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Summary of 4MLD: The Fourth Money Laundering Directive

27th October 2016

Summary of the Fourth Money Laundering Directive (4MLD)

Last summer on 5th June 2015, the Fourth Money Laundering Directive (also referred to as 4MLD or MLD4) was published in the EU Official Journal.

4MLD looks to give effect to the updated standards that have been set by the Financial Action Task Force (FATF).

There will be a number of significant changes under 4MLD as well as additional more subtle changes and revisions to the existing rules, terminology & definitions that will require firms (or “certain obliged entities”) to review and revise their current practices and procedures.

If firms have not already started to assess the impact 4MLD will have upon their business, they should do so now, as a number of new burdens and responsibilities are set to be imposed.

The primary modifications relate to areas of risk–based approach; Customer Due Diligence (CDD); Politically Exposed Persons (PEPs); Beneficial Ownership, Third party reliance and record keeping requirements.

Background to 4MLD:

Set to strengthen the AML regime across the EU, the Fourth Money Laundering Directive (4MLD) was published in the official journal of the EU last June.

4MLD is largely in response to the Financial Action task Force’s (FATF) updated recommendations that were laid out in February 2012.  The new directive will look give effect to these updated standards and replace the Third Money Laundering Directive (3MLD) when it comes into effect across the EU next summer.

Member States across the EU have until 26th June 2017 to transpose the measures contained within 4MLD into national legislation, thus HM Treasury have recently issued a consultation on how the Fourth Money Laundering Directive will be tackled within the UK. This consultation identifies the changes 4MLD will bring and how the government intends to approach and plan for its implementation and transposition into national law.

The UK’s current anti-money laundering (AML) and counter-terrorist financing (CTF) regime is based upon the previous international standards set by FATF and are currently covered through the Third Money Laundering Directive (3MLD).

It is now thought that parts of 3MLD may have been overly lenient and permissive and 4MLD looks to address these deficiencies and give effect to many of the new recommendations made by FATF.

Risk Assessments

Central to 4MLD are risk assessments, and these will need to be undertaken with regards to money laundering and terrorist financing at a firm, member state and supranational level.

For firms, this means identifying and assessing risks, taking into account factors including:

• Customers
• Countries/geographical areas
• Products
• Services
• Transactions; and
• Delivery channels

This risk assessment will need to be documented and kept up-to-date as well as made available if requested by the regulators.

Firms will also need to put into place policies, procedures, systems and controls that are proportionate to their nature and size in order to mitigate and manage the risks of terrorist financing and money laundering.

Controls must include:

• Development of internal policies, controls and procedures including:

• Risk management practices,
• Customer due diligence (CDD)
• Reporting
• Record-keeping
• Internal controls
• Screening of employees; and
• Compliance management (including where appropriate, the appointment of a compliance officer at management level)

• In addition, where appropriate in relation to the size and nature of the business, an independent audit function should be established to test the internal policies, procedures and controls mentioned above.
• Policies, procedures, systems and controls that are put in place, including monitoring and enhancing measures, should be approved by senior management.

“Beneficial Owner” Redefined

Whilst 3MLD defines the Beneficial Owners of a Corporate entity as a person owning or controlling more than 25% of the shares/voting rights, 4MLD will alter this so that the 25% level is simply indicative of beneficial ownership.

This means that member states may select a lower percentage and in situations where no beneficial owner is identified, or there is doubt over the person that has been identified, then the senior managing official of the corporate entity will be treated as the Beneficial Owners.

For trusts, those in the UK that are obliged to fill in a tax return will also be required to submit Beneficial Ownership information to the central register.

4MLD requires trustees to maintain current information on Beneficial Ownership and make this information available to others when entering a new business relationship or carrying out occasional transactions.

This information includes details of the settler, trustees, the protector (if any), the beneficiaries or class of beneficiaries and any other natural person that exercises effective control over the board.

Central Register of Beneficial Owners

Under 4MLD, member states across the EU will have to establish a central register that contains up to date information on Beneficial Owners of corporate and legal entities in a bid to enhance transparency.

However, firms will not be able to rely solely upon the information on the central register for Customer Due Diligence (CDD) purposes.

The UK has this year established such a register, entitled the People with Significant Control (PSC) regime and this became operational over the summer.

The PSC regime requires entities to hold their own up-to-date PSC information upon their own register and to update the central public register at Companies House annually. This is done via the new Confirmation Statement process introduced in June this year that replaces the previous Annual Return process.

“Politically Exposed Persons” (PEPs) Redefined

Politically Exposed Persons or PEPs will be widened and redefined under 4MLD with the removal of any distinction between domestic and foreign PEPs. Thus, 4MLD will  include those holding prominent positions in their home country.

