopt voluntarily. Over the years, these recommendations experienced two revisions, and one add-on: After the 9/11 attacks, the FATF published “Eight Special Recommendations on Terrorist Finance” (later extended to nine). Though money laundering and the finance of terrorism are two rather distinct activities, linking them has given an enormous boost to the issue. The FATF was now engaged in the “war on terror” (Winer & Roule 2002). Today, the “40 + 9 Recommendations” are widely accepted as the international standards against money laundering and the finance of terrorism (Kern 2001; Drezner 2007).

In the early years of its existence FATF successfully focused on its member states’ adoption of the 40 Recommendations (Drezner 2005). However, since the mid-1990s FATF shifted its attention toward non-members, arguing that anti-money laundering could work only if there were no “money laundering havens” (see Hülsse 2008, p. 102). Similar to other regulatory initiatives, the FATF wanted its club rules to become global rules (Black 2008). In the absence of any legal instruments to make non-members follow its rules, FATF relied on soft instruments like “seminar diplomacy” and peer review (Sharman 2008). These efforts were quite successful. By the end of the 1990s, many non-FATF members had voluntarily adopted the 40 recommendations.

And yet, this may be too cozy a view of the international anti-money laundering regime. The relationship between FATF members and non-members is hardly symmetrical (Tranøy 2002). On the one side we have the world’s richest countries led by the global hegemon, the US (Helleiner 1999, 2002; Simmons 2000, 2001; Williams 2001; Naylor 2002). On the other side, there is a heterogeneous group of states, ranging from developing countries to offshore centers, with none of them being anywhere near equal in power to the FATF members. Though legally free to ignore the FATF rules, it may not be very wise for non-members to do so. The fact that they depend on the member countries of the FATF in a number of ways means that turning against them in the realm of money laundering could quickly become disadvantageous in other issue areas. Hence, there surely exists a shadow of hierarchy, which explains why non-member countries comply even in the absence of explicit threats and coercive measures. Yet, voluntary compliance hardly seems the correct label for such rule following behavior.

More importantly, the FATF also made use of direct hierarchical means to enforce non-members’ compliance with its rules. The first such instance occurred in 1996, as a reaction to the Seychelles’“Economic Development Act” which the FATF interpreted as an invitation to money launderers (Simmons 2000, pp. 258–259; 2001, p. 608; Rawlings & Unger 2005, pp. 5–6; Sharman 2006a, pp. 15–16). The FATF invoked its Recommendation 21, asking its members to advise their financial institutions to give heightened attention to any transactions with the country. The pressure worked as the Seychelles eventually backed down. However, this remained the only instance of direct coercion until 1999, when the G-7, and in particular the Clinton administration, frustrated over the lack of progress in the fight against money laundering, pressured the FATF to reconsider this practice (Wechsler 2001; Sharman 2006a,b, 2008). This time, the use of coercion should be more formal and systematic – through the publication of an official blacklist of countries unwilling to comply. After the FATF had laid out the criteria and the procedure of its evaluations, it reviewed 29 jurisdictions, and, in June 2000, published the result, a list of 15 “Non-Cooperative Countries and Territories” (NCCT). After a second round of assessments of 18 other countries, another eight were added to the list. Countermeasures were not imposed on these countries immediately, but the FATF threatened that it would do so, should its conditions not be met. Options ranged from the FATF members releasing financial advisories, as in the Seychelles case, to the restriction or even prohibition of financial transactions with the blacklisted countries (Drezner 2007).

Yet, for the most part the FATF did not have to apply sanctions beyond invoking Recommendation 21, because most of the countries quickly revised their regulatory systems in accordance with FATF standards, and, in consequence, were delisted. Only two on the list, Nauru and Myanmar, actually became the target of economic sanctions (Gardner 2007). Eventually Nauru, and finally even Myanmar gave in. When Myanmar was delisted in October 2006 the FATF was able to declare on its website that “there are no Non-Cooperative Countries and Territories.”4 Within six years the blacklist had apparently secured the compliance of those countries which – until then – were the least willing to participate in the anti-money laundering regime. And it had an indirect effect also, as it enhanced the “pre-emptive compliance” (Sharman 2007, p. 20) of countries not on the list but afraid of ending up there (Doyle 2002; Drezner 2005, 2007; Sharman 2008).

Against this background, FATF’s judgment that “overall the NCCT has proved to be a very useful and efficient tool to improve worldwide implementation of the FATF 40 Recommendations” (FATF 2005a, p. 2) seems warranted. This view was shared by practitioners, such as one law enforcement expert who declared that “the NCCT process has saved at least 10 years of work” (BBC News Online, 2 September 2002). Scholars, too, regard the NCCT list as having greatly increased compliance with anti-money laundering standards (Tranøy 2002; Hägel 2003; Drezner 2005; Sharman 2006a; Gardner 2007; Leong 2007).5 The blacklist is seen as proof that the anti-money laundering regime is voluntary only on paper but de facto based on “coerced standards” (Drezner 2005, p. 850). Even authors who emphasise the regime’s softer aspects concede that the blacklist marks a “crucial turn” (Sharman 2006b, p. 34) or “dramatic change” (Winer 2002, p. 31) in the FATF’s history, as a confrontational tactic replaces the consensual approach of the 1990s. What has started out as a narrative of a friendly regulator making “recommendations” has ended up in a rather conventional power story.

