1.2.2 The Role and Activities of Regulators
Governments are responsible for setting the role of regulators and in so doing will clearly look to see that international best practice is followed through the adoption of IOSCO objectives and principles and by co-operation with other international regulators and supervisors.
As an example of this, European governments co-operate regionally to ensure there is a framework of regulation that encourages the cross-border provision of financial services across Europe by standardising or harmonising each country’s respective approach. European regulators co-operate to co-ordinate activities and draft the detailed rules needed to introduce pan-European regulation through the European Securities and Markets Authority (ESMA).
In Asia, the basic structure and content of securities regulation is increasingly similar to the model adopted in most other parts of the world and most countries are members of IOSCO and subscribe to its principles of securities regulation.
2. Money Laundering
Money laundering is the process of turning dirty money (money derived from criminal activities) into money that appears to be legitimate. Dirty money is difficult to invest or spend and carries the risk of being used as evidence of the initial crime. Clean money can be invested and spent without risk of incrimination. Money laundering disguises the proceeds of illegal activities as legitimate money that can be freely spent. Increasingly, anti-money laundering provisions are being seen as the front line against drug dealing, terrorism and organised crime.
There can be considerable similarities between the movement of terrorist funds and the laundering of criminal property. Because terrorist groups can have links with other criminal activities, there is inevitably some overlap between anti-money laundering provisions and the rules designed to prevent the financing of terrorist acts. However, these are two major differences to note between terrorist financing and other money laundering activities:
• Often, only quite small sums of money are required to commit terrorist acts, making identification and tracking more difficult.
• If legitimate funds are used to fund terrorist activities, it is difficult to identify when the funds become ‘terrorist funds’.
Terrorist organisations can, however, require significant funding and will employ modern techniques to manage them and transfer the funds between jurisdictions, hence the similarities with money laundering.
According to the KPMG Global Anti-Money Laundering Survey published in 2007, a staggering US$1 trillion per year is being laundered by financial criminals, drug dealers and arms traffickers worldwide. Unsurprisingly, therefore, anti-money laundering (AML) policies and actions are high on the international agenda.
2.1 International Approach to Combating Money Laundering
Learning Objective
2.2.1 Understand the role of the Financial Action Task Force
In response to growing international concerns over money laundering, the Financial Action Task Force on Money Laundering (FATF) was created by a G7 summit in 1989.
FATF was given the responsibility for examining money laundering techniques and trends, reviewing existing initiatives and producing recommendations to combat money laundering. In 1990, it issued a report containing a set of 40 recommendations which provide a comprehensive plan of action for fighting money laundering and which have been subsequently added to with recommendations on tackling terrorist financing. Its recommendations form the international standards for combating money laundering and terrorist financing and their implementation is regularly reviewed by audits of national systems. FATF focuses on three principal areas:
• Setting standards for national anti-money laundering (AML) and counter-terrorist-financing programmes.
• Evaluating how effectively member countries have implemented the standards.
• Identifying money laundering and terrorist-financing methods and trends.
FATF has established four regional groups covering the Americas, Asia Pacific, Europe and the Middle East and Africa. Using input from these groups, the FATF has undertaken an exercise to identify countries with inadequate AML measures, referred to as ‘non-co-operative countries and territories’. Its purpose has been to put pressure on those countries to bring their AML systems up to international standards.
In conjunction with this, countries have been implementing AML laws and notable among these are:
• US Patriot Act – includes extensive regulatory requirements for financial institutions including requiring them to implement a client identification programme and to screen transactions and clients for risk on a routine basis.
• UK Proceeds of Crime Act 2002 (POCA) – earlier legislation had moved AML on to a statutory basis and this Act substantially extended the anti-AML environment, made disclosure of income sources compulsory and enabled the seizing of assets earned from illegal activities.
• EU Money Laundering Directives – extended the range of activities considered to be financial crimes and extended the requirement to have in place AML obligations to firms outside the standard financial services environment.
Of particular relevance to the wealth management industry is the private sector Wolfsberg Group.
The group is an association of 11 global banks – (Banco Santander; Bank of Tokyo-Mitsubishi; Barclays;
Citigroup; Credit Suisse; Deutsche Bank; Goldman Sachs; HSBC; JPMorgan Chase; Société Générale; and UBS) – which aims to develop financial services industry standards and related products for know your customer, anti-money laundering and counter-terrorist-financing policies.
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2.2 Money Laundering Offences and Firms’ Regulatory Obligations
Learning Objective
2.2.2 Know the main offences associated with money laundering and the regulatory obligations of financial services firms
While the specific rules and regulations in relation to money laundering will differ from country to country, it is worth noting that there are common features in the types of offences and the regulatory obligations placed on financial services firms.
