The Fifth European Union (EU) Anti-Money Laundering (AML) Directive (5AMLD)1 which entered into force on the 9 of July 2018, must be implemented by the EU member states by January 2020. Firms affected by the new directive, obliged entities, face new challenges resulting from the relevant amendments to the Fourth EU AML Directive (4AMLD) of 2015 (implemented in 2017).2
Business relationships with high-risk third world countries, countries assessed by the European Commission as having strategic deficiencies in their anti-money laundering/counter-terrorist financing (AML/ CTF) regimes, are of particular concern.3 The new directive imposes enhanced due diligence (EDD) requirements and suggests possible business restriction with respect to these high-risk countries (see box 2). However, the selection of countries for the blacklist has proven to be a politically controversial process (see box 1).
Box 1 - EDD Measures With Respect to High-Risk Third Countries
Article 18a (Dir. 2018/843) requires EDD measures including obtaining additional information on the customer and the beneficial owners; the intended nature of the business relationship; the source of funds and wealth; and the reasons for the intended or performed transactions.
One particular precautionary measure may require that the “first payment be carried out through an account in the customer’s name, with a credit institution subject to customer due diligence standards that are not less robust than those laid down in this directive.”
In addition to increased relationship monitoring and mitigating measures on transactions with high-risk countries, the regulation suggests limitations of the business relationships, such as “refusing the establishment of subsidiaries, branches or representative offices of companies from a high-risk third country,” and “prohibiting the establishment subsidiaries, branches or representative offices in a country concerned.”
Another clause stipulates that “correspondent relationships with respondent institutions in a high-risk country should be reviewed and if necessary terminated.”
Box 2 - Controversial List of High-Risk Third Countries
Based on Article 9 (2) of Directive 2018/843, on the 13 of February of 2019, the European Commission presented a list of 23 high-risk third countries, which had been assessed as having strategic AML/ CTF deficiencies.4 The list went beyond the FATF list of “high-risk and monitored jurisdictions” and included 11 additional jurisdictions, among them Saudi Arabia, Panama and three U.S. territories: Puerto Rico, American Samoa and U.S. Virgin Islands. The U.S. Treasury was critical of the list.5 At the same time, the list also drew criticism for omitting a number of countries considered to be strong candidates.6 More importantly, the list was not supported by the European Council, which raised its veto on the 5 of March of 2019.7 Officially the council objected for methodological reasons, although the commission explained in its proposal—C(2019)1326—why it had selected each country, and it had apparently also consulted the affected countries before including them on the list.8
The quarrels over the list of high-risk countries are opposite to the original idea of pursuing a harmonised approach toward high-risk countries with a focus on standard EDD and mitigant measures where applicable. In any case, the commission is reconsidering the list and will have to reach the consent of both the European Council and the European Parliament at an early stage at the risk of ending up with a watered-down list, which would harm the credibility of the whole process.
On 12 of March of 2019, the EU finance ministers adopted a revised list of countries considered to be tax havens including American Samoa, Bahrain, Aruba, Barbados, Belize, Bermuda, Dominica, Fiji, Guam, Marshall Islands, Oman, Samoa, Trinidad and Tobago, the U.S. Virgin Islands, United Arab Emirates and Vanuatu.9 Questions remain if this list can be considered complete and meaningful, or cut short for political reasons. Of course, the list gracefully omits EU member states considered to be problematic tax jurisdictions.
Financial institutions and other obliged entities should be aware that a country blacklist resulting from political negotiations is necessarily biased and may not represent the full picture. Any EU list or similar lists, such as the Financial Action Task Force’s (FATF) list, should be complemented by a company-specific country risk assessment, based on their countries of operations, and reliable expert and media reports about relevant AML deficiencies. This is also true for possible associations with tax havens, which appear on a separate selective EU list.
This article discusses some other modifications contained in the 5AMLD, which entails notable consequences for the practice of risk-based customer due diligence (CDD).
Centralised Ownership Information
The 5AMLD entails regulatory improvements for advancing the basic step of any CDD, namely the establishment of the beneficial owner of a relevant entity. The EU member states’ beneficial ownership registries will be more centralised, extended and more accessible for the public in the future. This means that the registries shall be interconnected via the envisioned European Central Platform by March 2021, and there will then be an obligation to consult this platform before entering in a new business relationship. Trusts and similar arrangements will be included in the beneficial ownership registries’ common platform. Unlike the current practice in some member states, the general public will be given access to the ownership information—with some restrictions regarding trusts—essentially allowing greater scrutiny by the press and civil society organisations.
Should the EU manage to effectively implement a centralised database platform containing reliable ownership information, the effect may extend well beyond the improved efficiency of know your customer (KYC) research, essentially carrying the message that any country that does not provide access to such ownership information should be regarded as a highrisk country from a regulatory perspective. In practical terms, this would imply that KYC research, which encounters barriers when establishing beneficial ownership information from public registries, could trigger risk-based EDD measures or even the next level of integrity due diligence (IDD), including an in-depth country investigation.
The fight against money laundering engages in strategic interaction, where tightening the regulation means that potential perpetrators will likely become more inventive instead of giving up. This means that an ultimate beneficial owner (UBO) who wants to stay in the hiding will either use jurisdictions that do not provide ownership information, or will hide behind layered and complex shareholding structures. In any case, intransparent structures where it is not possible to identify the UBO will further increase the risk exposure in the future.
