UK Government Proposes Changes to Its AML Regulations
Alexandra D’Acosta | Bloomberg Law
Following a review of its Money Laundering Regulations 20071 (MLR) and public comments received in response to an earlier Call for Evidence, HM Treasury published proposals to amend the MLR, and responses to the public comments. It also issued another Call for Evidence, requesting further comments on issues still under consideration. Comments are due by 30 August 30 2011.
The Treasury expects to finalise the MLR amendments in 2012.
Proposal to Amend the Money Laundering Regulations
HM Treasury proposed to amend the following provisions of the MLR: 1) criminal penalties; 2) businesses subject to the MLR (e.g., covered businesses); 3) customer due diligence; and 4) registration and appeals process for money services businesses (MSBs).
— Criminal Penalties
Independently from the Proceeds of Crime Act 2002 (POCA) and the Terrorism Act 2000, the MLR provides for criminal penalties for violations of its provisions. This enforcement capability, however, has not been widely utilised. In this rulemaking, the Treasury proposes to abolish it in order to encourage covered businesses to implement a risk-based approach towards anti-money laundering (AML) compliance. As the Treasury explained, covered businesses have been reticent to implement risk-based AML programs out of fear that this approach would subject them to criminal prosecution for minor procedural irregularities. As a result, businesses have instead opted to take a conservative, “tick-box” approach. According to the Treasury, removing the criminal penalties from the MLR would send a strong message to covered businesses and supervisors that the Government strongly supports a comprehensive risk-based approach.
In the alternative, the Treasury is debating whether to take a more measured approach rather than abolishing the criminal penalties outright. For example, it is considering the following proposals: 1) keeping the criminal sanction for the most important requirements (e.g., customer due diligence under Regulation 7); 2) keeping the criminal sanctions for certain high-risk businesses; or 3) strengthening or creating new civil powers to compensate for the loss of criminal sanctions, such as authorising supervisors to order remedial action. The Treasury specifically requested comments on this issue.
— Covered Businesses
The Government proposed to expand the scope of the MLR to cover UK real estate agents that handle property outside the UK. The justification for including these businesses is that they transact in potentially high-priced property outside the jurisdiction of UK authorities, which can be used to launder proceeds of local criminal activity.
The government also proposed to exempt the following businesses from the MLR: 1) very small businesses; and 2) non-lending businesses that allow payment for goods or services in instalments (non-lending credit institutions).
Under the MLR, all covered businesses are subject to the rules regardless of their size because there is a recognition that criminals tend to exploit businesses of all sizes to launder money. However, despite the risk of such exploitation, the Treasury proposes a de-minimis exemption for very small businesses or a reduction in the applicable requirements as a way to ease what it perceives as “unnecessary and excessive costs and bureaucracy” imposed on these businesses. The Treasury sought comments on the criteria it should adopt in determining which covered businesses qualify as “very small businesses.”
The MLR currently covers non-lending credit institutions, such as health clubs offering annual subscriptions that are paid in monthly instalments. To exempt such businesses, the Treasury set forth a proposal to exclude businesses that extend credit for payment of goods or services for a period of a year or less. The objective of this measure is to capture only those institutions that are in the business of issuing consumer loans.
— Customer Due Diligence
The MLR requires covered businesses to verify their customers’ identity, assess their particular level of risk, and manage and monitor their activity in accordance with such risk (i.e., perform customer due diligence (CDD)). Depending on the level of risk posed by the customer, simplified due diligence (SDD) may suffice, otherwise enhanced due diligence (EDD) is required where the customer is higher-risk, such as in the case of a politically exposed person (PEP).
Currently, covered businesses may rely on the CDD of other businesses that are regulated by the supervisors listed in Part 1 of Schedule 3 of the MLR. Covered businesses, however, may not rely on the CDD of businesses that are regulated by the supervisors listed in Part 2 of Schedule 3. Because the distinction between Part 1 and Part 2 supervisors is no longer relevant, the Treasury proposes to permit reliance on the CDD of both types of regulated businesses.
Additionally, the Treasury proposes to permit reliance in the context of debt purchases between supervised lenders, and corporate loans, such as syndicated loans.
— Registration and Appeals Process for MSBs
MSBs must register with HM Revenue & Customs (HMRC) before they can begin operations. To register with HMRC, a business must pass a “fit and proper” test. Currently, if a business has been convicted of a financial or terrorist related crime, it is not deemed fit and proper to become a registered MSB.
HMRC and law enforcement agencies have criticised this rule because it does not take into account convictions for other serious crimes. In support of their position and noting the significant risk of money laundering and terrorist financing associated with MSBs, the Treasury proposes to expand the MSB fit and proper test to incorporate all prior criminal offences.
In addition to making the fit and proper test more stringent, the Treasury proposes providing MSBs the right to appeal a decision by HMRC denying registration.
Government Response to Public Comments
In response to comments received from the earlier Call for Evidence, the Treasury addressed various issues, including the following: 1) the MLR’s risk-based approach; 2) the scope of covered businesses; 3) CDD; and 4) written policies and procedures.
— Risk-Based Approach
In addressing the comments regarding the MLR’s risk-based approach, the Treasury reiterated the importance it places on this approach as a means to accomplishing the objectives of the MLR, and noted the general support for this approach among commenters, who consisted primarily of covered businesses.
