Cyprus is the third largest and third most populous island in the Mediterranean. It is located south of Greece and east of Turkey. The country has been a member state of the European Union since 2004 and of the eurozone since 2008.
In recent years, and in particular following the financial crash and subsequent bailout, Cyprus has often been criticized for its alleged involvement in financial crime activities resulting from its offshore sector. Since the 1990s, Cyprus has regularly been mentioned in relation to financial crime activity investigations, specifically regarding funds coming from Eastern European countries. Recently, Cyprus featured in the Securities and Exchange Commission (SEC) investigation into HSBC’s money laundering activities whereby the country appeared as a conduit and was used to set up shell companies through which to channel illegal funds.
By outlining the political background of the country’s current situation, the development of its financial center and the efforts which have been undertaken in recent years, we can better understand and ensure compliance, regulatory oversight and ultimately attain more overall stability for the islands’ financial system and make it less vulnerable to financial crime activity.
The Political Context—A Divided Island
The events in the summer of 1974 continue to dominate the politics on the island, as well as Greco-Turkish relations today. Following the Cypriot coup d’état, in 1955, the island was finally divided in the 1970s. Geopolitically, the island is divided into four segments: The Republic of Cyprus occupies the South; the Turkish Republic of Northern Cyprus the North; and the United Nations-controlled Green Line separates the two. Two bases under British sovereignty are located on the islands of Akrotiri and Dhekelia. The Turkish Republic of Northern Cyprus is recognized only by Turkey and not by the international community. Decades of unfruitful negotiations between the Turkish and Greek sides to reunify the divided island of Cyprus continue to this day.
Although a federation is widely recognized to be the best outcome, partition might have to be considered as an option too if the ongoing negotiations fail. The book Resolving Cyprus: New Approaches to Conflict Resolution edited by James Ker-Lindsay was reviewed by the Economist, which noted that many experts who are skeptical about reaching an agreement for federation pointed out that although partition is not the preferred outcome, it would at least reopen the border, return more property and land (including the ghost resort of Varosha, next to Famagusta) to the Greek Cypriots and stop the Turkish Cypriots’ international isolation.
Natural Reserves and Geopolitical Interests
In 2014, marking the 40th anniversary of the invasion of Cyprus by a Turkish army avenging an attempt to unite the island with Greece, the stalled peace talks were revived. On February 11, 2014, a joint declaration was made marking the start of renewed negotiations to settle the Cyprus dispute.
The discovery of vast oil and gas reserves in the eastern Mediterranean in Ankara, Athens and Nicosia was seen as a potential game changer as exploitation of the hydrocarbons would require regional stability not only on Cyprus but between Israel and Turkey as well. According to The Guardian, “The cheapest and most expeditious way of exporting the reserves, discovered first by Israel and then by Cyprus, would be through an underwater pipeline to Turkey. U.S. interest has been dictated partly by the desire to see Europe lessen its dependence on natural gas from Russia.”1
Although Greek-Cypriot officials initially spoke of a ‘seismic shift’ in Turkey and were confident that hydrocarbons could foster cross-border cooperation—“much in the same way that coal and steel helped unite Europe’s once warring partners in a community of nations in 1950”—the peace talks came to a standstill in late 2014 due to rising tensions in the eastern Mediterranean between Athens, Ankara and Nicosia over oil and gas reserves in the region. Instead of bringing the feuding communities closer to conciliation, the prospect of finding alternative energy supplies appears to have widened the gulf between them. In January 2015, “the United Nations Special Adviser on Cyprus, Espen Barth Eide, voiced concern over the difficulties to get negotiations back on track.”2
Cyprus’ Offshore Business
Since the mid-1970s, Cyprus has built a successful offshore financial industry, attracting billions of euros in deposits from the Middle East, Northern Africa and the former Soviet Union. Since the collapse of the former Soviet Union, Cyprus’ “offshore sector boomed while its banks bulged with Russian moneys in transit to Switzerland and other offshore havens,” according to an article published by Forbes in 2013.3
However, since the financial crisis in 2007, following the collapse of Lehman Brothers, the outflows from the industrialized nations to offshore havens, including Cyprus, also slowed. Cyprus took on more debt as a result of the slowdown in offshore activity, which finally led to the country’s financial crash. This also led to uncertainty amongst investors and further reduced the level of investment into the country.
