The European Union's 5th Anti-Money Laundering Directive and the KYC Impact
Monday 24 August 2020
Introduction: Regulation Change and KYC
Over the last decade, KYC requirements have become more complex than ever before, driven by frequent changes in the regulatory landscape. Significant regulatory differences between geographical regions and ever-evolving requirements have made keeping up with the new regulations both difficult and expensive. The costs of KYC compliance are very high, with major financial institutions reportedly spending up to $500 million on KYC annually.
In addition, by having so many new requirements to meet, onboarding now typically takes 1-3 months on average. These long wait times have been challenging for clients, many of whom expect a straightforward and efficient process. A Thomson Reuters survey in 2017 found that, as a result of KYC issues, 12% of clients switched banks.
The increased pace of change can be evidenced in the EU series of Anti-Money Laundering Directives (AMLDs). There were almost 10 years between the 3rd and 4th Directives; however, the 4th, 5th, and 6th Directives are all due to be implemented in the space of just five years. This increased rate of change is not limited to the AMLDs; in fact, the last few years have seen changes from the Financial Action Task Force (FATF) guidelines, the Bank Secrecy Act (BSA), MiFID II and, more recently, FinCEN’s CDD.
AML Recent History
In 2017, Europol published a report estimating that money laundering accounts for between 0.7% and 1.28% of the European Union’s entire GDP. Furthermore, it was indicated that there was a lack of unity across EU member states when tackling AML. In recent years, the European Union has looked to address this ongoing issue with their 5th Anti-Money Laundering Directive (5AMLD), which came into force on 10th January 2020.
As implied by the name, 5AMLD builds on the groundwork laid by 4AMLD, which was largely designed to bring the EU into alignment with FATF guidelines in order to facilitate global uniformity of AML policies. The 4AMLD was legislated in the UK as The Money Laundering Regulations 2017, which required an overhaul in how businesses approached money laundering from a legal perspective. It formalised the risk-based model for KYC, and several automatic exemptions from due diligence were eliminated.
5AMLD focuses on a number of growing concerns, including changing regulation around Beneficial Ownership (BO) and the completion of BO registers, providing unity when dealing with High-Risk Third Countries and the rules around each country’s definition of Politically Exposed Persons (PEPs). The goal is clear across these sections: to provide coordination and harmony across all EU member states. Additional areas of emerging focus include Cryptocurrency, Prepaid Cards and High Value Goods (e.g. works of art costing over €10,000).
5AMLD puts a large focus on Cryptocurrencies and their potential risks, which previously had not been well understood; however, that changed following the Paris terrorist attack. Alluding to their potential use in terrorist fundraising, and money laundering, EU minsters requested tighter controls to combat the risks created through abuse of the technology.
Beneficial Ownership and Registers
4AMLD introduced the requirement for beneficial ownership registers. These registers required those in the member states to obtain and hold adequate, accurate and current information on corporate and other legal entities.
The 5AMLD clarifies the timeframe for the completion of such registers: the deadline for setting up these central registers is 10th January 2020. An additional requirement is that EU member states must guarantee that they are interconnected to other registers across the EU by 10th March 2021. However, due to questions around timeliness of updates and accuracy of the registers, financial institutions should give consideration to the reliability of the data in these registers when implementing controls.
For the first time public access will be granted to any individuals or organisations that demonstrate a “legitimate interest” in the beneficial ownership information. 5AMLD also makes it clear that there must exist a balance between preventing financial crime and an individual’s right to data privacy. This is particularly sensitive in situations where this information could lead to peripheral crimes such as kidnapping or extortion. It is also key to remember that this requirement only covers EU member states and appropriate measures and controls should still be implemented when dealing with jurisdictions that do not have BO registers.
High-Risk Third Countries
Stopping the transport of criminal funds across international borders is one of 5AMLD’s main goals. As a result, the changes to High-Risk Third Countries all revolve around developing a consistent approach to which all members states within the EU are to adhere.
The goal is to reduce differences in regulatory requirements between member states. This, in theory, will diminish cases where a few EU member states benefit financially, relative to others who adopt more rigorous Enhanced Due Diligence requirements. However, the main goal is to reduce terrorist activity which, in the past, would have targeted countries with less stringent regulations.
From a practical perspective, 5AMLD will require obtaining extra information such as evidencing the source of funds and wealth. Moreover, information on the background of the intended transaction must also be recorded.
5AMLD also looks set to change the way in which some client information is verified. The directive outlines a preference to get ‘where available, electronic identification means’ when gathering from reliable and independent sources. This looks to be a forward-facing policy, ideally designed to add an extra level of verification to any information provided by clients.
Using the guidelines of the 5AMLD and building on the approach taken by FATF, the European Commission created a ‘blacklist’ of these High-Risk Third Countries. After some revisions, this list was published in February 2019.*
Politically Exposed Persons (PEPs)
As part of the 5th Directive’s goal to provide more unity across all member states, there are also changes relating to Politically Exposed Persons. Each EU member state is required to independently compile and publicly release a functional PEP list. This is a list which details prominent roles within the relevant member state that could be considered ‘politically exposed’. The directive also requires accredited international organisations to provide the same. It is expected that the EU will also release an EU-level version of the list.
For clarity, these lists created by the EU member states will feature only the positions that are considered politically exposed but will not name the person fulfilling the roles (which can change). These lists are designed to make it easier for compliance teams to identify the PEPs that they should be screening against and should also allow for easier identification of any changes to risk. However, as with the BO registers, consideration should also be given to the reliability of the information in the lists when implementing processes and controls.
The European Union is set to continue attempts to prevent the financial system being used for money laundering and funding of terrorist activities: the 6th Anti-Money Laundering Directive (6AMLD) is due by December 2020. This directive widens the scope of money laundering offences and introduces harsher punishments for those convicted. However, because member states have until July 2021 to implement this, and the UK may by this point have fully separated from the European Union, it is unclear as to whether they will have to comply with 6AMLD.
Regardless, after Brexit the UK is likely to continue building on the groundwork laid by the EU Directives. In 2018, the Sanctions and Anti-Money Laundering Bill came into force. This will give the UK power to introduce its own AML and sanctions legislation once it has left the EU.
6AMLD will not be the only new regulation to be put in place in the coming years: as the techniques used by criminals change, there will be no shortage of new money laundering supervisions that will impact financial institutions. Evidence shows this will have a large influence on KYC with related regulations continuing to change at an extremely rapid pace. Banks and firms are already looking to leverage automation and new technologies to be able to adapt to these advancing and complex regulations. In addition, the more regulatory unity we do see across countries, the greater the ability for companies will be to leverage nearshoring opportunities. In the long term, this should allow companies to remain competitive whilst still adhering to the ever-changing regulatory landscape.
* It is worth noting that there has been some contention over the countries included in this list and therefore an updated version is expected at some point.
The 5th Directive (5AMLD) from The Official Journal of the EU
List of High-Risk third Countries as Defined by the European Commission - https://ec.europa.eu/info/sites/info/files/annex_commission_delegated-regulation_hrtc.pdf
Europol’s report on money Laundering Impact (2017) - https://www.europol.europa.eu/publications-documents/suspicion-to-action-converting-financial-intelligence-greater-operational-impact
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