New EU and UK Anti-Money Laundering Rules: The Fifth AML Directive Extends to Cryptocurrencies

 

The Fifth Anti-Money Laundering Directive (“MLD5“) entered into force in July 2018. MLD5 updates the legal framework under the Fourth Anti-Money Laundering Directive (“MLD4“) and must be implemented by the EU member states by January 2020. In response to the growing concerns over terrorist financing and the revelations of the Panama Papers, the amendments in MLD5:

  • increase transparency with respect to the beneficial ownership registers, which EU member states are required to establish under MLD4;
  • clarify and harmonize the enhanced due diligence measures that need to be applied to business relationships or transactions involving “high risk third countries”;
  • require EU member states to create and maintain a list of public functions that qualify as “politically exposed persons” or “PEPs” in their jurisdiction;
  • restrict the anonymous use of prepaid cards in order to mitigate the risk that they may be used for terrorist financing;
  • grant new powers for financial intelligence units, including the power to request, obtain and use information from any obliged entity based on their own analysis and intelligence, rather than just when triggered by a prior suspicious activity report; and
  • require member states to establish centralised registers or data retrieval systems to enable financial intelligence units and national competent authorities to access information about the identities of holders of bank and payment accounts and safe-deposit boxes.

In addition to these broad objectives, MLD5—for the first time—brings certain virtual currency service providers within the scope of EU anti-money laundering and terrorist financing regulations. Click here to read the full Orrick-authored alert.

Joint Committees of ESAs Recommend Action to Address Risks and Uncertainties in EU Financial System

 

On September 11, the Joint Committee of the ESAs published a report on the risks and vulnerabilities in the EU financial system (JC 2018 34), which sets out recommendations for policy action. The report can be found here.

The report states that in the light of ongoing risks and uncertainties, especially those around Brexit, supervisory vigilance and co-operation across all sectors remains key. As a result, the ESAs advise the following policy actions by financial institutions and by EU and national competent authorities:

  • Stress tests. Stress test exercises should continue to be conducted and developed further across all sectors, especially given rising interest rates and the potential for sudden risk premia reversals, which should be factored into the scenarios.
  • Risk appetite. Supervisory authorities need to pay continued attention to the risk appetite of all market participants. Banks should accelerate addressing their stocks of non-performing loans (NPLs) and adapt business models to sustainably improve profitability, and financial institutions need to carefully manage their interest rate risk.
  • Contagion risks. Macro and micro prudential authorities should contribute to addressing possible contagion risks, including continuing their efforts in monitoring lending standards.
  • Brexit. It is crucial that EU financial institutions and their counterparties, as well as investors and retail consumers, plan appropriate mitigating actions to prepare for the UK’s withdrawal from the EU in a timely manner, including the risks associated with a no-deal scenario.

European Parliament Votes to Adopt Resolution on Regulatory and Supervisory Relationships between EU and Third Countries

 

On September 11, the European Parliament voted in plenary to adopt a resolution on relationships between the EU and third countries concerning financial services regulation and supervision (2017/2253(INI)). It has published the minutes of the vote, found here, and a provisional edition of the resolution, found here.

The resolution was set out in a report prepared by rapporteur Brian Hayes that was adopted in July 2018 by the European Parliament’s Committee on Economic and Monetary Affairs (“ECON“).

The resolution contains recommendations relating to the equivalence framework in financial services legislation. In particular, it recommends that third countries should keep the European Supervisory Authorities (“ESAs“) (that is, ESMA, EIOPA and the EBA) informed of any national regulatory developments through the EU’s equivalence framework and that the Commission should introduce a standardised process for the determination of equivalence.

New EU and UK Anti-Money Laundering Rules: The Fifth AML Directive Extends to Cryptocurrencies

The Fifth Anti-Money Laundering Directive (MLD5) entered into force in July 2018. MLD5 updates the legal framework under the Fourth Anti-Money Laundering Directive (MLD4) and must be implemented by the EU member states by January 2020. In response to the growing concerns over terrorist financing and the revelations of the Panama Papers, the amendments in MLD5:

  • increase transparency with respect to the beneficial ownership registers, which EU member states are required to establish under MLD4;
  • clarify and harmonize the enhanced due diligence measures that need to be applied to business relationships or transactions involving “high risk third countries”;
  • require EU member states to create and maintain a list of public functions that qualify as “politically exposed persons” or “PEPs” in their jurisdiction;
  • restrict the anonymous use of prepaid cards in order to mitigate the risk that they may be used for terrorist financing;
  • grant new powers for financial intelligence units, including the power to request, obtain and use information from any obliged entity based on their own analysis and intelligence, rather than just when triggered by a prior suspicious activity report; and
  • require member states to establish centralised registers or data retrieval systems to enable financial intelligence units and national competent authorities to access information about the identities of holders of bank and payment accounts and safe-deposit boxes.