The main types of offences involved in money laundering are:
• concealing – it is an offence for a person to conceal or disguise criminal property;
• arrangements – it is an offence for a person to enter into an arrangement that they know or suspect facilitates the acquisition, retention, use or control of criminal property for another person;
• acquisition, use and possession – it is an offence to acquire, use or have possession of criminal property;
• failure to disclose – three conditions need to be satisfied for this offence:
the person knows or suspects (or has reasonable grounds to know or suspect) that another person is laundering money;
the information giving rise to the knowledge or suspicion came to the person during the course of business in a regulated sector (such as the financial services sector);
the person does not make the required disclosure as soon as is practicable;
• tipping off – it is an offence to tell a person that a disclosure of a suspicion has been made.
Money laundering regulations place requirements on firms that cover three main areas:
• Firms are required to carry out certain identification procedures, implement certain internal reporting procedures for suspicions and keep records in relation to anti-money laundering activities.
• The regulations also require firms to train their staff adequately in the regulations and how to recognise and deal with suspicious transactions.
• There is a catch-all requirement that firms should establish internal controls appropriate to forestall and prevent money laundering. This includes the appointment of an employee as the firm’s money laundering reporting officer (MLRO).
Officers of firms that fail to comply with the money laundering regulations are liable to a jail term and fine, and firms may have their licence to trade terminated.
As noted above, it is an offence to fail to disclose a suspicion of money laundering. Obviously this requires the staff at financial services firms to be aware of what constitutes a suspicion, and this is why there is a requirement that staff must be trained to recognise and deal with what may be money laundering transactions.
2.3 Stages of Money Laundering
Learning Objective
2.2.3 Know the stages of money laundering
There are three stages to a successful money laundering operation: placement, layering and integration.
• Placement is the first stage and typically involves placing the criminally derived cash into some form of bank account.
• Layering is the second stage and involves moving the money around in order to make it difficult for the authorities to link the placed funds with the ultimate beneficiary of the money. Disguising the original source of the funds might involve buying and selling foreign currencies, shares or bonds.
• Integration is the third and final stage. At this stage, the layering has been successful and the ultimate beneficiary appears to be holding legitimate funds (clean money, rather than dirty money).
Broadly, the anti-money laundering provisions are aimed at identifying customers and reporting suspicions at the placement and layering stages, and keeping adequate records that should prevent the integration stage being reached.
2.4 Client Identification Procedures
Learning Objective
2.2.4 Know the client identity procedures
Money laundering regulations require firms to adopt identification procedures for new clients and keep records in relation to this proof of identity. This obligation to prove identity is triggered as soon as reasonably practicable after contact is made and the parties resolve to form a business relationship.
Failure to prove the identity of your client could result in an unlimited fine and a jail term.
The identification procedures that a firm must carry out are usually referred to as customer due diligence (CDD) and the procedures that must be carried out involve:
• identifying the customer and verifying their identity;
• identifying the beneficial owner, where relevant, and verifying their identity;
• obtaining information of the purpose and intended nature of the business relationship.
It is also a requirement that financial institutions undertake checks to determine the source of funds that the client wishes to invest. They must also check international sanction blacklists to ensure that the client is not one with whom doing business is prohibited. Firms must also conduct ongoing monitoring of the business relationship with their customers to identify any unusual activity.
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The types of documentary evidence that are acceptable to prove the identity of a new client would include the following:
• For an individual – an official document with a photograph will prove the name, eg, passport or international driving licence; a utilities bill (gas, water or electricity) with name and address will prove the address supplied is valid.
• For a corporate client (a company) – proof of identity and existence would be drawn from the constitutional documents (Articles and Memorandum of Association) and sets of accounts.
For smaller companies proving the identity of the key individual stakeholders (directors and shareholders) would also be required.
Checks should be made that the client is not a politically exposed person. In such cases of higher risk, and, if the customer is not physically present when their identities are verified, then enhanced due diligence (EDD) measures must be applied on a risk-sensitive basis.
Note: a ‘politically exposed person’ (PEP) is a term used by regulators to identify persons who perform important public functions for a state. These are individuals who require heightened scrutiny because they hold or have held positions of public trust, such as government officials, senior executives of government corporations, politicians, important political party officials and so on, along with their families and close associates.
For some particular customers, products or transactions, simplified due diligence (SDD) may be applied. Firms must have reasonable grounds for believing that the customer, product or transaction falls within one of the allowed categories, and be able to demonstrate this to their supervisory authority.