Europe's Financial Crime Hunters
The EU has created a new agency, AMLA, to track international money laundering. But this is not the region's first attempt to empower supranational detectives.
In a brutal concrete office building in Ljubljana, facing a barren square where Slovenia once declared its independence from Yugoslavia, there is a remarkable international organization that almost no one knows exists.1 Its name is ACER, and it was set up by the EU in the early 2010s to regulate Europe’s energy markets. This sounds very boring. And, indeed, ACER does perform a lot of mind-numbing tasks, like issuing guidelines on the interoperability of gas transmission pipelines.2 But ACER is not your average EU agency. Nor, for that matter, is there another international organization on Earth quite like it. Because in addition to the standard fare of writing rules and hosting meetings, ACER’s staff are also supranational detectives.
For much of modern history, state-owned utility companies held monopolies on the production of electricity and gas.3 Energy was considered an essential element of public infrastructure, one that should be closely overseen, if not directly controlled, by governments.4 This all changed in the 1980s. Energy was “liberalized” during this period, with state monopolies giving way to competitive markets which promised to lower costs for consumers. The basic theory is that private markets will encourage suppliers to compete on price and facilitate a more efficient distribution of energy to where it’s most needed.5 Liberalization is also supposed to encourage long-term investment in energy production to ensure there is always enough power for hospitals and other important needs. These claims are hotly debated.6
What we can say for certain is that liberalization created new opportunities to engage in financial crime. One example is withholding, in which energy producers artificially suppress supply to drive up prices. In the early 2000s, Enron colluded with various power plants to do just that. “We want you guys to get a little creative,” one Enron trader said to a Las Vegas plant operator in an infamous audio recording, “and come up with a reason to go down.” Enron’s actions would contribute to rolling blackouts across California, setting in motion a bizarre series of events leading to the election of Arnold Schwarzenegger as governor.
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Such schemes are possible because liberalization facilitated the creation of financial markets for energy. The primary function of energy markets is to facilitate the trading of actual electricity and gas. But there is also a secondary market for trading financial contracts related to these products. These are meant to help companies hedge against risk. Imagine, for example, that you run a factory which manufactures high-precision jig grinders. Electricity is one of your key costs, and any sudden increase in that cost would put pressure on your profit margins. One solution is to enter into an agreement with a supplier (or, more likely, a reseller) to obtain a certain amount of electricity at a fixed price in the future. This is a “futures contract,” which can be traded on the open market like a stock.
Some of these contracts are traded to facilitate the actual delivery of energy. But the vast majority is simply speculation — side bets on changes in the price of electricity and gas. These speculators have no interest in receiving real energy.7 They close out the contracts before delivery, usually through a cash settlement. By 1998, more than 98% of futures positions closed this way.8 Put simply, the market for gambling on energy prices is much bigger than the market for energy itself.
This creates lots of fun criminal opportunities. One could, for instance, spread false rumors of a fire at a coal plant to manipulate the price of futures contracts on thermal power. Another approach is to manipulate indices. Most of us have heard of one index: the S&P 500. This measures the performance of the 500 largest U.S. stocks, serving as a signal of general market conditions.9 Energy markets have similar types of indices. And, according to regulators, Barclays engaged in loss-making trades to manipulate the price of one such index.10 Why? Because Barclays had side bets that were tied to the index’s price. This is the magic of manipulation. Complex linkages between markets and financial contracts provide endless opportunities to trade one product for the purpose of influencing another.
And those opportunities for manipulation are most enticing when the interlinkages are international.11 New York traders can, for example, manipulate the price of Italian electricity with one hand while using the other to eat gabagool.12 Nowhere is this more true than the EU, which has engaged in a decades-long effort to link together member states’ national markets. But despite the fact that EU energy markets became increasingly international, surveillance of those markets remained constrained to national silos, making it impossible to piece together cross-border schemes to manipulate prices. Enter ACER.
