AML and geographical risk

Our AML risk manager Jenni Rodgers looks at geography when considering anti-money laundering risk and the potential need for enhanced due diligence in her update and sets out questions you need to ask when considering risks that may be associated with a jurisdiction.

Geographical risk and applying enhanced due diligence

When considering appropriate and effective risk levels and due diligence, relevant persons must be mindful that there are jurisdictions with weaker measures to combat money laundering and terrorist financing, some of which are listed as high-risk third countries (HRTC).
The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the ‘MLRs’) require the UK regulated sector, including legal practices, to apply enhanced customer due diligence (EDD) in relation to higher risk jurisdictions.

Our blog aims to assist with:

• identifying a HRTC under the MLRs
• exploring the EDD measures required
• referencing other geographic risks to consider as well as higher risk indicators
• identify reoccurring themes related to these jurisdictions
• assist with applying a risk-based approach

Combining the above should assist with applying a more holistic approach to EDD to allow a more informed judgment and also allow for tailoring of due diligence to align with the inherent risks present.

Identifying an HRTC

HM Treasury amended the definition of 'high-risk third countries. It removed Schedule 3ZA, which contained the list in the Money Laundering Regulations 2017.
Instead of referring to a separate schedule, regulation 33(3)(a) now defines a high-risk third country as:

      "a country named on either of the following lists published by the Financial Action Task Force (FATF) as         they have effect from time to time

        1. high-risk jurisdictions subject to a call for action
        2. jurisdictions under increased monitoring".

These lists are updated three times a year, on the final day of each FATF plenary meeting, held every February, June and October.

The lists are available on the FATF website.

Other geographical risks to include in risk assessments

In addition to the specific requirements surrounding the HRTC list, Regulation 33(6)(a)(ii) within the MLRs, requires other geographical risk factors of concern to be considered. These include:

(i) countries identified by credible sources, such as mutual evaluations, detailed assessment reports or published follow-up reports, as not having effective systems to counter money laundering or terrorist financing;

(ii) countries identified by credible sources as having significant levels of corruption or other criminal activity, such as terrorism (within the meaning of section 1 of the Terrorism Act 2000 F183), money laundering, and the production and supply of illicit drugs;

(iii) countries subject to sanctions, embargos or similar measures issued by, for example, the European Union or the United Nations;

(iv) countries providing funding or support for terrorism;

(v) countries that have organisations operating within their territory which have been designated—

(aa) by the government of the United Kingdom as proscribed organisations under Schedule 2 to the Terrorism Act 2000 F184,

or

(bb) by other countries, international organisations or the European Union as terrorist organisations;

(vi) countries identified by credible sources, such as evaluations, detailed assessment reports or published follow-up reports published by the Financial Action Task Force, the International Monetary Fund, the World Bank, the Organisation for Economic Co-operation and Development or other international bodies or non-governmental organisations as not implementing requirements to counter money laundering and terrorist financing that are consistent with the recommendations published by the Financial Action Task Force in February 2012.

The anti-money laundering guidance for the legal sector (LSAG) further states at Section 5.6.2, when assessing risk at practice, client and matter risk levels, you should consider if the practice operates in, receives funds from or has a specific client base outside the UK/EU or equivalent jurisdictions.

Further higher risk indicators – LSAG section 5.6.2.3

LSAG Section 5.6.2.3 also lists indicators of higher geographic risk to take into consideration when assessing the risk of a jurisdiction. The below questions should be asked when assessing the risk of a jurisdiction:

• Does it have deficient anti-money laundering legislation, systems and practices and/or inadequate AML supervision?
• Does it have high levels of crime or higher levels of corruption?
• Is it a jurisdiction where the production of drugs, drug trafficking/trade, terrorism or corruption is prevalent?
• Is it considered to be 'offshore financial centre' or tax haven?
• Does it permit nominee shareholders to appear on the share certificate or register of owners?
• Are there local requirements around company structure or equivalent governance that is unclear or makes it challenging to understand the control structure of an entity?

Recurring Themes

Higher risk jurisdictions are deemed as such for numerous reasons however, key themes such as lack of beneficial ownership transparency, limited domestic anti-money laundering supervision and higher corruption risk are apparent. These themes are explored below and should be held in mind when collecting EDD.

Transparency of beneficial ownership may be a deficiency for these jurisdictions. The ultimate owners of an entity may not be available through a central public registry. Some jurisdictions may be in the process of establishing a national public register of beneficial owners however, there is still gaps where safe havens can be misused for corruption using shell and other opaque complex corporate vehicles. Fully identified and verified ownership structures should be obtained and understood in all instances and it also key to understand the source of wealth.

These jurisdictions may also have limited mitigating weight attributed to their domestic anti-money laundering supervision. To conclude in your risk assessment that an entity is supervised for anti-money laundering purposes in these jurisdictions should be considered with limited mitigation.

It should also be considered that some of these jurisdictions are not members of FATF and so do not endorse or support their recommendations or methodology or undergo any evaluations for compliance.

Higher corruption risk may be present with these jurisdictions. Active and detailed negative news or adverse media checks should be carried out in relation to this with a risk-based approach applied.

Risk-based approach – EDD measures

Practices must apply a holistic approach to due diligence collected, including consideration of the above factors, to allow a more informed judgment and tailor that due diligence to align with the inherent risks present.

Regulation 33(1)(b) of the MLRs requires legal practices to apply mandatory enhanced due diligence measures and enhanced ongoing monitoring in any business relationships with a person established in a high-risk third country or in relation to any relevant transaction where either of the parties to the transaction is established in a high-risk third country. While this is mandatory for HRTC’s, these measures should also be considered to mitigate the risk of other higher risk jurisdictions identified.

Regulation 33(3A) of the MLRs require the enhanced customer due diligence measures to include:

(a) obtaining additional information on the customer and on the customer’s beneficial owner; - It is important to remember that the beneficial owner of a client is the party on whose behalf a transaction is being conducted and should be treated as a client. In higher-risk situations it may be appropriate to examine beneficial owners with less than 25% ownership to fully understand the control and ownership of the client.

(b) obtaining additional information on the intended nature of the business relationship; - this should include considerations around the nature of the client/transaction and what this suggests regarding the business relationship. Is it likely to be one transaction or repetitive work, will the transaction inherently take time to complete, is the client represented by an agent or been referred by another legal practice?

(c) obtaining information on the source of funds and source of wealth of the customer and of the customer’s beneficial owner; - this should include considerations around understanding the financial situation of the client. This should include thoughts on the level and nature of verification required, obtaining information from independent sources, and asking the question – does it make sense that the client has obtained their wealth in the way they advised?

(d) obtaining information on the reasons for the transactions;

(e) obtaining the approval of senior management for establishing or continuing the business relationship; - has someone with sufficient knowledge of the practices money laundering and terrorist financing risk exposure and with sufficient authority made a decision to onboard or continue the relationship?

(f) conducting enhanced monitoring of the business relationship by increasing the number and timing of controls applied, and selecting patterns of transactions that need further examination – this could include a greater level of information and explanation from the client when ongoing work changes nature or could mean greater frequency of checks on transactions and undertaking more frequent due diligence checks.

If the requirement is met or the decision is made to apply enhanced customer due diligence in relation to higher risk jurisdictions, regulation 33(3A) measures must be incorporated into that due diligence. These measures are practical examples of mitigation that you must undertake.

It must also be kept in mind that there are additional higher-risk themes and due diligence must be tailored with these in mind.

For further information and guidance, please refer to the useful links in the drop down below.