The Legal Character Of Soft Law - A Critical Analysis Of FATF’s Role In International Anti- Money Laundering Regulation

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THE LEGAL CHARACTER OF SOFT LAW: A CRITICAL

ANALYSIS OF FATF’S ROLE IN INTERNATIONAL ANTI-

MONEY LAUNDERING REGULATION

Pranaya Ramesh, O.P Jindal Global University

ABSTRACT

This paper explores how soft law functions within the international antimoney laundering (AML) framework, with a specific focus on the role of the Financial Action Task Force (FATF). Although FATF’s Recommendations are not legally binding, they have been widely adopted by states, raising questions about whether they function as binding in practice. The paper discusses this tension by comparing two perspectives: one that sees compliance as the result of coercion through tools like blacklisting, and another that highlights voluntary adoption based on legitimacy and global consensus. Drawing on examples and recent commentary, it argues that while some states may initially comply out of fear of reputational or economic harm, the lasting influence of FATF’s standards is better explained by the belief in their legitimacy and the benefits of international cooperation.

The paper concludes that FATF’s soft law model reflects a more complex form of influence—neither entirely voluntary nor wholly coercive, but a mix of both, shaped by evolving global financial norms. The fight against money laundering globally relies on recommendations and guidelines set by organisations like the Financial Action Task Force (“FATF”). Even though these rules aren't legally binding, most countries have adopted them into their own laws. This raises a question: do these rules essentially become binding because so many countries follow them? This essay aims to look closely at whether these recommendations effectively force countries to comply, despite not being official laws and delve into the effectiveness of these soft laws in the global fight against money laundering, examining the implications of widespread adoption for international cooperation and financial integrity.

Given the prevailing understanding that binding international legal rules govern only limited areas of the international financial system. Most of the international rules, guidelines, standards, and other arrangements that govern financial regulation are not of a legally binding nature and are therefore

generally referred to as “international soft law1. ” Article 38 of the Statute of the International Court of Justice2 describes traditional sources of international law. The two most cited sources are treaties and customary law, where the former creates a legally binding rights and obligations in the form of agreements and the latter is based on the state practice and acceptance of legal obligation (opinio juris). The absence of a binding international legal commitment to implement the FATF Recommendations and other international anti-money laundering (AML) standards has taken these standards outside the scope of customary international law and treaties. Nevertheless, more than 200 countries and jurisdictions3 are members of the FATF and claim to have implemented the FATF 40 Recommendations. Many are also undertaking efforts to enhance their AML regimes in line with FATF standards.

It should not be forgotten that several key international and regional bodies have incorporated and reinforced the FATF Recommendations. For instance, the United Nations Conventions against Transnational Organized Crime (Palermo) and Corruption cross-reference and call upon states to use the FATF Standards as guiding principles when establishing AML/CFT regimes. Similarly, the European Union's anti-money laundering directives are substantially aligned with and build upon the FATF's Recommendations for EU member states. Thus, the growing consistency of state practice with FATF suggests that it is possible to have a uniform practice of states without opinion juris, that is general practice of states which does not have as its motive the formation of customary rules of international law.

4 The lack of legal obligation gives regulators and standard setters the flexibility needed to respond quickly to developments in financial markets. 5 It allows them to implement non-binding standards in ways that best fit the specific needs of their jurisdictions. 6 This flexibility ensures that international soft law continues to be an effective tool for reforming international financial regulation. 7

1 Kern Alexander, Rahul Dhumale, and John Eatwell, 'Global Governance of Financial Systems: The

International Regulation of Systemic Risk' (Oxford University Press 2020) 134-154. 2 Statute of the International Court of Justice [1945], available at: https://www.icj-cij.org/en/statute (last visited

9 April 2024).

3 Financial Action Task Force, 'Countries', available at: https://www.fatf-gafi.org/en/countries.html.(last visited 9 April 2024).

4 supra 1.

5 ibid.

6 ibid.

7 ibid.