This means that when firms undertake client reviews, they will need to ensure that domestic persons that hold prominent public positions are correctly categorised. For example, this may include members of parliament, directors or board members of international organisations, high ranking military staff, ambassadors, members of supreme courts and managers of state-owned enterprises. 4MLD’s provisions will likewise apply to ‘close associates’ and family members of PEPs (parents, spouses/partners, children and their spouses/partners).

The new directive also clarifies that PEPs will always be subject to enhanced due diligence measures (EDD) and that approval from a senior manager is required before a business relationship can be established or continued.

Thus firms will need to review their existing customer records to ascertain if any will need to be re-classified and have EDD measures undertaken to continue the relationship.

Customer Due Diligence (CDD) & Simplified Due Diligence (SDD)

The Third Money Laundering Directive (3MLD) allowed for a more permissive approach to simplified due diligence (SDD) since it allowed blanket exemptions for certain entities. For example financial institutions and listed companies admitted to trading upon a regulated market could all have SDD measures applied.

4MLD on the other hand, whilst still allowing for simplified due diligence, firms will first be required to ascertain that a lower degree of risk is presented by the proposed business relationship or transaction before being able to apply SDD.

4MLD sets out a non-exhaustive list of factors that could be considered when determining if SDD is appropriate. These can be found in Annex II of the directive.

Whilst the UK government is currently proposing to remove the list of products that could be subject to SDD from the UK’s current Money Laundering Regulations 2007 (MLR 2007) and replacing these with those detailed in Annex II, this is up for consultation.

Reliance on Third Parties

Firms subject to 4MLD may, in certain circumstances, rely upon third parties to meet their CDD requirements. However, the responsibility for meeting those requirements ultimately remains with the firm and not the third party.

4MLD descries that third parties may be relied upon, however in general there can be no reliance on third parties that are established in high-risk third countries.

For those third parties that are not in high-risk third countries, 4MLD permits reliance upon:

 Certain obliged entities;

 Member organisations or federations of those obliged entities; and

 Other institutions or persons located in a Member state or third country that applies CDD and record-keeping requirements consistent to those in 4MLD and have their compliance with the requirements supervised in an appropriate manner.

It should be noted that the second of these reliances above is a new ability not previously afforded under 3MLD’s reliance on third parties.

Record keeping requirements

Currently the UK Money Laundering Regulations 2007 (MLR 2007) require entities to retain their customer due diligence records for a minimum period of five years from the date when the business relationship ceased or last transaction was completed.

4MLD on the other hand imposes a new obligation for firms to delete personal data at the end of the five year retention period, however this may be extended for an additional five years should it be justified as necessary for the prevention, detection and investigation of money laundering or terrorist financing.

It is unclear yet, what the retention period will be since the UK government’s current consultation questions the government’s potential for requiring firms to retain due diligence documents for up to 10 years after the end of a business relationship or transaction.

4MLD: Next Steps for Firms

Earlier this summer (July 2016), in the wake of 2015’s terrorist attacks across Europe in Brussels, Copenhagen and Paris - and the release of the Panama Papers - institutions across Europe called for a speedy implementation of 4MLD’s new rules to enhance the AML/CTF framework in Europe. Thus in July 2016 the European Commission proposed that the transposition of 4MLD across the EU should be brought forward to 1st January 2017. However a large number of Member States have expressed concerns about the earlier timing for transposition and thus the UK Government is continuing to work towards an effective date of 26 June 2017.

Whether the implementation date is brought forward or not, firms will need to ensure they are prepared for the changes 4MLD will bring and will need to ensure they have the measures and resources in place. Staff will need to be trained by firms and policies and procedures updated ready to be effectively implemented in their day to day business. In addition, firms will need to be able to undertake any required remediation work from reviewing existing customer records to the new requirements.

As mentioned, the government’s final policy decisions will look to be implemented through legislation to come into force by 26th June 2017. This will mean that the UK’s existing Money Laundering Regulations 2007 (MLR 2007) will be revoked and replaced at this time.

To have your say on the transposition of the 4MLD requirements in UK law, your comments must reach HM Treasury before their current consultation closes on 10th November 2016.

4MLD Compliance Support:

Financial crime and AML remain high on the regulatory agenda and will continue to be so. It is thus incredibly important to ensure your firm puts in place the right policies and procedures to ensure compliance with 4MLD requirements.

All firms should now ensure they understand the changes 4MLD will bring and review how they will be affected. If you would like any support or assistance in preparing for the new requirements, please get in touch with our experienced regulatory consultants.

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