The Coronavirus has changed much, but not HM Government’s determination to follow through with Brexit — it still insists that the transition period must not outlast the year. When it comes to money laundering regulations, though, we have already seen big changes that many might have missed.
All the recent attention has been on the enshrinement of the European Union's fifth Money Laundering Directive (MLD) into the law of the UK; this came into force on 10 January. Another amendment to the Money Laundering Regulations 2017 that took effect at the end of the same month received much less attention.
That is perhaps because, in one sense, the Money Laundering and Transfer of Funds (Information) (Amendment) (EU Exit) Regulations 2019, known as the "Brexit amendment," is an exercise in tidying up. It merely helps the UK to keep existing anti-money-laundering laws while removing references to such European institutions as the Commission and to EU directives.
It does, however, make one significant change in and of itself. The definition of a “third country,” referred to several times within Money Laundering Regulations (as amended), is no longer a country outside the European Economic Area (EEA), but any country outside the UK. This seemingly small change could have profound consequences for some regulated firms.
A fresh look at jurisdictions
The change in the meaning of this odd-sounding term is going to have two consequences. First, the requirements to conduct enhanced due diligence on HNWs in “third countries” now applies to anyone outside the UK. Second, it removes various assumptions regarding the “equivalence” of EEA member states’ AML regulations. To continue to comply with the Money Laundering Regulations, as amended, firms may have to assess the so-called "money-laundering risks" of jurisdictions on the Continent that harbour their HNW customers.
The effect that this could have is most evident when it comes to correspondent banking. Regulation 34 obliges a firm to enhance its "due diligence" (to perform "enhanced due diligence" or EDD, looking at every correspondent bank's ownership, structure, directors etc more intently than normally) and some additional measures for relationships with respondent banks in "third countries." They must determine the reputation of this-or-that respondent, assess the quality of supervision to which it is subject and obtain the approval of senior managers to establish a relationship with it.
The extra job of checking relationships with banks in the EEA will be a bothersome chore, particularly when one looks - as one has to - into the "equivalence" or otherwise of the AML regulations in various countries. The UK's standards are higher - often far higher - than those of most EU countries on this subject. Firms cannot merely assume that all EU countries are following Brussels' fourth and fifth directives to the letter; they are not. They should find out how well each country is obeying the directives and whether its standards are “similar” to those of the UK. As readers of Compliance Matters know, the EU has often criticised various countries for failing to implement the fourth directive in time, or at any rate to adhere to its spirit, so this is not a foregone conclusion.
There are other changes as well. For instance, Regulation 20 dictates that a British firm with a subsidiary or branch in a third country with AML regulations “not as strict” as the UK’s must ensure that it applies measures that are "equivalent" to those in the UK.
There are even more changes. For instance, the 100-page Guidance on Risk Factors issued by the European Supervisory Authority no longer forms part of the amended Money Laundering Regulations. This may mean that the onus of keeping up-to-date, robust and consistent standards for assessing the risks posed by HNW customers (and perhaps their businesses) can fall on the Joint Money Laundering Steering Group (JMLSG) or the Financial Conduct Authority. If this does not happen, firms might relax the criteria according to which they decide whether to apply EDD.
It is obvious that these changes will not improve standards of "due diligence" in every case. One provision of the Money Laundering Regulations (as amended) requires firms to apply EDD when dealing with customers in countries that the European Commission (one of the organs of the EU) judges to be "highly risky" in accordance with Article 9.2 of the fourth directive, unless those customers are branches or majority-owned subsidiaries of firms whose regulators reside in the EEA. The "Brexit amendment" to the Money Laundering Regulations retains the substance of Article 9.2 but replaces the reference to the EEA with the mention of "a third country" with regulation equivalent to that engendered by the fourth directive. With this, the scope of the exception now extends to branches and subsidiaries in jurisdictions outside the EEA.
A similar effect is to be seen in customer risk assessments in accordance with the Money Laundering Regulations (as amended) and the factors that firms must consider when deciding whether to apply EDD or "standard due diligence." Because of the "Brexit amendment," firms assessing credit or financial institutions may consider the fact that the customer is based in a jurisdiction that implemented the fourth directive in its national law as a factor that decreases the risk. Previously, that applied only to those customers in countries that had directly enshrined the directive in their laws.
These are the exceptions, however. In general, the requirement to review relationships in the light of the amendments and the need to assess the worth of AML laws in various parts of the EEA will probably increase the workloads of money-laundering reporting officers (MLROs) significantly.
A way out?
It is open to question whether that extra workload will be of benefit to reporting institutions. After all, the "country risk" of EEA states has not changed since January. Neither have many of the firms that are now required to conduct EDD.
It is quite possible that HM Government will step in. It could, for instance, make some prounouncements in the next edition of its National Risk Assessment. HM Treasury is supposed to produce one of these in the middle of every year. It might say that correspondent banking remains a highly risky business but not if the correspondent bank is in the EEA. The FCA (which up to now has been curiously quiet about the Brexit-related changes to AML law) also has the power to publish its "sector views" that delineate risks that regulated firms must consider. Again, it could use this to limit the required "due diligence" for transactions involving EU firms. So far, however, there is no sign of either of these things happening. Perhaps this is for the best, in view of the Scandinavian scandals and other examples of EEA banks failing to spot money launderers until it is too late.
* Julius Kania can be reached on +44 2070890803 or +44 7776470294 or at email@example.com; Maria Evstropova can be reached on +44 20 7089 0861 or at firstname.lastname@example.org