Dirty Money

By Zhenglin (Alex) Li

As one of the leading financial centres of the world, London should be a shining example of propriety. However, the reality seems to be that the example set by the city shines a good deal less than it should.

The General Introduction

The importance of reducing “dirty money”, defined as money flow that is immoral or illegal (Cambridge Dictionary), which has been rapidly increasing in recent years, has been noticed by policymakers and social groups, who would like to prevent it from growing. Although it has been agreed by most economists that freedom of trade is beneficial to economies according to the comparative advantage theory (Do, Levchenko, and Raddatz, 2015), this principle seems not to be conducive to stopping money laundering.

Quirk (1996) has shown some significant consequences of the unhealthy circulation of currency, specifically from the macroeconomic point of view. First of all, the illegal transfer of money is not calculated into the official balance of payments, which would give policymakers a measure of the current economic status. Hence, if the problem of dirty money is ignored and allowed to grow to a greater scale, the judgement and expectation of the economy might be inaccurate, which results in a misdiagnosis of government macroeconomic policy. Furthermore, the presence of criminal dirty money may prevent legal activities from taking place due to the loss of market confidence and the system of profit incentive owing to corruption and crime. Lastly, the tax revenue of the government would be reduced, as tax evasion is easier. Thus, for the long-term growth of the economy and secure justice, governments need to set up anti-money-laundering policies and treat this issue seriously.

As the Financial Times (2022) has described, the crashing of two leading powers of the world – the British Empire and the Soviet Union – brings these two countries together. Thatcher’s relaxation of financial supervision and the commission on deregulation of the New Labour government gave the UK a chance to accept dirty money from corrupt Russian bureaucrats and oligarchs. By funding British politicians and manipulating legal loopholes, Russian dirty money has found London a great place for laundering, which has seriously disturbed the order of the financial market (The Economist, 2022). In this essay, the problem of the causes of this terrible situation is analysed and some possible solutions, involving either legislation or directive policies, will be provided and discussed.

London as a shelter for dirty money – and the problems caused by it

London as a shelter for dirty money

Generally speaking, the normal practice of money laundering takes place in four steps: placement, layering, integration, and defence (Financial Times, 2022). First, a shell company, which is a company that legally exists but is not operating (Kenton, 2022), will be set up to transfer oligarchs’ money from the bank account, which gives Russian dirty money a legal tunnel for investing in the UK. There are limited barriers to setting up a shell corporation, as the requirements for registration with Company House are very few (Company House), and there is almost no serious supervision of your information (Barnes, 2017).

Furthermore, commercial bankers are hired to transfer dirty money from bank to bank, or “layering” in professional terms, making supervision of the oligarchs much more difficult. The City of London has been described by Cooke (1986) as an independent community that requires self-governance rather than supervision by bureaucrats. Although the Banking Act 1987 has provided the Bank of England with more systematic and standardised supervision of banking activities, there is still plenty of space for illegal financing activities to occur. Owing to the information asymmetry between government and banks and the principle of “credit first”, which prevents the Bank of England from publishing most of the information on illegal activities, the banking supervision of the UK is weak and unable to protect the proper operation of the financial market (Hotori et al., 2021)

Moreover, the money in commercial banks is integrated into the British financial system by investing in UK properties. Langton, in an interview with the Financial Times (2022) has proved that Russian investors are interested in buying valuable properties, especially real estate such as a house in Knightsbridge. This would also impact the domestic agenda of the UK. From 2008 to 2015, 60 per cent of “golden visas” – a visa that is given to investors and businesspeople – were issued to Chinese and Russian nationals (Transparency International UK, 2015), which gives oligarchs a legal opportunity to stay in or even immigrate to the UK.

The City of London has been described by Cooke (1986) as an independent community that requires self-governance rather than supervision by bureaucrats.

Lastly, to defend their properties, Russians and their assistants would hire expensive professional reputation lawyers and media experts. In cases where there are media that wish to attack dirty-money activities, several experienced problem-solvers will be asked to stop their movements by intimidating them into discontinuing the proceedings or stopping news from getting to the newspapers. More extremely, this anti-democratic activity has spread into Westminster. Boris Johnson claimed during his mayorship of London that he welcomed dirty money from Russia (Cunningham-Cook, 2022), and even gave a peerage to Russian oligarch Evgeny Lebedev in 2023, which gave him a legal seat on the legislation of the UK (Walker, 2023).

An additional influence on the public includes that the activity of money laundering would lead to a moral issue in the British economy. As it is considered that the illegal financial activities of leading investors should not be punished, large domestic firms may underestimate the economic supervisory magnitude, which would possibly lead to a fall in ethical problems. There is a risk that if the principle of releasing control on financial crime is passed down through the country, the amount of financial crime may grow exponentially. Furthermore, the rise in the price of capital in the process of integration would cause inflation, owing to the change in investment. As a consequence, the real income of the public would decrease in general, since increasing wages is problematic, making British people’s lives even harder.

