Defining illicit financial flows

Illicit financial flows (IFFs) are a massive but often hidden problem. Such financial flows are understood as being cross-border but there is no universally agreed definition regarding what IFFs cover. Nevertheless, there are two main ways to define IFF.

For a summary of the the debates see:

1. lllicit financial flows: Concepts and definition (PDF)
2. Addressing illicit financial flows for anti-corruption at country level

Narrow IFF definition

With the narrow definition, IFFs are understood as ‘the illegal movements of money or capital from one country to another’ – Global Financial Integrity uses this definition. The focus is on illegal activities – those prohibited by law such as corruption, tax fraud, human or drug trafficking, etc. This definition excludes activities that may be legal such as tax avoidance but unethical in nature.

Broad IFF definition

With the broad definition, IFFs include unethical behaviours. For example, UNCTAD and UNDOC define IFFs as ‘financial flows that are illicit in origin, transfer or use, that reflect an exchange of value and that cross country borders’. UN Member States accept this approach, which is used by intergovernmental organisations such as the FACTI Panel. The illicit nature of the transaction refers to the source of the funds, the channels used to transfer value, the economic impact, or the involved actors. If one of these elements of a cross-border value transfer is frowned upon by society according to its laws, regulation or custom, we speak of IFFs.

According to this broad definition, there are four IFF categories:

1. Illicit tax and commercial practices
   Illegal activities such as tax evasion, duty and revenue offences and market manipulation, and legal activities, eg aggressive tax avoidance practices, including the manipulation of transfer pricing and tax treaty shopping.
2. IFFs from illegal markets
   Financial flows emerging from illicit goods and services, eg arms and drugs trafficking, and migrant smuggling.
3. Corruption
   Among others, bribery, embezzlement, abuse of functions, trading in influence, and illicit enrichment as defined by the UN Convention against Corruption.
4. IFFs from exploitation-type activities
   Financial benefits linked to activities such as slavery and exploitation, extortion, trafficking in persons, kidnapping, and the financing of crime and terrorism.

To be considered as IFFs, the financial flows also need to be cross-border. Illicit financial flows within a country’s borders are therefore not considered as IFFs. For example, income from corruption that is spent within the borders of the same country does not count as IFFs, while the same proceeds used to buy property abroad do.

Estimating the scale of IFFs

Because of the hidden nature of IFFs, it is difficult to measure and assess its magnitude, although several organisations have provided estimates.

Global Financial Integrity (GFI) used trade statistics from the International Monetary Fund to calculate trade-related IFFs. It estimated that US$ 1,935 billion were lost in IFFs in 2015 for 148 countries. This is 28.5% of total trade that year and a truly staggering amount.

In 2021, GFI published a follow-up report detailing trade-related IFFs from 134 developing countries for 2009 until 2018. Interestingly, of the 2018 global trade gap of US$ 1,626.9 billion about half – US$ 835 billion – occurred when trading with the 36 so-called advanced economies as identified by the International Monetary Fund, eg USA, UK, Canada, Germany, France, the Netherlands, Singapore, Norway, Hong Kong, and Australia. Overall, around 60% of all IFFs are estimated to be trade-related.

The United Nations Conference on Trade and Development (UNCTAD) is leading a project on measuring trade-related IFFs in 11 African countries. In 2020, UNCTAD estimated that Africa loses about US$ 88.6 billion per year in illicit capital flight.

In June 2022, the 11 pilot countries presented their experience implementing the methodology and findings so far. From 2009 to 2018, an estimated US$ 278 billion of IFFs occurred in Africa related to extractive industries such as oil, gas, and mining. Findings differ greatly from country to country. For example, for South Africa the meeting report mentions that ‘[t]ax non-compliance is shown to have a long history among the top income receivers in South Africa’.

The advocacy group Tax Justice Network estimates the global loss of direct tax revenue across the globe in 2021 to be US$ 312 billion due to tax evasion or aggressive tax avoidance by multinational corporations and wealthy individuals. According to the authors, the UK and its dependent territories is responsible for a third of corporate tax losses while the UK and its dependent territories, the Netherlands, Luxembourg, and Switzerland combined are responsible for half.

