Extending the net of AML/CFT: The need for public awareness

• The extension of mandatory obligations for Designated Non-Financial Businesses and Professions (DNFB&Ps)

Public policy implications

Tuesday, 21 November 2017

By Press Notice, the Central Bank of Sri Lanka (CBSL) through its Financial Intelligence Unit(FIU), has drawn the attention of the public to “Extraordinary Gazette Notification No. 2015/56 dated April 21, 2017 prescribing ‘Suspicious Transactions (Format)’ to be followed by Institutions defined under Section 33 of the FTRA”.

The purpose of this Notice, it is said, “is to inform the Designated Non-finance Businesses (DNFBs) (specified in the Notice), of their obligation to report any transaction where there is reasonable ground to suspect that the transaction may be related to commission of any unlawful activity/criminal offence as defined in Section 33 of the FTRA”.

This Notice has thus made it mandatory for DNFB&Ps to comply with the KYC/CDD requirements hitherto applicable only to licensed financial institutions, as defined in the Financial Transactions Reporting Act (FTRA). This is, in effect, an extension of the international requirements relating to Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) to these non-financial businesses and professions.

Hitherto, AML/CFT obligations, though applicable to DNFB&Ps equally in terms of the law, were implemented and enforced only in respect of financial institutions.

Accordingly, of the 40+9 recommendations which have been issued by the FATF and compliance with which is used to rank countries on AML/CFT risk, four recommendations (12, 16, 24 and 25) were created in relation to the preventive measures that a number of non-financial businesses and professions, supervisory authorities/self-regulatory organisations, and other authorities concerned, should adopt to combat ML/TF in designated situations. This was one of the most important amendments to the 40 Recommendations of the FATF in 2003.

Implications

The implementation of these recommendations is very far-reaching and covers a very wide sphere of business and professional activity outside the financial system of the country.

In its commitment therefore to enforce these measures and eliminate the gaps in the level of country compliance with the global standards, and not merely to pay lip-service to the recommendations, the authorities will need to equip themselves with the human resources and the administrative supervisory and investigative infrastructure necessary, for effective implementation.

The non-financial businesses and professions designated are:

• casinos, 
• real estate agents, 
• dealers in precious metals, 
• dealers in precious stones, 
• lawyers, notaries, other independent legal professionals and accountants, 
• trusts and company service providers,
• Offshore units as defined.

What are some of the risks envisaged?

The risks connected to lawyers, accountants (as independent professions) and some other professions in the ML/TF field, lie basically in the potential misuse of these professions in concealing the identities of the beneficial owners of the transactions done through them. Therefore, countries are required to impose certain obligations on these categories to combat ML/TF, when they carry out the stated activities in the relevant FATF recommendations.

For instance with regard to real estate agents – money laundering through the real estate sector is considered a traditional way of ML, especially in cash-based societies and may have several forms, most of which are universal but some of which may be country specific. In Sri Lanka today, as it is in most countries, real estate transactions show an increasing trend, leading almost to what has been reliably identified as a “bubble” with significant economic implications. The financial transactions in this sphere of activity are large and demand very close scrutiny to ensure the legal source of funds.

Dealers in precious stones and metals – The risks of misusing the dealers in precious stones and metals are due to the fact that precious metals, particularly gold, attracts money launderers, as it has a high actual value and can be found in relatively small sizes, thus facilitating its transport, purchase and sale, in several regions around the world. Gold also preserves its value, regardless of its form, whether it comes in the form of bullion or gold articles. It is said that dealers are often interested in gold more than gems as it can be melted to change its form while preserving its value.

Diamonds can also be traded around the world easily as the small size of diamond stones and their high value, facilitate their concealment and transport and make it one of the most sought after gems and jewels with the risk of being misused as a ML means. In some cases, it was noted that diamonds are used as a means to finance terrorist acts and groups.