Why the blacklist was suspended

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

Surprisingly, given its success in securing compliance, the NCCT list was suspended in November 2002 (Sharman 2006a,b). The FATF continued to monitor those countries already on the list and updated the list whenever a blacklisted country had made sufficient progress, but it did not review or blacklist any new country. As countries not yet on the list no longer faced the danger of ending up there, the blacklist had lost its edge (Favarel-Garrigues 2003, 2005b; Scherrer 2006). And Myanmar’s removal in October 2006 marked the NCCT initiative’s definite end. But why did FATF give up its most powerful instrument? An answer is difficult to find as the FATF has not given an official explanation nor has the issue attracted much attention from journalists and scholars. Therefore I also draw on explanations given to me in a series of interviews with anti-money laundering officials in the second half of 2003, that is, not long after the FATF’s decision to suspend the blacklist.6

According to a first explanation, the blacklist was called off because it had accomplished its goal (Sharman 2006b). As all countries on the list had implemented anti-money laundering regulations, it was no longer needed. While compelling at first glance, a closer look reveals this explanation’s major weakness: The suspension of the NCCT list truncated an ongoing and unfinished process. At the time, the FATF had only assessed a total of 47 countries, yet others were to follow – and it is quite certain that some of them would have shown up on the blacklist. The mission had not yet been accomplished, so the first explanation fails.

A second explanation holds that the blacklist was suspended for administrative reasons (Sharman 2006b).7 The FATF secretariat, given its small size and budget, was simply unable to cope with the additional workload that came with the NCCT practice. This explanation is unconvincing because it disregards the actors behind the FATF – the world’s richest countries. Considering that the fight against money laundering figured high on these countries’ political agendas, and that until then the blacklist was very successful, is it really plausible that they abandoned the NCCT practice for such mundane reasons? I am skeptical. The members of the FATF could certainly have afforded to strengthen the FATF in terms of staff and other resources, thus enabling the continuation of the NCCT process.

The suspension of the blacklist, following a third interpretation, is an effect of a policy shift in the US. Whereas the Clinton government had been the driving force behind the NCCT process, George W. Bush’s administration was “less interested in multilateral approaches and strong regulatory actions” (Wechsler 2001, p. 55). As a result, support for the FATF decreased. The 9/11 events further weakened US support for the NCCT list, because the list was only about anti-money laundering measures, whereas countering the finance of terrorism was now a US top priority (Gardner 2007; Leong 2007). While I accept that the new principled beliefs in the US administration have influenced the fate of the blacklist, I doubt that this should have resulted in such a radical outcome so quickly, namely the suspension of the FATF’s most successful instrument. Furthermore, the fact that the blacklist does not deal with the finance of terrorism could hardly have been a serious obstacle, as this deficit could have easily been repaired by the FATF members. After all, the events of 9/11 have in general made the US quite willing to apply coercive measures in any terrorism related issue, so why should it want such a measure to be withdrawn in the field of anti-money laundering and terrorism financing?

The fourth and most common explanation points to the role played by the IMF and the World Bank (Favarel-Garrigues 2003; 2005b; Holder 2003; Kremer 2004; Scherrer 2006; Sharman 2006b; Gardner 2007; Tsingou 2007).8 In the late 1990s, the FATF was trying to cooperate more closely with the International Financial Institutions (IFIs), not least because it felt that its own limited resources would no longer allow for an effective fight against money laundering (see above) (Schott 2003).9 However, the IFIs strongly opposed the NCCT practice, which – according to one IMF official – is “against the nature of the Fund” (quoted in Sharman 2006b, p. 156).10 The IMF’s self-understanding was fittingly expressed by another official: “Everything we do is uniform, it’s voluntary, and it’s co-operative” (quoted in BBC News 2002) (see also Reuter & Truman 2004). Hence, there was a clash of philosophies between confrontation and coercion on the one side, and consensus and voluntarism on the other (BBC News 2002).11 As a result, the IFIs made the end of the blacklist a precondition for their engagement. The FATF gave in. On the one hand, this makes for a good explanation of our puzzle: The stronger international organisation could impose its conditions for co-operation on to the weaker one. On the other hand, it suffers from the same problem as the second explanation because it takes the weakness of the FATF as a given. Yet, the G-7 and other OECD countries could also have decided to strengthen the FATF, and thereby make it independent of the IFIs’ willingness to cooperate. This would have cost some extra money, but it would have allowed a well-equipped FATF to continue the NCCT practice. Therefore, it is unlikely that the members of the FATF sacrificed the organisation’s most successful instrument only to safeguard the help of the IFIs. There must be an additional reason for why the FATF gave in to the IFIs’ demands.

Why the blacklist was considered illegitimate

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

The IFIs’ opposition clearly had an influence on the suspension of the blacklist, yet I doubt that this was a purely strategic move to secure greater resources. The more important underlying reason, I suggest, was that the IFIs’ critique of the FATF’s confrontational tactic resonated with similar concerns raised by many other actors, namely the blacklist’s lack of legitimacy. This criticism threatened the entire regime’s effectiveness. This section illustrates the reasons for why the blacklist’s legitimacy was contested, before I explain in the next section why the FATF could not ignore this criticism.

