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Supplements » Luxembourg Report 2021

Anti-money laundering: Money’s always on the move

Money_launderingLuxembourg’s collective investment funds industry may be unfairly tarnished amid wider accusations of lax anti-money laundering processes, even so, the funds industry does have AML issues to deal with, finds Nicholas Pratt.

Money laundering is a topic that “never stands still”, according to Silke Bernard, a Linklaters lawyer (see ‘Regulation: what’s coming down the regulatory track?Funds Europe, October 2020).  

Sure enough, it started to move again with considerable velocity in February when the Luxembourg financial services industry found itself at the centre of ugly allegations. 

The news media’s ‘OpenLux’ investigation involved 17 press organisations and a year-long look into more than 3 million documents. It examined Luxembourg’s register of beneficial ownership: a publicly accessible list of beneficial owners that was introduced in 2019.

OpenLux alleged companies and assets in Luxembourg were linked with the Italian mafia, the Russian underworld and Hollywood celebrities. It also cited “anonymous investment funds” buying up swathes of real estate. French newspaper Le Monde, a key player in the investigation, concluded that there were 55,000 offshore companies with no offices or employees, and a collective value in excess of €6.5 trillion.

Le Monde also accused the Luxembourg authorities of not committing enough personnel to manage the control of the funds that pass through the country. “The trade register only employs 59 people to ensure compliance with the legal obligation to declare the beneficial owners of more than 100,000 entities,” the newspaper stated.

Although described as unhelpful, misleading and nothing to do with actual anti-money laundering (AML), the OpenLux report did lead the Luxembourg government to issue a lengthy statement refuting the various allegations. 

Luxembourg’s government said the country was “fully in line and compliant with all EU and international regulations and transparency standards” and was “fully aware of its responsibility as an international financial centre”.

On AML and counter-terrorist financing (CTF), the staff at Luxembourg’s financial regulator, the CSSF, had increased by 46% over the past three years, according to the statement. More recently, Luxembourg was one of the first countries in Europe to set up a public Ultimate Beneficial Owners Registry (UBO).

“Importantly, it is one of the only European Union countries to have opted for a completely open and transparent registry, which is accessible, online and free of charge, without any restriction to the public (including journalists),” the government statement added.

Getting it right
Funds Europe asked Bernard, who is a partner at Linklaters in Luxembourg, for her perspective. 

“AML is taken very seriously in Luxembourg and everybody is interested in getting it right,” she says, adding that some of the allegations were misleading and were explained partly by the way funds operate. 

“For example, the report correctly states that 80% of Luxembourg funds don’t have a beneficial owner – but that is because a Ucits fund will typically have thousands of shareholders and none of them will have a stake anywhere close to 25%, as would be required to qualify as a beneficial owner,” Bernard says. 

Almost all Ucits funds are designed to be sold to large numbers of individual, non-sophisticated investors – not to a small number of usually wealthy individuals. Every investor in a Ucits fund comes through a bank or other financial firm and is subject to thorough know-your-customer (KYC) requirements. 

“Likewise, with alternative investment funds, you will rarely have fund structures held by fewer than four individual investors. In many alternative funds, you will see between ten and 40 investors and it is very rare that any one of them is an individual person owning 25% of the fund,” says Bernard. 

She adds that the UBO is not designed to prevent money laundering but to disclose ownership in large entities: “In most investment funds there simply are no large ownership stakes.”

Nevertheless, critics say the UBO is flawed. The ramifications of OpenLux continue to place Luxembourg under scrutiny. The fuller investigation is documented at occrp.org.

More accountability
Away from the furore and more into the day-to-day AML operations in Luxembourg’s funds industry, it may not be the abundance of unclaimed assets or a lack of reporting that are so much the problems, but a lack of progress on developing efficient processes to deal with increased reporting requirements. This is particularly the case in private-capital funds – at least according to one management consultant in the industry.

Many fund professionals involved in delivering AML services in Luxembourg are focused on the latest regulation to emerge from the CSSF. Last year saw a key AML development when it became a requirement that funds must establish two functions responsible for managing their AML and CTF reporting. 

These functions are the responsable du respect des obligations, known as the RR, which manages compliance at the board level; and the responsable du contrôle du respect des obligations, known as the RC, which is the control function, acting as the eyes and ears of AML compliance. The person in this latter function reports to the board. 