Noteworthy for DNFB&Ps

Accordingly, the Customer Due Diligence (CDD) and record-keeping requirements set out in Recommendations 5, 6, and 8 to 11 apply to designated non-financial businesses and professions in the following situations:

a) Casinos – when customers engage in financial transactions equal to or above the applicable designated threshold (still to be specified by the authorities).

b) Real estate agents – when they are involved in transactions for their client concerning the buying and selling of real estate.

c) Dealers in precious metals and dealers in precious stones - when they engage in any cash transaction with a customer equal to or above the applicable designated threshold (still to be specified by the authorities).

d) Lawyers, notaries, other independent legal professionals and accountants, when they prepare for, or carry out transactions for their client concerning the following activities: buying and selling of real estate; managing of client money, securities or other assets; management of bank, savings or securities accounts; organisation of contributions for the creation, operation or management of companies; creation, operation or management of legal persons or arrangements, and buying and selling of business entities.

e) Trust and company service providers when they prepare for, or carry out transactions for, a client concerning the activities listed in the definition in the Glossary.

According to the requirements set out in the relevant Recommendations:

Lawyers, notaries, other independent legal professionals, and accountants acting as independent legal professionals, are not required to report their suspicions if the relevant information was obtained in circumstances where they are subject to professional secrecy or legal professional privilege.

Recommendation 24 requires that: Designated non-financial businesses and professions should be subject to regulatory and supervisory measures as set out below:

a) Casinos should be subject to a comprehensive regulatory and supervisory regime that ensures that they have effectively implemented the necessary AML/CFT measures. At a minimum:

• casinos should be licensed;
• competent authorities should take the necessary legal or regulatory measures to prevent criminals or their associates from holding, or being the beneficial owner of, a significant or controlling interest, holding a management function in, or being an operator of a casino
• Competent authorities should ensure that casinos are effectively supervised for compliance with AML/CFT requirements.

b)The competent authorities, in Sri Lanka’s case, the Central Bank of Sri Lanka, should establish guidelines, and provide feedback, which will assist designated non-financial businesses and professions in applying national measures to AML/CFT, and in particular, in detecting and reporting suspicious transactions (STRs).

It is believed that this is still a work in progress, although ideally, the rules or guidelines specifying the thresholds, where applicable, and the broad framework within which these DSNBF&Ps are obligated to operate, should have been issued simultaneously. On the contrary there has been more than a pregnant pause between the issue of the Press Notice and the Gazette Order and the issue of the rules and guidelines, which are an imperative if the authorities concerned are serious about their commitment to enforce the KYC/CDD obligations imposed on this sector.

It is also recommended that the relevant authorities should eliminate any confusion or misunderstanding some DNFBPs might have, especially, lawyers, accountants, notaries, and other independent legal professions, regarding a contradiction between the professional secrecy privilege and the reporting of STRs.

Gazette Order of 21 April 2017 – simultaneously, regulations cited as the Suspicious Transactions (Format) Regulations of 2017, have been notified and shall apply to every Institution within the meaning of Section 33 of the Act which are deemed to have obligations under AML/CFT.

While all institutions specified in the Gazette Order in Schedules I to IV have been identified and the formats comprehensively elaborated for reporting purposes, the DNFB&Ps referred to in Schedule V have not been fairly treated, in that examples of suspicious transactions elaborated in the other four schedules, have been completely left out. This is contrary to the recommendations of the FATF in this regard.

This is a serious omission, especially in circumstances where this category of entities have only recently been brought into the AML/CFT net and where no public awareness has so far been created by the authorities, of the circumstances in which these businesses and professionals can be used, or are vulnerable to, money laundering and terrorist financing.

Particularly where the legal profession is concerned, as a result of the “legal fog that is inevitable through interpretation of various laws based on stated cases and the inevitable legal arguments, we stand to lose the whole concept of what the law really means” (Money Launderers by Bob Blunden).