Money laundering also plays an important role by hiding, mixing, and disguising illicit proceeds through the international financial system. UNODC estimates the money laundered annually at 2–5% of global GDP, or between US$ 800 billion and 2 trillion. In October 2022, Eurojust – the EU Agency for Criminal Justice Cooperation – published its first ever money laundering report detailing a doubling of cases from 2016 to 2021. The report details different money laundering schemes including the use of ‘banks and law firms, […] to launder criminal proceeds and to reintroduce them into the financial system’, the misuse of cryptocurrencies, gold, expensive cars, and cultural goods amongst others.

IFFs' impact on sustainable development

IFFs are included in target 16:4 of the Sustainable Development Goals (SDG), stating that we shall, ‘[b]y 2030, significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organised crime’.

Countering IFFs is seen as contributing to ‘peaceful and inclusive societies for sustainable development’ and ‘effective, accountable and inclusive institutions’, which is the overarching aim of goal 16. Ending terrorism, trafficking of children, and corruption are other elements contributing to this goal.

IFFs cause broad and far-reaching negative impact. According to the Global Initiative Against Transnational Organized Crime (GI-TOC), illicit activities and their financial flows ‘distort economic and political competition, subvert government institutions, generate conflict and violence, and undermine the integrity of legal and financial systems’. GI-TOC further assesses that out of 169 targets of the Sustainable Development Goals, 23 could be ‘significantly’ hampered by IFFs.

UNCTAD’s 2020 Economic Development in Africa Report divides the negative impact of IFFs on development into:

1. Economic impact
2. Institutional harm
3. Negative influence on environmental sustainability

The report concludes that capital flight can ‘reduce productive investment, impacting institutional capacity to control corruption, weaken institutions with regard to environmental standards and lower financial sector ratings’.

Countries with higher IFFs also typically have ‘lower agricultural productivity’ and ‘lower levels of environmental sustainability’, according to the report. UNCTAD estimates that some African countries with high IFFs spend ‘on average 25% less on health and 58% less on education compared with countries with low IFFs’.

Measures to prevent, detect, and investigate IFFs

Anti-IFF efforts should target not only the countries where IFFs originate but also the transit and destination countries. Depending on the type of actor, different accountability avenues are available – domestically or internationally.

IFF actors are diverse – operating in public, private, and criminal sectors. For example, they may be government officials who transfer the proceeds of procurement fraud abroad, multinational organisations conducting aggressive profit shifting, terrorist groups paying for illicit arms trafficking, and organised crime networks engaged in narcotics or human trafficking.

National measures

Countering IFFs at the origin requires extensive coordination and data sharing among national agencies. UNCTAD notes that it is often necessary to involve a myriad of agencies to track IFFs. These may be, for example, customs and revenue authorities, central banks, trade and finance ministries, national statistics offices, financial intelligence centres, anti-corruption authorities, and the police. Therefore, it is vital to strengthen national-level coordination and collaboration.

National governments should also improve preventative measures such as tax and public administration reforms, governance reforms, capacity building, and technological support to investigate crime and corruption. Open contracting standards, beneficial ownership registries that are freely accessible online, data transparency, and support to critical civil society and media are anti-IFF avenues that can increase accountability.

Transit and destination countries should also aim to implement beneficial ownership registries as well as publicly available property registries. They should also close the loopholes leading to tax avoidance, make sure that financial institutions apply anti-money laundering legislations, and investigate the role of IFF actors.

International measures

When IFF cases emerge, their cross-border nature often requires international cooperation. Mutual legal assistance requests from one country to another can be time-demanding at the same time as speed is often crucial. Joint investigative teams are therefore increasingly common where competent authorities collaborate for a specific time period to facilitate investigations.

To prevent aggressive profit shifting, the EU adopted the EU Directive on public country-by-country reporting in November 2021. This directive requires multinationals with revenue higher than EUR 750 million to report their activities, revenue, and paid taxes.

In 2021, 136 countries entered a deal to establish a 15% global minimum tax rate for multinational companies from 2023. This aims to prevent profit-shifting for tax purposes. The United Nations is also discussing a tax convention for which a proposal was submitted in 2022.

In March 2022, the European Commission also called on member states to ‘immediately repeal any existing investor citizenship schemes’, or so-called ‘golden’ passports and residency permits. The European Commissioner for Justice and Consumers, Didier Reynders, notes that such arrangements ‘[open] the door to corruption, money laundering and tax avoidance’.

