THE ANTI-MONEY-LAUNDERING DIRECTIVE IMPLEMENTATION GROUP OF THE LEGAL PRACTICE DIVISION OF THE INTERNATIONAL BAR ASSOCIATION RESPONSE TO:

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1 THE ANTI-MONEY-LAUNDERING DIRECTIVE IMPLEMENTATION GROUP OF THE LEGAL PRACTICE DIVISION OF THE INTERNATIONAL BAR ASSOCIATION RESPONSE TO: THE WORKING DOCUMENT IN RELATION TO THE DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF COUNCIL ON THE PREVENTION OF THE USE OF THE FINANCIAL SYSTEM FOR THE PURPOSE OF MONEY LAUNDERING AND TERRORIST FINANCING I. Introduction In its role as a dual membership organisation, comprising 20,000 individual lawyers and over 190 Bar Associations and Law Societies, the International Bar Association (IBA) influences the development of international law reform and shapes the future of the legal profession. Its Member Organisations cover all continents and include the American Bar Association, the German Federal Bar, the Japan Federation of Bar Associations, the Mexican Bar Association and the Law Society of Zimbabwe. Grouped into two Divisions the Legal Practice Division and the Public and Professional Interest Division the Association covers all practice areas and professional interests. It provides members with access to leading experts and up-todate information as well as top-level professional development and network-building opportunities through high quality publications and world-class conferences. This submission is made to the European Commission ( the Commission ) on behalf of the Anti-Money Laundering Directive Implementation Group ( the Group ) established as a specialised working group of the Legal Practice Division of the IBA to address the practical difficulties that anti-money laundering legislation and its requirements is causing the legal profession in Europe and the world. The members of the Group are set out in Annex A. We hope that the Commission finds these comments helpful and we remain available to provide further elaboration as required by the Commission, indeed we believe that it would very constructive if we were able to meet with the Commission to discuss our proposals. We are grateful for this opportunity to participate in this invitation for public comments and we hope to contribute constructively to the process. LS795761/

2 Question 1: Would the application of the Risk Based Approach in connection with normal CDD procedures be, in your view, enough for institutions and persons covered by the Directive to deal normally with low risk situations? If a case-by-case approach implying the need to adopt implementing measures is followed, would the practical application of the Directive Rules be more difficult for the institutions and persons covered by the Directive? What would be in your view the costs and benefits of both approaches? II. The Principle of Risk Based Analysis It is important, we feel to set client identification and verification procedures in an appropriate context. For most entities, including law firms, that are subject to regulation by the Directive, the overwhelming percentage of customers/clients will pose absolutely no threat with respect to money laundering or the funding of terrorism. In this regard, it is necessary for the scope of simplified customer due diligence ( simplified CDD ) to be as broad as is prudent. In most cases, only a very small percentage of the client base of a law firm will merit detailed investigation to ensure there is no chance of money laundering - perhaps 5%. On the other hand, at the moment, the scope of simplified CDD may only extend to 10% of the client base in a typical law firm with the effect that the firm will have to investigate extensively as many as 85% of its clients unnecessarily. This burden is particularly onerous for smaller law firms, which are unable to spread the administrative burden and cost associated with compliance across a larger practice. The verification based regime for AML to date has been roundly criticised throughout the European Union ( the EU ) as being disproportionate in terms of the costs involved relative to (i) the impact on money laundering activities; and (ii) the generation of suspicious activity reports ( SARs ) that are actually used by law enforcement for productive ends. A loss of the hearts and minds of those who are subject to regulation is disastrous for achieving the laudable ends of the legalisation. Imposing requirements on the basis of risk has the potential to improve this situation dramatically and is to be welcomed but in order to achieve this end the Commission needs to think laterally. Given that the overwhelming percentage of businesses and individuals are perfectly law abiding, we feel that the starting assumption should be one of low risk unless there are particular risk factors to take account of - not the other way around. This means that simplified CDD should be extended considerably and that the implementing measures should be along the lines that broad categories of entities should be subject to simplified CDD unless they present identified risk factors. We would advocate that the Commission should then devote its efforts to seeking to establish technical criteria associated with the existence of higher risk factors which would mitigate against reduced due diligence. In this regard we think the Commission will be well advised to take extensive advice from law enforcement agencies. Surely those at the forefront of prosecuting those involved in money LS795761/ Page 2