Nonetheless, Cyprus continues to provide investors with attractive services like the 10 percent maximum corporate income tax for holding company structures, which draw capital to the country. The services of some 2,000 lawyers and more than 1,200 accountants active in setting up companies and advising investors on trusts and offshore companies in Cyprus will also continue to provide services to investors. Investigative journalist and economic expert, James S. Henry, was quoted in The Real News claiming that “a lot of Russian inbound investment is channeled through Cypriot companies to avoid corporate taxes” and that this will continue.4
Russia and Cyprus
According to Moody’s, some “$31 billion in Russian money was held in Cypriot bank accounts: $12 billion from banks and $19 billion from business and individuals.”5 A large amount of Russian money has been invested in Cyprus over the last two decades and an estimated one half to a third of all Cyprus bank deposits are of Russian origin. According to the June 2013 study published by the EU-funded Centre for Economic Policy Research (CEPR), “[t]he Russian State Statistical Agency, ROSSTAT, estimates that Cyprus has been the main country for Russian foreign investment after the Netherlands in terms of accumulated capital as of the end of 2011. At the same time Cyprus has been the third largest foreign investor into the Russian economy (after the U.K. and Switzerland) between 2005-2011.”6 The study concludes that the large amounts of Russian funds deposited in Cyprus banks combined with the foreign investment into Russia is evidence for ‘round-tripping’, and further states that the relationship between the level of corruption and the amount of round-trip investment across Russia finally proves this thesis.7
Interestingly, more than 80 Russian oligarchs have reportedly been given citizenship in the EU by way of Cyprus and Henry claims that there are about 50,000 Russian-speaking residents in Cyprus now.
Loopholes in Customer Due Diligence Procedures
Although Cyprus has emerged positively from various assessment programs regarding the implementation of international anti-money laundering (AML) standards, it has suffered severe criticism as a result of the financial crisis and allegations which resurfaced again regarding their role in laundering the proceeds of crime from Russia and other Eastern European states.
This criticism was boosted further by an investigation commissioned by the eurozone finance ministers into the customer due diligence (CDD) practices within Cypriot banks. According to EUObserver.com, almost 60 percent of one Cypriot bank’s clients were identified to be “high risk” in terms of money laundering and almost a third of all bank depositors’ records contained errors.8
The investigators identified that some 10 percent of the institutions clients were politically exposed persons (PEP) and that 58 percent posed to be high risk on money laundering. Gatekeepers were also identified as being high risk. The investigator’s report underlined that in only 9 percent of cases did institutions undertake enhanced due diligence (EDD) when dealing with complex structures and accounts held by firms with three or more layers of nominal owners between the bank and the beneficial owner. Although the number of suspicious transaction reports (STRs) filed between 2008 and 2011 was minimal, these figures appear to have improved since 2012. Also, the report claimed that the overall awareness regarding high-risk clients was identified to be solid.
In April 2014, Moneyval conducted an assessment on whether CDD measures are implemented effectively within the Cypriot banking sector. The assessment was conducted from March 19 to March 29, 2013. The key findings therein are summarized in the following:
A significant part of international business aimed at tax optimization is conducted in and through the Cypriot banking sector
- A significant part of international business aimed at tax optimization is conducted in and through the Cypriot banking sector. These activities were seen as being inherently vulnerable to misuse for money laundering (ML) and financing of terrorism (FT) purposes and as posing the highest ML/FT risk to the banking sector in Cyprus. These transactions include setting up complex corporate structures, cross-border transactions with counter-parties in various jurisdictions, introduced business, the use of nominee shareholders/directors, trusts, client accounts and cash-collateralized loans.
- The banks interviewed were overall knowledgeable and aware of AML/CFT issues, risks and requirements and broadly committed to implementing CDD requirements, shortcomings with the potential to undermine the effectiveness of CDD were identified in many of the banks interviewed. Also, in many of the banks the compliance function was not always adequately consulted in the acceptance of high-risk customers.
- Some of the banks interviewed were said to maintain business with a significant number of PEPs. The measures being applied to PEPs are not yet fully effective in some of the banks interviewed in respect of measures to determine the source of wealth of PEPs, identifying family members and close associates of PEPs and identifying a customer who subsequently becomes or is found to be a PEP.
