Illustration of how ESG framework bolster banks' AML compliance efforts

Environmental and social crimes like labor displacement, slavery, and deforestation are increasingly viewed as predicate crimes to money laundering activities.  No financial institution wants to be linked to a business that contributes to environmental harm or human rights violations. No wonder a growing share of banks are incorporating environmental, social, and governance (ESG) framework into their anti-money laundering (AML) operations and KYC/CDD practices.

A recent discussion at the ACAMS Europe conference made it clear that ESG initiatives are more than just the latest buzzwords in financial services. ESG is a serious method for financial institutions and businesses to demonstrate they are good corporate citizens. In fact, a poll shared at ACAMS Europe found 70% of FIs have either fully, partially, or are just starting to implement ESG into their CDD process. 

Here’s what FIs need to know to start implementing an ESG framework.

4 key risks of non-ESG compliance

By adopting an ESG framework, FIs deliver transparency to financial investors and proactively address regulatory scrutiny. It’s also an important strategy for FIs to demonstrate their values to their customers and staff.

At the same time, there are serious risks for FIs that don’t implement an ESG framework. These risks include:

  • Risk of shareholder abandonment. If an FI has a client attached to crimes like human trafficking or forced labor in their portfolio, investors could pull their funding. This loss of capital ultimately cuts into the FI’s revenues and makes it more expensive for customers to borrow funds.
  • Risk of public reputation damage. The FI’s public image will be forever tarnished if any of its clients are connected to forced labor or are the subject of adverse media. This threatens the FI’s ability to attract new customers and may result in existing customer abandonment.
  • Risk of talent exodus. It’s not just an FI’s external-facing brand that is damaged. The FI’s internal brand also takes a hit. The FI’s current employees will likely consider switching to another company rather than support an organization connected to serious crimes. It also threatens the FI’s ability to recruit new talent.
  • Risk of falling behind regulatory requirements. At the moment, regulatory requirements on ESG elements for AML aren’t consistent globally. Currently, the European market is leading the push for greater ESG adoption. It therefore makes sense for FIs worldwide to get ahead of regulators by implementing their own frameworks.

How to implement a strong ESG framework for enhanced AML compliance

FIs need to take a deeper look at how it classifies risk in the first place to avoid these outcomes. This means understanding their customers at a granular level and aligning crimes linked to money laundering into their ESG framework. 

Here’s how FIs can implement a strong and effective ESG framework to strengthen their AML compliance efforts.

Make sure bank staff are trained on KYC/CDD

Asking the right question during customer onboarding and during the customer’s lifecycle is a key component of an ESG framework. The purpose of CDD and KYC operations are for bank employees to understand their customers and where their revenues originate. Let’s say a customer’s revenue comes from a part of the world considered risky or its earnings don’t align with similar businesses. These could be warning signs that the organization is linked to money laundering activities. If the risk level is higher than expected, bank staff can consider the ESG risks for the areas where the bank operates. 

Make sure data providers align with ESG priorities

Data providers are a critical part of the KYC/CDD process. But not every data provider makes ESG a priority. For example, environmental crimes like deforestation and pollution are not considered crimes in certain regions. This means providers may not deliver adverse media reports related to environmental crimes because they were not required from that particular country or region. These adverse media blind spots put FIs at risk if the client is linked to a serious ESG offense that gets splashed across the headlines.

Plan for on-site visits to client facilities

The best way to ensure a client isn’t involved in any illegal or unethical practices is to see for yourself. Bank staff can plan to visit a client’s facility personally to inspect how the company operates. Banks can proactively review satellite imagery to see if any widespread deforestation has occurred as part of the client’s operations. From there, banks can ask clients hard questions about their practices and whether they are a high ESG risk.

Focus on Responsible AI

While it’s not a part of the ESG framework, embracing responsible artificial intelligence (AI) is another important step for banks to demonstrate their commitment to being good citizens. Implementing a Responsible AI framework allows banks to ensure they treat all their customers fairly and does not treat some groups unfairly. Responsible AI should also offer explanations for its decision-making to ensure it continuously makes fair decisions.

The EU and UK markets are currently leading the push for greater ESG implementation. This trend will likely spread to other global regions in the coming years. Given that ESG is becoming more a serious consideration for FIs’ KYC/CDD efforts, the best course of action is for FIs to get ahead of the trend and start implementing a framework immediately. After all, it’s better for FIs to demonstrate to investors, customers, and employees how committed they are to ESG responsibilities than to be linked to a scandal later.

If you are looking for a KYC/CDD provider to implement a strong ESG framework, we’d like to help you. Schedule a demo with us today to see how our experts and technology can help demonstrate your commitment to social responsibility.