FATF: An Introduction The Financial Action Task Force (FATF) was launched in 1989 by the G7 Summit held in Paris to combat money laundering associated with international narcotics trade. With 37 member states, along with the European Commission and the Gulf Co-operation Council, and nine associate members, FATF is recognized as a leading international standard-setter in anti-money laundering (AML) and counterterrorist financing (CTF). Additionally, numerous observer organizations, such as the IMF and OECD, contribute to its work. FATF operates through consensus-driven decision-making processes, peer review mechanisms, and engagement with high-risk jurisdictions. Its Plenary, the ultimate decision-making body, approves standards, peer review results, and decisions on high-risk jurisdictions by consensus.

FATF Recommendations guide member states on combating financial crimes, while mutual evaluations assess compliance and highlight shortcomings. In severe cases of non-compliance, FATF can designate jurisdictions as "high-risk8," prompting global action to protect the financial system. Despite its influence, FATF's mandate explicitly states it does not create legal obligations for member states, operating instead on voluntary adherence to its standards, making its recommendations a form of soft law. Non-Compliance and Consequences Despite their legally non-binding nature, the FATF Recommendations are far from toothless9. In addressing non-compliance, FATF employs several measures to encourage adherence to its standards.

One primary mechanism is the publication of public statements identifying jurisdictions with strategic deficiencies in their anti-money laundering and counter-terrorist financing regimes. This can lead to reputational damage for the identified jurisdiction and may result in reduced access to international financial markets. In more severe cases, FATF can call for enhanced due diligence measures by member countries when dealing with transactions involving high-risk jurisdictions10. Additionally, member countries may choose to impose their own sanctions or restrictions on transactions involving identified high-risk jurisdictions. Overall, while FATF does not have the authority to impose direct punishments, its actions can 8 Financial Action Task Force, 'High-Risk and Other Monitored Jurisdictions', available at: https://www. fatfgafi.

org/en/topics/high-risk-and-other-monitored-jurisdictions. html. (last visited 9 April 2024) 9 Christine Jojarth, ‘Money Laundering: Motives, Methods, Impact, and Countermeasures’ in Heinrich-Böll- Stiftung and Regine Schönenberg (eds)Transnational Organized Crime: Analyses of a Global Challenge to Democracy (2013) Transcript Verlag JSTOR accessed 10 Apr 2024.

10 Ibid.

have significant repercussions for countries that do not comply with its standards. Coercion or Voluntariness? At the heart of evaluating whether the widespread global adoption of the Financial Action Task Force's (FATF) anti-money laundering and counter-terrorist financing (AML/CFT) recommendations has rendered these soft laws effectively binding on jurisdictions lies a fundamental debate. On one side are the “coercive” explanations which emphasize the FATF’s blacklisting capabilities as the key to coercing compliance against non-compliant countries. 11 This model depicts the FATF as an enforcer capable of quasi-legislating binding rules.

Conversely, the voluntarist perspective underlines its nature as an intricate network where influence is born in largely voluntary processes of mutual cooperation and benchmarking, leading ultimately to the creation of norms that countries voluntarily comply with due to their perceived legitimacy. 12 Evaluating these competing explanatory models is crucial for assessing whether the FATF's pioneering role has indeed established a new binding international regulatory paradigm, or merely an influential framework encouraging legitimate but still discretionary implementation. The coercive explanation portrays the FATF as a powerful body able to compel state compliance through threat of economic sanctions and financial sector countermeasures against non-co-operative jurisdictions.

Proponents argue the most potent coercive tool is the FATF’s public blacklisting and “call for action” against high-risk countries. 13 The cost of FATF’s countermeasures could therefore include restrictions to access to global financial market, decreased credit ratings, increased costs of borrowing and other concrete and quantifiable negative effects on the non-compliant. In simpler terms, the coercive view suggests that countries follow FATF standards not because they genuinely agree with them, but because they fear the consequences of not complying. These consequences, like harsh penalties or being labelled as high-risk, could seriously harm a country's economy and reputation. So, countries go along with FATF standards mainly to avoid these punishments, even if they don't fully agree with them.

Thus the portrayal of FATF as a “soft law instrument” suggests that the coercive regulator is capable of sanctioning with 11 Aleksi Pursiainen, 'The FATF and Evolution of Counterterrorism Asset Freeze Laws in the Nordic Countries: We Fought the Soft Law and the Soft Law Won' in [Editor(s)], 'International Actors and the Formation of Law' (Oxford University Press 2021).

