TI-UK Submission to Money Laundering Regulations 2017

HM Treasury’s Consultation on Money Laundering Regulations 2017 SUBMISSION FROM TRANSPARENCY INTERNATIONAL UK

Introduction In this submission, Transparency International UK (TI-UK) responds to questions in HM Treasury’s consultation on the Money Laundering Regulations 2017 (MLR 2017).1 TI-UK previously made a submission in response to HM Treasury’s consultation on the transposition of the Fourth Money Laundering Directive (4MLD) in November 2016.2 The UK is a prime destination for corrupt individuals looking to invest or launder the proceeds of their illicit wealth, enjoy a luxury lifestyle and cleanse their reputations. While it is difficult to determine the exact figure, the UK’s National Crime Agency (NCA) estimates that at least £36 billion to £90 billion in illicit funds may be flowing through the UK’s financial system each year.3 Transposing 4MLD and updating the UK’s money laundering regulations is essential to aiding the detection and deterrence of this money.

In this submission TI-UK recommends: 1.

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Simplified due diligence should not be applied to company formations.

HMRC should lead a thorough thematic study of the particular risks within the Trust and Company Service Provider (TCSP) sector and conduct an assessment of overall anti-money laundering AML compliance levels, with the results made public, as soon as possible.

The Government should consider money laundering risks associated with company formations made directly through Companies House.

Lettings agents ought to be brought within the scope of the MLR 2017.

The definition of Politically Exposed Persons (PEPs) should include members of international sporting federations, along with their family members and those known to be close associates.

The Government should revisit its proposals to extend the requirement to hold Customer Due Diligence (CDD) information, with a view to extending it beyond the current 5 year period.

The Government should review the enforcement tools for tackling money laundering in the UK and ensure that all AML supervisors have the necessary sanctions to provide a credible deterrent to money launderers.

It should be made a requirement under the MLR 2017 for professional body supervisors to meet the Macrory standards of transparency by publishing an enforcement policy and the details of the sanctions they impose.

Professional body supervisors should be institutionally separate from their promotional and commercial activities.

https://www.gov.uk/government/consultations/money-laundering-regulations-2017/money-laundering-regulations-2017 [Accessed 3 April 2017] 2 http://www.transparency.org.uk/publications/hm-treasurys-consultation-on-the-transposition-of-the-fourth-money-launderingdirective/ [Accessed 3 April 2017] 3 http://www.nationalcrimeagency.gov.uk/publications/731-national-strategic-assessment-of-serious-and-organised-crime-2016/file page 28 [Accessed 6 April 2017]

Due diligence requirements and reliance We support the Government’s decision that when a Trust and Company Service Provider (TCSP) is asked to form a company, this is to be treated as a business relationship whether or not the formation is the only transaction being carried out for the customer. Legal entities are crucial tools for corrupt individuals, therefore it is essential that due diligence is carried out upon those seeking their formation.

In order to recognise this significant risk, TI-UK also think that simplified due diligence should not be applied to company formations. The application of the lowest degree of due diligence ought to be reserved for those situations where there is little opportunity or risk of money laundering. In light of the scale of abuse of legal entities in laundering the proceeds of corruption and the magnitude of harm caused, simplified due diligence is not typically appropriate for company formation.

We also note concerns that there are currently no due diligence checks on any individuals forming companies directly through Companies House. This could present a loophole for individuals looking to incorporate multiple UK entities for the purpose of furthering illicit activity, and should be included in the Government’s considerations for protecting against the use of UK incorporated entities for money laundering.

The role of UK legal entities in laundering the proceeds of corruption It is widely accepted that legal entities are the ‘getaway car’ for corrupt individuals. A total of 50 UK entities were named in the Kroll report into ‘The Great Moldovan Bank Robbery’ – one of the largest corruption scandals in recent years.4 A complex web of firms was used to raid US$1 billion from three Moldovan banks in 2014, costing the country around an eighth of its annual Gross Domestic Product (GDP).

According to an investigation by the Organized Crime and Corruption Project (OCCRP) and Novaya Gazeta, at least US$20.8 billion was secretly moved out of Russia between 2010 and 2014 through a vast money laundering machine comprising over 5,000 legal entities, a large number of which were incorporated in the UK.5 The basis of the scheme involved the creation of 21 core entities, with UK-based entities playing a major role, alongside others based in Cyprus and New Zealand.

