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How servicing post-Soviet elites weakens the rule of law

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The growth of London as a centre for financial and professional services coincided with the collapse of the USSR and the rise of post-Soviet kleptocracies in the 1990s. These states and their elites have since become a major source of clients for UK-based services firms and of investors in UK assets.

In keeping with global standards, the UK has officially adopted a risk-based approach to anti-money laundering. However, failures of enforcement and implementation of the law – plus the exploitation of loopholes by professional enablers – have meant that little has been done in practice to prevent kleptocratic wealth and political agendas from entering Britain.

Based on extensive research on the laundering of money and reputations by elites from the post-Soviet successor states, this paper details how the UK is ill-equipped to assess the risk of corruption from transnational kleptocracy, which has undermined the integrity of important domestic institutions and weakened the rule of law. It concludes by calling for the UK government to adopt a new approach to this problem focused on creating a hostile environment for the world’s kleptocrats.

01 Introduction

Amid legal uncertainty as Soviet state institutions unravelled in the 1990s, opportunities arose for the elites of the successor states to profit individually from the transfer of Soviet-era assets. The ensuing wealth transfers have provided much business for British professional services firms. But the provision of these services to post-Soviet kleptocrats and their associates has undermined the integrity of important UK institutions and weakened the rule of law.

Financial and professional services firms have long made the UK a comfortable home for dirty money. The rapid deregulation and growth of London as a centre for these services since the 1980s coincided with the end of the USSR and the rise of the post-Soviet kleptocracies. As Soviet state institutions unravelled and Russia and other successor states were governed in the context of legal uncertainty, new opportunities arose for the elites of those countries to profit individually from the privatization and transfer of Soviet-era property, natural resources and industrial holdings.

The ensuing transfers of wealth in the early years of post-Soviet independence required a host of wealth management services to secure these newly acquired fortunes and holdings, providing much business for British banks, law firms and wealth managers. The UK has since adopted new measures to tackle illicit finance and money laundering, but they have had little impact so far on stemming large-scale capital flight from developing nations. The development cost of such outflows from post-Soviet states is well documented.1

Less understood is how the enabling of these transfers of wealth has affected the rule of law within the UK itself. The concept of the rule of law can be defined, according to the Law Society of England and Wales, as characterizing a system where ‘laws are made democratically, everyone is protected by and accountable to the same laws – including government – with independent courts there to uphold these in a way that is accessible, fair and efficient’.2

Yet evidence is mounting that all are not equal before the law – and that the implementation and enforcement of the law is not efficient. Weaknesses in the law, and crucially the exploitation of these loopholes by professional enablers in the service of kleptocrats and their associates, have eroded the legal system’s capacity to assess the risk of corruption, undermined the implementation and enforcement of new anti-corruption measures, transplanted authoritarian agendas and rivalries to UK settings, and undermined the integrity of important domestic institutions.

The UK is not alone in this complicity. Banking scandals in Denmark and Germany have demonstrated how dark money from kleptocracies passes with ease through Western financial systems,3 while investigations into European bodies have shown how malign influence can be exerted by autocratic powers.4

This paper draws on the authors’ knowledge of the UK, its legislation and links to Eurasia, and considers the risks that work undertaken by the UK professional services sector for post-Soviet Eurasian kleptocrats poses for the UK’s rule of law and its foreign relations. It exposes the regulatory failures and absences of enforcement and concludes by calling for a new anti-kleptocracy strategy on the part of the British state.

What is kleptocracy? What is enabling?

Classically understood as ‘rule of thieves’, kleptocracy has found a new generation of analysts in the last decade. The term has been popularized in Oliver Bullough’s Moneyland,5 Tom Burgis’ Kleptopia,6 and Sarah Chayes’ Thieves of State,7 while it has also been widely deployed by civil society organizations.8 The UK’s Financial Conduct Authority (FCA) indirectly provides a definition in its guidelines on countries with a high risk of corruption: ‘a political economy dominated by a small number of people/entities with close links to the state’.9 A similar term is ‘grand corruption’ (i.e. ‘the abuse of high-level power that benefits the few at the expense of the many, and causes serious and widespread harm to individuals and society’10), which may be used interchangeably with kleptocracy, as both indicate the subversion of political office for personal enrichment and advantage. According to a recent definition employed in the Journal of Democracy:

Kleptocracy is a system in which public institutions are used to enable a network of ruling elites to steal public funds for their own private gain.11

The geographic focus of studies of kleptocracy is often the post-Soviet states, with the books mentioned above covering Azerbaijan, Kazakhstan, Ukraine and Uzbekistan among others. Meanwhile, influential but controversial recent books by the journalist Catherine Belton and the academic Karen Dawisha have both deployed kleptocracy as the prism through which to understand Russia and its network of politically connected oligarchs.12 UK media tends to focus on Russia, yet the fact that kleptocracy has gripped many of the other post-Soviet states suggests a systemic problem.

