What is Layering in Anti-Money Laundering?

Definition

Layering in Anti-Money Laundering (AML) refers to the process of conducting a series of complex financial transactions designed to obscure the origin of illicit funds and separate them from their criminal source. It is the second stage in the classic three-stage model of money laundering—placement, layering, and integration. The objective of layering is to make tracing the illegal proceeds as difficult as possible by adding multiple layers of transactions, often involving transfers between various accounts, institutions, jurisdictions, or asset types.

Purpose and Regulatory Basis

Role in AML

Layering is critical in the overall AML framework because it attempts to dismantle the audit trail linking dirty money to its criminal origin. Authorities and compliance officers monitor for layering to prevent criminals from legitimizing illicit proceeds. Effective detection and disruption of layering transactions impede the criminals’ ability to integrate those funds into the legitimate economy.

Why It Matters

Since layering transactions are designed to confuse and complicate financial trails, they pose significant challenges to financial institutions and regulators. Detecting layering enables the disruption of money laundering cycles, thereby supporting anti-crime efforts in areas such as drug trafficking, fraud, terrorism financing, and corruption.

Key Global and National Regulations

• FATF Recommendations: The Financial Action Task Force (FATF) establishes international AML standards requiring member countries to implement robust controls over money laundering phases, including layering, through customer due diligence (CDD), suspicious activity reporting (SAR), and enhanced due diligence (EDD).
• USA PATRIOT Act: This U.S. law mandates financial institutions to identify and monitor complex or suspicious transactions consistent with layering activities and file SARs as necessary.
• EU Anti-Money Laundering Directive (AMLD): The directive imposes obligations on EU financial institutions to detect and prevent layering by requiring rigorous KYC processes and transaction monitoring.

When and How it Applies

Real-World Use Cases

• A criminal deposits illegal cash into a bank (placement).
• The funds are quickly moved through multiple accounts, sometimes across borders or using different financial products such as wire transfers, securities, or cryptocurrencies (layering).
• Finally, the cleansed funds are integrated into the economy via legitimate purchases or investments (integration).

Triggers and Examples

Typical layering triggers might include:

• Unexplained transfers between multiple accounts in different jurisdictions.
• Sudden changes in transaction patterns inconsistent with a customer’s profile.
• Structuring transactions beneath reporting thresholds (smurfing).
• Use of shell companies, trusts, offshore accounts, or innovative financial products like cryptocurrencies to obscure origins.

For example, a money launderer might convert illicit proceeds to casino chips, conduct minimal gambling, then cash out the chips as seemingly legitimate winnings. Alternatively, the funds may be transferred through various international banks and converted into art, real estate, or cryptocurrencies in sequential transactions.

Types or Variants

While layering is broadly the process of transaction layering to disguise illicit origin, some variants or tactics include:

• Structuring: Breaking large sums into smaller transactions to avoid regulatory reporting.
• Cross-border layering: Using international transfers to exploit jurisdictions with weak AML controls.
• Asset conversion layering: Converting cash into different asset classes like gold, luxury goods, real estate, or cryptocurrencies.
• Shell entities and intermediaries: Moving funds through companies or intermediaries that add complexity.

Procedures and Implementation

Steps for Institutions to Comply

To combat layering, financial institutions implement multiple AML systems and controls:

• Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD): Verifying customer identities and continuously monitoring high-risk accounts.
• Transaction Monitoring Systems: Automated software identifying unusual patterns, such as frequent transfers between multiple accounts or large value changes.
• Suspicious Activity Reporting (SAR): Filing reports with regulatory authorities when layering suspicion arises.
• KYC Verification: Ensuring updated and accurate customer information.
• Staff Training: Equipping employees with knowledge to spot layering indicators.
• Audit Trails and Record-Keeping: Maintaining comprehensive transaction history for investigations.

Financial institutions also utilize machine learning and AI technologies to detect and predict layering behavior hidden within complex transactional data.

Impact on Customers/Clients

From a customer perspective, layering-related AML processes may lead to:

• Enhanced scrutiny: Additional documentation requirements and transaction verifications.
• Restrictions or freezing of accounts: If suspicious layering activity is detected.
• Delays: In processing legitimate transactions while investigations occur.
• Rights to information and appeal: Customers may have rights under data protection or financial law relating to investigations.

While necessary for AML compliance, institutions balance these controls against customer service and privacy rights.

Duration, Review, and Resolution

• Duration: Layering activities can span from days to years, depending on the complexity.
• Ongoing Monitoring: Institutions perform regular reviews of accounts flagged for layering patterns.
• Periodic Audits: Compliance teams review AML controls and transaction histories to ensure alignment with regulatory requirements.
• Resolution: Cases identified as layering may lead to SAR filings, account restrictions, or law enforcement referrals.

Reporting and Compliance Duties

Financial institutions have the responsibility to:

• Implement AML policies consistent with applicable laws.
• Monitor transactions continuously for layering indicators.
• Document and retain records for legal and audit purposes.
• Report suspicious transactions promptly to regulatory bodies.
• Ensure staff training on detecting layering.
• Cooperate with law enforcement during investigations.

Failure to comply may result in regulatory penalties, fines, reputational damage, or criminal charges.

Related AML Terms

Layering is closely connected to other AML concepts:

• Placement: Initial introduction of illicit funds into the financial system.
• Integration: The final stage where laundered money is absorbed into the economy.
• Structuring: Often part of layering, breaking transactions into smaller amounts.
• Smurfing: A layering technique involving many small deposits.
• Know Your Customer (KYC): Essential for identifying and preventing layering.
• Suspicious Activity Report (SAR): Reporting suspect layering transactions.

Challenges and Best Practices

Common Issues

• High transaction volumes making manual detection tough.
• Use of advanced technology and cryptocurrencies complicating traceability.
• Cross-border transfers with varied regulatory standards.
• Sophisticated layering schemes combining multiple techniques.

Best Practices

• Employ advanced AML technology with AI/ML capabilities.
• Foster collaboration between compliance teams and law enforcement.
• Continuously update risk-based approaches and watchlists.
• Provide ongoing training for frontline staff to detect suspicious behavior.
• Maintain robust customer profiling and transaction monitoring.

Recent Developments

• Increased use of cryptocurrencies and decentralized finance (DeFi) complicates layering detection.
• Adoption of Artificial Intelligence and machine learning significantly improves real-time detection.
• Regulatory bodies worldwide are tightening AML regulations with a focus on layered transactions.
• Enhanced international cooperation under FATF recommendations strengthens cross-border layering detection.

Summary

Layering is a pivotal stage in money laundering where illicit funds undergo complex, multi-step transactions to obscure their criminal origin. It plays a critical role in AML efforts globally, requiring financial institutions to implement vigilant controls, advanced monitoring, and strong regulatory compliance. Understanding layering’s tactics, regulatory requirements, and challenges empowers compliance officers and institutions to better detect and prevent the integration of dirty money into the legitimate economy, thereby reinforcing the integrity of the financial system.