3 laundering and terrorism could help identify the risk indicators for such persons and businesses. Definition of a higher risk profile would have considerable benefits if extensive due diligence was required to be carried out only in respect of those entities who matched a higher risk profile that would make the cost of compliance with the legislation more proportional to the benefits achieved. Moreover the technical criteria so established would serve to educate the regulated as to the typologies and other factors associated with money laundering thus boosting the levels of accurate and useful SARs. If we really want to combat these types of crime the regulators including the Commission have to assist the regulated to perceive where the risks actually lie. III. Comments on the Specific Proposals in the Working Document As noted above, the Group would like to see that the technical criteria for assessing low risk money laundering and terrorist financing situations as envisaged by Article 40(1)(b) of the Directive are enhanced and thoroughly developed to ensure that simplified CDD is both proportionate and effective and that the administration and compliance requirements that arise due to simplified CDD and consequences for client service are minimised. This is imperative if the Commission is to be sensitive to adverse cost implications for regulated entities. In Article 11, simplified CDD does not apply in respect of: 11(1) Credit and financial institutions within the EU or equivalent jurisdictions; How are equivalent jurisdictions to be established? Is this to be a subjective assessment by the regulated or would the Commission accept that it could greatly improve the consistency and efficiency of the process by publishing information regarding equivalence? On what basis is equivalence meant to be judged, for example, are all FATF members equivalent simply because they are signed up to all recommendations even though those recommendations may not have been implemented? Do FATF observers qualify as equivalent? We submit that use of the term equivalent is problematic, due to the subjectivity in defining what countries or markets are equivalent the determination will be painstaking for regulated entities and the ultimately non-equivalent, we would like to see greater definition and clarity from the Commission. 11 (2) (a) Listed companies whose securities are admitted to trading on a regulated market within the meaning of Directive 2004/39/EC; Again how is a regulated market to be identified? The above Directive delegates identification of regulated markets to the local competent authority with consequent uncertainty as between member states. This means that a multi jurisdictional law firm may need to observe different rules in the different jurisdictions in which it operates with consequent cost and inefficiency. LS795761/ Page 3

4 11(2)(b) Beneficial owners of pooled accounts held by notaries and other legal professionals from Member States; and 11 (2) (c) Domestic, public authorities. We are concerned that the provisions of Article 11 exempting the above categories do not also apply to other entities regulated and supervised under the Directive. By way of derogation other regulated entities ought to be exempted just as financial and credit institutions are. To retain the categories in their current, limited form is inequitable as there is recognition for one part of the regulated sector being low risk however there is not recognition of all others, including lawyers. We submit that on a risk-based approach regulated entities, including lawyers ought to be regarded as low risk within Article 40(1)(b) and therefore exempted from simplified CDD. Without prejudice to our more general comments regarding the overall approach that we feel should be adopted to the risk assessment as set out at the start of this paper, we also submit that whilst the above groups listed in (a)-(d) above qualify for simplified CDD, there are many other categories of customers that would fall within the technical criteria as envisaged by Article 40(1)(b) and pose a low risk of money laundering. We would advocate a full exemption from simplified CDD, or at least an exemption from CDD as to the determination of the ultimate beneficial owner as it applies under Article 7(1)(b), in relation to the categories of entity set out below: (a) Members of regulated markets within the meaning of Directive 2004/39/EC and members of regulated markets in third countries having consistent disclosure requirements with Community legislation; In this regard again the issue of equivalence/consistency arises with the risk of subjective determination we would advocate that the Commission disseminate for the benefit of the Member States as part of its technical criteria setting mandate a list of appropriate third countries and markets. (b) Companies incorporated within the EU and other jurisdictions that are deemed to be equivalent 1 or acceptable. We make this suggestion having regard to the practicalities rather than the theory of verification of beneficial ownership. It is straightforward to prescribe that beneficial ownership should be ascertained but actually in practice this is both overwhelmingly time consuming and often impossible to achieve with any degree of certainty. Suppose for example, that that company structure comprises numerous legal shareholders, all holding their shareholdings individually and with no apparent connection. How will a regulated entity be able to be certain as to the disposition of those shares at a beneficial level it is quite possible that the beneficial ownership of the company may have little correspondence to the apparent legal distribution. 1 Please see our earlier comments regarding the problematic use of equivalence. It is likely in our view that this will lead to greater subjectivity and therefore not a common standard across the regulated sector and also consume greater use of employee resources in doing so. LS795761/ Page 4

