Money Laundering Advisory Committee:

Discussion Paper II - Revision of the 1993 Money Laundering Regulations

The European Parliament adopted the Second Money Laundering Directive (2001/97/EC) on 4 December 2001 and the text was published in the Official Journal on 28 December. The Directive amends the 1991 Money Laundering Directive to introduce changes in three main areas:-
It updates the definition of regulated credit and financial institutions, to include branches of institutions whose head offices are located in another member state, and investment firms as defined in Directive 93/22/EEC
It widens the scope of predicate offences for which suspicious transaction reports are mandatory from drug trafficking to all serious offences
It brings within the regulated sector the following "legal or natural persons acting in the exercise of their professional activities":
- Auditors, external accountants and tax advisors
- Real estate agents
- Notaries and other legal professionals acting on behalf of their client in any financial or real estate transaction (including specific areas of assistance defined in the Directive)
- Dealers in high-value goods, such as precious stones or metals, or works of art, auctioneers, whenever payment is made in cash, and in an amount of EUR 15 000 or more;
- Casinos

2. The UK system already meets the requirements of the Directive in several respects: under existing legislation, all indictable (and some summary) crimes are predicate offences for the purposes of money laundering, and the definition of relevant credit/financial institutions already includes EU institutions operating in the UK according to the conditions of the Financial Services and Markets Act (reg 4.1.e). The main change under the Directive will therefore be the extension of the regulations to new professions and activities.

3. Member States are obliged to implement the Directive in national law by 15 June 2003; in the UK, this will be done through a revision of the 1993 Money Laundering Regulations. Outlined below are some of the issues raised by the expansion of the regulated sector, with some options for consideration. We also intend to take this opportunity to consolidate and redraft the text, in the interests of clarity, and to ensure that references are consistent with recent legislation. More substantively, we intend to revisit a number of points where problems in the 1993 Regulations have become apparent. Some key elements of the proposed changes are set out below.

4. We welcome views from the Committee on these outline proposals, although there will undoubtedly be a need for ongoing, detailed consideration. Following discussion by the Committee, we will move to a three month consultation on the draft regulations, with the intention that legislation will be in place before the end of the year. This is intended to allow those included in the regulated sector for the first time to prepare their systems before the deadline of 15 June 2003: however, some provisions of the regulations may enter into force earlier - these will be clearly highlighted in the consultation document.

Expansion of the regulated sector

5. Our aim must be to provide clear, enforceable regulations, consistent with the Directive. In achieving this, we continue to support the principle of risk-based regulation, minimizing the regulatory burden on both industry and consumers and taking into account possible competitive distortions where different professions offer comparable services.

External accountants, auditors and tax advisors

6. The Directive requires us to regulate "auditors, external accountants and tax advisors?. in the exercise of their professional activities". In the UK, the term "accountancy" covers a wide range of activities, including external auditing and taxation: it would be very difficult to provide an inclusive definition. Moreover, many of these activities are performed not only by qualified accountants, but also by professionals such as lawyers, management consultants and insolvency practitioners, or indeed by unqualified accountants. While the Directive refers specifically to the class of individuals and firms to be included, we may need the regulations to apply more widely, where other professionals engage in similar activities. This question of application is the principal issue: discussions on the potential difficulties of compliance [e.g. auditors concern at burden of reporting under POCB] will follow.

Option 1

7. One interpretation of the Directive would be to regulate individuals and firms who are members of the Institutes on the Consultative Committee of Accountancy Bodies, or of the Chartered Institute of Taxation (which might be added to the list of supervisory authorities). Individuals would be subject to the regulations only when providing external accounting services: the internal finance department of a company would not be affected, nor would an individual qualified to practice as an accountant but acting as the director of a company, or performing some other function unrelated to his qualification. Trainees would not be covered, although there would still be a responsibility on the employing firm to have adequate lines of reporting to a more senior level.

