By Samantha Sheen, AML Director Europe, ACAMS
2 August, 2016

EU Proposals to Bolster the Fight Against Financial Crime

On 5 July 2016, the European Commission (“EC”) announced its proposal to further reinforce the European Union’s rules on anti-money laundering (“AML”), to counter terrorist financing (“CFT”), tax evasion and increase transparency around beneficial ownership (“Proposals”). The Proposals consist of a number of key revisions to the Fourth Anti-Money Laundering Directive (“4AMLD”) first introduced in May 2015, along with a number of other related Directives.

In its Impact Assessment on the Proposals (“Impact Assessment”), the EC points to evidence that certain types of trust structures have been used to conceal the identify of beneficial owners (“BOs”) and the assets held by them. The EC has determined that the most effective and proportionate way to crack down on this problem is to address it at the EU level. As a result, a number of revisions have been proposed to the 4AMLD and other Directives. This post summarises those proposed changes.

Misuse of Trust Structures

For those unfamiliar with trusts, a trust is considered to be “discretionary” when the trustee has the power to either:

  • identify a specific beneficiary out of a class of beneficiaries, or
  • decide whether to pay trust assets to its beneficiaries and if so, in what proportions.

When assets have been settled into a discretionary trust, the settlor (who can sometimes also be a beneficiary) effectively hands over complete control over the trust’s assets to the trustee.

Often the BO’s identity is not apparent until the trustee decides to exercise its discretion by making a payment in their favour. Some discretionary trust documents (called a deed, declaration or instrument) will identify a general class of beneficiaries, for example, the future grandchildren of the settlor. Other trust documents will provide no indication as to the intended BOs. From an AML perspective, and depending upon the local AML regulations, the identity of the BOs are only known when the trustee decides to exercise its discretion in their favour.

Trusts and other legal arrangements which operate in this way can be misused to keep the identity of intended BOs hidden. This can make it difficult to draw a link between the assets settled in the trust and the parties who expect to benefit from them.

To try and address this, the 4AMLD contains specific CDD requirements to ensure that BOs of trusts are properly identified (Article 3/ Article 31). However, the EC proposes that further improvements could mitigate the misuse of trust structures to achieve greater transparency around their BOs.

Importance of AML Requirements to Tax Matters

The last several years have seen greater awareness of the importance of CDD requirements of AML regulations to identify BOs for tax purposes. The amendments outlined in the Proposals take account of this connection so both AML and tax evasion risks can be effectively mitigated.

Relevance of a Trust’s Location – From Governing Law to Location of Administration

Under Article 31 of the 4AMLD, Member States must require trusts "governed under their law" obtain and hold adequate, accurate and up-to-date information on the trustee.

The EC has subsequently assessed that Article 31’s wording still risks that some types of trusts or legal arrangements will fall through the cracks and not be monitored by local regulators in the following two ways.

  • Some Member States don’t consider trusts set up under another Member States’ law to fall within their jurisdiction, even if the trust is administered in their territory. This is because some Member States do not recognise these types of legal structures.
  • Those Member States who follow the common law do not consider trusts set up under their own law to fall within their jurisdiction unless they are also administered there (i.e. not in another country). What this essentially means is that in some Member States, as long as a trust is not recognized under local law, it does not need to be included on the national register of trusts (“Trust Register”).

To address these concerns, Article 31 will be amended so that its requirements will apply to any express trust administered in that Member State. This also reflects the approach taken in the Directive for Administrative Action relating to Investment Entities.1

Maintaining Up-To-Date BO Information – Clarification About Monitoring

Article 14(5) of the 4AMLD provides that CDD measures should be applied to existing customers on a risk-sensitive basis, including at times when a relevant customer’s circumstances change. This, in effect, requires that a review be undertaken of the CDD held for an existing customer to ensure that the nature and purpose of the business relationship, including knowledge about its BOs, remains accurate and up-to-date.

The EC has identified that the current wording of Article 14 risks that trustees of structures like discretionary trusts might not review the CDD they hold for several years. This review may only take place at the time the trustee chooses to exercise its discretion.

The EC determined that this potential infrequency could delay the detection and assessment of emerging risks, also delaying any action which law enforcement might take in response. For example, the Impact Assessment summarises a case from the Panama Papers in which a considerable period of time had elapsed before it was discovered that a BO was actually listed as an SDN on a sanctions list.

To address these risks, the EC proposes that Article 14(5) be amended so that a periodic review of existing customers must be undertaken in conjunction with a review required by Directive 2011/16/EU (“Directive on Administrative Cooperation”). This Directive requires that financial institutions collect and report information about accounts held by non-resident individuals and entities and in certain instances, information about their BOs, and the country where the BO is resident. The criteria used to identify the BO is based upon the CDD requirements under the 4AMLD.

Under the Directive on Administrative Cooperation, financial institutions must obtain a self-certification with respect to the BOs of “Passive Non-Financial Entities”that hold pre-existing accounts with a balance over $1 million. The term “Passive Non-Financial Entities” is defined under this Directive and covers entities like trusts, other legal arrangements and legal entities such as foundations. The self-certification exercise must be undertaken in 2016/17. The EC determined that it would be effective to capitalise on this requirement by also using it to prompt financial institutions to review and, if necessary, update the CDD held for trusts and their BOs.

