Freezing of Funds Used for Terrorist Financing (SR III)

259. In 2010 the FIU issued several Directives to reporting entities, including financial and non-financial institutions as well as government departments²⁶ prohibiting these institutions and agencies from conducting transactions with terrorist organisations. The Directives lay out a basic framework for dealing with:

 Terrorists listed under UNSCR 1267;

 Terrorist listed by South Asian Association for Regional Cooperation (“SAARC”), the European Union (EU) and other regional or international inter-governmental organisations”; and

 Terrorists listed by “different foreign jurisdictions”.

260. Section 80 of BAFIA is potentially relevant. As noted in section 2.3 of this report, s 80 empowers the NRB to order licensed financial institutions to freeze accounts. This power is available in the course of investigation or for the purpose of “maintaining the national interests by controlling national or international terrorist activities or organised crimes”. Arguably, this section enables the NRB to issue Directives concerning UNSCR 1267 compliance. However, none have been issued.

Legal Status of FIU AML Directives

261. An important issue is the legal status of the FIU AML Directives. The Directives require reporting entities to do certain things in relation to the UN Security Council Resolutions, including obtaining information necessary for the identification of terrorist by accessing the UN website. These Directives are stated to be issued “in exercise of the power under s 10(3) of ALPA and AML Rule 7(1)”:

 Section 10(3) of ALPA empowers the FIU to issue directions “regarding reporting” and specifically, “reporting of details, statistics, notices and information” pursuant to s 10(1)(a) (which relates to details of threshold or suspicious transactions).

 AML Rule 7(1) provides that the FIU may “for the purpose of controlling the offence”

(and in a way that does not “contradict” the Act) issue Directives in relation to customer identification, suspicious transactions, record keeping, internal controls and “other necessary matters”.

262. Officials stated that “other necessary matters” in relation to AML Rule 7(1) extends to matters relating to compliance with UNSCR 1267. On a plain reading, however, it is likely that a court would read “other necessary matters” as relating to the sorts of matters previously listed, namely preventive AML measures. Further, the power under AML Rule 7 is expressly limited to issuing directives “for the purpose of controlling the offence” (being a reference to the offence of ML)—not the separate purpose of securing compliance with UNSCR 1267.

263. More fundamentally, the FIU cannot confer upon itself via the rule-making power additional powers not contemplated by the governing legislation. Indeed, under ALPA s 46 the power to formulate rules extends only to “the Government of Nepal” (not the FIU) and only for

“implementation of the objectives of this Act”. The objectives of the Act are self-evident from both a reading of the Act, generally, and from its preamble, which indicates that the purpose of

26 Banks, Securities, Casinos, Cooperatives, Money Changers, Money Remitters; and Government entities (Company Registrar; Land Revenue; Customs; Inland Revenue; Transport; Department of Cooperatives; Commerce; Industry;

the Act is “to provide for the prevention of laundering of criminal proceeds”— and therefore not the freezing of terrorist assets.

Implementation of S/Res/1267 List

264. Nepal has no statutory or regulatory mechanism to recognize the consolidated list of entities named by the UNSCR 1267 Committee. There is no act or requirement otherwise that specifically indicates that the list of 1267 entities shall be given effect to under Nepalese law.

In and of itself this may not necessarily defeat the effectiveness of a domestic 1267 mechanism, but Nepal also lacks an effective mechanism to freeze terrorist assets. When asked why Nepal did not have such a mechanism officials from the Ministry of Foreign Affairs indicated only that no 1267 entities operated in Nepal.

Freezing assets under S/Res/1267

265. For the most part, the various FIU AML Directives use the same wording in relation to situations where the institutions become aware of transactions with 1267 terrorists. The Directives vary slightly between them (for instance, some use the word

“freeze” while others use “suspend” transactions) but for the most part they require reporting entities to establish the following structure:

 Reporting entities shall not conduct or cause to conduct any transactions with 1267 listed entities.

 Reporting institutions/agencies shall immediately put in place necessary mechanisms for

“identification and control of the related transaction”.

 If any transaction is found or is evident, the reporting institution shall immediately freeze/suspend such transactions and report it to the FIU as a suspicious transaction.

 Reporting institutions/agencies are required to download information from the UN website in relation to UN listed terrorists.

266. The Directives are unclear on a number of points:

 Reporting entities are not directly required to freeze terrorist assets—the requirement is merely to freeze or suspend “transactions” with 1267 entities;

 It is not clear what institutions must do to implement the requirement to “put in place mechanisms” to identify and control transactions. As noted later in the analysis, the FIU has not issued any guidance note to assist reporting entities to give effect to this requirement.

267. The Directives prohibit “transactions”, or require reporting entities to freeze or suspend

“transactions”. They do not explicitly direct reporting entities to freeze “terrorist assets”—

indeed, there is no definition of “terrorist asset” in the Directives or in ALPA. "Transaction" is defined in ALPA s 2 to mean: “any act or agreement made in order to carry out any economic or business activities and the term also means the purchase, sale, distribution, transfer or investment and possession of any assets.”