8. The main advantage of this approach would be that it catches a discrete group of qualified professionals, who are already required to meet certain standards of competence and integrity, and are under the supervision of a recognised professional body.

9. However, the ICAEW has voiced concerns that this approach might put the accountancy profession at a competitive disadvantage where they offered (as is increasingly the case) services equivalent to those of other, unregulated professions. Examples of overlap might occur in the work of lawyers, insolvency practitioners, or management consultants: with further complications if a qualified accountant undertook such work on behalf of a consultancy firm. Unqualified accountants or "tax technicians" offer further competition, and the ICA has suggested that unscrupulous clients might turn to accountants that had been struck off the membership list of professional associations, if they were not also covered. These issues will need to be considered carefully.

Option 2

10. While it may not be possible to accommodate all these concerns, an alternative approach could apply the regulations with reference both to profession and to activities. For example, it would be reasonable to include insolvency practitioners, company formation agents, and other qualified tax advisors. Regulation of management consultants as a profession is unlikely, as they are not explicitly covered by the Directive, and we have no evidence from law enforcement that this is an area of particular risk. However it is worth pointing out that some aspects of consultancy work may already fall within the definition of regulated activities at 4(1)(h): the annex to the Banking Consolidation Directive lists "advice to undertakings on capital structure, industrial strategy and related questions and advice and services relating to mergers and the purchase of undertakings".

11. Accountants practising without qualifications might also be covered in principle, although it would be very difficult to assess compliance. Moreover, given the criminal penalties for failure to comply, imposing regulations on such unqualified technicians would need careful consideration: it could not be assumed that practitioners would have sufficient expertise or training to enable them to fulfil their obligations.

12. The ICAEW has highlighted their desire to see a carve-out from their reporting obligations similar to that enjoyed by lawyers in many jurisdictions While lawyers who provide tax advice or engage in other regulated activities will be covered, a key issue for the accountants will be whether UK accountants are able to withhold information on the grounds of professional privilege. There is as yet no indication of the extent to which legitimate clients would be deterred by the knowledge that an accountant would not be able to withhold suspicions of money laundering from law enforcement. The concept of professional privilege is based largely on a large body of case law, and has traditionally been confined to lawyers: while there is some precedent for its extension to accountants, this is an issue requiring careful consideration. We also note that privilege may not be used as a defence for failing to report knowledge or suspicion under drugs or terrorism legislation where the information came to the lawyer in relation to advice sought to further a criminal purpose.

Real Estate Agents

13. This requirement in the Directive reflects a body of evidence from law enforcement that many criminals invest their money in real property. Although most estate agents already take careful steps to identify clients for their own business reasons, their client is usually the vendor rather than the purchaser of property. We are not currently minded to impose any obligations on Estate Agents to identify purchasers, as they will not usually have a business relationship with them. In addition, the money laundering risks are mitigated by the fact that UK estate agents do not generally handle the client's assets: transactions would normally be subject to scrutiny by intermediaries such as lawyers, banks and mortgage lenders as well. We therefore see this area as sitting at the lower end of the risk spectrum, and we do not anticipate imposing a new system of supervision of estate agents for compliance with the regulations. We would, however, look to industry associations to raise awareness of money laundering across the sector, and develop guidance notes in consultation with HM Treasury.

Lawyers

14. The Directive provides a clear description of the activities which are to be regulated, when carried out by independent legal professionals: it lists any assistance to/representation of clients in transactions concerning:

buying and selling of real property or business entities
managing of client money, securities or other assets
opening or management of bank, savings or securities accounts
organisation of contributions necessary for the creation, operation or management of companies
creation, operation or management of trusts, companies or similar structures

15. In addition to these activities, the Directive stipulates that lawyers should be regulated when engaged in the provision of taxation advice. In practice, the regulations will be more relevant to solicitors than barristers, but all qualified legal practitioners will be caught in principle. Our intention is to ensure consistent treatment of people offering equivalent professional services, such as Company Formation Agents and trust service providers. The Directive offers the option of lawyers making suspicious transaction reports to an appropriate self-regulatory body, rather than to the central FIU. We do not intend to take this course, and reports will be made to NCIS according to the current practice. This is consistent with representations received from legal professional associations. Nor will we be taking the option of a further concession, exempting lawyers from the tipping-off offence. We intend to treat legal professional privilege in a similar manner to existing legislation - legal professional privilege may not be cited as a defence for a failure to report offence where a/the client has sought advice to further a criminal purpose.

