Regulation: How realistic are the latest AML proposals for cross-border funds?

The European Commission needs to consider the structure of the funds industry so that proposed anti-money laundering measures don’t affect Luxembourg adversely, experts tell David Whitehouse.

EU proposals to combat money laundering and terrorist financing need to take greater account of the specific features of cross-border fund management, industry representatives in Luxembourg argue.

The Grand Duchy is the largest fund domicile in Europe and a global leader in cross-border distribution of funds. Managers such as Franklin Templeton, Fidelity International and HSBC use the country as a global distribution hub.

The stakes are high. Europol has estimated that about 1% of the EU’s GDP comes from “suspect financial activity”. That’s about equivalent to the annual EU budget.

And most of it is not being caught. Europol estimates only about 2% of criminal proceeds are frozen and 1% confiscated in the EU. The Commission has said that the biggest risks are linked to anonymous transactions involving pre-paid cards, virtual currencies and a lack of transparency on beneficial ownership.

A package presented by the European Commission in July aims to create a single EU rulebook on anti-money laundering (AML) and countering the financing of terrorism (CFT). The result will be uniform due diligence rules applying to a firm’s clients and beneficial owners, and a proposed new AML/CFT authority. The new authority will directly supervise the riskiest financial institutions in EU member states and coordinate the work of national supervisors and financial intelligence units.

Yet the language of the proposals suggests that the EU doesn’t fully grasp Luxembourg’s decentralised fund management model, says Maria Teresa Fulci-de Rosée, head of compliance at Kredietrust, which is part of private banker Quintet Group in Luxembourg.

The country has a model of delegation unlike any other in Europe which needs to be taken into account, she argues. Making onsite visits to funds, as demanded by the proposals, is not feasible as most funds rely on management companies and other service providers, Fulci-de Rosée adds.

Visits need rather to be targeted at transfer agents, where she herself carries out her own spot checks.

Ucits funds are a case in point. These are open-ended funds which invest in shares and bonds and fall under a harmonised EU regulatory regime. Luxembourg was the first EU member state to transpose Ucits into national law. Analysis from EY says that step has helped the country gain “first-mover advantage” in the EU funds industry.

Such funds benefit from a “passport” that allows them to be freely distributed throughout the EU. The fact that Ucits funds are so widely distributed makes it unrealistic to impose documentary know-your-customer (KYC) requirements on funds, Fulci-de Rosée says.

High-risk entities
The Commission says the proposal for a single EU rulebook is necessary because the current framework is in the form of a directive that is transposed into national law. That can mean divergence between different sets of national rules, as well as potential delays in implementation. Further, the current regime is not detailed enough to ensure full convergence, and the lack of a central coordinating body hinders cooperation.

As well as harmonising previous regulations, there are new features in the proposals. For example, there is a Europe-wide limit of €10,000 on cash payments because limiting large cash payments makes it harder for criminals to launder dirty money, the Commission says. Also, to ensure consistency with EU data protection rules, a shorter time limit is provided for retention of personal data.

The list of entities covered by the rules is also expanded to include cryptoasset service providers, crowdfunding platforms and migration operators.

The EU argues that regulated cross-border entities will benefit from having a single supervisor instead of having to deal with different national authorities. But national supervisors will remain in place, being replaced by the new authority only as supervisor of any entities deemed highest risk. The list of financial sector entities chosen will be reviewed every three years, though the new authority will be able to request that the Commission puts an entity under its supervision at any time.

The plan is for the new AML authority to be established in 2023 and start most of its activities in 2024. It will have a staff of around 250, about 100 of whom will work on direct supervision of high-risk entities. The first selection of these entities will be carried out in 2025, and AML should reach full staffing and start supervising the following year.

‘Collegial approach’
An opinion paper published by the Association of the Luxembourg Fund Industry (Alfi) in November argues that the proposals are “very much banking oriented” and “do not necessarily take into account the specificities of the investment fund industry”. A key point, Alfi argues, is that the proposals for a compliance manager do not allow the appointment of the board to serve as a “collegial body”. A board, the association says, develops “collective intelligence” on AML over the years.

Fulci-de Rosée agrees that making the whole board responsible is the more robust model. “The whole board must be knowledgeable,” she says. “They cannot escape responsibility.”

A spokeswoman for Alfi said that the role of compliance manager in Luxembourg can either be one person from the board, or the board members collegially. This is aligned with Luxembourg commercial law which lays down the principle of collective and joint liability of board members. The new EU regulation “should allow the possibility for the appointment of the board as a collegial body to serve as compliance manager”, the spokesperson said.

The current Luxembourg regulatory framework is “already well developed and has embedded several texts on the European and international level which clarify the obligations” of the funds industry in relation to money laundering, the Alfi spokeswoman added. “The European Commission will continue its work towards harmonising the AML framework further, which we believe is the right direction of travel.”

The spokeswoman said that the association supports the setting up of an independent European AML authority. But for the new body to function efficiently, certain draft provisions should either be further adapted or be clarified, she said. There needs to be more detail on the criteria for determining which entities should be subject to direct supervision by the AML authority, whether they will be supervised for all or part of their activities, and relationships with the entities and with local regulators will be organised.

Harmonisation benefits
Some see Luxembourg as well placed to benefit from the proposals. The creation of common regulatory technical standards “can certainly be beneficial to Luxembourg managers”, says Sarah Noville, senior associate at Zeidler Group in Luxembourg.

At the moment, other players in the EU can have difficulty understanding and accepting Luxembourg’s “relatively onerous” requirements, and there is everything to gain from greater harmonisation and a common regulatory approach, Noville says.

The European Fund and Asset Management Association (Efama) also welcomed the proposals as a way to strengthen Europe’s resilience against financial crime. However, it will be important to ensure that, in closing any gaps in the current regime, the new rules do not inadvertently create duplicative requirements for the affected entities, says Efama regulatory policy adviser Gwen Lehane.

The Commission is right to emphasise the importance of a risk-based approach, which is already reflected in sectoral guidelines from the European Banking Authority and the intergovernmental Financial Action Task Force, Lehane says. The rules will need to effectively encompass the broad range of entities affected by financial crime, “and to do so, a one-size-fits-all approach must be avoided so that the specificities of each sector can be taken into account”, she adds. “Efama is confident that this concern is shared with the Commission.”

Compliance requests
The real, unaddressed problem, Fulci-de Rosée argues, is to oblige intermediaries and nominees to respond to compliance requests for information. She spends a lot of time making such requests and often receives late responses or none at all.

“That’s the issue,” she says. “That’s the real difficulty we have. The EU should emphasise that any intermediary or nominee should respond to requests without delay,” and there should be consequences for not doing so.

The point applies especially to fund platforms in the US and Europe, she says. “They say that they are transaction-only, so who does the KYC?”

Despite the unresolved problems, Fulci-de Rosée says the Commission’s proposals are “a move in the right direction”. She believes that the outstanding issues can be resolved. The increased regulatory burden is likely to mean higher costs as more compliance officers will be needed.

Some firms with a single compliance officer will in the future need two: one for internal compliance and one for anti-money laundering, she adds.

Still, Fulci-de Rosée says, the overall result will be a “more secure investor environment”.

© 2022 funds europe

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