The UK’s kleptocracy problem

How ser­vic­ing post-Soviet elites weak­ens the rule of law

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 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

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

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 2021
ISBN: 978 1 78413 510 2

Original source of arti­cle : CHATHAM HOUSE