Casinos

16. In the case of casinos, the Directive requires us to supplement the normal requirements on identification, record keeping etc with a requirement to obtain identification wherever a customer buys chips over the value of 1000 euros. It offers casinos the option of conducting identification either of individual clients at the point when the purchase of chips rises above the threshold, or of all clients on entry, irrespective of their subsequent gaming.

17. The British Gaming Board, which supervises the activities of all UK casinos, already issues a Code of Practice relating to the prevention and detection of money laundering. This requires the identification of both members and guests, and systems of reporting, record keeping etc. The main change required to comply with the Directive will be to strengthen the identification procedures for guests, who are currently signed in by a member without the information being verified. Given that 1000 euro is a fairly low threshold for the industry, and that guests are already required to register in some form on entry to a casino, this identification of everyone on entrance will probably be the easiest route to compliance. When the British Gaming Board updates its guidance, the main issue will be to ensure that the types of evidence accepted are both a reliable means of establishing identity, and flexible enough not to deter or delay clients. Industry representatives have already agreed to consider appropriate guidance and to propose a new Code of Practice that will bring the industry into compliance with the Directive. This Code will be agreed with the Gaming Board, Police and Government and will be underpinned by Regulations.

Dealers in high value goods

18. The Directive requires us to bring within the scope of the regulations

"dealers in high value goods, such as precious stones or metals, or works of art, auctioneers, whenever payment is made in cash, and in an amount of EUR 15000 or more".

This provision is intended to address the risk of criminal assets being transferred through the purchase of material/physical goods, rather than through monetary or financial channels. The Directive identifies certain goods which would be especially attractive to criminals, as being of high and stable value, and easily converted/sold on at a later date. The definition of "dealers in high value goods" is at the discretion of Member States, but the implication is that it would include at least the areas identified. However, it would be rational to extend the requirement to other areas of business, if there was evidence that they were being used as conduits for money laundering. A more radical approach might be to take the view that any large cash payment carries a risk of money laundering, and to limit the use of cash in transactions above a certain value (this is already the case in France and Italy, where large cash transactions are prohibited).

19. The fact that individuals and firms would only fall within the scope of the regulations on receiving a cash payment above the EUR 15,000 threshold raises the question of whether all of the requirements of the regulations are appropriate. For example, the obligation to train staff and establish internal reporting systems would be an unnecessary burden on businesses which rarely received large payments in cash or indeed in any other form. We would wish to avoid a situation where a small business engaged in very few high value transactions was required to maintain costly compliance procedures, or was suddenly subjected to criminal penalties of whose existence he had previously been unaware.

Option 1

20. The regulated sector would include firms and individuals whose regular activities involved frequent transactions above the value of EUR 15,000, dealing in the well-developed markets specified in the Directive. Businesses with no record of making regular large transactions would not be included.

21. This interpretation would recognise that money launderers do not buy goods for their intrinsic qualities, but for the ease with which they can be purchased, stored, and sold on; in short, because they provide conduits to conceal the origins of assets. By this reasoning, we would wish to avoid the need to impose a regulatory burden on the countless businesses which do not offer such good opportunities, even where goods are of a high value. Concentrating on the key areas identified in the Directive would take into account the fact that this method of money laundering is not of primary importance in the UK and that for many businesses the costs of compliance would outweigh the gains to law enforcement. Should NCIS later obtain evidence of significant money laundering activity using certain high value goods, the list of regulated businesses could be extended beyond the requirements of the Directive.