Four UK-incorporated entities also helped transmit a series of payments to an Italian MP who is alleged to have solicited these funds in return for lobbying on behalf of the Azeri Government at the Council of Europe.6 Although the entities were registered in the UK, their bank accounts were based in Latvia and Estonia. Italian prosecutors are still conducting investigations into these allegations, and have noted that as much as $1 billion could have been moved through one UK incorporated Limited Liability Partnership alone. 7 The role of TCSPs in laundering the proceeds of corruption Although TCSPs provide essential and legitimate services to a range of clients, their expertise in establishing and maintaining networks of companies that can be used for money laundering and bribery makes them particularly useful to corrupt individuals. Numerous international bodies – including the Financial Action Task Force (FATF), the Organisation for Economic Co-operation and Development (OECD) and the G20 – have recognised this risk by recommending greater supervision of this sector. Domestically, the NCA has also

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http://candu.md/files/doc/Kroll_Project%20Tenor_Candu_02.04.15.pdf [Accessed 24 February 2017] https://www.occrp.org/en/laundromat [Accessed 23 March 2017] 6 http://www.esiweb.org/pdf/ESI%20-%20The%20Swamp%20-%20Caviar%20Diplomacy%20Part%20two%20%2017%20December%202016.pdf [Accessed 11 April 2017] 7 https://www.occrp.org/en/investigations/6301-businessman-suspected-in-italian-bribery-case-linked-to-azerbaijan-s-first-family [Accessed 11 April 2017] 5

identified TCSPs as key enablers in high-end money laundering through the UK, acting as witting and unwitting gatekeepers to structures that help mask the true ownership and control of illicit wealth. 8 A UK entity – Fortuna United LP – actually owns the rights to the entire sum owed to Moldova following the ‘Great Moldovan Bank Robbery’. Fortuna United LP was created only months earlier in August 2014 and has its principle place of business at 18/2 Royston Mains Street, Edinburgh. Little else is known about Fortuna United, other than that its incorporation documents was presented to Companies House by a UK TCSP, Royston Business Consultancy Ltd. – also based at 18/2 Royston Mains Street.9 Our analysis of the UK-incorporated entities used in the three corruption and money laundering scandals above has identified common characteristics in their structures and registration details that suggest the entities had been set-up, and possibly managed, by TCSPs. Concerns about the TCSP sector TI-UK is concerned about the level of understanding in relation to money-laundering risk within the TCSP sector, and observes warning signs that could mean this sector represents a weak spot in the application of risk-based approaches to applying money laundering obligations. As recognised in the last National Risk Assessment for Money Laundering and Terrorist Financing (NRA), the scale of misuse of services provided by UK TCSPs is an intelligence gap.10 However, there is compelling evidence to suggest that it is failing to consistently comply with the UK’s money laundering rules.

A recent Reuters study into the practices of 20 TCSPs provides a worrying snapshot of the due diligence standards in the UK.11 Two company formation agents contacted by Reuters revealed that they did not offer services to offshore controlled companies at all, citing barriers to adequate due diligence as the reason – the managing director of one firm adding “it’s not an industry I want to be involved with”. This perception of risk was not shared among competitors, however. Half the TCSPs contacted by Reuters explained that where a potential customer is a legal entity they would not require proof of the ultimate beneficial owners.

In 2012, a group of academics conducted an experiment to examine whether international rules on the collection of beneficial ownership information by TCSPs were being implemented in practice. Posing as highrisk customers – including would-be money launderers, corrupt officials, and terrorist financiers – the research team contacted 3,700 different TCSPs in 182 countries asking to set-up anonymous companies that would help mask their identities. The study sought to assess adherence to the international standard that countries ought to take measures to prevent the misuse of legal persons for money laundering or terrorist financing by ensuring there is adequate, accurate and timely information on the beneficial ownership and control of these entities. The experiment revealed that in a staggering 22 per cent of tests the TCSPs did not ask for any identification documents at all, while 48 per cent required some information but not government issued photo-ID. It also found that offering to pay providers a premium not to apply the rules did in fact encourage significantly fewer providers to follow these rules, even where sanctions for non-compliance was mentioned.

