Unity Eludes Africa In Fight Against Illicit Financial Outflow: AU Report

Opaque business ownership data, lack of sanctions for offenders pose risks in Ethiopia

African countries remain divided against the African Union-led target of curbing tens of billions of dollars of annual illicit financial outflow on the continent, a new report from the AU reveals. The report also indicates the magnitude and depth of illicit financial outflow has surged substantially in many African countries, including Ethiopia.

The report published this week is the second of its kind from the AU High Level Panel on Illicit Financial Flows, which issued its first report in the series three years after its establishment in 2012.

“A decade after the [first] AU HLP Report, Africa is still divided in its actions against Illicit Financial Flows (IFFs),” reads this week’s report.

The AU estimates that Africa loses around USD 88 billion every year due to IFFs, with commercial activities accounting for two-thirds of the losses. The figure is much higher than the USD 50 million quoted in previous estimates.

“Over the last 10 years Africa’s effort to curb IFFs have yielded mixed results. While significant progress has been achieved in sensitising various stakeholders about the severe negative impacts of IFFs and the need for appropriate legal, policy and institutional responses, there has been limited success in establishing an effective continental coordination platform to consolidate Africa’s responses to these issues,” reads the report.

Ten years on from the first AU HLP report, the continent is still unable to realize a “coherent and coordinated African response to IFFs.

In elucidating the intricacy of IFFs, the AU HLP finds that it is a mix of commercial, criminal and corrupt activities that lead to the loss of nearly USD 90 billion a year.

Commercial activities leading to losses include transfer pricing, trade mispricing, misinvoicing of services and intangibles, unequal contracts, aggressive tax avoidance, and illegal export of foreign exchange, according to the report.

Outright criminal activities, including money laundering, human trafficking and drug trafficking, aggravate the case for African countries. A major facilitator for these two types of IFF is corruption and abuse of office.

The report notes that various factors—global, continental and national—have a bearing on IFFs. For instance, the growing external debt service obligations and the deepening commodity dependence exacerbate capital flight, making Africa more vulnerable to external shocks.

How well the continent responds to the opportunities and the challenges induced by the ongoing geopolitical global shifts depends largely on grasping the nature of these shifts to reduce IFF risks while taking advantage of emerging opportunities, according to the report.

Globalisation, with its increased cross-border financial flows creates avenues for IFFs to thrive, implying that dependence on foreign flows is harmful for African economies, and that domestic financing of investment is preferable, reads the report.

The Panel notes the issues are compounded by institutional shortcomings in African countries, including failure to adopt resolutions like the  Common African Position on Asset Recovery (CAPAR), a lack of inter-agency cooperation within individual countries, poor governmental cooperation between AU member states, and a lack of data availability and qualified manpower.

While Africa’s response to IFFs remains slow, the continent is disproportionately vulnerable to the impacts of the illicit flow, according to the report. It cites weak regulatory capacity, high dependence on extractives, poor regulation of financial institutions, negative perception of the Continent, liberalised capital accounts, and small domestic capital markets, as factors behind the vulnerability.

IFFs negatively impact foreign exchange reserves, inflation, domestic capital mobilisation, interest rates, and most importantly, the availability of resources for investing in productive sectors, the Panel notes.

The prevalence of IFFs in Ethiopia is mentioned in the report.

“Even in countries with stringent banking and foreign exchange controls, such as Namibia, Algeria, Tunisia and Ethiopia, banking regulation standards are insufficient. Backdoor channels between banking and the informal sector, the unchecked role of significant shareholders, the role of Politically Exposed Persons (PEPs) in the boardrooms and shareholding structures, exposure to foreign liabilities, correspondent banking, instant money transfer systems, and enforcement of sanctions are all areas where the banking sector continues to fall short of expectations. Therefore, financial intermediation remains a major enabler of IFFs in the continent,” it reads.

The report does not specify IFF data by country.

While it characterizes banks as major IFF enablers, the report notes that non-banks like microfinance institutions (MFIs), credit cooperatives, and fintech firms are also part of the equation owing to weak regulation.

“Their financial intermediation role is perceived to be limited, and thus they receive less regulatory attention. The close relationship of cooperatives with religious institutions and communal structures could increase their vulnerability to bleeding,” it reads.

The Panel perceives this as a risk in Mali, Senegal, Sudan, and Ethiopia, where “community” organizations could play a role in IFFs.

The report names Ethiopia among the countries where legal loopholes pose serious obstacles when it comes to fighting IFF, but notes that Ethiopia has done a relatively good job in terms of institutional setup and capacity.

The 2015 report recommended the establishment of financial intelligence units, price transferring control systems, beneficial ownership databases for companies and businesspeople, among others as viable methods for fighting IFFs.

Although Ethiopia has established a dedicated financial intelligence unit, gaps remain in other areas. Among them is the glaring absence of a ‘beneficial ownership database’ to keep track of ownership in businesses.

There is also no mechanism to publicly disclose a list of sanctioned companies, businesses, or officials in Ethiopia, or even a functioning sanctioning system at all. As a result, an individual implicated in illicit financial networks has the ability to commit similar crimes again after facing penalties for the initial offense.

The absence of an ownership database, poor communication between government institutions, and the lack of sanction mechanisms are particularly evident in Ethiopia’s mining sector, where a lack of transparency has led to massive capital outflows through the extractive industry.

The report advises African governments to increase and streamline inter-agency cooperation and collaboration, especially in information and data sharing. The Panel calls on governments to widen their focus on anti-money laundering and terrorism financing to include IFFs in the wider commercial sector, which its experts estimate accounts for nearly 70 percent of all IFFs.

Although African countries have made strides in creating institutions to fight IFFs, such as Financial Intelligence Units (FIUs), Transfer Pricing Units (TPUs), Corporate Registration Offices, Beneficial Ownership Databases, financial reporting standards and other compliance processes, there remain significant gaps in effective use of institutions to contain illicit outflows.

Drivers of massive loss of financial resources through tax evasion include natural resource trading contracts, involving exceedingly low unit prices compared to global prices, and sticky extraction contracts, which provide little or no leeway for countries to renegotiate, according to the report.

It highlighted a total of two-dozen recommendations, which were endorsed by AU Assembly Declaration 17 for implementation by African countries. Creating a robust policy, as well as legal and institutional firewalls against IFFs at national level is the main objective of the recommendations.

The report notes surging IFFs come at a time when the continent’s financing needs are growing quickly, estimated at between USD 900 billion and 1.3 trillion each year. Infrastructure needs alone account for up to USD 220 billion a year, while Climate Policy Action 25 estimates that Africa needs an average of USD 230 billion a year for climate adaptation and mitigation purposes.

The continent faces a total financing gap of over USD 400 billion to accelerate structural transformation, provide infrastructure, and ensure basic service for its growing population, according to a recent report from the African Development Bank (AfDB).

Donors are expected to fill part of that gap, but the Panel’s report warns that donor money could come with strings attached that further hamper the fights against IFFs. The report notes that donors are actively lobbying governments to prioritize anti-money laundering and terrorism financing over IFFs, despite what is lost illicitly being considerably higher than what is laundered.

The report notes that this intrusive nature of donor money remains a huge roadblock for Africa’s effort to create an effective and responsive coordinating platform. Its authors stress that stakeholders must ensure that financing agreements provide the required institutional autonomy.

Strengthening African sources of financing development activities, including structures to fight IFFs, will also be crucial, it observes.

IFFs involve not only direct losses of financial resources that could have been invested in crucial development projects, but also represent a huge opportunity cost to the 1.5 billion Africans on the continent, concludes the report.