Therefore the simple question one needs to ask oneself is, as a financial institution, business or professional, “do you wish to handle the proceeds of any criminal or illegal activity, whatever that activity may be?” In other words do you wish to transact, or provide a safe haven to, what is commonly referred to as “dirty money”? If you do, you would end up profiting from a criminal or illegal enterprise.

Recommendations of the FATF for successful implementation

• Countries should work on providing a list of suspicious indicators to the various categories of DNFBPs to help them detect suspicious transactions. This could take place by coordination and constructive dialogue, amongst supervisory authorities i.e. the Financial Intelligence Unit (FIU) and the DNFB&Ps. This is an imperative and there is a lot of best practice in the literature available on the subject and from the region, not to want to reinvent the wheel. It is a cut and paste job with the addition of course of the inevitable local experience in the specific sectors which may be country specific.
• It is expected that forms have already been designed for reporting suspicious transactions and have been distributed to all categories of DNFBPs which conduct activities mentioned above. This is what the Gazette Order of April 2017 attempts to do, by specifying the reporting methods, the way of filling the reporting form, the minimum information required, and the competent authority responsible for receiving the reports. 
• More importantly, countries should direct DNFB&P categories to perform the financial operations and activities they carry out, through bank accounts – if possible - and lessen their reliance on cash in order to reduce the related risks and make monitoring and follow up procedures easier. 

In conclusion it is apparent thus that onerous obligations ensue for

• Banks

It is pertinent that even where these transactions are conducted in cash, the recipient of the cash, or their agents, the DFNB&Ps, would invariably deposit this cash in their bank accounts or those of their clients. It then becomes the obligation of the banks to perform the necessary due diligence, particularly where the DFNB&P concerned, it becomes apparent to the bank, has not done so, in identifying the source of funds for the relevant transaction. This then is incumbent upon the bank concerned to do so.

• The DNFB&Ps

The DNFB&Ps themselves, particularly the professionals, should realise the importance of protecting themselves by not entertaining large cash transactions and if they do, they will do so at their own risk. This therefore, does not need to be mandated if they conduct their business as responsible citizens and professionals at all times. The simple question one needs to ask oneself is “why should anyone want to transact in cash, particularly where the volumes are so large?” 

• The regulatory authorities

Large cash transactions through the licensed banks and non-bank financial institutions, over a specific threshold, are captured by the Regulator in the Cash Transaction Reports (CTRs), mandated to be filed by these institutions with the authority. It naturally follows that the authorities should be equipped to detect and flag these transactions and raise the level of inquiry necessary to detect their legality? It is pertinent to ask how many of such transactions were detected over the last so many years when AML/CFT obligations were applicable to even the DNFB&Ps, though not implemented, but which found their way into the banking system? 
After all this is the prime objective of money laundering and terrorist financing – laundering the proceeds of crime through the banking system!! The vibrant real estate sector, the casinos etc., have been flourishing over a considerable period of time regardless of AML/CFT concerns. There is naturally going to be quite a lot of resentment and angst when they feel the noose suddenly tightening round their necks. If these transactions had been probed as they should have been, the level of due diligence required from the banks too could have been significantly enhanced over the last decade since the law was enacted, to eliminate any reckless disregard that could have taken place for the necessary checks and balances to be put in place to ensure that this sector of businesses and professionals too were aware of their obligations under AML/CFT.

Additionally, it would be useful for the authorities to also consider the new threat on the horizon which looms large – crypto currencies – and what can be done to mitigate the AML/CFT concerns posed. The recent commentary by W.A. Wijewardena, the former Deputy Governor of the Central Bank of Sri Lanka, on the subject is indeed an eye opener.

As regulators the authorities always need to be proactive and ahead of these threats and not lag far behind, attempting to close the door after the horse has bolted so to speak. There has to be international best practice that can be used to formulate the necessary policies and safeguards and the use of the many forums available, particularly through the FATF, to assist in this regard.
(The writer was a consultant to the FIU of the Central Bank in its formative years, ex-Director of Bank Supervision and more recently Advisor to the Governor of the Central Bank.)