In addition to these broad objectives, MLD5—for the first time—brings certain virtual currency service providers within the scope of EU anti-money laundering and terrorist financing regulations.

Extension of the AML Regime to Virtual Currencies

Virtual currencies, as defined in MLD5, are “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.”

Under this definition, most of the coins, tokens, and cryptocurrencies known today probably qualify as “virtual currency.” While not all of the tokens are necessarily used as a “means of exchange,” and this may not be their intended purpose, MLD5 adds that its objective is to cover “all the potential uses of virtual currencies,” such as “means of exchange, investment, store-of-value or use in online casinos.”

As for the reason behind the extension of the AML regime to virtual currencies, in its 2016 Communication on an Action Plan for Strengthening the Fight Against Terrorist Financing, the European Commission identified the ability for virtual currencies to be abused to conceal transactions related to terrorist financing, due to the relative anonymity of the virtual currency environment and the lack of an EU-level reporting mechanism for identifying suspicious activity.

To tackle these issues, MLD5 brings the “gatekeepers” of virtual currencies within the scope of EU anti-money laundering and terrorist financing legislation. Providers engaged in exchange services between virtual currencies and fiat currencies (“virtual currency exchange platforms”) and providers of services to hold, store and transfer virtual currencies (“custodian wallet providers”) have been made “obliged entities” for the purposes of the EU anti-money laundering and terrorist-financing framework. This means that providers of those services will be subject to the same obligations to carry out customer due diligence and report suspicious transactions as other firms designated as obliged entities under EU law, including credit institutions, financial institutions and certain professionals such as auditors and accountants.

The EU acknowledges that regulating virtual currency exchange providers and custodian wallet providers will not entirely address the issue of anonymity attached to virtual currency transactions, since users can transact without going through such providers. But to combat the risks related to anonymity, MLD5 states that national financial intelligence units should be able to obtain information allowing them to associate virtual currency addresses to the identity of the owner of virtual currency.

What’s Next for the UK AML Regime?

EU Member States have until January 10, 2020 to implement MLD5 into their national legislation. Since the implementation date falls within the anticipated transitional period of the UK’s exit from the EU, it is widely assumed that the UK will implement MLD5. MLD5 takes the form of a minimum harmonising Directive, which means that it sets minimum EU-wide standards that the UK could, if it chooses, go beyond.

Going forward, the Sanctions and Anti-Money Laundering Act 2018 (“SAMLA 2018”), which received Royal Assent on May 23, 2018, establishes a broad framework allowing the Secretary of State to pass UK anti-money laundering and terrorist financing regulations after the UK leaves the EU. Regulations may be passed to detect, investigate or prevent money laundering and terrorist financing and implement standards published by the Financial Action Task Force. SAMLA 2018 does not affect the substantive UK money laundering and terrorist financing offences under the Proceeds of Crime Act 2002 and Terrorism Act 2000, which can only be amended by Parliament. However, the broad enabling powers created under the legislation give rise to the possibility that the EU and UK anti-money laundering regimes could start to diverge over time.

Rating Agency Developments

 

On September 4, 2018, Moody’s updated its methodology for the mining industry, replacing the last version published on April 3, 2018. No rating changes are expected to result from this update. Release.

As of August 28, 2018, S&P Global Ratings is requesting comments on proposed revisions to its methodology and assumptions for rating certain insurance-linked securitizations (“ILS“). The rating on an ILS addresses the likelihood of timely payment of interest and principal when due based on the original promise, even if the terms permit a reduction in principal or interest. The proposed criteria covers specific methodologies applicable to natural peril, mortality, longevity, medical benefit ratio, and auto bonds. Release.

Joint Committee of ESAs Report on Automation in Financial Advice

 

Over the past two years the Joint Committee of the European Supervisory Authorities (“ESAs“) have been undertaking a monitoring exercise on the evolution of automation in financial advice in the securities, banking and insurance sectors. On September 5, they published a report setting out their results, and made the following conclusions:

  • Analysis shows that while automation in financial advice seems to be slowly growing, the overall number of firms and customers involved still seems to be quite limited.
  • The risks and benefits of automation in financial advice, which were originally identified by the ESAs in their original discussion paper and related report, have largely been confirmed by national competent authorities and seem to be still valid.
  • In terms of emerging business models, it appears that automated services are being offered through partnerships, by established financial intermediaries, rather than by pure FinTech firms.
  • While some new trends seem to have emerged (such as the use of Big Data, chatbots and extension to a broader range of products), there seems to have been no substantial change to the overall market since the publication of the ESA report on automation in financial advice in December 2016

The ESA considered that as there has been limited growth of automated financial advice and a lack of materialization of identified risks, no immediate action by the ESAs is necessary. The ESAs also stated that no new monitoring exercise will be undertaken until the market has further developed enough for a third monitoring exercise to be deemed warranted.