268. When asked whether the Directive meant that assets in their possession are to be frozen, banks and other reporting entities were not clear. They indicated that they would not enter into any transactions with listed terrorists, i.e., open any accounts. But for those accounts already open they were very unclear what they would do. Some of them indicated that they would seek advice from the FIU or Police. Others stated that they would seek legal advice.

None indicated that they would immediately freeze the account in its possession as they did not view a bank account with deposited funds as a “transaction” for the purposes of the Directives.

269. Further, transactions involving assets that may be jointly owned or controlled, or controlled only indirectly by designated entities, would not fall under the Directives if one of the transacting parties was not itself a designated entity.

Implementation of S/Res/1373

270. In addition to (purporting to) require the freezing of assets of UNSCR 1267 listed entities, the Directives prohibit more generally “transactions with the terrorist groups, organisation or individuals or any groups, organisations or individuals related to them which are listed as terrorist by SAARC, European Union and other inter-governmental international or regional organisations”. The Directives extend also to “transactions with” entities that are listed as terrorist by another country.

Communication of Listings

271. FIU AML Directives oblige reporting entities to check the UN 1267 list themselves. No government department or Ministry distributes, publishes or otherwise disseminates the 1267 list or its updates to reporting entities. While most banks indicated that they were aware that they should check the UN website to determine who is on the 1267 list, many said that had not done this, and those that had check the site only intermittently—“perhaps once a month”.

272. With respect to terrorists listed by foreign governments or organisations (SAARC, EU and “other intergovernmental, international or regional organisations”) no list is provided to reporting entities. Indeed, organisations qualifying as “other intergovernmental, international or regional organisations” are not identified. Nor do the Directives provide any information on how the identity of a foreign-listed terrorist could be determined.

Guidance to Financial Institutions

273. As noted, the only guidance provided is that contained within the Directives by way of providing the URL address of the 1267 list. Otherwise, the Directives do not assist reporting institutions to identify who the terrorist entities are - no information is provided which directs reporting entities to a list or other information to help them identify individual names. Nor has any guidance been provided concerning matters such as potential identification mismatches, means of addressing unforeseen consequences resulting from freezing action, authorising access to funds, the scope of permitted transactions or the administration of frozen funds generally.

Procedures for delisting or unfreezing

274. Nepal has not developed any processes for considering evidence that may negate the basis for freezing funds or other assets or for reviewing the proprietary of freezing action. It has no domestic listing process, so has no delisting process.

Authorising access to funds

275. Nepal has not developed procedures relating to, or designated any competent authorities with respect to, providing access to frozen funds or other assets to mitigate the consequences of freezing action.

Review of freezing decisions

276. As noted earlier in this report, the Interim Constitution enables a person whose constitutional rights have been infringed to petition the Supreme Court for redress. Article 19 of the constitution affords the “right to acquire, own, sell, dispose of, and otherwise deal with, property.” However, this right is expressly subject to “the public interest”.

Freezing, seizing and confiscation in other contexts

277. None of the powers of confiscation available under Nepal’s laws would enable the confiscation of assets purely on the basis that they would be assets otherwise under the control of a terrorist entity. Even if (i) provisional restraint under s 12(f) of ALPA - which enables the freezing of “assets relating to” ML - enables the freezing of proceeds of predicate conduct (which is far from clear) and (ii) TF, although not criminalised, is nonetheless regarded as constituting predicate conduct (also unclear), reliance upon ALPA to freeze terrorist assets would still require actual proof of the initial financing that funded those assets. Proceeds of crime legislation cannot substitute for a clear and simple freezing mechanism, particularly where, as here, the underlying TF offence is seriously deficient. Furthermore, as discussed in section 2.3 of this report, powers under ALPA to ultimately confiscate frozen assets are clearly limited to proceeds of ML, not proceeds of predicate offending. Capacity to use this power for the purpose of confiscating terrorist assets is negligible. The utility of other restraint and confiscation provisions in other legislation is similarly limited for the simple reason that those provisions relate to proceeds of only specific predicate offences.

278. As noted in section 2.6 of this report, the DRI (responsible for the detection of TF and tracing of proceeds of TF) does not have powers critical to these tasks, most notably the power to engage in communication interceptions. Further, expertise in funds tracing appears to lie within Nepal Police, not the DRI.

279. There are no provisions in any legislation that would enable a court to void actions intended to ensure that proceeds of TF or terrorist assets more generally are unable to be confiscated.

Protection of rights of bona fide third parties

280. As noted above, the only available mechanism is that provided by the writ process enabling a petitioning of the Supreme Court.