12 ibid.

13 ibid.

penalties that are as “hard” as any within the sphere of international law14 For instance, when a country has low FATF scores which increases to 5% if it is on the Black List15. Goldbarhst argues that the FATF’s alleged ability to leverage existing international hard laws like UN Security Council Resolutions into framing its standards as legally obligatory, even when no such binding framework truly exists. 16 The involvement of economic power like the U. S. amplifies perceptions of FATF standards as de facto requirements. The explanation of the FATF as a coercive entity makes it susceptible to criticism. Critics may argue that the process by which the organization creates rules lacks democratic legitimacy.

They may also claim that it contributes to increasing the influence of already powerful economies and could punish countries that lack the resources to meet the standards set by wealthier nations. 17 However, contrasting voluntarist perspective challenges several assumptions underlying the coercive model. Heng and McDonagh18 argue that countries seek to comply with the standards, not because of legal obligation or fear of being sanctioned but because they perceive the standards as reflective of the values of the community of which they wish to be accepted members. 19 Skeptics question whether the blacklisting by FATF and the resulting countermeasures actually cause significant economic harm, citing analyses that fail to prove such impacts.

If there are no real punitive costs, why would countries still go through the extensive legislative and regulatory changes required to adopt FATF standards? The voluntarist viewpoint provides a different explanation: countries adopt FATF norms willingly because they believe in their legitimacy as the best practices endorsed by a reputable group of regulatory experts and stakeholders. FATF is not seen as a coercive institution, but rather as a platform that promotes collective agreement and "experimentalist governance20. "

14 ibid.

15 Jonah Anderson and others, ’The Economic Impact of FATF Grey-Listing' (White and Case, 30 Oct 2023) accessed 10 April 2024 16 Goldbarhst D., 'Global Counter-Terrorist Financing and Soft Law: Multi-layered Approaches' (Edward Elgar Publishing 2020).

17 supra, 10.

18 Heng Y-K, and McDonagh K, 'The Other War on Terror Revealed: Global Governmentality and the Financial Action Task Force’s Campaign Against Terrorist Financing' (2008) 10 Global Governance 45.

19 Ibid.

20 supra 10.

This suggests that countries see value in adopting FATF standards even without coercion, viewing them as beneficial guidelines for combating financial crimes. FATF's decision-making processes rely on consensus, while its peer review mechanisms offer chances to enhance standards through iterative feedback. Additionally, it welcomes participation from various states and stakeholders. Through such inclusive structures, FATF norms gain legitimacy by incorporating a wide range of perspectives rather than being dictated by dominant powers. Initially, FATF received criticism for being imperialistic and biased against the “small fish”, it reacted to the criticism by strengthening its methodology for assessing compliance and expanding and diversifying its membership base from the initial sixteen Western members21.

According to the voluntarist model, jurisdictions voluntarily implement FATF standards not because of threats of punishment, but because of "deep persuasion22" an internalized belief that these policies are the most appropriate regulatory norms and should be adopted. FATF is seen as a forum that facilitates shared learning and gradual development of norms, rather than simply issuing rules. This perspective challenges the idea of FATF standards being akin to binding hard laws. Instead, it suggests that while these standards maintain their soft law nature, they gain credibility through the perceived legitimacy of FATF's inclusive working methods, which prioritize inclusivity over coercion. Based on the arguments presented, I would lean towards the voluntary approach in explaining the widespread adoption and influence of the FATF's AML/CFT standards.

While the threat of punitive countermeasures like blacklisting likely played a role initially, the voluntary model rings truer when considering the FATF's collaborative working methods, openness to diverse stakeholders, and focus on developing legitimate best practices through consensus-building. Countries seem driven more by a belief in the legitimacy of the FATF's norms as optimal policies, rather than sheer compliance out of fear of sanctions. The FATF's soft laws derive their efficacy from this perceived legitimacy and bottoms-up embrace, not just

21 supra 9.

22 ibid.

coercive enforcement, reflecting an innovative model of soft law implementation through voluntary adoption of collectively cultivated standards.