In the UK, only half of TCSPs who responded were compliant with anti-money laundering (AML) rules.12 Under the Proceeds of Crime Act 2002 (POCA), TCSPs are required to submit Suspicious Activity Reports (SARs) to the NCA if they identify transactions or business relationships that could signify money laundering.

Just 0.03 per cent of reports made to the UK Financial Intelligence Unit following the identification of 8

http://www.nationalcrimeagency.gov.uk/publications/731-national-strategic-assessment-of-serious-and-organised-crime-2016/file [Accessed 6 February 2017] 9 http://www.heraldscotland.com/business/13414235.The_Moldova_Connection/ [Accessed 13 February 2017] 10 HM Government, National Risk Assessment on Money Laundering and Terrorist Financing (October 2015), page 52 11 http://uk.reuters.com/article/uk-regulations-mailbox-insight-idUKKBN13U168 [Accessed 15 February 2017] 12 M. Findley, D. Nielson and J. Sharman, Global Shell Games: Testing Money Launderers’ and Terrorist Financiers Access to Shell Companies (October 2012) https://www.griffith.edu.au/__data/assets/pdf_file/0008/454625/Oct2012-Global-Shell-Games.MediaSummary.10Oct12.pdf

suspicious activity were made by TCSPs in the year up to September 2015 – that is, just 101 reports. This is both worrying and surprising given their regular proximity to transactions with high levels of inherent risk and features that could indicate risk of money laundering. These types of transaction include dealing with legal person customers, customers based in jurisdictions that are known secrecy havens, complex corporate structures behind a customer, and non-face-to-face transacting – situations where it would be reasonable to expect enhanced due diligence.

To help provide a more comprehensive assessment of the current level of understanding and compliance within this sector, HMRC should lead a thorough thematic study of the particular risks within the TCSP sector and conduct an assessment of overall AML compliance levels, with the results made public, as soon as possible.

Estate agent business In response to HM Treasury’s consultation on the transposition of the 4MLD in November 2016 TI-UK recommended: “There needs to be stronger defences against money laundering in the property sector: this includes bringing letting agents within the scope of the money laundering regulations, introducing client checks by estate agents on the buyers of property and reforming the system for anti-money laundering (AML) supervision.”

TI-UK welcomes the proposed clarification by the Government that for the purposes of the MLR 2017, an estate agent is to be considered as entering into a business relationship with a purchaser as well as with a seller, meaning that estate agency businesses must apply Customer Due Diligence (CDD) to both contracting parties in a transaction.

TI-UK remains of the view that lettings agents ought to be brought within the scope of the MLR 2017 as this unregulated area of the UK property market provides the means to launder substantial amounts of corrupt or illicit funds over a period of time. TI-UK notes the Government’s recognition that lettings remain an ‘intelligence gap’ and eagerly awaits how this will be addressed in the updated NRA, which is due to be published before the end of this year.

Politically exposed persons In response to HM Treasury’s consultation on the transposition of the 4MLD in November 2016, TI-UK recommended that the definition of Politically Exposed Persons (PEPs) needs strengthening, not weakening.

This should be done by:   

expanding the definition of PEPs to include members of international sporting federations, along with their family members and known to be close associates ensuring both supervisors and the regulated sector have a firm understanding of how risk assessments work in theory and practice not watering down the existing definition of PEPs

TI-UK is disappointed that the Government has decided not to proceed with the proposal to include members of international sporting federations, along with their family members and known to be close associates within the definition of PEP. Sport’s ties to private and political interests make it an industry that is rich in

opportunities for corruption – clearly evidenced by the major international scandal surrounding senior figures in FIFA.13 TI-UK notes the Government’s assurance that regarding a distinction between low-risk domestic PEPs and other PEPs, ‘a proportionate approach will continue to form the cornerstone of HM Treasury’s approach’. TIUK reiterates that while it acknowledges that the level of risk is not the same for all PEPs and indeed all countries, dishonest and corrupt PEPs exist in almost any country. In developing a sensible and tailored approach to what is a complex risk, TI-UK would urge the Government to avoid creating a situation whereby UK PEPs, their family members and close associates are less scrutinised than those in other jurisdiction simply as a matter of course.

