30 August 2021, the Financial Action Task Force (FATF) released the “Fourth Round of Joint FATF/AFG Mutual Evaluations of Japan”, highlighting the gaps in Japan’s AML regime and areas in need of improvement. The report lauds Japan’s understanding of ML and TF risks and the rigour of her interagency cooperation while urging a ‘joint agency’ coordination.
Japan is bestowed with a ranking near the top of Transparency International PI (Perceptions Index) on account of her commitment to transparency, and a corruption-free system. A formidable economy with political and institutional stability and a “capable and independent judiciary”, Japan’s solid understanding of ML and TF risks has been documented by NRAs published since 2014. In response to the FATF report, Japanese Ministry of Finance has announced a three year action plan that will put in place stricter supervision.
Japan is a global financial hub with one of the most sophisticated systems in the world. Japanese banking sector has been on a steady pace of rise and this position exposes Japan to ML risks from overseas. Increasingly challenged by the competition rising from nearby markets such as China or South Korea, Japanese FIs operating in higher risk regions with insufficient controls primarily face foreign bribery-related risks.
FATF report emphasizes that the JFSA (Japanese Financial Services Agency) has concentrated efforts on the banking and VCEP sectors by adopting AML/CFT guidelines toward a standard for risk apprehension for sectors under its supervision, however a holistic AML/CFT review of the industry is still lacking.
The most significant threat to Japan’s AML efforts is found to be organized crime groups within the country.
The most significant threat to Japan’s AML efforts is found to be organized crime within the country. Criminal groups (referred to as “Boryokudan”) are actively engaged in money laundering (ML), to launder illicit profits of their drug trafficking and gold smuggling activities through a range of businesses. Diagnosing the crime groups to “remain the primary source of ML risks in the country”, the FATF report urges a framework to address key risks; a targeted focus on the ML component of criminal exploits as opposed to investigations limited to predicate offenses, and consistency in policy-enforcement.
While depicted as ‘highly banked’, with more than 98% if the population having bank accounts, the Japanese society intensely uses cash in transactions. The absence of threshold reporting obligations, and authorities being alerted only on suspicious cross-border transfers substantiate cash-based ML risks in Japanese economy. The cash economy is also related to the dangers posed by organized crime groups as Boryokudan members tend to launder their proceeds in cash.
Most Significant Industries at Risk: The Banking sector and VSEPs
With regards to their risk exposure relative to their vulnerabilities, the report ranks Banking sector as the most significant. The scale of Japan’s sophisticated financial system and its overseas presence renders it attractive to criminals. Following the Banking sector are VSEPs, whose popularisation of virtual assets brought with it a heightened risk of cybercrime. The report states that criminal organisations in Japan look out to exploit conveniences offered by virtual assets and singles out the VCEP sector and the developing ecosystem as a high-risk area. The importance paid to the virtual asset providers in the FATF report reflects the increasing concern in greater Asia, most recently evidenced by the stringent crypto currency regulations put in force by South Korea.
Risks posed by virtual transactions had already been assessed in Japan’s 2015 NRA, in the wake of the Mt. Gox hacking incident and virtual assets had been indicated as a high-risk service back in 2016, the year the Act on the Prevention of Transfer of Criminal Proceeds (APTCP) was amended accordingly. Today, the license application process for VCEPs requires an AML/CFT risk assessment, an in-situ evaluation, as well as interrogations done with the managers. Untraceable assets and anonymity-enhancing currencies are considered to pose a escalated risk. The report mentions 19 virtual asset service providers operating in Japan as of March 2019.
Japan is found to be facing a low risk of Terrorism Financing on an international scale, (“minor but present”). FATF report evaluates the threat primarily in relation to the domestic terrorism – the infamous terror group Aum Shinrikyo who perpetrated the sarin gas attacks on Tokyo metro in 1995 – and provides assessment in view of the potential activities of the group’s successor organisations.
Lack of information management with regards to the country’s large and varied NPO sector is found to be a deficiency.
An equally serious yet internationally sourced terrorist financing risk is found in relation to Japan’s NPOs (non-profit organisations). Lack of supervision and information management with regards to the country’s large and varied NPO sector that includes a minimum of 300’000 registered bodies, is found to be a significant deficiency. Abuse by terrorist entities is a close risk for NPOs operating in high threat conflict zones.
While Japan’s governance of the sector is evaluated to be satisfying as far as transparency is concerned, FATF report points out to the sheer lack of TF-related assessments of NPOs and recommends a rather exhaustive list of measures. They include periodical assessments, and mobilisation of sources to identify and categorize the entities with regards to the nature of their operations, against risks of TF abuse. It is also pointed out that collecting and processing key information obtained via the NPOs’ regular contacts with authorities should be processed to construct perspective on TF risks, toward a holistic understanding.
Sanction-related risks by proximity
The factor of proximity comes into play also with regards to sanctions-related risks. Japan’s geographical closeness to the Democratic People’s Republic of Korea (DPRK) and ties of some of her citizens to the DPRK places the country high on the vulnerability scale as far as sanction evasion attempts go. DPRK-related sanctions rank highest among Japan’s national security concerns and the understanding of the sanction regimes in question are found to be satisfactory for large FIs and basic for smaller FIs and Designated Non-Financial Businesses and Professions (DNFBPs). The report designates trade finance, maritime trade, fisheries and insurance as at-risk sectors.
The areas flagged for improvement in Fourth Round of Joint FATF/AFG Mutual Evaluations of Japan cover unusual financing channels, wider risks inherent to the market and the Banking/Finance sector and certain cross-border threats.
Japan’s stability and her lack of political hard power grants the country insulation against several risk factors that other countries face. With the exception of DPRK-related activities, the report’s findings converge on risks from the internal, both in means of organized crime groups’ (Boryokudan’s) ability to exploit the vulnerabilities of the system, and the deficiencies in Banking / Finance sector that prompts a joint-agency body coordination to set AML / CFT policies and activities. FATF’s prescription of a strategic framework emphasizes the needs to assign well-defined roles to every authority as well as allocation of adequate resources to counter main risk factors described in NRAs.