Recovering illicit assets and repatriating them to the countries of origin are an essential element to combat IFFs. The Stolen Asset Recovery Initiative (StAR) supports asset recovery processes. StAR has helped freeze or recover over US$ 1 billion in stolen funds. Although significant, the amount recovered remains a drop in the ocean compared to total IFF estimates. Hence, we need more efforts in place to recover stolen funds.

See the 2019 U4 primer on Addressing illicit financial flows for anti-corruption at country level for a more in-depth overview of domestic and international efforts.

The role of enablers

IFFs cannot happen without the involvement of actors based in other countries. Often, the proceeds of illicit activities end in tax havens, secrecy jurisdictions, and countries where the IFF benefactor can access and enjoy the illicit proceeds.

Enablers of IFFs include lawyers, notaries, accountants, trust and company service providers, real estate agents, art auction houses, and the precious stones sectors. Which sectors and professions enable IFFs varies from country to country. National authorities should make a risk-based assessment and adapt their approach accordingly. For example, while USA and the UK may focus on law firms and real estate, Germany and the Netherlands may focus on trusts and casinos, and Belgium on dealers in precious stones based on their national assessments.

The Financial Action Task Force recommends specific anti-money laundering and terrorism financing measures for professions that enable illicit finance, eg:

• Apply anti-money laundering regulations to relevant sectors
• Design internal policies
• Conduct employee screening

Ending anonymity

A significant obstacle to exposing IFFs is the use of anonymous shell companies and secrecy jurisdictions. Tax Justice Network publishes an annual Financial Secrecy Index – ‘a ranking of jurisdictions most complicit in helping individuals to hide their finances from the rule of law’, where USA ranks top in 2022.

The Netherlands is also high on the Financial Secrecy Index at number 12. In November 2021, the Committee on Conduit Companies in the Netherlands published findings on shell company use – or conduit companies. The committee reported a total of 12,400 shell companies in 2019, with assets of around EUR 4500 billion, or five and a half times the size of the entire Dutch economy. On average, these companies only contributed 0,2% of the total tax revenue and directly employed between an estimated 3,000 and 4,000 workers.

The main recommendation to end the use of anonymous shell companies is by creating beneficial ownership registries of legal entities (companies and trusts).

The UK and the EU were the first to establish a beneficial ownership registry, and there are ongoing efforts to develop a global beneficial ownership registry using aggregated data from registries around the world.

The UK government also requires the identification of people who buy land. On 1 August 2022, the UK launched the Register of Overseas Entities which requires ‘anonymous foreign companies owning or seeking to buy UK land to reveal their true owners’.

Several organisations have also proposed to establish a Global Asset Register that would provide information on the relevant wealth and their owners.

In December 2021, the European Commission presented a proposal for a directive to prevent the misuse of shell entities for tax purposes. The proposal aims at ensuring that entities in the European Union (EU) that have no or minimal economic activity are unable to benefit from any tax advantages. If a company is deemed a shell company, it will not be able to access tax relief and the benefits of the tax treaty network of the EU.

The role of civil society and journalists

Civil society and media play an essential role in exposing IFFs – as has happened with the Panama Papers, Paradise Papers, Luanda Leaks, etc. If IFF actors are part of a national government or armed groups, civil society and media often face considerable risk uncovering IFF cases related to them.

Development agencies and countries providing overseas development aid should support civil society and media through capacity-building workshops, and offer financial support and public condemnation against repressive actions including arbitrary arrests and lawsuits.

The role of development agencies

Development agencies also have a role to play, and, unfortunately, development and humanitarian aid are not immune to illicit activities. Corrupt private and public actors can divert aid funds to their private bank accounts, and nepotism can lead to inflated costs and low quality of delivered goods and services.

The World Bank’s 2020 report Elite capture of foreign aid found that on average 7.5% of provided aid ends up in bank accounts in secrecy jurisdictions, most notably Switzerland and Luxembourg – which are both in the top 10 of the 2021 Corporate Tax Haven Index by the Tax Justice Network.

Transparency requirements are essential for development projects as well as accountability mechanisms. These measures should apply to the entire aid supply chain including all subcontractors and financial intermediaries.

At multiple stages of the aid process, donor agencies should consider the risk of IFFs and how their own countries enable such harmful practices.