3. The purification of investment income and potential terrorism financing risks
Depending on the preference of the sharia fund, either the investors themselves or the IFM can have the responsibility to carry out the purification process and hence, the selection of the NPO. In the first mentioned scenario, the investment fund would provide the percentage of earnings to be purified to the investor. Either way, the charitable distribution might pose an inherent risk of TF which would need to be addressed and prevented accordingly, as further elaborated below.
3.1. NPOs exposure to terrorism financing risks
Already in 2014, the relevance to protect NPOs against TF risk have been highlighted by the Financial Action Task Force (FATF)4. Moreover, in November 2023, the FATF also issued their best practices to support countries and professionals in their efforts to protect NPOs from TF abuse5.
In their publication, the FATF has emphasized the importance of NPOs and state that they play an important role by providing support to economies, communities or individuals in need. In fact, this may also lead to the prevention of radicalization which otherwise could lead to terrorism. At the other hand, the FATF has recognized that NPOs are frequently abused for the funding of terrorist groups or extremist in different ways (non-exhaustive):
- The public trust which NPOs enjoy could be exploited by terrorist groups as donators would contribute considerable amount of funds without further considerations. Furthermore, potential exploitation is not limited to donated funds. Human resources, for example, may also be at risk, as they could be utilized for purposes of radicalization and recruitment for terrorist organizations.
- Due to the global nature of some NPOs, including in areas or close to areas which are exposed to terrorist activities, transactions might appear in line with the activity of an NPO, while funds might be misused for financing non-legitimate purpose. NPOs could be abused as legitimate front for a terrorist group or the management could be infiltrated by terrorists, which in turn would be able to make fundraising and -distribution decisions.
As a result, it is pertinent to understand the characteristics and activities of an NPO. The FATF urges to conduct a TF risk assessment and to apply risk-based due diligence measures on charitable organizations. Thus, prior to any donation of purified gains, the NPO receiving the donation has to be examined in regard to their ML/TF risk profile and mitigation measures should be enforced.
Furthermore, in regard to Luxembourg, the recent mutual evaluation report of the FATF6, published in September 2023 subsequent to their on-site inspection, pointed out that Luxembourg must strengthen the understanding of TF across public and private sector stakeholders. Despite Luxembourg’s capacity to identify non-governmental organizations potentially exposed to a higher risk of TF abuse, it was emphasized that the sector’s understanding of TF is still low.
It is by now commonly known that NPOs are increasingly targeted by terrorist organizations to raise funds, either through effective fraud schemes or in some occurrence through indirect exploitation. As a result this might cause professionals to refrain from business relationships or transactions when NPO are involved. However, the so-called de-risking of an entire group of actors undermines the effectiveness of NPOs which are crucial in certain areas of the world. Indeed, it is common that charities operate in high risk areas and undoubtedly in geographic closeness to terrorism treats or in the proximity of areas of conflict the TF risk is stronger. Nevertheless, this does not imply that de-risking should be the immediate course of action. Instead, considerable thought should be given to enhancing the risk assessment and due diligence procedures.
3.2. Prevention of terrorism financing risks when dealing with NPOs
Related to the above mentioned outcome of the FATF on-site inspection, the CSSF has issued Circular 23/842, complementing CSSF Circular 21/782 relating to the implementation of the revised EBA guidelines on customer due diligence and material risk factors. The complementing Circulars focal point was to indicate relevant ML/TF risk factors for NPOs for the professionals ML/TF risk assessment.
From a broad prospective the risk assessment methodology has to include an evaluation of TF risks relevant to NPOs, which would be targeted in framework of the purification process. Both, CSSF Circular 23/842 and the best practices issued by the FATF (as referred to above), provides the professional with sound guidance on typical ML/TF risk factors related to NPOs. These usually focus around the following and should be reflected in the respective procedures of the sharia fund on the selection of NPOs (non-exhaustive):
- type of activity, funding methods and category of beneficiaries,
- governance and legal structure,
- exertion of controls in place,
- size of the organization and location of the activities,
- reputation and adverse media findings
With respect to the geographic ML/TF risk, it should be highlighted that even if located in a low risk jurisdiction, NPOs likely have operations in countries with a high risk of TF. Consequently, the country risk of the NPO should encompass the country of their activity as well.
The questions stated within CSSF Circular 23/842, relating to each of the above criteria listed, should be considered when modifying or enhancing the existing risk assessment methodology, or alternative, to draft a dedicated risk assessment methodology for NPOs. The latter is particularly sensible if you are a professional frequently working with NPOs. In the context of sharia funds, this might often be the case.
The CSSF Circular 23/842 does not describe due diligence measures which are specifically limited to NPOs, however, IFM should take risk-based due diligence measures, focusing on the pillars of the Law of the 12th November 2004 on the fight of ML and TF, as amended. Those bear a beneficial aspect for the due diligence process towards NPOs.
In their risk assessment and application of due diligence measures, professionals should keep in mind that the aim is not to burden NPOs but to establish a comfort level with the relationship, ensuring trust, safety, and adherence to legal and sharia standards.