Beneficial ownership In response to HM Treasury’s consultation on the transposition of the 4MLD in November 2016, TI-UK recommended that beneficial ownership transparency should be further enhanced. Firstly, TI-UK recommended that the PSC regime could be strengthened by requiring the exact proportion of shares of voting rights controlled and by bringing other types of entities within scope, such as Scottish Limited Partnerships (SLPs).

TI-UK notes that Department for Business, Energy and Industrial Strategy (BEIS) will publish a written ministerial statement in due course regarding the scope of entities included within the remit of the PSC and look forward to this update.

Secondly, TI-UK were of the view that certain trust information should be publicly disclosed.

TI-UK notes that there are on-going discussions within the European Union about the scope of these provisions, and that the European Parliament recently voted in favour of requiring that all trust beneficial ownership information be published. 14

Reporting obligations We note that the Government is not extending the data retention period for retaining CDD documents and transactions data beyond 5 years, something that it has the flexibility to do under Article 40. In response to HM Treasury’s consultation on the transposition of the 4MLD in November 2016, TI-UK recommended that the longer retention period was essential in the global fight against corruption.

We would again highlight that it can take a long time for evidence of corruption to come to light. For example, the recent investigation by the OCCRP and Novaya Gazeta into the Global Laundromat unearthed a scandal dating back to 2010.15 Similarly, the FIFA scandal has been described as a “24 year scheme” by US Courts.16 In failing to extend the retention period, TI-UK believes the Government could be impeding law enforcement agencies’ ability to conduct investigations in the future and strongly urge that it revisits its position.

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https://www.justice.gov/opa/pr/sixteen-additional-fifa-officials-indicted-racketeering-conspiracy-and-corruption [Accessed 10 April 2017] 14 http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//TEXT+REPORT+A8-2017-0056+0+DOC+XML+V0//EN&language=en [Accessed 12 April 2017] 15 https://www.occrp.org/en/laundromat [Accessed 23 March 2017] 16 https://www.justice.gov/opa/pr/nine-fifa-officials-and-five-corporate-executives-indicted-racketeering-conspiracy-and [Accessed 12 April 2017]

Supervision of obliged entities Enforcement powers and a credible deterrent We note that the proposed MLR 2017 does little to create a consistent approach to enforcement amongst supervisors, even within the same sector. For example, only the Financial Conduct Authority (FCA) and HMRC continue to have civil penalties provided for under the MLR 2017 and are the only bodies who are required to publish the details of the use of these powers. Similarly, the Government has not sought to standardise the sanctions other supervisors would have at their disposal, despite industry supporting such a measure to improve legal certainty.17 This inconsistent approach to enforcement leaves the UK’s AML system in danger of being exploited.

Criminals can ‘supervisor shop’ and target regulated communities which are at less risk of serious sanctioning.

It also allows businesses who fail to comply with the rules to gain an unfair advantage over businesses who have invested in systems and resources to address money laundering risks.

TI-UK recommends that the Government should review the enforcement tools for tackling money laundering in the UK and ensure that all AML supervisors have the necessary sanctions to provide a credible deterrent to money launderers.

Transparent Enforcement TI-UK has previously highlighted the lack of transparency around AML enforcement as a significant issue in the UK’s AML supervisory regime. Providing information about what sanctions are imposed for noncompliance is a key element of providing a credible deterrent against future non-compliance by others. It is also essential that supervisors are clear about how they use these sanctions through having publicly available enforcement policies.

We welcome the increased levels of transparency over enforcement actions required of HMRC in the new MLR 2017, and the new requirement for supervisors to submit to HM Treasury’s annual supervision report, which will help provide a better aggregate view of AML compliance and enforcement. This represents progress and would take HMRC closer to achieving the Macrory standards of enforcement.

The danger still remains, however, that an inconsistent approach to publishing enforcement information will leave the UK’s AML supervision ineffective. Under the proposed MLR 2017, only the FCA and HMRC are legally obliged to publish information about the sanctions they have imposed. Other supervisors ‘may’ make this information public, but there is no requirement to do so. This situation will lead to an incomplete picture of supervisory enforcement against money laundering breaches, as well as contribute to a lack of credible deterrent for sectors where supervisors do not publish this information.