Despite general support for the risk-based approach, however, commenters identified certain challenges in applying it, such as: a lack of government guidance targeted to specific business sectors and of information gleaned from suspicious activity reports (SARs) about where the risks lie; inconsistent supervisor expectations about the proper application of the risk-based approach; and, conflicting requirements in other laws (e.g., sanctions laws that prescribe more absolute requirements).
The Treasury advised that it intended to make Approved Guidance and other resources more readily accessible on its website, and to work with supervisors and law enforcement to provide covered businesses more targeted guidance and useful information, including relevant data obtained from SARs. It also provided examples of helpful guidance currently available to businesses.
With respect to inconsistent supervisor expectations, HM Treasury said it is working with supervisors (local and international) to further standardise supervision and enforcement of the risk-based approach. According to the Treasury, a standardised supervision and enforcement regime does not require businesses to go beyond the statutory requirements (despite claims by some commenters of supervisor instructions to the contrary). The Treasury proposal to remove criminal penalties for MLR violations is intended to drive this point home. It is meant to neutralise fears of uncertain supervisor reactions to judgment calls made by businesses when applying a risk-based approach, particularly when dealing with grey areas.
Finally, the Treasury acknowledged that a risk-based approach may be more challenging than a prescriptive approach, as it requires covered businesses to understand the risks that their customers pose, and customise their compliance programs accordingly. Nonetheless, the Treasury considers the risk-based approach a more effective way to address financial crimes.
— Covered Businesses
While the government proposed amendments to the scope of the MLR, it declined to include and exempt certain businesses despite receiving comments urging it to do so.
For example, the Treasury rejected requests to subject clearing houses, online gambling businesses, betting shops, letting agents (rental agents), and high-value services businesses to MLR regulation. The general reasoning behind the its refusal to extend MLR regulation to these businesses was that the risks they pose do not warrant it, and neither the Financial Action Task Force Recommendations nor the EU 3rd Money Laundering Directive2 have proposed it.
Specifically, concerning letting agents, the Treasury cited a lack of documented evidence connecting these businesses to money laundering, despite the use of rental properties in connection with the drug trade, human trafficking, and counterfeiting. With respect to high-value services businesses, the Treasury drew a distinction between these businesses and high-value goods businesses, which criminals have used to launder money by buying and re-selling goods. According to HM Treasury, the risks associated with high-value services businesses are “less clear-cut.”
The businesses that the Treasury refused to exempt include real estate agents and pawn brokers. The Treasury rejected the arguments advanced by real estate agents, mainly that they are comparatively low risk because they do not deal in cash, and regulating them is duplicative because other parties to real estate transactions perform due diligence checks on customers. In its response, the Treasury said that real estate agents are in a position to know their customers and detect suspicious activity, and therefore should remain regulated. The Treasury also rejected the arguments of pawnbrokers, who argued that the small value of their transactions backed by assets make them low risk. The Treasury did not agree, and determined that pawnbrokers should not be exempt because they are susceptible to criminals, who seek to monetise stolen property.
— Customer Due Diligence
The Treasury responded to various comments regarding CDD, including comments pertaining to 1) beneficial ownership; 2) PEPs; and 3) copies of identification documents.
Commenters identified certain challenges faced by covered businesses in establishing the beneficial ownership of their customers (i.e., the individuals, who are the ultimate beneficiaries). The challenges stem from a number of issues, including the absence of independent sources to verify beneficial ownership, and the uncertainty as to how far covered businesses should drill down the ownership chain. In response, the government explained that it intends to work with other countries to “review and improve international standards on beneficial ownership,” and with supervisors to give covered businesses guidance on how much due diligence on beneficial information is sufficient.
Other commenters raised the difficulties with performing CDD on PEPs as a problem, in particular identifying PEPs and their family members and close associates, and knowing how much due diligence is necessary to satisfy the requirements of the MLR. The government responded that covered businesses should apply a risk-based approach to identifying and conducting CDD on PEPs. For instance, a covered business serving foreign, high-net worth individuals has a higher risk of encountering a PEP than a small, locally-focused business. As such, the higher risk business should tailor its CDD to meet the greater compliance demands of its business. Additionally, businesses should not depend so heavily on commercial PEP databases to identify PEPs. While these databases may suffice for most customers, they may not be sufficient in higher risk situations.
Another issue raised in connection with PEPs related to the scope of the definition of term. Some commenters requested that the definition be expanded to include domestic PEPs, not just foreign ones. Other commenters requested that the definition not be limited to persons who have held a prominent public position within the last year. They argued that the one-year limitation should be eliminated. The Treasury declined to amend the definition of PEP, although it stated that it is open to considering the issue further.
Finally, with respect to CDD, some commenters requested that the MLR be amended to require copies of identification documents. Currently, covered businesses may keep a copy or a record of the document details. After weighing the benefit to investigators of having available copies against the burden on businesses to maintain the copies, as well as taking into consideration public concern over the reproduction of their documents, the Treasury decided against amending the identification requirements.
— Written Policies and Procedures
The MLR requires covered businesses to maintain policies and procedures to ensure compliance with key requirements of the regulations. The policies and procedures, however, do not have to be in written form.
While there were calls from certain commenters to require written policies and procedures, the Treasury declined to adopt this measure. In explaining its position, the Treasury stated that “the real point of substance may be left unaddressed, if businesses acquire a written policy only for it to remain ‘on the shelf.’”
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