Suggested solutions and reflection on them

In the stage of layering, money is transferred from a foreign account with limited supervision of its purpose and ownership. However, if the supervisory authority requires the appropriate information on the sources of money, then it is obvious that a great number of money laundering activities could be stopped. The Bank Secrecy Act 1970 (BSA) was introduced to prevent transfers of dirty money, requiring, specifically, the negotiable instruments and file records of any daily aggregate exceeding $10,000 (Meltzer, 1991). The files that are requested by the BSA have included the detailed personal information of clients on transactions over $10,000 (US Department of Treasury). More specifically, any client who has control of a foreign bank account will be asked to file a Foreign Bank Account Report (FBAR), which supervises potential illegal activities (Internal Revenue Service). These regulations have been confirmed by the Supreme Court of the United States (Bittner v. United States, 2023) as a help to the government to deter financial crime.

Additionally, the idea that London should set up less protection for financial order is an unhealthy influence on reducing money laundering. On the contrary, the British government should show its opposition to financial crime and illegal movements. For instance, although the EU sanctions on Russian oligarchs, which froze Russian assets in the central banks (European Council), is widely considered a political weapon, in fact it stops Russian dirty money objectively, since Russian investors thus are aware that there is a danger of losing their money due to non-economic issues. However, a negative further impact might be a reduction in market confidence in the domestic financial market, since investors from other countries would also worry about the security of domestic assets, which consequently leads to a fall in the global importance of a currency and the exchange rate (Jha, 2023).

It should be noticed that apart from political problems, systematic issues also play a significant role in the cause of enormous financial crimes. The English-style common-law system is a good example of this. Studies have shown that this system is more favourable to the rich and businesspeople, since its protection to shareholders is stronger than that of the French-style legal system (Prota et al., 1998). Hence, it creates barriers for government and social groups to supervise Russian oligarchs, since they can afford more-experienced lawyers, which gives them a greater chance of winning in court trials. If the UK legal system could favour the poor more by learning from the French-style system, the defence of illegal assets would be much harder and one could be confident that money laundering activities would be restricted. However, from the economic point of view, the English-style legal system would contribute to a more efficient financial system as, whilst shareholders benefit, creditors’ rights will also be protected, which generates greater economic growth, according to the Solow-Swan model, with the microeconomic foundation that small businesses are easier to finance, so national assets are allocated more efficiently (Levine and King, 1993). Thus, the reform of the legal system should not be radical, otherwise the price will be growth.

The idea that London should set up less protection for financial order is an unhealthy influence on reducing money laundering. On the contrary, the British government should show its opposition to financial crime and illegal movements.

Another risk led by the electoral and political system of the UK is that the Political Parties, Elections and Referendums Act 2000 has a loophole that lending money at the commercial interest rate as a form of donation is not required to be published, which caused the “cash for honours” scandal (Jones, 2005). If this system is abused by oligarchs in order to gain support from British politicians, it would be a great disaster that the MPs elected by British citizens, who are supposed to serve the public, will focus their efforts on behalf of a small group of corrupt rich people. Consequently, it is necessary for Westminster to legislate a stricter version of political donation that stops any sort of financial interference in politics.

Potential difficulties of the solutions and a forecast for the future

the solutions and a forecast for the future

A possible difficulty that might occur is unfair influence of politicians due to vested interest gained from financial crimes, such as donations to political parties and bribery of high-ranking officials. However, people should be aware that in the British democratic system, the public has a great impact on Westminster, since the attitudes of swing voters towards policies affect the popularity of parties. Thus, it is practical for the British and their social pressure groups to enforce justice by, for instance, criticising the current British anti-money-laundering (AML) policies in newspapers or social media. It has been proved by Kolstad and Wiing (2016) that, in general, the more democratic a nation is, the cleaner it could be. Hence, it is certain that supervision by the public over Westminster would be effective.

In their book Why Nations Fail: The Origins of Power, Prosperity and Poverty, Acemoglu and Robinson (2012) have stated from the institutional economic point of view that the social system of countries can be separated into exclusive and inclusive. While the latter encourages competition and innovation, which is the origin of prosperity, the former would lead to a centralisation of power on dictators and oligopolistic businesspeople, which causes inequality and poverty. As the historical record has proved, ignorance of such illegal activities which contribute to inequality would change the UK’s economy from inclusive to exclusive, whilst the most effective solution is the intervention under a democratic system, which attacks the unconscionable power of “the few” over the wishes of “the many”. Hence, a necessary involvement in reducing money-laundering activities is the attention and appeal of social pressure groups.

London, as one of the most influential and prosperous financial centres in the world, has not only gained a significant place in the UK but also in the entire global financial network. It is responsible and necessary to say that the cleaning of London is not only important for investors, creditors, and other financial sector employees, but for the development of human beings. What policymakers should be concerned about as the highest priority is not the short-term interest that would last no longer than one decade, but the long-term gain based on market confidence and legal market operations.

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About the Author

Zhenglin (Alex) LiZhenglin (Alex) Li is an independent researcher based in China. His research area focuses on the financial market, pension reforms, the Chinese economy, and international citizenship. He was one of the delegates of China in the United Nations Youth Training Program in 2023.

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