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Beneficial Ownership: Compliance vs Business

Part 1 of 4

Beneficial ownership recently came to the fore once again with two high profile leaks – mostly recently the Bahamas leaks which saw the exposé of the names of directors and shareholders of nearly 176,000 shell companies trusts and foundations, an event that was preceded five months previously by the Panama Papers leaks which saw 11.5 million documents leaked detailing financial and attorney-client information for more than 214,488 offshore entities. This, along with heightened anxieties arising from a number of recent high profile terrorist activities, has resulted in a significant shift towards increasing corporate transparency and weeding out shell companies in an attempt to bolster the defences against money laundering and terrorism financing.

In light of this, there have been considerable developments on both sides of the Atlantic to strengthen and enhance anti-money laundering (AML) regulations. In May of this year, FinCEN pushed through with the long-awaited US beneficial ownership rules that had been in stalemate for quite some time. Across the water, Europe has decided to make beneficial ownership and ultimate beneficial ownership (UBO) a clear focus area in its forthcoming Fourth EU Anti-Money Laundering Directive.

The aim is simple: to ensure that financial institutions know exactly who their customers are (and, indeed, who their customers’ customers are) and where their sources of funds originate and to, ultimately, avoid unwittingly facilitating the money laundering or terrorist financing agenda. To do this, financial institutions must be capable of identifying the beneficial owners of every legal entity customer they have.

The Challenge

The challenge, of course, is that legal entity accounts pose the most difficult for financial institutions in terms of identifying beneficial owners. There are a number of facets to this challenge:

  1. Multiple legal structures and/or corporate vehicles (particularly in the case of offshore entities subject to different laws, regulatory requirements and client documentation – not to mention secrecy havens) can obscure the ownership of a legal entity. While used by many legitimate legal entities, the combination of different sophisticated legal structures, corporate vehicles and offshore entities create a playground for money launderers, fraudsters and terrorists to transfer illicit gains under perfectly respectable guises.
  2. Legal structures or corporate vehicles with more than one layer of ownership (and they may have several layers) increased the number of entities to be verified.
  3. No public office of entity/corporate vehicle registration across different jurisdictions make it even harder to get independent records to identify and verify beneficial owners (although the UK is spearheading efforts for central registries).
  4. A lack of standardized documentation across various countries make the job of supporting compliance obligations and validating ownership much more difficult.
  5. In jurisdictions where it is easy to transfer ownership, the financial institution may not be aware of such changes, which may impact the client risk profile and risk appetite of the bank to do business with the customer.
  6. Financial institutions not geared up for event-driven changes and lack of flexibility in responding to these changes may find themselves at the mercy of regulators.
  7. Complicated by layers of structures, corporate vehicles and jurisdictional laws, financial institutions may find it difficult to detect changes in profile or suspicious patterns.

Business vs Compliance

However, despite its obvious importance in the fight against financial crime and terrorism financing, the issue of beneficial ownership has always been a contentious one given the impact it can have on the relationship between onboarding (business development) and compliance teams.

With compliance tasked with applying a risk-based approach to ensuring regulatory compliance with local and global AML regulations, the bigger challenge for them involves the ability to dig into the intricate and complex ownership structures of every single customer to determine beneficial ownership and satisfy other compliance obligations.

For the business side of a financial institution, these complex entities usually bring with them a promise of large amounts of funds or assets. This puts the business onboarding and compliance teams at juxtaposed corners – with one side wanting an efficient, quick onboarding process and the other with the obligation to identify and verify beneficial ownership information in a risk-based capacity.

The Reaction

We have witnessed a risk-averse response deployed by some financial institutions, who have chosen to de-risk altogether by exiting countries typically touted as extremely high risk or those scoring highly on the corruption index. Of course, this goes against the practice of financial inclusion. The Financial Action Task Force (FATF) has spoken about the challenge for financial institutions to ensure that standards and regulations are adopted to limit the potential of threats and dangers involved in inadvertently doing business with an entity or customer they shouldn’t – but not at the expense of killing off innovation and customer experience.

With the increasing threat of terrorism financing, financial institutions have a moral obligation to ensure they are not facilitating the funding and transfer of funds for these illicit organizations. However, they continue to be challenged internally and operationally to achieve this.

In my next blog, I will share an analysis of beneficial ownership through the lenses of the FinCEN Final Rule and the 4th EU Money Laundering directive, and offer a perspective as to how technology (and the types of technology) can help financial institutions to solve the UBO (ultimate beneficial ownership) challenge.