A first argument raised against the FATF’s legitimacy concerns the organisation’s club character. The setting here is fairly typical of global governance, insofar as the FATF seeks to act beyond the area where it can legitimately act (cf. Reus-Smit 2007). The FATF is a club organisation, and yet it wants non-members to follow its club rules (Tsingou 2005; Scherrer 2006; Maurer 2008). This may be acceptable as long as the FATF merely tries to persuade non-members of doing so, that is, when it strives to achieve voluntary compliance. Yet, through the blacklist the FATF has made use of a coercive means, and this has been judged as illegitimate (Kremer 2004), and as “normative imperialism” (Mitsilegas 2003, p. 205). Criticism of this kind has been voiced by various countries, especially (but not exclusively) by those on the NCCT list (Johnson 2001). For example, a representative of Antigua, who was also the deputy chair of the Caribbean Financial Action Task Force (CFATF), stated that the FATF is “the creation of a handful of rich nations” (Sanders 2003) and declared it unacceptable “that a handful of states, however powerful, should usurp the right to dictate standards to the rest of the world under the threat or imposition of sanctions” (quoted in BBC Monitoring Latin America – Political Supplied by BBC Worldwide Monitoring 2003).

According to a second argument, the blacklist is illegitimate because it violates international norms as well as the anti-money laundering regime’s own principles. As to international norms, the NCCT list, and in particular the imposition of economic sanctions on non-cooperative countries, is regarded as a breach of the sovereignty norm. The prime minister of the Cook Islands, for example, argued that it is the sovereign right of his country to develop economic policies as it likes (Johnson 2001; Sharman 2007). In addition, the NCCT practice also violates the major principles of the anti-money laundering regime itself – that participation is voluntary and the recommendations are non-binding (Doyle 2002). And, the politicised practice of blacklisting contradicts the technocratic and apolitical character of the FATF as an expert body (Sharman 2004, pp. 18–22).

A third point concerns the real motives behind the blacklist, suggesting that the FATF actually has a hidden agenda – to rule out tax evasion (Mitsilegas 2003; Scherrer 2006). In fact, this suspicion was nourished by a G-7 statement a few years earlier, in which the potential of anti-money laundering measures for countering tax evasion was pointed out (Helleiner 2002, p. 190). The Caribbean countries in particular, accused the FATF countries of using money laundering as a pretext for fighting tax havens, and more generally for protecting their own financial centers from the competitive pressures from offshore countries. As the then executive director of the CFATF put it: “Caribbean countries feel there is a second agenda (…) to claw back revenues coming to the offshore centers because of their competitiveness” (quoted in Associated Press Worldstream 2000a). The view that a practice can only be legitimate if the subject is sincere about its motives connects with a similar position in the theoretical literature, according to which “honest communication” is an important aspect of legitimacy (Keohane 2002, p. 261).

A fourth criticism takes issue with the procedures of the NCCT process, dismissing them as non-transparent and therefore illegitimate (Unger & Ferwerda 2008, p. 12). Complaints about the lack of transparency of the NCCT process have also been raised by several of the affected jurisdictions, among them the Cayman Islands (PR Newswire 2000) and Liechtenstein. The latter country declared that it “considers the decision of the FATF unreasonable, particularly since FATF’s procedure at no point demonstrated the transparency that could be expected in a process of such gravity”12 (quoted in Associated Press Worldstream 2000b). In fact, that the NCCT process creates the impression of arbitrariness was a concern even inside the FATF (Tsingou 2007). Again, this is a view that can easily be linked to theoretical arguments according to which legitimacy requires transparency (Keohane & Nye 2002; List & Zangl 2003; Raustiala & Slaughter 2002).

The procedures of the NCCT process are also the target of a fifth criticism, as they are not only seen as intransparent but also considered unfair. Only non-FATF members run the risk of being blacklisted, although some FATF members, too, fall short of a full implementation of the 40 Recommendations (Reuter & Truman 2004; Sharman 2006b). More than that, the standards against which countries are assessed in the NCCT process are found to be more demanding than the 40 Recommendations (Kremer 2004, p. 23). If the NCCT process would be fair, several FATF members would also have to be on the blacklist. Moreover, one would find more close allies of FATF members on the list, for example Monaco (Financial Times 2000). In other words, the FATF applies double standards. This criticism has been raised by scholars (Doyle 2002; Levi 2002; Mitsilegas 2003; Kremer 2004; Daepp 2006, see also Rawlings & Unger 2005), the press (The Japan Times 2000), and by the affected countries themselves, among them the Philippines (AFX-Asia 2000), Panama (Latin America Regional Reports: Caribbean & Central America 2000), the Cayman Islands (PR Newswire 2000), and Russia (Favarel-Garrigues 2005a). As the then chairman of the CFATF put it, blacklisting leads to the “perception that the strong nations are poised to strike at the jugular of smaller and poorer nations” (quoted in The Economist 2000; see also BBC Monitoring Latin America – Economic Supplied by BBC Worldwide Monitoring 2000; Associated Press Worldstream 2000a).

All in all, the FATF’s blacklist has widely been criticised for being an illegitimate practice. This, of course, is no confirmation that the FATF suspended the blacklist because of this criticism. Without claiming this to be conclusive proof, the following section develops a plausible argument for why the FATF had good reason to take this crisis of legitimacy very seriously, and to call off the NCCT practice.