Modish terms are freighted with connotations, but our approach to kleptocracy emerges from the study of politics and economies as they intertwine and cross borders. From this perspective, the term post-Soviet or Eurasian kleptocracy is, strictly speaking, a misnomer.13 All kleptocracies are by nature transnational and, as they merge with one another, are potentially global – an idea captured in the titles Moneyland and Kleptopia.

This paper explores how the process of kleptocracy outlined in Moneyland occurs transnationally, with money flowing from post-Soviet Eurasia to the UK. Throughout this paper, ‘post-Soviet’ and ‘Eurasian’ are used to refer to the countries of the former USSR excluding the Baltic republics, which have been EU member states since 2004. Transnational kleptocracy is not essentially Eurasian in character, and the paper sometimes analyses other regions. However, the post-Soviet region’s contemporary history – and its blending of Soviet-era political practices with Western financial capitalism – provides some of the most acute examples of such kleptocracy in action.

Kleptocrats are empowered to gain from the system through their political connections and status and by a lack of institutional oversight and accountability. This paper discusses a wide range of wealthy individuals from kleptocratic states who we refer to as ‘post-Soviet elites’ or simply ‘elites’.14

‘Kleptocrats’ are generally government officials, senior officials or a close family member. ‘Oligarchs’ tend to refer to a member of the country’s business elite or a close family member, lacking formal power but sometimes with political influence. And a political ‘exile’ includes those who were once kleptocrats or oligarchs but have since fallen out of favour in their home countries.

Many of the financial services provided by enablers are legal, while others are of uncertain legality due to secrecy and lack of prosecution.

Whether a person falls into a particular category can often be difficult to determine. Accordingly, kleptocracy is not just a sum of corrupt acts. It is also the set of institutions, networks and norms, both domestic and transnational, that facilitates and structures such activities. A critical aspect of any such system is how global actors and institutions establish networks to effectively co-mingle illicit funds with legal ones. This service is known as enabling. The term captures a variety of behaviours – some licit and some illicit; some willingly complicit and some reflecting negligence rather than deliberate corruption.

The word ‘enabling’ is seen as pejorative by those offering such services. However, it is a term which grasps the phenomenon in practice. This paper concentrates mainly on estate agents, lawyers, accountants, and trust and company service providers – referred to as Designated Non-Financial Businesses and Professions (DNFBPs) by the Financial Action Task Force (FATF), an inter-governmental body created to promote global standards on preventing money laundering and terrorist financing – as it is these groups that have been found to be at high risk of exploitation for money laundering by the UK’s National Crime Agency (NCA), due to the services they provide and in part due to a lack of proper monitoring.15 The paper also assesses unregulated professionals, such as public relations (PR) agents and wealth managers.

Many of the financial services provided by enablers are legal, while others are of uncertain legality due to secrecy and lack of prosecution. Most of the illegal activity by enablers takes the form of money laundering – i.e. the ‘processing of these criminal proceeds to disguise their illegal origin’.16 Anti-money laundering (AML) regulations refers to individuals involved in politics as politically exposed persons (PEPs), a term that can apply to senior public officials, their close relatives and business partners.17 This designation is in recognition of the fact that kleptocrats and their associates have greater opportunities to earn money illicitly through influencing state business. We refer to PEPs throughout this paper when addressing AML laws and their enforcement.

