The fourth Anti Money Laundering Directive (AML4), or Directive (EU) 2015/849 to give its proper name, is due to be implemented into National Law by all EU member states by 26 June 2017. As with all directives there can be gold-plating at the national level. There will also be recommendations, guidelines and interpretation from various bodies especially the European Supervisory Authorities (ESAs).
I will start by saying that whilst AML4 (4th Anti Money Laundering Directive) naturally mentions bodies such as the Financial Action Task Force (FATF), it is also distinctly European protectionist in nature. A clear distinction is drawn, yet again, between European Union member states and “third countries” (i.e. the rest of the world). AML4 extols the virtues of cooperation between the Financial Intelligence Units (FIUs) of the EU member states whilst keeping true global cooperation to the periphery.
To begin to understand the potential that AML4 has to affect global fund distribution, we must first understand the global nature of UCITS distribution.
As we all know, UCITS (Undertakings for Collective Investment in Transferable Securities) is a European Directive (now up to version five) designed to provide retail investors across the European Union with cross-border distributed funds that all meet the same minimum standard. That is what UCITS was originally designed to be, however that is not what UCITS remained.
UCITS is now effectively a “brand mark” and has global recognition. Not all countries recognise UCITS for retail distribution, but a large number do. One has only to look at the distribution that UCITS funds currently achieve to recognise that distribution crosses continents and oceans.
Looking now at non-EU distribution, a single UCITS umbrella fund might:
This list has been kept intentionally short, however we can see that UCITS funds have global distribution and, more than that, investment via intermediaries is a global standard.
On 21 October 2015 the Joint Committee of the European Supervisory Authorities (ESAs) issued their Joint Consultation Paper JC 2015 061 in relation to AML4. This paper gave draft guidelines on risk factors that EU financial institutions should consider when assessing financial crime risk and on the application of either simplified or enhanced customer due diligence (SDD – simplified due diligence or EDD – enhanced due diligence).
It should be mentioned at this point that a final version of this document has yet to be released. The consultation period has ended, but there is no indication yet as to what (if anything) is going to be changed. Chapter 9 of this paper covers the sectoral guidelines for providers of investment funds and covers sections 200 to 215. Of particular interest in the context of this article are the final four sections, which cover intermediaries.
Section 213 covers financial intermediaries “subject to Anti Money Laundering/Combating the Financing of Terrorism (AML/CFT) obligations in an EEA jurisdiction” and, subject to certain other provisions, allows for the firm to undertake simplified due diligence. This is great where a Luxembourg fund has an investment from an Irish custodian… they don’t have to look through the Irish custodian to the underlying beneficial owners, although they must have the right to request details of the beneficial owners from the intermediary (section 214). This is also consistent with the application of both FATCA and CRS as the Irish custodian would be classified as a Foreign Financial Institution (FFI) and again there would be no need to look through to the underlying beneficial owner.
The problem comes for third country intermediaries investing into an EU fund, and this is covered under section 215 of the joint consultation. “Where the financial intermediary is established in a third country… firms should apply full CDD (Customer due diligence)… or EDD measures as appropriate”. What does this mean? Full CDD would include looking through to the beneficial owners and identifying them with verification of that identity, EDD means additional measures to verify the beneficial owner’s identity, source of funds/wealth, etc.
Until now the global distribution of UCITS has been largely governed by recognition of the brand in the jurisdiction where distribution is taking place. AML4 is bringing additional regulatory cost of compliance to bear, both for the fund operator and for the intermediary client.
Take the example of a Hong Kong nominee account with three hundred underlying beneficial owners invested in a Luxembourg fund. There is additional burden on the bank operating the nominee account… they must supply three hundred certified copies of identification documents and proofs of address (more if holdings are joint) and should do so before each new beneficial owner invests. The additional burden on the fund administrator is to keep record of the beneficial owner records, verify all the documents meet the required standard, confirm to the Hong Kong bank that each new beneficial owner has been properly identified, ensure ongoing review of each client. They must also rely on the Hong Kong bank to properly disclose all underlying beneficial owners and to not deal for a new beneficial owner before due diligence is complete.
This is an example of the EU wanting to regulate EU financial products out of the markets, in this case by making it more difficult for non-EU clients to invest into EU products. Increasing EU protectionist legislation will ultimately work against the EU/EEA financial services industry.
Many jurisdictions outside the EU/EEA operate retail fund structures with striking similarities to UCITS but without many of the restrictions that the EU/EEA have towards third country clients. If jurisdictions, such as Guernsey, can come up with a more pragmatic approach towards the future use of intermediaries then there is an opportunity for those jurisdictions to begin encroaching on the UCITS dominance of the retail fund space.
Let’s hope that non-EU/EEA regulators don’t follow the example of the European Supervisory Authorities like a group of lemmings!