TI-UK strongly disagrees with the view that publishing enforcement activity “could lead the public to draw incorrect conclusions about specific supervisors and their populations”. There is more danger of the public becoming misinformed due to a lack of accessible information on this. 18 These are not novel requirements, with similar provisions enshrined in law for a number of the UK’s largest regulators. For example, authorities given civil sanctions under the Regulatory Enforcement and Sanctions Act 2008 (“RES Act”) are under a legal obligation to publish an enforcement policy 19 and the details of their enforcement actions.20

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https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/600340/Anti-Money-Laundering-Supervisory-Regimeresponse-call-for-further-information.pdf [Accessed 12 April 2017] 18 https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/600340/Anti-Money-Laundering-Supervisory-Regimeresponse-call-for-further-information.pdf p.8 [Accessed 11 April 2017] 19 Sections 63 and 64, RES Act http://www.legislation.gov.uk/ukpga/2008/13/part/3/crossheading/guidance [Accessed 12 April 2017] 20 Section 65, RES Act http://www.legislation.gov.uk/ukpga/2008/13/part/3/crossheading/guidance [Accessed 12 April 2017]

By neither requiring supervisors to publish enforcement policies or the details of sanctions they impose, the Government is letting professional body supervisors miss out on three of the seven key characteristics identified by Macrory in his review of effective regulatory enforcement standards.21 TI-UK recommends it should be made a requirement under the MLR 2017 for professional body supervisors to meet the Macrory standards of transparency by requiring them to:  

Publish an enforcement policy outlining the powers and sanctions they have, how they intend to apply them in practice and the process for making appeals and representations against decisions Publish the details of individual cases of enforcement

Control and mitigation of conflicts of interest within professional body supervisors We note that the Government partially recognises that there is a potential conflict of interest for a professional body supervisor being both the regulatory body and a promotional body for their respective regulated communities. In the draft MLR 2017 it states that “Self-regulatory organisations [professional body supervisors] must make arrangements to ensure that— (a) their supervisory functions are exercised independently of any of their other functions which do not relate to disciplinary matters”. However, TI-UK thinks this leaves uncertainty as to how this should be implemented in practice.

Where this has been implemented elsewhere, for example, the separation of the Solicitors Regulation Authority from the Law Society in England and Wales, there is an oversight body – the Legal Services Board – that is required to make sure the governance arrangements for the sector’s supervisors controlled for conflicts of interest. There is no similar arrangement under the MLR 2017 as currently drafted, which appears to allow for the professional body supervisors to determine themselves what is appropriate. This would leave the possibility for professional body supervisors to have institutionally combined promotional and supervisory responsibilities, which would fail to comply with the Clementi principle.

To remove conflicts of interests within the new proposed AML supervisory regime, TI-UK recommends that professional body supervisors should be institutionally separate from their promotional and commercial activities.

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http://webarchive.nationalarchives.gov.uk/+/http:/www.bis.gov.uk/policies/better-regulation/reviewing-regulation/improvingcompliance-among-businesses [Accessed 12 April 2017]

About Transparency International UK Transparency International (TI) is the world’s leading non-governmental anti-corruption organisation. With more than 100 chapters worldwide, TI has extensive global expertise and understanding of corruption.

Transparency International UK (TI-UK) is the UK chapter of TI. We raise awareness about corruption; advocate legal and regulatory reform at national and international levels; design practical tools for institutions, individuals and companies wishing to combat corruption; and act as a leading centre of anti-corruption expertise in the UK. We work in the UK and overseas, challenging corruption within politics, public institutions, and the private sector, and campaign to prevent the UK acting as a safe haven for corrupt capital. On behalf of the global Transparency International movement, we work to reduce corruption in the high risk areas of Defence & Security and Pharmaceuticals & Healthcare.

We are independent, non-political, and base our advocacy on robust research.

Contact Steve Goodrich Research Manager steve.goodrich@transparency.org.uk Gemma Cartin Research Officer gemma.cartin@transparency.org.uk

www.transparency.org.uk