A "Third EU Money Laundering Directive" – when less is more

1. Why a new Directive?

On 22 March 2004, the European Commission (the "Commission") published its draft proposal (the "Draft Proposal") for a Third Money Laundering Directive (the "Directive") and a formal Commission proposal for the Directive was presented on 30 June 2004 (the "Formal Proposal"). The Directive's aim is to update and, for the sake of clarity, replace the 91/308/ECC (the "First Money Laundering Directive") as amended by Directive 2001/97/EC (the "Second Money Laundering Directive") and to incorporate the Financial Action Task Force's ("FATF") revised 40 recommendations as well as the FATF Special Recommendations on Terrorist Financing. The Directive will now cover not only money laundering but also terrorist financing1.

2. The key headlines

• The Formal Proposal broadens the definition of money laundering to cover concealing or disguising the proceeds of a wider range of serious crimes as well as the financing, whether from legitimate or illegitimate funds, of terrorism. Furthermore, the definition of "criminal activity" will also be extended. "Serious crimes" will now cover all offences punishable by a minimum of six months imprisonment2. Currently, the UK already follows the "all crime" approach not applying any "de minimis" threshold at all to the definition of criminal conduct and The Terrorism Act 2000 (as amended) covers terrorist financing, so little impact is expected in the UK in this respect.
• The Formal Proposal extends the First and Second Money Laundering Directives' scope of coverage3 to (i) providers of services to companies and trusts4, (ii) life insurance intermediaries and (iii) all persons dealing in goods or providing services for cash payment of €15,000 or more whether in a single transaction or a series of linked transactions. The extended coverage in itself should not be controversial in the UK as these sectors are already captured by the Money Laundering Regulations 2003 SI 3075/2003 (the "UK ML Regs"), except that Regulation 2(2)(n) of the UK ML Regs covers high value goods dealers only, but not service providers (e.g. private schools, consultants not otherwise covered) so some of these entities are likely to be hit for the first time5. Furthermore, the proposed registration or licensing requirements for, for example, "trust and company service" providers would be new to the UK in relation to a number of such service providers.
• The Formal Proposal now prohibits the maintenance of anonymous accounts and "accounts in fictious names". Furthermore, measures are also introduced to prevent the misuse of bearer instruments and shell banks are also on the radar. Again, little impact is expected in the UK.
• The Formal Proposal introduces more detailed and onerous customer due diligence ("CDD") requirements, albeit on a risk-based approach. To a great extent the proposed CDD requirements should represent current UK industry best practice introduced by the JMLSG (Joint Money Laundering Steering Group) Guidance Notes (although not necessarily legal requirements in the UK). In our view, some of the detail might better be left to be addressed in implementing measures as this would allow for the implementation of a truly risk-based approach and the application of the new, more onerous CDD requirements where their use and the cost consequences of it are justified and proportionate.
• The universal "beneficial owner"transparency requirements are likely to prove controversial. In the UK, the JMLSG Guidance Notes set out the industry best practice requirements to establish beneficial ownership. However, broadly speaking, the threshold for the control/ownership test is higher, it is not statute based and only applies in relation to higher risk business in the private company/trust context. Complying with the beneficial owner identity verification requirements may prove particularly difficult in respect of ultimate beneficiaries based overseas. In relation to certain types of transactions where rapid response is crucial in writing a particular type of business, the time and cost implications of establishing the full picture of the ownership and control structure of each customer and verifying the identity of ultimate beneficiaries prior to executing a transaction may result in otherwise perfectly legitimate business having to be dropped. In any event, the requirement may not be relevant and/or appropriate in relation to every business type6.
• On a practical level, we are already used to seeing UK banks discontinue relationships where corporate customers are unwilling to provide satisfactory evidence of ultimate beneficial ownerships.
• In contrast with the Draft Proposal, the Formal Proposal clarifies that a zero due diligence regime will be applicable in relation to certain types of customer, products and transactions considered to represent lower money laundering risk. Further, it refers to third country anti-money laundering compliance requirements and/or disclosure requirements being "consistent with international standards and/or Community legislation", rather than "equivalent", which is a small but significant improvement on the Draft Proposal.
• The Formal Proposal also contains enhanced CDD requirements, albeit on a risk-based approach, in relation to situations which by their nature may represent a higher risk of money laundering (non face-to-face business, correspondent banking and dealing with politically exposed persons ("PEP"). Article 11 sets out a non-exhaustive list of situations where enhanced CDD should be exercised, also prescribing the extra measures to be taken. As currently drafted, it seems that businesses will be required to apply one or more of the enhanced measures prescribed in Article 11 in relation to the three high risk situations it sets out, regardless of whether these situations actually represent a higher money laundering risk in the context of their specific business. For example, non face-to-face business may represent enhanced money laundering risk in the retail environment in relation to which the enhanced measures prescribed in the Formal Proposal seem appropriate. In the context of wholesale business, conducting business non-face to face is the rule, rather than the exception and such an approach is not necessarily justified.
• The definition of PEPs remains a concern, although a welcome improvement is that the current draft introduces an element of "quantifiable risk" (i.e. the "having substantial or complex financial or business transactions which may represent an enhanced money laundering risk" test) to establish whether or not the enhanced measures should be applied to a particular individual, which removes a degree of uncertainty7.
• It is now clear from the Formal Proposal that "mutual recognition of customer identification" will not be mandatory, but will remain optional only. Furthermore, the description of entities whose CDD can be accepted under the "mutual recognition rules" retained the reference to CDD and record keeping measures "equivalent" to those under the Directive in relation to third country institutions. This is, of course, unhelpful as measures are unlikely to be "equivalent". Whilst performance of CDD may be delegated, responsibility will remain with the institution to which business is introduced, which is the case in the UK already. Relevant copies of identification and verification data and other relevant documentation on the identity of the customer or the beneficial owner must immediately be forwarded to the institution to which the customer is being referred on request.
• The Formal Proposal contains whistleblower provisions: employees who make suspicious transaction reports must be protected and cannot be discriminated against or victimised.
• A proposal that is likely to prove controversial is the application of EU anti-money laundering compliance standards to non-EU branches of institutions covered by the Formal Proposal.
• Article 37 and 38 call for implementing measures in relation to further elaborating the definitions set out in the Formal Proposal, establishment of detailed rules in relation to identifying situations which represent lower or higher money laundering risk, etc.