Elites linked to kleptocratic states also seek to protect their reputations to counteract current or future allegations of malfeasance. Therefore, enablers also undertake what can be described as ‘reputation laundering’ – the process of ‘minimizing or obscuring evidence of corruption and authoritarianism in the kleptocrat’s home country and rebranding kleptocrats as engaged global citizens’.18 Again, most of this activity is legal. Together, the laundering of money and reputations begets ‘a web of interrelated practices that go beyond the economic realm to encompass various social-networking and political techniques’, including ‘securing the right for the kleptocrat to reside overseas, running an aggressive image-crafting and public relations campaign, and using philanthropic activities to ensconce the kleptocrat in a web of transnational alliances’.19

How is kleptocracy enabled?

In Moneyland, Oliver Bullough highlights how elites from kleptocracies follow a three-step process: ‘steal-hide-spend’. While individual actions necessary to complete the second and third stages may be legal, cumulatively they are recasting bilateral relationships between the UK and the post-Soviet states and undermining domestic deliberative processes that usually safeguard and scrutinize policymaking.20

The first step is the ‘theft’ itself, which in the post-Soviet period constituted the wilful seizure of putatively private assets and the creation of what in Russian is known as obshchak, the ‘shared treasure’ utilized by a criminal gang. Here, the lines between the state (especially the security services), private business and criminality were blurred just as these countries were consolidating their domestic institutions.21 In the period after the collapse of the USSR, this [https://www.opendemocracy.net/ https://www.opendemocracy.net] theft was of such magnitude – Stealing the State, in Steven Solnick’s formulation22 – that it was only in cases where an elite had fallen out of favour that they were convicted of an offence. As such, most kleptocrats and associated individuals were not criminally sanctioned in their home country.

In the 1990s, much depended on the unwritten but firmly established rules of the hierarchy, where top political figures act as a krysha (‘protection’; literally ‘roof’ in Russian) for those lower down the chain whose job it is to send money upwards in a system that resembles that of an organized crime structure.23 Then, during the 2000s and 2010s, these single sources of income were expanded as oligarchs diversified their portfolios and holdings through new domestic and international investments, wealth management and integration with international capital markets. Post-Soviet elites intermingled illicit and licit funds and exploited the opacity of this capital in making these investments – and they have continued to do so to this day.

The second step is ‘hiding’, often via offshoring, where money is sent out of the host country using complex structures that obscure both the origin of the funds and the ultimate owner. This is typically the point at which enablers in rule-of-law settings first appear, helping the individual in question – who is usually also a PEP – to set up a variety of trusts, shell companies and bank accounts. Such structures are ‘layered’ through multiple jurisdictions (for example, a Singapore company, owned by a British Virgin Islands (BVI) company, in turn owned by a Liechtenstein trust) and utilize nominee ‘proxy’ owners and directors, with the aim of obstructing political rivals and any would-be investigators.

The ‘Azerbaijani Laundromat’ scandal saw $2.9 billion funnelled through four UK shell companies over a two-year period.

Even though such structures are flagged in money-laundering regulations as posing a high risk, PEPs will cite reasons such as tax efficiency, personal security and political instability in their home country as justification. Far from being a recent innovation for Russia and Eurasia, the KGB made use of such offshore companies in the Soviet period and they were crucial to the transition to market economies in the successor states.24 Moreover, as research has shown, it has been shell company providers in jurisdictions normally associated with a strong rule of law – the US and the UK – that have tended to flout international recommendations concerning the identification of the company’s owner.25

The third step involves the spending of some of the questionably obtained capital – now ‘cleaned’ through the offshore system – on social, economic and political goods. Much of this will be purely personal – the Azerbaijani banker’s wife who spent £16 million in Harrods is often cited as an extreme example26 – and will find itself in ‘safe’ investments abroad, such as luxury London property, providing the elite with future sources of income and assets should the situation at home ever turn against them. Yet outflows may also include more sinister activities: for example, ‘the Azerbaijani Laundromat’ scandal saw $2.9 billion funnelled through four UK shell companies over a two-year period, some of which was used on lobbying activities, including the bribing of European politicians.27