Relevance of a Trust’s Activities for Registration – From Tax Generation to Economic Activity

Article 31 of the AMLD requires that information on the BOs of trusts which “generate tax consequences” must be included in the Trust Register set up by each Member State (Article 31(4)).

The EC determined that limiting information disclosed on the Trust Register to trusts which “generate tax consequences” could have the effect, intentionally or otherwise or due to a mismatch of tax systems, of causing trusts to fall outside of taxation rules in the Member State (e.g. in some cases, a trust could have no tax residence). These trusts would not only be exempt from paying taxes but would also fly “below the radar” and no information would be known about their BOs.

To address this possible risk, Article 31 is to be amended by expanding the CDD requirements to trusts more generally and other types of legal arrangements that have a structure or functions similar to trusts, of which some examples are provided.2

Availability of Information on the Trust Register – Economic Activities and Legitimate Interest

The EC proposes that the public must have access to the Trust Register. To achieve this, amendments are to be made to the Directive which clarifies the rules around registration of, and access to, information about trust BOs.

Directive 2009/1-1/ED (“Company Law Directive”) will be amended to require Member States to transpose into their local laws a requirement that the public be given access to certain trust BO information.

The proposed amendments will create a new set of rules around the collection of information about trusts, intended to complement the proposed amendments to Article 31 of the 4AMLD. The disclosure will include trusts that, “comprise any property held by, or on behalf of, a person carrying on a business which consists of or includes the management of trusts, and acting as trustee of a trust in the course of that business with a view to gain profit, and other types of legal arrangements having a structure or functions similar to such trusts”.

Article 31 is to be amended so that the public can access information about trust BOs “that engage in economic activities with a view to gain profit”. The information that must be disclosed on the Trust Registry must consist of each BO’s:

  • Name,
  • Month and year of birth,
  • Nationality and the country of residence
  • Nature and extent of the beneficial interest held.

Article 31 will require that Member States ensure that obliged entities are allowed timely access to the CDD information on the register. Further elaboration is given on the types of authorities who can access the register, including tax authorities, those who investigate and prosecute money laundering and other predicate offences including terrorist financing along with the seizing, freezing or confiscating of criminal assets.

The Company Law Directive will also require that information be maintained on the Trust Register “for no longer than 10 years after the company has been struck off from the register".

For privacy reasons, access to information about trust BOs not engaged in economic activities (e.g. family trusts) is to be limited to persons and organisations that can demonstrate a “legitimate interest”. This information will comprise of the name, month and year of birth, nationality and country of residence of BOs.

The concept of a “legitimate interest” is drawn from the Company Law Directive. The Proposals stipulate that a “ legitimate interest” must be in relation to money laundering, terrorist financing and the associated predicate offences and must be shown by “readily available means, such as statutes or mission statement of non-governmental organisations, or on the basis of demonstrated previous activities relevant to the fight against money laundering and terrorist financing or associated predicate offences, or a proven track record of surveys or actions in that field”. Competent authorities and FIUs, however, will not need to meet this requirement in order to access this information.

Additional CDD Measures – Evidence of Registration

On top of the existing trust CDD requirements, Article 31 is to be amended to require that obliged entities also collect proof of registration where the trust is subject to registration on a Trust Register.

Grounds for Limiting Access to Register

The Proposals also introduce a new provision in Article 31 of the 4 AMLD that will allow the Member State to limit access to all or part the information about a BO to be disclosed on the Trust Register (“Exemption”).

Article 31 of the 4AMLD gives Member States the power to provide for this Exemption, subject to certain conditions. An Exemption may be granted where publishing information about a BO would expose them to the risk of fraud, kidnapping, blackmail, violence or intimidation, or where the BO is a minor or otherwise incapable.

Each Exemption request must be considered on a case-by-case basis, in exceptional circumstances. This effectively means that Member States may not pass regulations which exempts broad classes or categories of BOs (for example, all BOs who are PEPs). Exemptions cannot apply to the credit institutions and financial institutions, and notaries and other independent legal professionals who are public officials.

Conclusion

The changes described are extensive and will require careful thought on the part of local regulators and financial institutions. The work involved may be extensive. Member States will need to consider:

  • What regulatory body will decide whether Exemption requests should be granted and the process by which such decisions can be appealed.
  • The criteria used by regulators when reviewing the disclosure of trust BO information, especially in distinguishing between trusts that engage in economic activities with a view to gain profit and those that do not.

Finally, it will be interesting to see the extent to which these requirements are adopted by the Crown Dependencies and other offshore jurisdictions where trust administration is provided. In the absence of their voluntary participation or cooperation, attempting to obtain a clear and complete picture of BOs identity and economic interests might still prove challenging.

  1. Under this Directive, where a trust can be classified as an Investment Entity, it is considered to be a Reporting Financial Institution in the Member State where the trustee of the trust is resident. The assumption made here is that this is also the place where the trust is administered.
  2. Fiducie, Treuhand or fideicomiso.