Why club organisations seek legitimacy

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

Why should the FATF be impressed by criticism regarding its legitimacy? Or, more generally speaking, why do international club organisations long for legitimacy?13 According to the conventional view, they do so because without legitimacy securing compliance is costly. The argument developed here is that club organisations take allegations of illegitimacy seriously, because only if they are considered legitimate can they achieve actual compliance and thus effective solutions to policy problems.

An international club organisation has three options to secure non-members’ compliance with its rules. It can set material incentives and thus turn the unwilling countries into ones that comply out of self-interest. It can (threaten to) punish them, that is, use coercion. Lastly, it can try to legitimise its rules so that the unwilling countries accept them as a legitimate standard of behavior and comply voluntarily (Hurd 1999; Checkel 2001; Steffek 2003; Reus-Smit 2007). The problem with the first two options is that they might be costly. Hence, the reason for “the commonly observed impulse of the powerful to try to legitimate their power” (Hurd 1999, p. 388) is that they want to reduce the costs of securing compliance (Suchman 1995; Clark 2007b; Reus-Smit 2007; Koppell 2008). Applied to our case, the FATF would have called off the blacklist because it was too costly a strategy. However, such an explanation is reminiscent of the cost explanations referred to above, according to which the FATF suffers from scarce resources and therefore cannot sustain the NCCT practice. Although I conceded that cost considerations might have played a role, I also argued that it is difficult to imagine that this alone made the FATF give up its most successful instrument, given the resources of the FATF members. The same reasoning applies here.

What other reason could there be for the FATF and international club organisations generally to give up coercion as a means of securing compliance, and to rely on a strategy of legitimation instead? The main reason, I claim, is the greater problem solving effectiveness of legitimation as compared with coercion. Crucial for my argument is the distinction between two types or levels of compliance, which is, considerable terminological confusion notwithstanding, quite common in the literature (Mitchell 2001; Börzel & Risse 2002; Raustiala & Slaughter 2002; Risse 2006; Unger & Ferwerda 2008): The first is what I call formal compliance, meaning the adaptation of national laws to international rules, including the creation of the institutions necessary to apply these laws. The second is what I refer to as actual compliance, which is behavioral change so as to conform to the new rules in practice.

Let me first discuss how this distinction relates to coercion: Coercion is good at securing formal compliance, but not at securing actual compliance. As the rule-maker can easily establish whether a rule-addressee has passed laws in accordance with the international rules, the latter has little choice but to formally comply if it wants to avoid punishment. However, it is much more difficult for the rule-maker to find out whether or not – and to what degree – the rule-addressee has really changed its behavior, that is, its actual compliance. Although not impossible, assessments of actual compliance necessitate an encompassing control system which is intricate, expensive, and therefore not a realistic option for most regulators. The double effect is that the rule-maker puts its focus on formal compliance with its rules, while the rule-addressee decouples its behavior, that is, its actual compliance from formal compliance – a process well described by sociological institutionalists (Meyer & Rowan 1991; see Börzel & Risse 2002). The rule-addressee, in other words, formally complies with the international standards, while its actual behavior is not in line with these standards. This explains why the problem solving effectiveness of coercion is low. Coercion does not achieve the behavioral change that is necessary for a specific set of rules to have an impact on the policy problem in question. For rules to become effective, it is necessary that they are complied with in practice, and not just on paper.

The money laundering case confirms this claim, at least with respect to the negative relation between coercion and effectiveness: The NCCT practice is widely regarded as successful, yet the measure of success is basically the formal compliance of blacklisted countries with the FATF rules. Many authors have pointed out that the FATF in general, and its NCCT practice in particular, focuses on “paper compliance” (Biersteker et al. 2008, p. 241) or “compliance in the books” (Unger & Ferwerda 2008, p. 4), hence on what I have termed “formal compliance.” The FATF evaluates if rule-addressees have passed anti-money laundering laws in accordance with the recommendations, and have taken the necessary administrative measures, for example, have created Financial Intelligence Units (FIUs). However, it is much less attentive to the actual compliance with, and the enforcement of, the rules. In the anti-money laundering regime – according to many authors – form is elevated over substance (Simmons 2000; Williams & Baudin-O’Hayon 2002; Harvey 2005; Gardner 2007; Roberge 2007; Tsingou 2007; Biersteker et al. 2008).14 The world of anti-money laundering is one of “mimicry” (Sharman 2008, p. 646) and “Potemkin villages,” where countries are “engaging in cosmetic forms of conformity but doing little to implement their obligations” (Williams & Baudin-O’Hayon 2002, p. 140). Consequently, the NCCT practice “simply results in a ‘window-dressing’ exercise by ‘non-cooperative’ jurisdictions so that their names can be removed from the list” (Leong 2007, p. 152; see also Daepp 2006). It is therefore fair to say that the FATF’s use of coercion has enhanced formal compliance, but not actual compliance. In effect, the NCCT practice did not mitigate the general ineffectiveness of the anti-money laundering regime. It has increased formal compliance with the FATF rules, but it has – according to most observers – done little to reduce, leave alone rule out money laundering (Sica 2002; Doyle 2002; Kremer 2004; Sharman 2008; Reuter & Truman 2004; see also Levi 2008; Naylor 2002).