Kavitha Ramachandran, a regional head of business development and client management at fund administration firm Maitland, says: “The appointed person must be named because the CSSF wants them to be identified and to be accountable. The regulator also wants to see evidence of experience and knowledge about compliance. It wants to bring more capability to the AML process.”

A key feature of the process is an annual online AML/CFT survey that must be completed by either the RR, RC or a delegated third party such as a fund administrator or management company, and submitted to the CSSF. 

“The survey is part of the CSSF’s ongoing evaluation of the money-laundering risks present in the sectors under its supervision and forms part of the risk-based supervision put in place by the CSSF,” says Cécile Rechstein, partner at Luxembourg law firm Chevalier & Sciales. 

“Thanks to the survey, the CSSF collects data, identifies shortcomings and raises awareness on the obligations facing fund managers,” says Rechstein. “It should be noted that last year, the CSSF sent back less than 5% of the AML surveys, which shows that the industry is following a good practice.”

The survey for 2020 was released on February 15 and while largely the same as in previous years, it includes questions on the use of regtech firms by fund managers and to what extent the technology offered by these start-ups meets their legal and regulatory requirements, says Rechstein.

The CSSF is also imposing its AML requirements on a wider number of fund vehicles beyond Ucits.  As of December 2020, managers must complete their questionnaires for Reserved Alternative Investment Funds (RAIFs) as they do for other funds in Luxembourg.

And while a questionnaire may not sound the most taxing of administrative tasks, there is a growing processing burden that is leading more firms to look to third parties – typically external management companies or fund administrators – for help.

The private markets problem
The biggest problem in AML compliance lies within the private markets sector – funds that invest in assets such as private equity and real estate, says Paul Bratch, managing partner for financial services consulting firm Sionic. Bratch has been advising Luxembourg fund managers and administrators on their AML compliance process and has found a lack of progress, which he says has been frustrating. 

He adds that private markets funds have faced a perfect storm. Firstly, there has been a massive move of investment capital from public to private markets as investors look for higher returns in a zero interest-rate world. This has coincided with greater scrutiny and reporting requirements, including on AML, which is one of many areas where the rules continue to be enhanced, all while the Luxembourg market continues to endure a scarcity of resources across the sector.

“Unfortunately, the private markets sector is not generally equipped to deal with these AML issues. There is less automation, with most AML processes done manually, using spreadsheets and emails, to paper-based documentation for identification and sources of income. There are also typically historic shortcomings where records have not been maintained because they haven’t always had to be.”

Many firms now face the dual challenge of retrofitting details in their historical records and upgrading processes and systems to meet today’s requirements.

“It is not that there aren’t third party systems or AML outsourcing providers out there, or that firms couldn’t do a better job, but some are just not doing what needs to be done,” says Bratch.

Perhaps the greater regulatory pressure and the fear of being named and shamed will serve as an impetus, but it will take time, he adds. “It is an area where there has been underinvestment for some time, compounded by the shortage of resources out there and firms struggling to hire quality people.  Furthermore, many firms in the private funds space have limited budgets and internal change management resources.”

Those chronic shortages are partly due to the success of the Luxembourg funds industry, which has grown enormously. However, people aren’t naturally attracted to the compliance sector within the funds market.

Nor does Bratch think that an increase in personal accountability will be a significant driver for private market funds to address their AML shortcomings. “The notion of personal accountability has been around for some time,” he says.

Most likely a spur will come from the technology market or the services market, says Bratch. There is no shortage of regtech firms that have AML offerings, or software solutions from the traditional banking and retail funds sectors. There is also no shortage of specialist outsourced service providers focused on AML processing. However, in the private markets sector this is still a nascent area, where many of the providers do not have the battle-hardened and robust reputation that the industry is looking for.

Time will obviously help providers develop a more robust reputation and make the technology or services solutions more accessible and affordable, says Bratch. But it is only when a widely recognised product or solution emerges that significant progress will be made, he says.

“Most firms follow the herd and if a proven, robust and affordable piece of technology or outsource solution came to dominate the market, it will be the biggest driver. Right now, there is a lot of pressure – but a shortage of resources and no proven product that stands out.”

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