To strengthen the fight against money laundering, the European Union’s Fourth Anti-Money Laundering Directive came into force in June 2015, and all EU members states must implement the changes into their domestic law by 26 June 2017. What’s this directive about and how does it affect UK businesses?
What is money laundering?
Legend has it that ‘money laundering’ dates back from the early 20th century when Sicilian mafia leader Al Capone purchased ”sanitary cleaning shops” in Chicago in order to disguise profits from illegal activities and give them the appearance of legitimate business sales. Since then, money laundering has become widespread, the estimated volume of money laundered globally amounting to 2 to 5% of the gross world product, or roughly 1 to 3 trillion US dollars a year, most of which are being used to finance terrorism and organised crime.
Money laundering is the process of converting money or assets that derive from a criminal activity into ”clean” assets, for the purpose of disguising their illicit origin. The process usually takes place in three stages:
- Stage 1 – Placement: criminally derived funds are introduced into the financial system.
- Stage 2 – Layering: assets are being ‘laundered’ by means of conversion, transfer or concealing.
- Stage 3 – Integration: laundered assets are re-introduced into the legitimate economy.
Money laundering therefore enables criminal organisations to seep illegal profits in the financial system, and facilitates criminal activities such as terrorism, corruption, tax evasion, smuggling, drug or human trafficking.
What’s the 4th Anti-Money Laundering directive?
The Fourth Anti-Money Laundering Directive replaces the Third Directive and aims at strengthening the EU’s defences against money laundering and terrorist financing, by ensuring that all member states prohibit such activities. It intends to protect the financial system by means of prevention, detection and investigation of money laundering.
The fourth directive differentiates from its older sisters by focusing on a ‘risk-based approach’, which consists in carrying out comprehensive money laundering risk assessments at three different levels:
- the EU Commission level
- the member states level, and
- ‘obliged entities’ level
While the Commission and the member states have been given responsibility to implement cross-border and national risk assessments, ‘obliged entities’ must carry out their own specific risk assessments, taking into account risk factors relating to customers, geographic areas, products and services, transactions and delivery channels.
What is an obliged entity?
The directive applies to what is called ‘obliged entities’, which include:
- financial services institutions, i.e. credit institutions, banks, insurance companies, investment firms, etc.
- auditors, external accountants and tax advisers
- notaries and other independent legal professionals who participate in any financial or real estate transaction
- trust or company service providers
- estate agents
- gambling services providers, and
- other persons trading in goods over EUR 10,000
What are firms’ obligations under the directive?
Internal procedures, policies and controls
To implement the risk-based approach, the directive compels obliged entities to develop internal policies, controls and procedures to mitigate money laundering risks. Internal procedures and controls can take various forms and can include:
- customer due diligence
- reporting and record keeping
- compliance management
- employee screening
- employee trainings
Depending on the size and the nature of the firm, it may be necessary to appoint a Compliance Officer to monitor these procedures or to have the internal policies tested by independent auditors.
Customer due diligence
Firms that fall within the scope of the directive will also need to apply different levels of customer due diligence (CDD) measures to manage money laundering risks. Customer due diligence consists in investigating customers in order to assess the extent to which they are exposed to money laundering risks. It includes verifying the customer’s identity, obtaining information about the customer’s background, monitoring the business relationship, etc.
The directive compels firms to apply CDD measures when:
- establishing a business relationship
- carrying out an occasional transaction with a customer that amounts to EUR 15,000 or more or that constitutes a transfer of funds exceeding EUR 1,000
- there is a suspicion of money laundering, regardless of any threshold
- there are doubts about the veracity of previously obtained customer data
Depending on the level of risk, due diligence measures can be either enhanced or simplified. Under the old directive, firms could be exempted from enhanced due diligence requirements in certain circumstances, where the risk of money laundering was very low. It will now no longer be possible to be exempted, and firms that want to carry out simplified due diligence will need to apply for it and justify it on the basis of risk.
The directive also widens due diligence requirements by extending the categories of politically exposed persons subject to enhanced due diligence. Politically exposed persons (PEPs) are individuals who hold or have held important public functions and who are likely to commit money laundering offences. The new law expands the definition of PEPs to domestic individuals, while it used to be limited to people residing abroad under the Third Directive.
Conclusion
The 4th Anti-Money Laundering Directive is set to impact a large number of organisations within the EU, and the affected entities will have extended responsibilities when carrying out business with customers. The overall objective of the directive is to ensure that the financial system is an increasingly hostile environment to money laundering. The administrative burden may be quite heavy on concerned entities, but it seems like that’s the price you pay for stemming the laundry cycle and fighting large-scale organised crime.
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