Having argued that coercion is ineffective, let me now show why legitimation is more effective. Rule-addressees who regard the rules as legitimate can be expected to comply voluntarily. Their compliance will not be limited to window dressing activities as they actually consider sticking to the rules as the right thing to do. Hence legitimation – if successful – achieves actual compliance, and thus is likely to improve the rules’ problem solving effectiveness. Yet, legitimacy reaches even deeper than that. Organisations which command legitimacy “can draw on the active support of other actors who do more than simply comply with their decisions, actively investing their resources and energies in the project that lies behind them” (Reus-Smit 2007, p. 163). This is to say that legitimation secures not just actual compliance but what could be called “proactive compliance,” which is particularly important in dynamic environments where the problem addressed by international rules is constantly changing. If this is the case, the rules tend to lag behind the problem they are supposed to solve. By the time international rules have been implemented on a national level, the problem to which these rules react has already changed so that even actual compliance is largely ineffective. Here, only proactive compliance can help, where rule-addressees orient their behavior not just to the international rules but to the problem itself, anticipating transformations of the problem, and adapting their behavior accordingly. This way they can react to changes before the international regulator can decide on an international response, as a result of which we can expect such proactive compliance to be quite effective.

The anti-money laundering regime operates in such a dynamic environment. Money laundering techniques are constantly changing because money launderers adapt to new anti-money laundering rules and countermeasures (see Levi 2002).15 This makes it difficult for regulators, financial authorities, and law enforcement to rule out money laundering – they can never quite catch up with their adversaries (see Pieth & Aiolfi 2003).16 This difficulty can be mitigated if the relevant authorities of a country believe in the legitimacy of anti-money laundering in general and the FATF rules in particular. In this case, anti-money laundering officials would update their money laundering knowledge continuously, they would try to find out about new techniques, and they would develop suitable countermeasures long before the FATF would ask them to do so.

To sum up the argument so far, the use of blacklists by international club organisations is problematic because they are likely to have a negative effect on the organisation’s legitimacy. The more an organisation’s legitimacy is put in doubt the less it can rely on the rule-takers’ actual, let alone proactive compliance. Countries which feel alienated by the methods of a regulator are much less willing to “invest their resources and energies” (Reus-Smit 2007, p. 163), and therefore the use of coercion damages not just the regulator’s legitimacy but also its effectiveness. Accordingly, we have to interpret the FATF’s suspension of the NCCT list not as an attempt to repair its legitimacy for legitimacy’s sake but as a measure to improve the regime’s effectiveness.

This argument turns a widespread assumption in the (global) governance literature on its head, according to which there is a dilemma between legitimacy and effectiveness (e.g. Dahl 1994; Scharpf 1999; Barnett & Finnemore 2004; Kerwer 2005; Eberlein & Newman 2008).17 Club organisations have a small and homogeneous membership which not only enables a fast and problem-adequate decision-making process, but also increases the chance that members can agree on tough international rules which actually make a difference if complied with. Club organisations, in this understanding, are quite effective but have to pay the prize of limited legitimacy. International organisations with a more universal membership, in contrast, have the advantage of greater legitimacy, yet they tend to produce lowest common denominator rules which make compliance easy but remain ineffective (Raustiala & Slaughter 2002). International regulators and their rules can therefore be either effective or legitimate, but not both.

The money laundering case, however, indicates that regulators might not necessarily face the dilemma of having to choose between legitimacy and effectiveness. The blacklist damaged the FATF’s legitimacy without improving its effectiveness. But does that also mean that enhancing its legitimacy makes the FATF more effective? I have argued above that theoretically there is good reason to assume a positive relationship between legitimacy and effectiveness. However, testing the claim’s empirical validity is beyond the scope of this paper. Measuring the effectiveness of anti-money laundering regulation is always difficult (Reuter & Truman 2004; Sharman 2008), and this is particularly so when it comes to evaluating the effectiveness of a particular measure. Therefore, my ambition in the following section is more modest. I show that FATF engaged in legitimatory practices after having suspended the blacklist, and that it framed these practices as measures for improving the organisation’s effectiveness. This, evidently, says nothing about whether or not these measures actually did improve FATF’s effectiveness. But, important enough, this indicates that FATF – unlike most global governance scholars – does not see legitimacy and effectiveness as mutually exclusive.

Legitimatory practices

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

In the preceding sections I have argued that international club organisations need legitimacy to be effective, and that the FATF’s blacklist damaged the organisation’s legitimacy. Together, this indicates a plausible explanation for why the FATF suspended its blacklist – it threatened the effectiveness of the anti-money laundering regime. But was this really the motivation behind the FATF’s decision? The standard approach in the social sciences to answer this question would be to interview representatives of the FATF and key member states, and ask them why they did what they did. Yet, as indicated above, most of the officials I have interviewed explain the end of the blacklist as the result of the IFIs’ pressure and the need for the FATF to gain greater resources. Is this sufficient evidence to reject my interpretation? I do not think so. This is hardly the place to discuss whether one can establish actors’ true motivations through interviews but there is more than one reason to be skeptical. For example, officials tend to reproduce the official version of their organisation rather than reveal their true motives – they would be bad officials would they to do otherwise. However, there are ways to work around this problem, and one way is to analyse an actor’s practices: What did the FATF do after it had suspended the blacklist? Is there any indication in its actions that confirms my interpretation that the FATF wants to increase its legitimacy? Does the FATF engage in “legitimating processes” (Bernstein & Cashore 2007)? More than that, are there any hints that the FATF regards improved legitimacy as instrumental for its effectiveness? The following analysis shows that the suspension of the blacklist was hardly the only legitimatory measure taken by the FATF at the time. Rather, it was one of several “practices of legitimacy” (Reus-Smit 2007, p. 159), which were carried out with a view toward enhancing the regime’s effectiveness.