- The interview partners did not emerge to be largely aware or clear about the implications of the recent amendment making certain tax crimes (including tax evasion) predicate offenses for money laundering.
- The reliance on introducers constitutes one of the largest areas of vulnerability for the banking sector in Cyprus. A large part of the international business is introduced to banks by professionals and trust and corporate service providers, the latter known in Cyprus as administrative service providers (ASPs). The banks, therefore, place significant reliance on the business introducers in Cyprus or other countries to certify the authenticity of many of the documents provided for CDD purposes and to perform some other elements of CDD.
- The large number of alerts generated by automated ongoing monitoring systems on high-risk accounts was identified to be disproportionate to the number of staff managing such alerts.
- None of the banks interviewed conducted an overall AML/CFT risk assessment specific to the individual bank, which could be used to determine the risk appetite of the bank across the whole range of its potential business lines.9
CDD on Cyprus-Based Entities
Given Russia’s involvement in Cyprus and the ongoing sanctions, financial institutions need to be diligent in their CDD to ensure that they are not being used to circumvent sanctions or to launder funds. The key questions regarding the source of funds and beneficial ownership is of utmost importance.
Foreign investors often engage local lawyers and accountants as incorporation agents and administrators for their activities in Cyprus. In recent years, a number of unlicensed operators have set up operations in Cyprus. In an attempt to maximize the control over the corporate service market, the Cyprus Parliament approved and adopted law 196(I)/2012 on Regulating Companies Providing Administrative Services and Related Matters in 2014. According to Mondaq, it is important that investors choose a licensed ASP company to administer their companies in Cyprus.10
Cyprus’ AML Regime and Regulatory Oversight
Cyprus AML legislation Prevention and Suppression of Money Laundering Acts Law, was approved by the Cyprus government in 1997 and ratified the International Convention for the Suppression of the Financing of Terrorism in 2001. Since then, amendments were made to the legislation with the most recent one dating back to 2012.
The Unit for Combating Money Laundering (MOKAS) was established to supervise the provisions of Prevention and Suppression of Money Laundering Activities Law and investigate any reports for potential money laundering.
The Cyprus Securities and Exchange Commission (CySEC) has reportedly been developing a risk-based supervision framework since early 2014. Within this context, a risk assessment will be performed for all entities at least every year and the outcome will be used to define each entity’s monitoring program for the forthcoming regulatory period. The assessment will be based on the impact, or potential harm that could be caused by a particular set of circumstances, weighted by the estimated probability of those circumstances actually occurring. The risk criteria can be based on quantitative or qualitative data. Following the assessment, the entities will be assigned one of four risk ratings, which will in turn define the level of supervision.11
CySEC has also released a risk assessment package for providers of corporate management and fiduciary services, which it refers to as ASPs. All authorized ASPs are required to register on CySEC’s electronic transaction reporting in January 2015 in order to attain formal authorization.
For AML professionals dealing with clients in and from Cyprus, EDD is recommended
Cyprus’ recent financial history is a textbook case of the devastating impact money laundering and misallocation of resources can have on a country’s monetary and economic stability, not to mention the social and security risks resulting therefrom. Moving on from the crisis with the aim of increasing the stability and resilience of the financial sector, Cyprus has implemented various measures including a risk assessment framework on the supervisory level in order to monitor and manage risk, including financial crime risk. For AML professionals dealing with clients in and from Cyprus, EDD is recommended. The political and geopolitical relevance of Cyprus, not least due to the discovery of natural resources combined with the island’s long-standing relationship with Russian investors, in particular given the ongoing dispute between Europe, U.S. and Russia and the sanctions attached, are all risk issues which need to be evaluated in the context of any one relationship or transaction in order to assess the customer, country, sector and product risk in a rounded risk assessment appropriately. Furthermore, given the role ASPs play in introducing clients to financial institutions, it is important to understand their CDD procedures as well as their own standing, integrity and reputation.
- Round-Tripping: is the transfer of funds abroad in order to transfer some or all of the investment back as foreign investment.
- http://www.mondaq.com/x/275652/Money+Laundering/Cyprus+Anti+Money+Laundering+Measures+And+The+New+Regulations+ For+The+Administrative+Service+Providers+ASP