5 Furthermore, how is it anticipated that this evidence concerning beneficial ownership is obtained? If the information is obtained from the customer the obligation is easily avoided by a nefarious client through either fraud, structuring multiple holding companies with small shareholdings or non-disclosure of unverifiable beneficial arrangements such as trusts. We believe that it is disproportionate to place this obligation on the regulated with respect to EU based entities or indeed companies based in respectable jurisdictions. It would be a far more appropriate mechanism to require this information to be disclosed to a local registry once only for the benefit of the thousands of regulated entities covered by the Directive rather than to require the information to be gleaned time after time by each successive service provider with considerable cost and time implications both for the regulated and the buyer of goods/services. We submit that until such time as the information is available publicly a broad exemption from the obligation to verify beneficial ownership for EU domiciled companies should exist. (c) Fund Structures should be considered by means of risk-based analysis. Certain fund structures for example UCITS are authorised within the EU, therefore these funds are effectively regulated and should be exempted entirely. Additionally, where funds are managed by a credit or financial institution regulated in a member state or equivalent jurisdiction, lower standards of CDD should apply. On a risk-based methodology, we submit that where managed by a regulated credit or financial institution in a member state or equivalent jurisdiction, fund structures should be exempted from the requirements to verify the beneficial owner. As the beneficial owners for fund structures change so frequently, a static verification of the beneficial ownership is unsatisfactory, impractical, time consuming and costly. Where new subscribers to the fund structure have their identity verified to an appropriate standard, by a regulated administrator in a member state or equivalent jurisdiction, lower due diligence with respect to the beneficial ownership should ensue. Question 2: Do you agree with the sets of technical criteria? Can you identify other relevant technical criteria/ Can you identify any entity which could possibly meet the set of technical criteria further to the entities already covered in the directive?. LS795761/ Page 5

6 Do you prefer having a broader non cumulative technical criteria? If so please specify those broader criteria. Please specify as well which checks and balances would justify the application as simplified CDD in those circumstances. What would be, in your view the costs and benefits of such criteria? As noted above we believe that the Commission should instead give consideration to the establishment of high risk criteria rather than low risk criteria if it wishes to introduce an approach to risk based assessment which will both resonate with the regulated and be effective in propagating awareness of risk. With respect to the specific proposals in the Working Document, however, we would like to see that both sets of cumulative technical criteria are applied in a risk proportionate and cost effective manner and that they are as inclusive as possible. The first set of cumulative technical criteria should be expanded to cover more than simply the anticipated credit and financial institutions and perhaps insurance companies to all of the regulated institutions that are the subject of the Directive. Also concerning the first set of cumulative criteria, it will be both improbable and difficult to verify whether all of the criteria are met and thereby rendering the criteria too unwieldy to offer any operational effectiveness. The Commission should give consideration to assigning low risk where any of the criteria are met, rather than the criteria cumulatively. We comment with respect to the cumulative criteria in seriatim: 1. We submit that, on a risk based approach, where a parent company meets national legislation transposed under the third directive and is therefore regarded as low risk, then the factors which make this customer a low risk entity ought to be applied to its inter related companies and subsidiary companies despite whether they are regulated or listed in their own right. At a minimum this should apply where the low risk entity has a majority legal ownership of the shares or voting rights. 2. Where there is evidence that the customer has a transparent, publicly available and well-recognised reputation this should be sufficient to ensure that the customer is considered to be low risk. Additionally, as above we feel that national corporate registries should increase their filing requirements to include information concerning the beneficial owner. This will go a considerable way in minimising the due diligence necessary for regulated entities and ensure that there is a joined up approach by both the private and public sector towards anti-money laundering measures. 3. We submit that all regulated entities should be assessed as low risk. Member states should be responsible to ensure that all regulated sectors are adequately supervised and monitored. With respect to the second set of cumulative technical criteria, we again submit that a cumulative set of criteria will be almost impossible ascertain in practice without LS795761/ Page 6