3. Too much too soon

On 7th December 2004 the meeting of Economic and Finance Ministers adopted its general approach on the text of the proposed Directive8. It is expected that the first reading of the proposed Directive in the European Parliament will take place during the Luxembourg Presidency, which has given priority to the adoption of the Directive. Formal agreement between the Council and the European Parliament on the Directive could be reached as early as the beginning of the UK Presidency in mid 2005.

Whilst it is fair to say that most of the proposed requirements should be broadly familiar to the UK financial services industry representing current law or best practice, the devil may lie in the detail. We believe that a framework directive with the details fleshed out in implementing legislation would be preferable to give real scope for a truly risk-based approach. Industry voiced concerns that the inflexibility inherent in procedures amending primary legislation at both European and domestic level could prejudice any meaningful implementation of the much welcomed "risk-based approach" by preventing a rapid response to developments in the field of financial crime and anti-money laundering compliance and addressing specific industry issues. Articles 37 and 38 already allow for the passing of implementing measures in relation to elaborating definitions and establishing detailed rules for identifying situations which represent lower or higher money laundering risk. Furthermore, the Directive requires financial information units to provide feedback to firms on suspicious transaction reports. Patterns arising from such feedback could also be worked into the details as and when necessary.

As at 17 October 2004, a number of EU Member States (Greece, Luxembourg9 and Sweden) were still struggling to implement even the Second Money Laundering Directive and several Member States, including the UK, were late in implementing it10. Considering this, perhaps further thought should have been given to the Directive before rushing it through Brussels within the prescribed tight timeframe. The cost consequences for the industry are likely to be significant without much necessarily being gained in preventative terms.

By Edina Cavalli and Duncan Aldred, of CMS Cameron McKenna's Banking and International Finance group.

Should you require further information on this topic please contact Duncan Aldred on +44(0) 207 367 2709 or at [email protected] or Charles Spragge on +44(0) 207 367 2525 or at [email protected] or Edina Cavalli on +44(0) 207 367 3126 or at [email protected]

Footnotes:

1A reason for the urgency in adopting the Directive is to comply with the Commission's obligation under Article 1(E) para 2 of the Second Money Laundering Directive to present a proposal for a directive before 15 December 2004, to include a new definition of "serious offences" to bring it in line with the Joint Action of 3 December 1998 as replaced by Council Framework Decision 2001/500/JHA. On 27th May 2004, the UK Treasury initiated an informal consultation process on the Draft Proposal by setting out its then main terms and the extent to which, in the Treasury's view, the Draft Proposal represented existing law in the UK. The UK Treasury also sought industry feedback on the expected impact of the Draft Proposal on market participants by 18 June 2004.

2The six month minimum applies, if the relevant domestic criminal system has a minimum threshold for offences. The applicable threshold is one year plus if the relevant system is based on maximum thresholds.

3Sectors already covered by the First and Second Money Laundering Directives will continue to be covered by the Directive.

4"Trust and company service providers" are defined in the Directive as "any natural or legal person which by way of business provides any of the following services to third parties: (a) forming companies or other legal persons; (b) acting as or arranging for another person to act as a director or secretary of a company, a partner of a partnership, or a similar position in relation to other legal persons; (c) providing a registered office; business address or accommodation, correspondence or administrative address for a company, a partnership or any other legal person or arrangement; (d) acting as or arranging for another person to act as a trustee of an express trust or a similar legal arrangement; (e) acting as or arranging for another person to act as a nominee shareholder for another person"; and which are not also auditors, accountants, external tax advisors, notaries or certain other independent legal professionals as set out in the Directive.

5Although it is worth noting that Art 2(2) of the Directive states that Member States may decide not to apply the Directive in relation to those entities which engage in financial activity only on an occasional or very limited basis and where there is little risk of money laundering occurring.

6In certain industry sectors postponement of CDD procedures to a later stage in the business relationship may help to ease the burden somewhat.

7Although industry has been arguing in favour of a definitive list of PEPs to remove uncertainty.

8At the time of writing the revised text is not available on the EU Commission's website.

9The Luxembourg Parliament has, however, passed new anti-money laundering and anti-terrorist financing legislation in the meantime.

10The deadline for implementation of the Second Money Laundering Directive was 15 June 2003.