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Article | Risk Management Matters

How UK law firms should be preparing for the Fifth Money Laundering Directive

Credit, Political Risk and Terrorism|Financial, Executive and Professional Risks (FINEX)|Securities
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January 7, 2020

The new directive is meant to enhance measures in fighting money laundering and terrorist financing.

Why 5MLD was introduced

Advances in technology and alternative financial systems are assisting criminals to fund terrorism and launder illicit proceeds.  In order to continue fighting such criminal activities the United Kingdom (UK) has to ensure that the measures and controls that have been implemented are robust and effective.

Following the escalation of terrorist attacks both here in the UK and across Europe, and the leak of 11.5m documents exposing details about companies and individuals which identified criminal activity in the global financial systems in the Panama Papers incident, it was acknowledged that further measures were needed to ensure that criminals were not taking advantage of any vulnerabilities in the existing anti money laundering and counter terrorist financing legislation. It was established that there was a need to increase the overall transparency of the European economic and financial environment hence the introduction for the Fifth Money Laundering Directive1 (5MLD) which aims to strengthen the measures and controls provided for under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 20172 (MLR 2017).

What risks UK law firms face from money laundering

The legal profession is considered to be attractive to criminals because funds can be handled confidentially through law firms’ client accounts. The services provided by solicitors are seen as crucial to criminals looking to launder their proceeds of crime, especially by purchasing property and creating companies and trusts.

Criminals will instruct solicitors to purchase property which allows large sums of money, often in single transactions, to enter the legitimate financial systems through law firms’ client accounts. The formation of companies and trusts is currently assessed as the greatest risk of exploitation from criminals as it enables companies and trusts to be created anonymously, concealing the identity of beneficial owners and disguising the true origins of the funds. By involving a legal professional adds a greater level of respectability and legitimacy to the transaction.

The misuse of law firms’ client accounts represents a further risk from money laundering as criminals will seek to exploit access to these accounts by transferring their ‘dirty’ money into the legitimate financial system with payments often being made to third parties unconnected with the transaction. There must always be a legitimate underlying legal transaction and law firms client accounts must not be used by clients as a banking facility.

The risks law firms face from money laundering and the potential damage it causes to the public interest and confidence in legal services is a key concern for supervisors of the legal profession. The scale of money laundering affecting law firms can vary, ranging from serious organised criminal groups to individuals dealing in drugs. The UK Government’s National Risk Assessment of Money Laundering published in 20173 (NRA) assessed the legal profession as high risk to money laundering (NRA, 2017, p.53), yet there is no specific evidence of services offered by law firms being exploited by terrorists. Therefore the risk associated with terrorist financing to the legal profession is considered to be low (NRA, 2017 p. 53) but the threat cannot be ignored.

Why the UK Government intends to adopt 5MLD despite Brexit

The UK is a major contributor in the fight against money laundering and terrorist financing, and despite Brexit the UK has promised to abide by all existing and new European Union (EU) legislation.  5MLD is seen as a crucial tool in fighting tax evasion, money laundering and terrorist financing by increasing the overall transparency of economic and financial environments. By implementing 5MLD the UK will be making the other global financial centres aware of its intention to strengthen its integrity as a leading international financial centre and seeking continuous access to the EU markets.

In the event of a no deal Brexit it is anticipated that the UK will still adopt the 5MLD in order to maintain full access to those markets and to retain its status as one of the world’s leading jurisdictions in combating money laundering and terrorist financing as identified by the Financial Action Task Force’s Mutual Evaluation Report published in December 20184 (MER).

How can UK law firms and financial services organisations transpose 5MLD ahead of 10 January 2020 deadline?

Law firms and financial services organisations are already subject to comprehensive regulatory and legislative anti money laundering and counter terrorist financing requirements. Despite the findings in the MER in which the UK is identified as a ‘global leader’ in fighting money laundering and terrorist financing, there is no room for complacency as the risk from these criminal activities is still considered significant.  