7 extensive and disproportionate levels of effort given the likely level of risk in most instances. In addition to public and supernational organisations there are circumstances when privately held companies will be both transparent enough and be known publicly such that they fit within the second set of cumulative technical criteria. For example certain family owned entities in Germany. Question 3: Do you agree with the approach in relation to transparency of legal entities to beneficial owners of pooled accounts and to the implementation of the domestic public authority exception in respect of simplified customer due diligence? We concur with simplified due diligence for these two exceptions however it is likely that there are other exceptions which, due to transparency and other factors should also be considered for simplified CDD. Question 5: Do you agree with this approach? Wherever possible duplication of CDD should be minimised and mitigated. Therefore we submit that there should be mechanisms in place for mutual recognition or passporting of CDD between member states and between differing members of the regulated sector. This is particularly critical for our members which have offices and practicing lawyers in more than one member state, as variations in CDD requirements between member states can lead to an onerous and disproportionate burden. Question 8: Do you agree with this approach leading to the interpretation of the three main parts of the definition of the PEP or do you consider that a closed list of categories of persons should be established? What would be in your view the costs and benefits of the two options? We are concerned that the Directive under Article 13(4)(a) includes the obligation for all regulated entities to have measures in place to determine whether a customer is a PEP. This has greater scope than what is envisaged under FATF recommendation 6 where the obligation to determine whether a customer is a PEP is only imposed on financial institutions, not the entire regulated sector 2. Therefore we submit that where the Commission can, efforts should be made to mitigate this impact on regulated entities other than financial institutions. We submit that not only is it necessary for the functions to be defined, but additionally, in order to minimise the operational cost to regulated entities the member states ought to maintain a register of their PEPs so that the same are easily accessible 2 Recommendation 6 provides: Financial Institutions should, in relation to politically exposed persons, in addition to performing normal due diligence measures: (a) Have appropriate risk management systems to determine whether the customer is a politically exposed person (b) Obtain senior management approval for establishing business relationships with such customers (c) Take reasonable measures to establish the source of wealth and source of funds (d) conduct enhanced ongoing monitoring of the business relationship. LS795761/ Page 7

8 by regulated entities. Governments are better placed to identify and retain details of PEPs than the regulated and of course this would prevent inconsistency. For example the United States, Central Intelligence Agency publishes online 3 a world factbook which contains PEP s from the Executive, Legislature, Political party leaders and pressure group leaders for all countries. This resource is an invaluable standard and if the aims of the Directive are to be implemented, a similar resource from the Commission, perhaps concurrently with the member states would be facilitative. We would prefer a closed, static list of those functions that would be regarded as giving political exposure. Although the DG Internal Market considers this to be a too rigid approach, the consequence will be that regulated entities in member states will make their own determinations as to social, political and economic differences and this will lead to unsatisfactory and inequitable results. Reference to individuals in Article 3(8) who have been entrusted with prominent public front functions, is not certain enough to ensure that all categories of politically exposed individuals are ascertained. For example there is no certainty as to whether when an individual retires from a prominent public function the person remains a politically exposed individual. In the alternative, and without prejudice to our earlier submissions, if the register is not feasible we would expect that the Commission would give greater direction to what public functions constitute political exposure on a finite basis and where regulated entities may access this information. We are cognizant that for regulated entities to both track politically exposed individuals internationally and furthermore to discern whether their public function is serious enough to warrant monitoring will be extremely subjective without the Commission s strong guidance. We believe that this is necessary to define when, if ever, a person who held public office is no longer politically exposed. As a more general point, we feel that further consideration needs to be given to the role that PEPs may play in relation to an entity that make wish to transact with a regulated organisation. Clearly transacting with the PEP on a standalone basis is a straightforward issue but how can a regulated entity be certain that a PEP does not have beneficial rights in relation to shares even though the legal ownership would indicate that this is not the case (of course this a facet of the broader problems associated with beneficial ownership that are touched on above)? More specifically should a regulated entity be concerned if a PEP is non-executive director of a company and therefore, ostensibly, would have no control over is direction? How should CDD requirements be managed when there are conflicting risk indicators for example what should happen in the case where the potential new client is a listed financial services entity and therefore exempt from CDD but that entity has a PEP on the board (which is not uncommon for newly retired PEPs)? 3 LS795761/ Page 8