Transparency of Funds
Furthermore, 5AMLD, in a new Article 10 (1), requires member states to prohibit their credit institutions and financial institutions from keeping anonymous accounts, passbooks or safe-deposit boxes, rendering their owners and beneficiaries subject to CDD measures (in force since 10 January 2019). Furthermore, a centralised automated mechanism will be set up to allow the identification of bank and payment account holders and safe-deposit boxes by September 2020. The information will be available for financial intelligence units and national authorities.
In practice, abolishing anonymous accounts will support establishing the source of funds of a customer. When entering a business relationship, the source of funds should always be clear. With respect to third countries, where it is not possible due to anonymity or other barriers to understand where the money came from, such high-risk factors should trigger EDD, essentially widening the scope to question the source of wealth of the customer as a whole.
From a practical perspective, in order to detect if funds come from illicit proceeds and/or are transferred as part of an ultimately illegal money laundering scheme, the flow of funds must be assessed in the context of the nature of the business relationship and the purpose of the transaction. Any suspicion that a transaction involves intermediaries—behind which ultimate owners of potentially illegitimate funds may hide—is a red flag and should trigger EDD or IDD.
Politically Exposed Persons
Another area where 5AMLD introduces some improvements for CDD relates to the identification of politically exposed persons (PEPs). Member states are required to develop a list of specific functions or offices (not names) that qualify as prominent public functions in the respective country, including those of registered international organisations. To what extent these lists will display differences in the classification of PEPs—for example, with respect to party leaders or mayors of larger cities—remains to be seen. In any case, the identification of a PEP, a relative or close associate of a PEP linked to any one customer relationship should be part of simplified due diligence procedure in order to trigger EDD measures should this high-risk criterion apply.
Relying on prepared PEP lists is a necessary starting point but may not be sufficient as indirect but crucial links to PEPs through associates may not be uncovered. Again, given that more and more actual PEPs will know that they are on the radar screen, those who have something to hide will try to use intermediaries in an attempt to avoid triggering a red flag.
EDD on an identified PEP comprises obtaining additional information on whether the high-risk qualification can be substantiated—for example, by proof of relevant business interests, any questionable use of power, links to irregularities or even corrupt practices—which increase the likelihood of involvement in money laundering activities. The PEP definition is a functional definition that needs to be considered in the context of the specific jurisdiction and business relationship. The threshold for defining a person with a political function as a PEP should be set lower rather than higher in order to be able to exercise the appropriate due diligence to detect corruption and money laundering when it exists.
The 5AMLD further raises the benchmarks for the practice of EDD on high-risk customers. Whilst the EU is struggling with political difficulties in defining high-risk jurisdictions both for money laundering/terrorist financing and tax purposes, the controversial discussion about the relevant country lists has provided financial institutions and other obliged companies with ample information about notorious countries of concern—hard to ignore when conducting due diligence on customers linked to these countries. With respect to verifying customer information, the 5AMLD carries the message that accepting a business relationship without knowing the ultimate beneficial owner and without knowing the source of funds entails serious risks of being associated with criminals and their illegal proceeds. EDD should reckon with layered ownership structures and intermediaries involved in the flow of funds. Similarly, the identification of a PEP’s hidden involvement in ownership and transactions requires in-depth knowledge of a customer’s political and business environment.
- “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,” EUR-Lex, 30 May 2018, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32018L0843
- “Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC,” EUR-Lex, 20 May 2015, https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=celex%3A32015L0849
- “EU Policy on High-Risk Third Countries,” European Commission, https://ec.europa.eu/info/policies/justice-and-fundamental-rights/criminal-justice/anti-money-laundering-and-counter-terrorist-financing/eu-policy-high-risk-third-countries_en; “EU Methodology for Identifying High-Risk Third Countries,” Global Risk Affairs, 11 July 2018, https://www.globalriskaffairs.com/2018/07/eu-methodology-for-identifying-high-risk-third-countries/
- “Commission Delegated Regulation (EU) of 13.2.2019 supplementing Directive (EU) 2015/840 of the European Parliament and of the Council by identifying high-risk third countries with strategic deficiencies,” European Commission, 13 February 2019, https://ec.europa.eu/info/sites/info/files/commission-delegated-regulation_hrtc.pdf
- “Treasury Statement on European Commission List of Jurisdictions with Strategic AML/CFT Deficiencies,” U.S. Department of the Treasury, 13 February 2019, https://home.treasury.gov/news/press-releases/sm610
- Simon Bowers, “European Commission shames Saudi Arabia, Panama with ‘dirty money’ blacklist,” International Consortium of Investigative Journalists, 14 February 2019, https://www.icij.org/blog/2019/02/european-commission-shames-saudi-arabia-panama-with-money-laundering-and-terror-financing-blacklist-but-attracts-criticism/
- Council of the European Union, 6964/1/19 REV 1; Bjarke Smith-Meyer, “EU countries revolt against Commission’s dirty money list,” Politico, 4 March 2019, https://www.politico.eu/article/eu-countries-revolt-against-commission-dirty-money-list-vera-jourova/
- “Anti-money laundering: Q & A on the EU list of high-risk third countries,” European Commission, 13 February 2019, http://europa.eu/rapid/press-release_MEMO-19-782_en.htm
- Bjarke Smith-Meyer, “EU adopts tax haven blacklist,” Politico, 12 March 2019, https://www.politico.eu/article/eu-adopts-tax-haven-blacklist-despite-romanian-doubts/