It is not anticipated that the implementation of 5MLD will require major changes to organisations’ policies and procedures, much of the work should have been carried out in the lead to the enforcement of MLR 2017 on 26 June 2017.

However, in preparation for the enhanced measures being imposed by 5MLD when it becomes national law on 10 January 2020, it is recommended that organisations should be checking the efficacy of their current policies and procedures and looking at what actions need to be taken.  The key changes that need to be considered are as follows:

Technological Advancements

As a consequence of advancements in technology, client due diligence verification will be able to be conducted electronically.  Furthermore, cryptocurrencies and custodian wallets providers will fall within the scope 5MLD the appropriate client due diligence procedures will need to be followed. 

Organisations will need to consider whether they are going to use this method to verify their clients’ identification, and how it will be used. It is recommended that organisations carry out the appropriate due diligence when choosing their provider. They will also need to understand their obligations in relation to reliance on using electronic identification providers and ensure that they have adequate measures in place to ensure compliance with GDPR about sharing the requisite information about their clients with the electronic verification provider.

Law Enforcement Improvements

New national bank account registers will be introduced to enable the Financial Intelligence Unit (FIU) to access all bank account information held in the UK. The FIU will be able to request this information even if a suspicious activity report as not been submitted. In preparing for 5MLD organisations will need to consider how they will deal with such requests from the FIU and who will be responsible for dealing with requests.

Increasing Transparency of Beneficial Owners

There will be greater public access to the beneficial ownership register for corporate entities and trusts in order to strengthen transparency. However, access to the beneficial ownership of trusts will only be limited to those with a ‘legitimate interest’. There is currently no definition of ‘legitimate interest’ and this will be determined by the UK upon enforcement of 5MLD.

There will also be a requirement for law firms and financial services providers to report any discrepancies identified between the information that they hold on corporate entities and the information held on the beneficial owners register for corporate entities. Again, organisations will need to consider how the registers will work in practice and who will be responsible for dealing with the information and reporting any discrepancies.

Enhanced controls relating to High Risk Third Countries

Existing policies and procedures will need to be reviewed to ensure that they adequately deal with the risk of business relationships or transactions involving high risk third countries and the need to conduct enhanced due diligence.

Politically Exposed Persons

The UK will be issuing a list clarifying which functions qualify as “prominent public functions”. However, whilst the UK government will be responsible for keeping the list up to date it is anticipated that individual law firms and financial services organisations will be responsible for ensuring that they have full access to this list and that all relevant staff aware of it in order to conduct the correct level of due diligence.

Cessation of anonymous accounts

From 10 January 2020 anonymous accounts such as safe-deposit boxes and passbooks will no longer be permitted. Organisations will need to determine whether they hold such items and how they will deal with reporting the changes to these anonymous clients and how they will deal with the closure such accounts.

Prepaid Instruments

The threshold requirement to conduct client due diligence has been reduced from €250 to €150 and prepaid instruments has been extended to include gift cards and travel cards. Again, measures need to be implemented to ensure that holders are made aware of the changes and provisions to deal with the appropriate client due diligence measures and that all relevant staff are aware of the changes.

By planning effectively and providing ongoing training will ensure that there is a culture of anti money laundering and counter terrorist financing embedded in law firms and financial services providers which should ease the burden that both the legal and financial sector may feel is being imposed on them with this additional piece of legislation.

It should not be forgotten that by having such robust measures in place will help the UK maintain its status as a global leader in the fight against organised crime and as an international financial centre, at the same time as keeping the UK safe from the threat of money laundering and terror attacks.

Footnote

1 Directive (Eu) 2018/843 Of The European Parliament And Of The Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU

2 The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

3 HM Treasury and Home Office (2017). UK national risk assessment of money laundering and terrorist financing. Retrieved from HM Government website

4 Financial Action Task Force (2018).  The United Kingdom's measures to combat money laundering and terrorist financing retrieved from the Financial Action Task Force’s website

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