9 Question 9: Do you agree with this definition of prominent public functions? In the case of persons having held public functions, when, in your view should they no longer be included in the PEP Category? Why would be in your view the costs and benefits of these options? We submit that it would be more useful if a schedule of PEPs is published by the Commission or, in the alternative the member states in order to avoid any subjective elements which may arise to preclude individuals who are bona fide PEP s. Certainty this will reduce costs for the regulated sector and ensure that all PEP s are being adequately identified. A politically exposed individual can also abuse the political connections they have obtained in the course of their public service for a period after they hold a public function and therefore a limited and closely defined sunset provision as to their political exposure might be constructive. We note that there is no inclusion of the senior members of the armed forces in the definition of prominent public function. This position, especially within less developed societies, is clearly a position of political influence. Question 10: Do you agree with the definition of immediate family member? Do you see the value in extending the definition of family member to other relatives in the case of PEPs originating from specific world regions? What would be, in your view, the costs and benefits of these options? There will be significant cost for regulated entities if the Commission and/or Member States does not retain firstly a register of politically exposed individuals and secondly a register of their immediate family members. The due diligence to ascertain and monitor relationships with family members of PEP s will be extremely costly and can only result is disparity between the approaches taken by the regulated. The notion that this could be extended in specific world regions to include other family members and not necessarily immediate family members will be very difficult for regulated entities to determine. We reiterate that a finite list of politically exposed individuals and their immediate family members should be published by the Commission or by the member states to reduce costs to regulated entities. Without a standardised list this requirement is wholly improbable and therefore will not be complied with. We appreciate that a list is difficult, however it is much more difficult for each regulated entity to go about the task individually. Question 11: Do you agree with this definition of persons known to be close associates of PEPs? We are concerned about the subjectivity of any methodology which is used to determine close associates of PEPs and reiterate that known close associates should LS795761/ Page 9

10 be published by the Commission and or member states with a view both to proportionality and consistency. Question 12: Do you find that these indicates provide a useful basis in evaluating the risk dealing with PEPs originating from high risk countries as far as corruption is concerned? We agree that non-governmental organisations that monitor corruption levels such as Transparency International and supra national organisations such as the OECD are useful indicators in determining a risk sensitive analysis when dealing with politically exposed individuals. We also feel that the existing scandals and typologies, as published by government authorities, are useful indicators. Question 13: Do you agree with this approach in relation to identification of PEPs in concreto? We agree that the problem of identifying PEPs in concreto is a very difficult task which will come at significant expense for regulated entities subject to the Directive. We would welcome guidance from the Commission concerning risk based circumstances and if the guidelines also include a schedule of PEPs identified within the member states then this is a progressive development. LS795761/ Page 10

11 ANNEX A Anti-Money Laundering Directive Implementation Group Members Stephen Revell, Group Co-ordinator, Partner of Freshfields, Bruckhaus Derringer and IBA Legal Practice Division Council Member Willem Calkoen, Advocaat, NautaDutilh N.V, Rotterdam, the Netherlands Jan Eijsbouts, Akzo Nobel NV, Arnhem, the Netherlands, Co-Chair, IBA Corporate Counsel Committee Alberto Gonzalez-Pita, Tyson Foods, Inc, Arkansas, United States Christopher Murray, Kingsley Napley, London, England Peter McNamee, CCBE Liaison to the Group Monty Raphael, Head of Fraud and Regulatory of Peters and Peters, London, England Senior Advisor to the Group and Chair of the IBA Anti-Corruption Working Group François Serres, Francois Serres & Associates, Paris, France Valentina Zoghbi, IBA Research Lawyer LS795761/ Page 11