Financial Institution Regulatory

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

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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.

Capital Markets Union: Commission proposals to reform European financial supervision regime

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European Commission published proposals to reform the EU’s supervisory structure, including to extend ESMA’s role and powers in respect of prospectuses and market abuse on 20 September 2017. This represents the first concrete step towards the creation of a single European capital markets supervisor.

It is proposed (amongst other things) that the Prospectus Regulation be amended so as to task ESMA, rather than national competent authorities, with approving:

  • Prospectuses for certain wholesale non-equity securities.
  • Prospectuses relating to asset-backed securities.
  • Prospectuses that are drawn up by property companies, mineral companies, scientific research-based companies or shipping companies.
  • Prospectuses drawn up by non-EU country issuers.

Where it is responsible for approving a prospectus, ESMA would also control related advertisements.

This proposal is intended to create a level playing field for issuers, to speed up approvals, to enhance supervision in the EU and to prevent forum-shopping.

ESMA  would also be given a greater role in coordinating market abuse investigations. This could extend to recommending that competent authorities initiate investigations and to facilitating the exchange of information relevant for those investigations, where ESMA has reasonable grounds to suspect that activity with significant cross-border effects is taking place that threatens the orderly functioning and integrity of financial markets or financial stability in the EU. ESMA would maintain a data storage facility to collect from, and disseminate between, competent authorities, all relevant information.  

The Commission invites the European Parliament and the Council to discuss and agree its proposals as a high priority, in order to ensure their entry into force before the end of the current legislative term in 2019.

 

 

 

Rating Agency Developments

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On November 9, 2016, Fitch updated its ratings criteria for analyzing U.S. wireless tower transactions. Report.

On November 8, 2016, DBRS published its ratings methodology for Canadian trade receivable securitization transactions. Report.

On November 8, 2016, DBRS published its ratings methodology for Canadian residential mortgages, home equity lines of credit and reverse mortgages. Report.

On November 8, 2016, DBRS published its ratings methodology for Canadian credit card and personal line of credit securitizations. Report.

On November 4, 2016, Fitch updated its ratings criteria for charter schools. Report.

European Commission Establishes Expert Group on Sustainable Finance

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On October 28, 2016, the European Commission published a decision creating a high-level expert group (“HLEG“) on sustainable finance in the context of the capital markets union (“CMU“).

The group is to have the following tasks:

  • Submitting to the Commission a set of policy recommendations that set out the scale and dimensions of the challenges and opportunities that sustainable finance presents, and recommending a comprehensive program of reforms to the EU financial policy framework. The group is to explore operational steps that financial institutions and supervisors should take to protect the stability of the financial system from environmental, social and governance risks. The accompanying press release suggests that this policy road map is due to be completed by the end of 2017.
  • Engaging in structured communication and advocacy towards interested parties about its work on sustainable finance.

Up to 20 senior experts will make up the group. They will commence work in January 2017. A call for applications for the selection of members of the group has been launched and will close on November 25, 2016.

OCC Issues Responsible Innovation Framework

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On October 26, the Office of the Comptroller of the Currency (“OCC“) announced that it will establish an office “dedicated to responsible innovation and implement a formal framework to improve the agency’s ability to identify, understand, and respond to financial innovation affecting the federal banking system [and stated that by] establishing an Office of Innovation, we are ensuring that institutions with federal charters have a regulatory framework that is receptive to responsible innovation and the supervision that supports it.”

The Office of Innovation will be headed by a Chief Innovation Officer assigned to OCC Headquarters. The office will be the central point of contact and clearinghouse for requests and information related to innovation and it will also implement other aspects of the OCC’s framework for responsible innovation, which include:

  • establishing an outreach and technical assistance program for banks and nonbanks,
  • conducting awareness and training activities for OCC staff,
  • encouraging coordination and facilitation,
  • establishing an innovation research function, and
  • promoting interagency collaboration.

The OCC expects the office to begin operations in first quarter 2017.

The OCC emphasized that its assessment of granting a special purpose national bank charter to nonbank financial technology companies, and under what conditions, continues.

See “Recommendations and Decisions for Implementing a Responsible Innovation Framework.”  Press Release.

European Commission Adopts Delegated Regulation on RTS on Minimum Details of Data to Report to Trade Repositories

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On October 19, 2016, the European Commission adopted a Delegated Regulation amending Delegated Regulation 148/2013 supplementing EMIR (Regulation 648/2012) as regards regulatory technical standards (RTS) on the minimum details of the data to be reported to trade repositories (C(2016) 6624 final).

EMIR requires all counterparties and central counterparties (CCPs) to report the details of any OTC derivative contract they have concluded and of any modification or termination of the contract to a trade repository.