More sophisticated versions of this scheme will see the trusted operatives within a regime manage certain assets and accrue further capital. For example, in October 2005, a Kazakh copper company, Kazakhmys, listed on the main market of the London Stock Exchange (LSE), despite the fact that questions had been raised over the company’s privatization in the 1990s and 2000s, which put virtually all of its shares in the hands of the company’s senior managers, including its chairman who was an associate of Kazakhstan’s president, Nursultan Nazarbayev.28 The following year after the listing, the chairman, Vladimir Kim (Annex, numbers 48–51), gifted a 2.5 per cent share of the FTSE 100 company to one of Kazakhmys PLC’s board members, Vladimir Ni (Annex, numbers 44–47) – Nazarbayev’s former chief-of-staff and close friend. The gift, worth £135 million, was described by one observer as ‘possibly the biggest ever loyalty payment to a single manager’.29 Following Ni’s death in 2010, a BVI company in which his family was a shareholder paid $30 million to purchase the remainder of its shares, which were owned by Assel Kurmanbayeva, the rumoured third wife of President Nazarbayev. According to the Organized Crime and Corruption Reporting Project, the BVI company is ‘not known to have done any business or to have owned anything valuable, and its purpose was unclear’.30

Why does kleptocracy matter?

Although diplomatic relations and national security questions are most prominent in international politics, day-to-day relations between the UK and Eurasian countries are largely concerned with other matters. Much of Britain’s connection to the region is through economic and financial globalization – examples have included the BP-led ‘contract of the century’ in Azerbaijan, the establishment of the Astana International Financial Centre court in Kazakhstan with English judges, the listing of Eurasian companies on the LSE and enormous investments in the London property market.

There is a tendency to think of this in terms of a liberal globalization process beneficial to both sides – each generating capital in a regulated and reputable environment, with abusers of the system sanctioned via asset freezes or visa bans. Yet the premise is questionable. Anyone looking to back another Kazakh-based company joining the LSE, for example, may think again after the ENRC debacle, which saw the Serious Fraud Office (SFO) open an investigation into the company following allegations of fraud, bribery and corruption.31,32 This paper thus poses the question of whether illiberal globalization is dominating UK–Eurasian economic relations, with kleptocrats and their companies joining the UK economy and society with corrosive effects for the rule of law in Britain.

Chapter 2 summarizes why the UK is a key hub for post-Soviet elites, and examines the array of people from such elites – from exiled former insiders to under-the-radar representatives of regimes still in power – who settle in the UK. It also looks at what the UK provides in terms of professional services in residency by investment (‘golden visas’) and property to meet the demand from these elites for places to hide and spend their suspicious wealth. Chapter 3 explores the current risk-based system of regulation to protect the UK from money laundering and finds that, despite recent promises and legislative innovations, the system remains inadequate and poorly enforced in regard to kleptocratic flows.

Chapter 4 focuses on two investigative tools introduced recently by the UK – Account Freezing Orders (AFOs) and Unexplained Wealth Orders (UWOs) – and on the professional enablers who allow post-Soviet elites to explain their wealth and sidestep this legislation. Chapter 5 discusses reputation laundering and political influence, demonstrating not merely how the rule of law is being corroded but how the UK is exposing itself to possible influence from those who retain allegiance to kleptocratic regimes. Finally, in Chapter 6, we show the damage being done to Britain and outline an anti-kleptocracy plan which, if adopted, would begin to address the structural weaknesses of its democracy.

We argue that the UK has a kleptocracy problem. The country’s international reputation has already been undermined by the inflow of suspect capital from the servicing of post-Soviet elites. Beyond this question of image, there are serious questions to consider of the integrity of the UK’s public institutions and the equitability of its laws. Efforts must be made to recover Britain’s reputation and integrity, not simply on moral grounds, but because the fairness and efficiency of the country’s rule of law are at stake.FULL REPORT

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AUTHORS

John Heathershaw

Professor of International Relations, University of Exeter

Alexander Cooley

Claire Tow Professor of Political Science, Barnard College, and Director of the Harriman Institute for the Study of Russia, Eurasia and Eastern Europe, Columbia University

Thomas Mayne

Visiting Fellow, Russia and Eurasia Programme

Email Thomas

Casey Michel

US author and journalist; Adjunct Fellow, Hudson Institute’s Kleptocracy Initiative

Tena Prelec

Research Fellow, Department of Politics and International Relations, University of Oxford

Jason Sharman

Sir Patrick Sheehy Professor of International Relations, Department of Politics and International Studies, University of Cambridge

Ricardo Soares de Oliveira

Professor of the International Politics of Africa, Department of Politics and International Relations, University of Oxford

RESEARCH PAPER 8 DECEMBER 2021ISBN: 978 1 78413 510 2

Original source of article : CHATHAM HOUSE

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