22. Disadvantages include the fact that any such list is to some extent an arbitrary one. An attempt to identify all the businesses which came within such a list would be harder still, especially where the average size of transactions was close to the threshold. While we could work with industry associations to raise awareness among the major players, we would not be able to ensure that all small businesses within the regulated sector were in a position to meet their obligations.

Option 2

23. An alternative approach would be to focus on the risks inherent in any large transfer of cash, rather than on the properties of the goods purchased. The use of cash would thus be limited to transactions below the threshold of EUR 15 000. The main advantage of this overarching requirement would lie in its clarity. It focuses on the "placement" stage of laundering and the fact that money launderers must introduce large volumes of cash into the system through any means available. It would apply to everyone in the UK, so would not lead to arbitrary application, competitive distortions, or indeed any regulatory burden other than the obligation to refuse large payments made in cash. This approach mirrors measures in place in France and Italy, and is based on the same premise as the US system, where it is mandatory to report all large cash transactions, suspicious or otherwise.

24. This approach appears to go well beyond the requirements of the Directive. While we can point to equivalent systems in other member states, we would need to be certain that our interpretation was backed with concrete evidence from NCIS and could withstand a legal challenge. As a significant change in the definition of legal tender, it would be likely to meet considerable opposition. In particular, it makes no concession to the fact that certain groups are accustomed to making large payments in cash for perfectly legitimate purposes - for example, in the agricultural sector, or in some ethnic minority communities. Nor is it at all clear that it would be effective in preventing money laundering: it would be difficult to detect breaches of the restriction, and easy for launderers to "smurf" below the threshold, with no fear of a report being made to NCIS.

Questions

1) Are you content that these proposals reflect the requirements of the Directive?

2) Are you broadly content with the approach we are taking? In particular, are there professions whose omission from the regulations might lead to competitive distortions?

3) How would you like work on implementation of the Directive to be taken forward? Would it be appropriate to form a working group?

Changes in the 1993 Regulations

Consistency with the Proceeds of Crime Bill

25. Clause 330 of the Proceeds of Crime Bill provides that it is an offence for someone working in the regulated sector not to make a report when he has knowledge, suspicion, or reasonable grounds to suspect that money laundering is taking place. A court considering this offence is required to take into account steps taken to comply with relevant guidance issued by a supervisory authority or other appropriate body and approved by the Treasury. We propose to align regulation 5 (3)(4) and (5) with the wording of this provision, creating an obligation on the court to take into account compliance with the relevant guidance notes. The guidance notes will be approved by a Treasury Minister for this purpose, and would then have the same status in relation to both primary and secondary legislation.

Change to regulation 8, the "postal concession"

26. Regulation 8 defines a limited set of circumstances, in which payment from an account held in a customer's name at a bank or other credit institution may be capable of constituting the evidence of identity required under regulation 7. The principle is that a client and his money must undergo due diligence procedures on entering the financial system, but that "double due diligence" is unnecessary. The concession is thus limited to accounts where payment may be made only to the account holder; it is further confined to circumstances where it is reasonable to pay via post/phone/electronic means; and where there is no suspicion of money laundering. The complexity of the regulation has in our view led to considerable misinterpretation. Moreover, the following difficulties have become increasingly apparent:
- The concession is distortionary

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27. Regulation 8 defines the accounts that can take advantage of the concession by excluding from the concession accounts opened at UK- or EC-regulated credit institutions. This drafting introduces a competitive distortion: those authorised to accept deposits under the Financial Services and Markets Act 2000 can only offer limited accounts using the concession, but other FSA regulated activities can offer any type of account whatsoever.
- The concession carries risks of money laundering if used indiscriminately