The Delegated Act updates existing standards that were published in the Official Journal of the EU (OJ) in February 2013 (see Legal update, Delegated regulations on EMIR regulatory technical standards published in Official Journal). It reflects recent developments and experience gained in the area of trade reporting. The revised RTS aim to:

  • Introduce new fields and values to reflect market practice or other necessary regulatory requirements.
  • Clarify data fields, their description or both.
  • Adapt existing fields to the reporting logic prescribed in existing Q&As or reflect specific ways of populating them.

The Commission has also published an Annex, which sets out the counterparty data and common data details to report to trade repositories.

The next step is for the Council of the EU and the European Parliament to consider the Delegated Regulation. If neither of them objects to it, the Delegated Regulation will enter into force 20 days after its publication in the OJ.

European Commission TTIP Advisory Group Report Considers Financial Services Under TTIP

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On October 17, 2016, the European Commission published a report documenting the meeting of the Commission’s Transatlantic Trade and Investment Partnership (TTIP) Advisory Group on September 6, 2016.

Financial services are considered at section 4 of the report in the context of TTIP. The group notes that the EU tabled its offer on financial services market access in July 2016 (see Legal update, European Commission releases EU financial services offer for 14th round of TTIP negotiations: July 2016) . Discussions relating to this offer will continue during the next round of TTIP negotiations in October 2016.

The report also refers to the new joint EU-U.S. Financial Regulatory Forum, which was launched in July 2016 with the aim of making continued efforts to improve EU-U.S. regulatory coherence (see Legal update, EU and US establish joint financial regulatory forum ). The EU would like to see the work of the forum “linked into” the final TTIP agreement because, for the EU, the real issue for the financial services sector in the transatlantic context is regulatory transparency and cooperation. Diverging regulation may have negative implications on trade in financial services, financial stability, and consumer protection.

At the meeting, the group also discussed transparency (members expressed an interest in seeing documents related to financial services regulatory cooperation), domestic and international legislation (neither the U.S. nor the EU is seeking, through the forum, to revise the other’s legislation), the TTIP market access offer in financial services (prudential measures, such as capital requirements for banks, are not covered as these are out of scope) and measures to help consumers navigate transatlantic financial services (such as reduced charges for international transfers and simpler opening of bank accounts).

SEC Office of Compliance Inspections and Examinations Issues Risk Alert on Whistleblower Rule Compliance

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On October 24, Staff in the Office of Compliance Inspections and Examinations (the “Staff”) issued a National Exam Program Risk Alert announcing that it is examining registered investment advisers and registered broker-dealers compliance with key whistleblower provisions arising out of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Commission recently has brought several enforcement actions charging violations of Rule 21F-17 of the Commission’s whistleblower regulations.

 

The Staff now is routinely reviewing, among other things, compliance manuals, codes of ethics, employment agreements, and severance agreements to determine whether provisions in those documents pertaining to confidentiality of information and reporting of possible securities law violations may raise concerns under Rule 21F-17.
Section 21F of the Securities Exchange Act of 1934 was added by the Dodd-Frank Act.  To implement Section 21F, among other things, the Commission adopted Rule 21F-173 thereunder which provides that “no person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.”

 

The Staff highlighted that “Recent enforcement actions have identified certain provisions of confidentiality or other agreements required by employers as contributing to violations of Rule 21F-17 because they contained language that, by itself or under the circumstances in which the agreements were used, impeded employees and former employees from communicating with the Commission concerning possible securities law violations. This potential chilling effect can be especially pronounced when such documents (e.g., severance agreements) provide that an employee may forfeit all benefits if he or she violates any terms of the agreement.” Alert.

The OCC Proposes Rule to Address Concerns Relating to Exercise of Default Rights Under Qualified Financial Contracts

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On October 3, 2016, the Office of the Comptroller of the Currency proposed a rule to enhance the resilience of federally chartered and licensed financial institutions. The proposed rule addresses concerns relating to the exercise of default rights under certain financial contracts that could interfere with the orderly resolution of systemically important financial firms. The rule requires, among other things, covered banks to ensure that covered qualified financial contracts (i) limit the exercise of default rights based on the insolvency of an affiliate of a covered bank and (ii) contain contractual stay-and-transfer provisions analogous to the statutory stay-and-transfer provision set forth under title II of the Dodd-Frank Act and the Federal Deposit Insurance Act. Comments on the proposed rule are due on October 18, 2016. Press Release.

The OCC Publishes Final Guidelines on Recovery Planning

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On September 29, 2016, the Office of the Comptroller of the Currency (the “OCC”) published final guidelines establishing enforceable standards for recovery planning. The final guidelines generally apply to banks with average total consolidated assets of $50 billion or more (“covered banks”). If a covered bank fails to meet a guideline, the OCC may require such bank to submit a plan specifying steps the bank would take to comply with the guideline. If, after being notified that it is in violation of a guideline, a covered bank fails to submit an acceptable compliance plan or fails to materially comply with a plan approved by the OCC, the OCC may issue an order enforceable under section 8 of the Federal Deposit Insurance Act. Press Release. Final Guidelines.