A first element in the FATF’s attempt to increase its legitimacy is the expansion of its membership. In the late 1990s, the FATF decided to open up for members outside the OECD-world. However, not just any country could apply for membership, only countries it deemed “strategically important” (FATF 1998, p. 9). While this decision was taken prior to the blacklist induced legitimacy crisis, it was only with that crisis that this more inclusive membership policy was put into practice. Six countries have been awarded FATF membership since (Argentina, Brazil, Mexico, South Africa, Russia, and China), two more are currently on the waiting list (South Korea and India), and the FATF is considering taking up yet more countries. This is justified as a means “to ensure a higher degree of participation and geographical balance” (FATF 2006: Foreword by the FATF President), hence as a legitimatory practice (see also FATF 2008b, p. 5). The membership expansion is said to “engender a greater sense of ownership of the work against money-laundering” (FATF 2006: Foreword by the FATF President), which makes the link between legitimacy and effectiveness. “A sense of ownership” is the prerequisite for what I have called proactive compliance, which is crucial for a regime’s effectiveness in dynamic environments.

The creation of regional anti-money laundering organisations, and the increased cooperation with these regional bodies can be regarded as a second legitimatory practice. While the idea of having FATF-style regional bodies (FSRBs) is almost as old as the FATF itself, early examples such as the Caribbean Financial Action Task Force (CFATF) played but a secondary role in the anti-money laundering regime until the end of the 1990s. This changed with the blacklist/legitimacy crisis, when the FATF initiated the creation of FSRBs in all those regions where they had not yet existed. As a result, four new regional anti-money laundering organisations in the Middle East and North Africa (MENAFATF), Eurasia (EAG), South America (GAFISUD), and West Africa (GIABA) were created.18 These organisations increase the legitimacy of the FATF rules in several ways. They all endorse the FATF’s recommendations, thereby providing them with greater legitimacy in the respective regions. They become regional rather than Western/OECD standards, thus creating a sense of ownership. Also, the members of the different FSRBs carry out mutual evaluations in a manner similar to the members of the FATF, making the peer review process more local, and thus arguably more acceptable than one where, for example, countries of the Caribbean would be evaluated by European countries (see Gardner 2007).

The FATF also intensified its relationship with the regional bodies. Until 2005, the status of an FSRB at the FATF was that of an observer. Now, the FATF grants them the right to apply for associate membership, which gives the FSRBs better access to, and influence on, FATF policies (FATF 2006). Five FSRBs have since met the conditions set by the FATF for acceptance, and have been awarded the new status. The FATF also intensifies cooperation with the FSRBs through various joint initiatives (FATF 2007a, p. 9). There is clear indication that this new policy has a legitimation background.19 FATF refers to “a spirit of inclusion of all our partners” (FATF 2006: Introduction by the FATF Executive Secretary), and hopes that the new status for FSRBs will increase “ownership of FATF strategies” (FATF 2006), which, as suggested above, links legitimation and effectiveness considerations.

The outreach to other international organisations is a third component of the FATF’s legitimation strategy. Linking to organisations which are more widely accepted as legitimate, is a legitimatory practice not uncommon with international regulators (Black 2008). Of particular importance is the FATF’s cooperation with the IMF and the World Bank, already referred to above. It started in 2000 and included the writing of a common methodology. The IFIs – their own legitimacy problems notwithstanding (Barnett & Finnemore 2004) – are universal organisations, and as such have a legitimacy advantage over the exclusive FATF (see Reuter & Truman 2004). Through the collaboration with the IFIs, the FATF hoped to borrow some of their legitimacy. Assessments carried out by the IFIs rather than by the FATF were expected to find greater acceptance in non-FATF countries (Gardner 2007; see also Drezner 2003). In fact, assessments by the IFIs are voluntary, and reviewed countries themselves may decide whether or not they want the resulting report to be published (Reuter & Truman 2004). An important legitimacy effect also derives from the IFIs’ formal endorsement of the FATF’s recommendations in 2002, as this constitutes the FATF standards as the legitimate rules of the IFIs and their member states. Importantly, the FATF did not regard the cooperation with the IFIs simply as a legitimacy enhancing exercise, but as a measure to achieve “the best possible results” (FATF 2004, Annex 1). Hence, there is once more a connection between legitimacy and effectiveness. The same can be shown with respect to the FATF’s relation with the UN. In July 2005, the Security Council passed its Resolution 1617 that urges all UN members to adopt the FATF standards (FATF 2006). This provides the standards with legitimacy, and is, in the words of the FATF, “a major step toward effective global implementation of the Recommendations” (FATF 2006: Foreword by the FATF President; emphasis added). Again, this demonstrates that the FATF sees enhanced legitimacy as instrumental to its effectiveness.

