The implementation deadline on 26 June for the EU’s Fourth Money Laundering Directive is fast approaching.
Member states have had two years to make the necessary legislative changes. But for the financial services industry, there’s an even bigger regulatory challenge looming: the demands of the new Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, currently still in draft.
The sector is bracing itself for a significantly increased compliance burden. Although the core requirements have been in place since the very first EU Money Laundering Directive back in 1991, each successive Money Laundering Directive has extended the regime, and the Fourth is the most ambitious yet.
Those who are likely to really feel the brunt of these changes, however, may yet be blissfully unaware. For the first time, those holding a prominent public post in the UK will be classified as a “Politically Exposed Person” (PEP).
Business relationships and transactions with PEPs, or with entities beneficially owned by PEPs, are presumed to pose a high risk of money laundering and terrorist financing unless the contrary can be demonstrated, triggering a series of specific steps over and above normal levels of due diligence and monitoring. A PEP’s family members and any person considered to be their “close associate” are to be treated as if they, too, posed the same high risk.
The concept of a PEP will be familiar. Introduced in 2003 by the Financial Action Task Force (FATF), the international standard setting body, it has been a feature of the EU anti-money laundering regime since 2005. The difference is that it is no longer limited to individuals who are politically exposed overseas or as a result of posts held with international organisations. Domestic public functions are now in scope, catching UK politicians, judges, ambassadors and high-ranking officers in the armed forces as well as those holding senior positions with or otherwise involved in the running of state-owned companies.
Legitimate customers caught out
The problem is an obvious one, flagged at an early stage by the UN in the 2003 Convention against Corruption. The theoretical proposition that PEPs pose a higher risk of money laundering does not mean that businesses should be discouraged or prevented from engaging with legitimate customers.
Both the FATF and the UK financial sector regulator, the Financial Conduct Authority (FCA), have in recent years denounced “de-risking” practices. This is when business relationships are declined or terminated, typically without any explanation other than a vague reference to “risk appetite”, because the costs of compliance are expected to exceed profits.
Businesses will say that this is a commercial decision and there is little to stop them. Parliament had tried to avert some of the worst consequences, by passing section 30 of the Bank of England and Financial Services Act 2016 last year, requiring the FCA to produce guidance to ensure that PEPs are treated in a “proportional” manner.
However, the draft guidance published alongside the draft regulations in mid-March was a disappointing read, and is unlikely to cause anyone to think twice before turning away a PEP customer.
Last year’s legislation had also envisaged that the FCA would be make compensation awards and impose financial penalties where firms treat PEPs unfairly.
Yet in a largely unexplained U-turn earlier this year, referring only to (unarticulated) reservations apparently expressed in response to an earlier consultation on the implementation of the directive, the government announced that the FCA would not be performing this role after all.
Instead, PEPs and those tainted by association are left with the Financial Ombudsman Service – whose (modestly exercised) powers are unlikely to amount to much of a deterrent or vindication for wronged PEPs. The result? Expect to see more PEPs forced to turn to legal action, creating a further strain on compliance budgets and a headache for all concerned.