ACER’s Supranational Surveillance
EU states were well aware of this issue when debating the creation of ACER. As I detail in a recent journal article, European Commission staff explicitly discussed how national surveillance was no longer sufficient to track international manipulation.13 Their solution: grant ACER the capacity and mandate to simultaneously surveil energy trading in all 28 member states.14
Here’s how it works. Energy market participants across the EU are required to report transactional data to ACER, thereby creating a consolidated database of European energy market trading.15 In 2022, that was about 4.4 billion transactions.16 ACER then employs algorithmic software to scan that data and generate alerts of potentially suspicious activity.17 When an alert appears, ACER staff conduct a review and, where deemed appropriate, forward their report to relevant national regulators who remain responsible for enforcement.18 Through this process, ACER can draw connections between trading activity in different states that appear innocent in isolation but are, in fact, part of an international criminal scheme.
This might sound like an obvious solution. But make no mistake: granting this power to an international organization is unprecedented.19 There are some international bodies, like the International Atomic Energy Agency, that perform onsite inspections within member states. Others, like Interpol and Europol, coordinate arrests and maintain databases for use by national police agencies.
But what ACER does is different. It is an international organization empowered to directly and continuously surveil the financial transactions of private persons across the EU to identify criminal activity.20 This is not supposed to happen. Political science tells us that states are wary to grant powers to international organizations that lack accountability and may act against their interests. Allowing them to directly monitor the financial transactions of your own citizens? Unthinkable!
Yet that is precisely what is occurring. And now the EU is seeking to address another form of financial crime that refuses to respect borders: money laundering. Like energy manipulation, their proposed solution is to empower a new international organization to exercise supranational detective capabilities. But the precise nature of those capabilities — and their likely effect — are not quite the same.
Europe’s Struggles against International Money Laundering
The EU is the undisputed heavy-weight champion of the world when it comes to issuing rules against money laundering. Some might protest that the US holds the title with the Bank Secrecy Act and its sanctions regime. And, in fairness, the US is certainly the world’s top enforcer. But when it comes to putting pen to paper, there is simply no contest. The crown jewel is the EU’s Anti-Money Laundering Directive, which, like the Fast and the Furious, has gone through various iterations (we are now at AMLD 6: insert your own tagline).21 This is supplemented by hundreds of pages of technical standards and ‘delegated acts’ specifying rules in more detail. There are also rules on information-sharing, high-risk third countries, and, most recently, the obligations of cryptocurrency markets.22 The list goes on.
Together, these rules define the European regime for combatting money laundering and terrorist financing. The basic structure is as follows. Banks and other financial institutions perform frontline defense by conducting due diligence on their clients and monitoring their financial transactions. When they spot something fishy, they are obligated to report those suspicions to national agencies called Financial Intelligence Units. These FIUs subsequently investigate the tips and, where deemed appropriate, forward the information to law enforcement.
But if you work at the Hungarian FIU and receive a tip related to potential criminal activity in Belgium, what do you do? You are supposed to proactively share such information with your Belgian counterparts.23 You are also supposed to promptly respond to any ad-hoc requests for information from other FIUs. The EU has even set up a decentralized computer network to facilitate information-sharing. Its capabilities, however, are limited. Staff of the Hungarian FIU can send prompts to this system to determine if, say, a company they are investigating has also been investigated by the Belgian FIU. But the information is not automatically produced. Rather, the Hungarian FIU still has to follow-up with a request for information.24
Unfortunately, this system is not working. One issue is that FIUs have vastly different budgets. In 2020, for example, the Dutch FIU had almost four times the amount of staff as the Croatian FIU.25 Therefore it should come as no surprise that some FIUs struggle to handle the volume of requests. There are also technical disagreements over, for instance, when exactly a case is ‘relevant’ to another country.26 The result is a system of information-sharing that is inconsistently utilized, painfully slow, and subject to the whims of reciprocity. And even if FIUs do reciprocate, they are limited to what information is reported by private firms, firms that have all kinds of perverse incentives to look the other way.
The EU’s solution, similar to its approach to energy manipulation, is to add a supranational layer of monitoring to the system: the Anti-Money Laundering Authority, or AMLA.