28. The term "relevant account" ensures that the postal concession can only be used to open a limited account (allowing payments only back to the account holder). With Regulation 8 as it stands, identification has to occur at least once in the system: this provides a deterrent to the "placement" of criminal funds, although multiple hurdles, with identification at each bank, would be more reliable. However, there is no such limit to the number of accounts that could be opened in reliance on the concession. Since only the payment that opens the account must be debited from an account at a credit institution, a criminal could use the concession to open a network of accounts through which to deposit and move around money. The bank relies on the identification procedures of another, and is unable to verify any KYC information it does have against documentary evidence. Without an accurate client profile, the bank would find it difficult to detect such "layering" activity.
- It has a tenuous basis in the Directive

29. The Directive provides a similar concession in respect specifically of insurance policies, a far more limited category. If regulation 8 were drafted as an absolute exemption from the identification requirement, it would be difficult to argue that it was compliant with the Directive. However, regulation 8 uses the words "'shall be capable of constituting the required evidence of identity". This is not an exemption from Regulation 7 per se. It means that a payment debited from a credit institution may assist in the cumulative process of identification. As such, payment debited from a credit institution may function as the "supporting evidence" that is referred to in Article 3(1) of the Directive.
- In effect, it adds nothing to the terms of regulation 7

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30. It is important to note that regulation 8 does not provide a blanket exemption or in any way dilute the terms of regulation 7, under which it is at the discretion of the financial institution or employee to decide what constitutes "satisfactory evidence" of a client's identity. It does not guarantee that such evidence of identity will always be sufficient in the specified circumstances - responsibility remains with the individual institution to judge what constitutes satisfactory evidence. The fact that payment is debited from an account in the account holder's name at a credit institution might satisfy the institution concerned, but if not they should continue with identification procedures in accordance with Regulation 7.

31. In the light of these arguments, we intend to remove regulation 8 from the revised version of the regulations. The idea underlying the current concession, that a payment debited from a credit institution is useful for identification purposes, remains valid and may still apply in certain circumstances. However, we feel that removing the apparent concession will clarify the responsibility on firms and individuals in the regulated sector to decide what form of identification is appropriate to the risks of their own business.

Insurance business and supervision

32. Regulation 10 (1) (e) exempts from the identification requirements

"insurance business consisting of a policy of insurance in connection with a pension scheme taken out by virtue of a person's contract of employment or occupation where the policy:
1. contains no surrender clause and
2. may not be used as collateral for a loan"

This wording closely follows the 1991 EC Directive, but it is not made sufficiently clear what types of business are intended. The ABI have written previously suggesting an interpretation allowing an exemption from identification procedures for stakeholder and personal pensions. While we do not agree that this interpretation can be considered compatible with the requirements of the Directive, we agree that it would be desirable to extend the concession to other pension schemes carrying a low risk of money laundering. This issue might be addressed in the anticipated third EU Directive: HM Treasury would be willing to support industry lobbying of the Commission when negotiations begin, and would welcome preparatory discussion of the issues involved.

33. Independently of the point above, we are considering including the Occupational Pensions Regulatory Authority (OPRA) in the list of supervisory authorities.

Exemption for business transacted only through regulated institutions

34. The definition of regulated business, as required under the Directive, includes activities listed in Annex 1 of the Banking Consolidation Directive. Slaughter and May enquired about the change in SI 2000/2952, whereby the listed activity "acceptance of deposits and other repayable funds from the public" now reads simply "acceptance of deposits and other repayable funds". They explained the impact of this change on issuers of debt securities, most of whom deal exclusively through a regulated bank or securities firm and have no contact with the individual clients. While these issuers would be exempted from the identification requirements, and would never have occasion to make a suspicious transaction report, they would nonetheless be required under the regulations to establish internal systems and controls.

35. We agree that it would be desirable in principle to provide an exemption from the regulations for those institutions that enter into business relations only with other regulated credit and financial institutions. However, we will need to consider very carefully whether such an exemption could be held to comply with the requirements of the Directive.

Question:

Are you content with the proposed changes to the 1993 Regulations?