A fourth aspect of the FATF’s legitimation strategy is its growing cooperation with the private sector. Although the banking system plays a key role in (anti-)money laundering, it was largely ignored by the FATF until the mid-1990s, when the FATF initiated the Financial Services Forum (Reinicke 1998; Simmons 2000). However, this forum met only every other year, and the private sector continued to feel marginalised.20 Also, an initiative by 12 major banks – the so-called Wolfsberg Group – of setting their own anti-money laundering standards was largely ignored by the FATF.21 This changed during the 2001–2003 review process of the 40 Recommendations, when the FATF made an effort to include the private sector’s views (FATF 2002a). Since then, the FATF has intensified its contact with the financial industry significantly (Kremer 2004). It now calls the Wolfsberg Group and the International Banking Federation its dialogue partners (FATF 2005b), it commits itself to regular consultation with the private sector (FATF 2006: Introduction by the FATF Executive Secretary), and even talks of a “public-private sector partnership” (FATF 2007a, p. ii). More recently, the outreach to the private sector was declared a top priority (FATF 2007a), and the FATF launched a new forum of consultation (FATF 2007b). Overall, the various measures can be interpreted as efforts to increase the FATF’s legitimacy by allowing for greater participation of a group of actors which, as the FATF now concedes, is “at the front line of the international battle against money laundering” (FATF 2008b, p. 4). As with the other elements of the FATF’s legitimation strategy, this is regarded as a means of making the regime more effective (FATF 2008b).22 The “full participation” of the private sector, the FATF writes in one of its annual reports, “is a precondition to effective measures against money laundering and terrorist financing” (FATF 2006, p. 4; emphasis added).

A fifth aspect of the FATF’s legitimatory efforts is its attempt to become a more transparent organisation. FATF has declared maintaining “high levels of transparency” a central objective of its new mandate (FATF 2008b), and has developed a “growing communications strategy” (FATF 2007a, p. i). “In support of increased transparency” (FATF 2008a, p. 8) the mutual evaluation reports, formerly treated as top-secret documents, are now published on the FATF website, and an overview of the organisation’s annual budget is now included in the annual reports (FATF 2005b). In order to reach a wider public, the FATF has begun to publish e-newsletters (FATF 2007a) and a “Chairman’s Summary” of its plenary sessions (FATF 2008a, p. 16). These public relations measures aim at a greater public acceptance of the FATF by providing information on what the organisation is doing. Again, the so increased legitimacy ultimately serves effectiveness: the FATF “provides the public with useful information to contribute to their efforts to combat money laundering and terrorist financing” (FATF 2007a, p. i).

The preceding reconstruction of legitimatory practices is hardly exhaustive. I have concentrated on measures intended to make the FATF more inclusive. Yet, this is not the only source of legitimacy exploited by the FATF. For example, FATF has recently strengthened its accountability to the ministers of its member states (FATF 2008b). This can be interpreted as a measure to overcome its image of being a technocratic body of experts, and an attempt to be perceived as a democratically legitimised international organisation instead.23 In addition, FATF’s awareness raising measures (Hülsse 2007) and its successive “securitisation” of money laundering (Mitsilegas 2003, p. 195) can be seen as efforts to legitimise its existence. The FATF’s shift into becoming engaged in the “war on terror” by setting standards against the financing of terrorism in October 2001 was – though logically hardly cogent (Roberge 2007; Williams & Baudin-O’Hayon 2002; Mitsilegas 2003; see also Levi 2008) – a brilliant legitimatory move, as no one (in the West) doubted that the fight against terrorism via financial regulation was a legitimate undertaking.

This section has demonstrated that the FATF has actively worked toward increasing its legitimacy, and that it has undertaken these efforts with a view to increasing the FATF’s effectiveness in the fight against money laundering. This, evidently, does not tell us whether or not these practices have actually increased the organisation’s legitimacy and effectiveness. Yet, it does show that legitimation and effectiveness have become central concerns of the FATF, and that it is therefore plausible to argue that the blacklist has been suspended largely out of legitimacy cum effectiveness considerations.

Conclusion

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

The analysis of the money laundering case pointed to the central problem with coercion in global governance. It is hardly able to secure the kind of actual and proactive compliance that is necessary for effective problem solving. Against this background, the suspension of the FATF blacklist is no longer puzzling. It can be seen as a move to regain legitimacy and thus to improve the regime’s effectiveness. On a general level, one can conclude from this case study that coercion is not a “sustainable” mode of governance. Even club organisations need legitimacy, as only then can they secure the compliance “all the way down” which makes rules effective.

Against this background, however, the latest empirical developments must come as a surprise. In October 2007, the FATF publicly expressed its concern about Iran’s insufficient anti-money laundering regulation, and called upon its member states to advise their financial sectors to step up due diligence in transactions with Iran (FATF 2007c). The same procedure was repeated in February 2008 (and confirmed in June 2008) with respect to Uzbekistan and the northern part of Cyprus. On the same occasion, Pakistan, Turkmenistan, and Sao Tome and Principe have also been named, though with no direct consequences, as due diligence has not yet been called for (FATF 2008c). Obviously, this procedure bears resemblance to the earlier NCCT practice. Does this indicate the return to a coercive strategy and a move away from the legitimation efforts described in this article?