AMLA: The New Frontier
AMLA, whose location has yet to be determined (prediction: Frankfurt), is meant to address the disjointed nature of EU oversight. The Commission summarizes:
All recent major money laundering cases reported in the EU had a cross-border dimension. The detection of these financial movements is however left to the national FIUs and to cooperation among them…These divergences hamper cross-border cooperation, and thereby reduce the capacity to detect money laundering and terrorism financing early and effectively. This results in a fragmented approach that is exposed to misuse for money laundering and terrorist financing and that cannot timely identify trends and typologies at Union level.27
The new agency will focus on the big fish. Among other tasks, AMLA will periodically assess credit institutions (banks) that are established in at least seven member states and meet other criteria.28 It will also assess other types of financial institutions that are established in at least 10 member states.29
When AMLA inevitably finds failures, it has some enforcement options. It can, for example, require the institution to change its procedures or, notably, divest from activities that pose intolerable levels of risk.30 It can also propose the withdrawal of the institution’s license to operate. Then there are the fines. These strike me as quite weak. For some breaches the maximum fine appears to be 1-2 million Euros, likely less than what many of these institutions spend on Christmas parties.31 But for some material breaches, AMLA will be able to cite aggravating factors and impose a fine up to 10% of annual revenue. That’s pretty, pretty…pretty good.
Another striking aspect of the proposal is the limited remit of AMLA to focus on only Europe’s largest institutions. The criteria for which entities qualify are arbitrary. Why seven member states rather than six? Further, these criteria may exclude institutions that have a presence in only a few member states but serve as channels to high-risk countries outside the EU. Nevertheless, it is a starting point. Institutions have a natural tendency to expand their turf and responsibilities over time, and therefore we can expect that AMLA’s scope will widen.
But AMLA is no ACER. Its supranational detective capabilities, while significant, are limited to ad-hoc reviews of large financial institutions. To match ACER, it would have to reach down through the system and directly monitor customer transactions itself to identify suspicious activity. This is the stuff of nightmares for those concerned about privacy and government overreach. But if the history of European energy markets are any guide, it is not impossible.
Paul L. Joskow, Lessons Learned From Electricity Market Liberalization. There was, of course, substantial cross-national variation in how these systems worked.
Natalia Fabra, Massimo Motta, and Martin Peitz summarize the process quite nicely with respect to electricity markets (p. 2):
Even though electricity market design differs across countries, they tend to have one feature in common: everyday, on a day-ahead basis, generators compete to supply their electricity through a centralized auction mechanism. The market operator selects the low bidding suppliers until total demand is met, and pays the winning firms at the market clearing price. This price becomes the reference for all transactions that are taken outside the market, i.e., through bilateral contracts, that typically have a longer duration.
Stoft, Belden , Goldman, and Pickle, Primer on Electricity Futures and Other Derivatives (p. 14).
It’s the 500 largest U.S. stocks by market capitalization. Market capitalization is calculated by multiplying the total number of shares by their value. The largest company in the world by market capitalization is currently Apple (a little over three trillion dollars).
At least this is what I would imagine to be most enticing. Actual market manipulators of the world: leave a comment if you disagree (not legal advice).
Example of a derivative available in the US: CME, ITALIAN POWER PEAKLOAD (GME) CALENDAR MONTH FUTURES - CONTRACT SPECS.
They also send monthly statistics to regulators.
Perhaps the closest equivalent is FRONTEX, the EU’s border control agency, which continuously monitors certain areas to identify private persons engaging in illegal immigration.
Primarily legal persons, but still!
Foivi Mouzakiti provides a concise summary of the history of these obligations in Cooperation between Financial Intelligence Units in the European Union: Stuck in the middle between the General Data Protection Regulation and the Police Data Protection Directive.
For more details, see Yana Daudrikh, IV. AML Directive: Problems related to exchange of information between Financial Intelligence Units (p. 28).
See the Commission’s summary of findings on divergence in interpretation of the “relevance” criterion.
Draft Article 12.
Other criteria apply here too, like whether that financial institutions is considered high-risk in at least one member state (see draft Article 13).
Draft Article 20.
Draft Article 21.