By Christine Duhaime, BA, JD, CAMS
Originally published in Financier Worldwide, London.
Governments all over the world, including the UK, US, China, Nigeria, Canada and Iran, have announced massive infrastructure projects to stimulate economic growth. Over $78 trillion is expected to be spent on infrastructure globally over the next 10 years.
Most of these projects will be private-public partnership (P3) deals that transfer obligations to design, build, finance and manage infrastructure assets to private asset management funds, in exchange for long-term, lucrative government payments.
However, P3 infrastructure projects carry financial crime risks as they are a high risk for corruption. Some studies have estimated that the global average cost of corruption in infrastructure, solely from bribery, ranges from between 5 and 20 percent of the project costs. The American Society of Civil Engineers, for example, estimates the cost of corruption to be between 10 and 30 percent of infrastructure costs. In Canada, the government’s corruption inquiry found that such costs tend to be higher with so-called ‘mafia taxes’ levied under the table for some large projects.
What this means is that if financial crime is not resolved in the infrastructure space, up to 30 percent of global infrastructure costs – between $4 trillion and $25 trillion – will be paid as corruption leakage in the next decade. There are significant economic incentives for both the private and public sector to implement financial crime mitigation programmes in infrastructure.
The problem with P3 infrastructure deals is that they suffer from financial crime risks due to a lack of transparency. Payments from governments to private sector infrastructure partners may be funnelled through asset management funds located in well-known tax havens that obfuscate financial flows through beneficial ownership structures. P3 infrastructure deals are also high risk because they may involve asset management fund CEOs who are undisclosed politically exposed persons (PEPs) with ties to political leaders, or who act as advisors to the political leadership.
Because they are undisclosed PEPs, their financial transactions are not flagged for corruption risks by financial institutions globally, as required by money laundering laws.
Corruption in P3 infrastructure deals leads to higher prices for the assets to be built and maintained for their life cycle, which could last for several decades, and is a cost borne by taxpayers. Corruption payments for infrastructure also reduce the tax dollars available for other public services. Moreover, financial institutions that are involved in the financing of P3 infrastructure deals bear substantial reputational and financial crime risks when they are dealing with infrastructure deals involving an undisclosed PEP or where there is criminality involved with financial transactions that are the proceeds of corruption.
The ongoing 1MDB financial scandal is illustrative – the Swiss regulator, FINMA recently fined BSI AG bank $93m for money laundering breaches for failing to verify the source of funds of several PEPs involved in what was supposed to be oil & gas infrastructure deals. Governments are also affected when the P3 infrastructure sector carries the taint of financial crime – in Canada, for example, Bloomberg News reported that a corruption inquiry soured sentiment among investors for Canadian P3 bonds linked to infrastructure projects. A recent evaluation by the FATF, which gave Canada a low grade for financial crime mitigation, also increases risks for investors.
To mitigate financial crime risks, P3 infrastructure projects need accountability and transparency.
The solution? Blockchain and smart contracts.
The Blockchain is a shared public distributed ledger that is the technology underlying digital currency financial transactions. The Blockchain is designed to prevent anyone from double-spending, and therefore it eliminates certain categories of fraud capability.
Unlike banking transactions, digital currency transactions are not processed through a centralised authority, or clearing house. They are processed through the Blockchain, which acts much like a third-party clearing house, except that the clearing (or reconciliation and verification of transactions) component is direct and machine-to-machine.
In the transactional validation process, transactions are time-stamped via a hash algorithm that was designed by the NSA, which creates an ongoing chain, and a decentralised digital record (a ledger) which cannot be altered and records transactions chronologically and publicly.
Ubiq, a new FinTech startup, is one of several companies developing Blockchain technology with so-called ‘smart contracts’ capability. Smart contracts are arrangements established by computer code whereby, upon the fulfilment of conditions precedent, payments in a digital currency held in escrow to a contracting party are released on the Blockchain automatically and instantaneously directly to an asset management fund’s account without going through the banking system.
In the P3 infrastructure regime, a smart contract system, such as Ubiq’s, can save governments and the private sector billions of dollars in the elimination of leakage payments. That is because the Blockchain’s ledger which records all the financial transactions, such as payments for asset management funds that are processed through it, are publicly available online and are recorded and linked. If P3 infrastructure payments are made using a digital currency, there is complete transparency on all parts of the payment ecosystem. Anyone can view the history of all the financial transactions associated with a project and, as a result, the risk of illegal corruption payments to PEPs or other parties is minimised. And even if they are made, they are traceable by anti-corruption enforcement officials immediately without the need for judicial intervention.
When well-designed by financial crime experts, distributed ledger technology for P3 infrastructure deals can be a perfect financial crime mitigation tool for law enforcement because it is a permanent depository of evidence in the legal sense and can not only eliminate systemic risk from corruption in infrastructure, but can instil public confidence in infrastructure and help stimulate the global economy.
The idea of using smart contracts and distributed ledgers for P3 infrastructure asset management payments has not been conceived of before this article and we are grateful to InstarAGF Asset Management Inc. in Toronto for contributing its expertise into P3 infrastructure asset management payments for this article.