Undeniably, the FATF once again employs a coercive measure to secure compliance. However, it has not simply reanimated its older NCCT practice. Instead, the latest use of coercive measures is part of a new, informal approach, which overall is clearly less confrontational than the NCCT practice.24 This approach was initiated as the NCCT practice ran out in 2006 and it basically included two elements. Firstly, the FATF invented a new category of countries, “low capacity countries,” and rather than threatening these countries with coercive measures, the FATF seeks to provide them with the assistance they need to implement anti-money laundering regulation (see FATF 2008d). Secondly, the FATF has created a new working group to deal with “vulnerable jurisdictions that are failing to implement effective AML/CFT systems” (FATF 2008b). While the International Cooperation Review Group (ICRG) can suggest the more coercive measure of public condemnation, this is only the last resort when it fails to secure compliance through dialogue and persuasion (Walker 2007). Hence it stands for a “more collaborative monitoring system (…) designed to engage more closely with vulnerable jurisdictions before condemning them” (Cockayne et al. 2008, p. 75; see also Money Laundering Advisory Committee 2008). That this approach is not a remake of the NCCT list, is also underlined by the language used. The FATF does not refer to the countries in question as “non-cooperative countries and territories.” Instead of publishing NCCT lists, it now merely makes “statements” on individual countries in which it declares its “concern,” but also “welcomes” progress already under way (FATF 2008c). In sum, the present approach is less openly confrontational than the former NCCT practice. The FATF seems to have learnt from its experience with the NCCT initiative that too much pushing may do more harm than good. Whether such benign coercion fits FATF’s quest for legitimacy and effectiveness better, however, remains to be seen.

Acknowledgments

  1. Top of page
  2. Abstract
  3. Introduction
  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References

I am grateful to Dieter Kerwer as well as the editors and the anonymous reviewers of Regulation & Governance for their helpful comments on an earlier version of this text. The empirical research for this article has partly been carried out in the context of the research project “Globalization and the Future of the Nation-State” (Sonderforschungsbereich 536, Deutsche Forschungsgemeinschaft) under the auspices of Edgar Grande.

Notes
  • 1
  • 2
  • 3

    Throughout this article the term effectiveness is used in this sense, that is, it denotes the extent to which a regime is able to solve a specific policy problem (Young 1994; Mitchell 2001).

  • 4
  • 5

    Note, however, that the blacklist’s success in enhancing compliance with the FATF standards does not mean that it was also successful in reducing money laundering. In fact, most observers agree that it has done little to improve the regime’s problem-solving effectiveness (see below).

  • 6

    In total, I have conducted 14 interviews with representatives from the FATF secretariat, from various EU bodies, the Basel Committee on Banking Supervision, the German Ministry of Finance and the Ministry of the Interior, the German Financial Supervisory Authority (BaFin), Germany’s Federal Criminal Police Office (BKA), and with the principal anti-money laundering officers of two major international banks which are also part of the Wolfsberg Group.

  • 7

    Author’s interviews, 13 November 2003, 11 November 2003, 18 November 2003.

  • 8

    Author’s interviews, 4 August 2003, 11 November 2003, 18 November 2003.

  • 9

    This has also been indicated by the then president of the FATF, Claes Norgren (Press conference, Paris, 26 February 2004).

  • 10

    Interestingly, other international organisations have expressed similar concerns with regard to the FATF’s blacklist. The Asian-Pacific Group on Money Laundering spoke of “philosophical difficulties” (quoted in Sharman 2006b, p. 156), the UN Office on Drugs and Crime argued that “culturally, it’s not what we do” (quoted in Sharman 2006b, p. 156).

  • 11

    Author’s interview, 11 November 2003.

  • 12

    See also a speech on the same topic, reproduced on Liechtenstein’s country website (http://www.llv.li/llv-pia-reden-2000.htm?language=1&rid30996; last accessed 2 May 2008).

  • 13

    Discussing the same question with respect to non-state international regulators, Black (2008) argues that such regulators need legitimacy because they do not dispose of hierarchical means to secure compliance.

  • 14

    This view is shared also by practicioners (Author’s interviews, 4 August 2003, 18 September 2003).

  • 15

    This dynamic is also referred to in the FATF’s “Typology Reports,” which describe money laundering as an “evolving activity” (FATF 2002b, p. 1). Similarly, the CFATF states on its website that “money laundering is (…) subject to ever changing techniques” (CFATF 2007).

  • 16

    Author’s interview, 4 August 2003.

  • 17

    Yet, it has also been argued that effectiveness can be a source of legitimacy (Lipset 1960, ch. III), and that such “output-legitimacy” can resolve the governance dilemma (Scharpf 1999).

  • 18

    Actually the GIABA had already been set up in 1999, but due to a number of deficiencies – among them the lack of a permanent secretariat – the FATF had refused to recognise the GIABA as an FSRB until 2006.

  • 19

    See International Enforcement Law Reporter (September 2006).

  • 20

    Author’s interviews, 22 July 2003, 11 November 2003, 26 November 2003.

  • 21

    Author’s interviews, 22 July 2003, 4 August 2003, 10 November 2003, 11 November 2003, 18 November 2003, 26 November 2003.

  • 22

    See also Speech by James Sassoon, President of FATF, 5–6 November 2007.

  • 23

    I thank one of the anonymous reviewers for having alerted me to this point.

  • 24

    Note that the following account is based on very few sources, and should therefore be regarded with some caution. The FATF has – despite its transparency goals – provided hardly any information on the ICRG; moreover, the group has hardly been taken note of in the press and the scholarly literature.

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  2. Abstract
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  4. The fight against money laundering
  5. Why the blacklist was suspended
  6. Why the blacklist was considered illegitimate
  7. Why club organisations seek legitimacy
  8. Legitimatory practices
  9. Conclusion
  10. Acknowledgments
  11. References
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