Enforcing obligations under SR III

281. Under s 10(1)(e) of ALPA, the FIU has powers to inspect records of a reporting entity.

However, the purpose of this right of inspection is to obtain “information or clarification” about transactions. In light of this, and given that ALPA is not concerned with freezing action under the Security Council resolutions, in context this power of inspection is intended merely to facilitate the FIU’s function of STR analysis.

Additional Elements

282. Nepal has not implemented the measures set out in the best practices paper for SR III.

Nor has Nepal developed procedures to authorise access to frozen funds or other assets.

Effectiveness

283. Despite the lack of a clear legal foundation for the FIU AML Directives, reporting entities are aware of the Directives and regard them as binding. However, compliance levels are unsatisfactory. None of the Banks and other reporting entities subject to these Directives have actually issued any internal policies to implement the Directives. One bank said it had plans to enable 1267 screening of its account holders but had not done so at the time of the on-site visit. Another had initiated (a few months prior to the on-on-site visit) only a manual practice of checking names of foreign account holders against the 1267 and OFAC lists and had plans to purchase World Check, which would then be integrated into its server. Another bank had no capacity to screen any accounts held outside Kathmandu and had no policy in place concerning

screening where this was possible. A fourth (global) bank adhered to a rigorous global policy requiring screening via an IT solution that was administered at a group level from outside Nepal. Entities screened include those on the 1267 list, the OFAC list and a specifically generated PEP list. No funds or assets have been frozen pursuant to UNSCRs 1267 or 1373.

284. Outside the commercial banking sector, awareness is low and institutionalised compliance is non-existent. Securities broking firms, insurance companies and Cooperatives lack policies concerning the freezing of terrorist assets or the capacity to automatically screen client accounts or lists. A merchant banking company suggested to the evaluation team during the on-site visit that the FIU had advised it the Directives did not apply to merchant banking operations. Although disputed by the FIU, this exemplifies uncertainty as to the scope of the regime.

285. Awareness within the money remittance sector appeared higher but, again, compliance is poor. One money remittance agency functioned as an agent for a global bank and so relied upon screening undertaken by that bank. This agency confirmed that, should a name-hit happen to be identified, it would not process the transaction (as opposed to accepting the funds then freezing them). This mirrored advice from certain of the banks that, in the event of a name-hit, an account would not be opened.

286. Further, because the Directives (purport to) prohibit “transactions with [designated entities]” rather than simply effecting a freeze on assets, they prevent licensed institutions from, for example, accepting deposits into entity-related accounts and then freezing those deposits, thereby making them unavailable to the entity or its donor. Enquiries with the private sector established that this is what happens in practice.

287. The NRB has not undertaken any supervisory action with respect to UNSCR 1267 or UNSCR 1373 compliance.

2.4.2 Recommendations and Comments

288. The following is a list of recommendations for Nepal:

 Provide comprehensive statutory provisions and related mechanisms and procedures to implement SRIII, including UNSCR 1267, 1373 and measures to freeze and confiscate terrorist property in other contexts.

 The NRB has apparent authority to issue Directives requiring compliance with UNSCRs 1267 and 1373. At least pending any amendment that might confer similar power upon the FIU, Nepal Rastra Bank Directives should be issued. Rather than precluding

“transactions”, Directives should be expressed in terms that require freezing of assets.

 Nepal should expedite its current plans to roll-out an “e-Network” enabling the FIU to provide up-to-date information as to those entities caught by the Directives and guidance relating to implementation.

 Those entities should, as far as possible, be expressly identified in the Directives, rather than being merely described. At the very least, the Directives should identify those

“other” organisations that are also said to list terrorists and terrorist entities.

 Nepal should consider establishing a domestic listing mechanism and attendant processes to consider de-listing requests and requests for unfreezing.

289. Any proposals for reform of Nepal’s laws governing confiscation should include proposals that enable (i) confiscation of assets frozen pursuant to the UNSCRs, (ii) deployment of powers appropriate to the task of identifying and tracing terrorist assets and (iii) powers to void actions intended to ensure that terrorist assets are unable to be confiscated.

2.4.3 Compliance with Special Recommendation III

RATING SUMMARY OF FACTORS UNDERLYING RATING

SR III NC  Directives aimed at ensuring compliance with the UNSCRs are not binding.

 The directives preclude transactions rather than requiring that assets be frozen.

 Only some of the terrorist entities to which the Directives relate are readily identifiable.

 No guidance to reporting entities with respect to compliance.

 No procedures enabling delisting or unfreezing.

 No procedures enabling access to frozen funds.

 The only mechanism for reviewing freezing decisions or protecting third party interests requires the petitioning of the Supreme Court.

 There are no powers enabling enforcement of Directives.

 No capacity to confiscate frozen assets or to void actions intended to ensure that proceeds of TF or terrorist assetsare unable to be confiscated.

 Inadequate powers to identify and trace terrorist assets. Levels of compliance with the Directives are low.

2.5 The Financial Intelligence Unit and its functions (R.26, 30 & 32)