Insights

Anti-Money laundering in the Real Estate Industry: Can we learn from the financial services experience?


03/07/2019

Introduction

Anti-Money Laundering and Counter-Terrorist Financing (‘AML’) regulations have increased compliance costs and regulatory scrutiny in the past four years with no less than three European Directives published since 2015. The scopes of the first regulations were originally focused on financial services but were extended to other sectors including the real estate industry. Penalties have already been imposed on a number of agents. How can estate agents mitigate their regulatory risk? This note explores the regulatory landscape in the Real Estate industry, then use the lessons learnt for the financial services industry to explore the possibility to implement a real estate solution.

The regulatory background and the impact of Brexit

The Financial Action Task Force (FATF) is an inter-governmental body set up to combat ‘money laundering, terrorist financing and other related threats to the integrity of the international financial system’. The body set up the international standards and monitors the implementation of the necessary measures in member jurisdictions.

The European Commission – which is a FATF member – has published the Fourth, Fifth and Sixth Anti-Money Laundering Directives (in 2015, 2018 and 2018 respectively) to include FATF recommendations. Unlike European Commission Regulations that are directly applicable to European Union members’ states, Directives need to be transposed into each member state’s national legislation. That national legislation then makes the Directive’s requirements applicable in the member state. In the UK, the 2015 Fourth Directive was transposed into the Money Laundering, Terrorist Financing and Transfer of Funds Regulation 2017.

The United Kingdom is also a member jurisdiction of FATF and therefore is expected to implement the recommendations regardless of its status within the European Union. The 2017 regulation will still apply in case of Brexit, and even if the 2018 Directives are not transposed, the UK will still be required to implement the FATF recommendations. The UK government has also indicated that it will continue to match, or even exceed, new anti-money laundering legislation passed within the EU in order to maintain its reputation as a positive investment centre for clean money.

This means that the regulatory focus on AML issues is not expected to drop regardless of Brexit outcomes. National legislation with similar scope to the Directives’ are expected to be passed in the coming years.

AML regulation and regulatory body in the Real Estate Industry

The 2017 regulation strengthens the role of estate agents in the fight against AML. The regulation is articulated around three key processes: 1) Governance and policies to ensure that the right staff are appointed, trained and empowered to implement a risk-based AML policy; 2) The ‘Business as Usual’ activities comprising Identification and Verification, Customer Due Diligence and ongoing monitoring and 3) Suspicious Activity Reporting.

The regulations are evolving into more responsibility being put on senior management at businesses in the real estate sector, including criminal liability for lapses. Firms will have to demonstrate that they took all the necessary steps to implement their policies and empower their staff to report suspicious activities.

With a low tolerance threshold on what should be reported – any suspicion that is “more than fanciful”– everyone in a business is involved and must keep detailed records demonstrating adherence to a robust process that adequately mitigates the risks specific to the business.

HMRC is the regulatory body overseeing AML compliance in the real estate sector. In March 2019, fines were issued following surprise visits made to 50 estate agents within a week. A record penalty of £215,000 was issued, 9 agents were named and shamed and further actions will be taken against other businesses that failed to comply. Discounts were applied to these fines that will not be available to repeat offenders in the future. The penalties can go as high as 10% of the gross profit figure of the estate agency business – which can represent tens of millions pounds fines for the largest institutions.

AML challenges in the Real Estate industry

Compliance with AML regulations is a data heavy exercise. It requires checking every single customer against a number of sanction lists, verifying if they are Politically Exposed Persons (or PEPs), checking for adverse publicity in the press, etc. The upcoming regulations will also require counterparty checks to be performed. The exercise is challenging with heavy system requirements, multiple data sources, and a plethora of false positive hits delaying the business.

Record keeping and ongoing monitoring are also a challenge. Businesses must be able to demonstrate robust processes, systems, governance and staff awareness during regulatory visits. This needs to be prepared as the regulator can choose to perform surprise visits or pick staff at random. These staff must be able to demonstrate that they are adequately trained and that they maintain compliant records.

Lessons learnt from the experience of financial services

An obvious parallel to the current situation facing the real estate industry is to look at financial services over the last ten years. For a long time banks have been faced with the requirement to screen customers and their activities so an obvious question is what have they done in relation to creating shared utilities and how successful have these been.

The short answer is “too little too late”.

For many years, AML was an internal administrative process that perhaps did not get the focus it deserved. Ultimately, this led to large, well-publicized fines for a number of banks including, in some cases, Deferred Prosecution Agreements. For example, HSBC’s 2012 money laundering settlement for breaches of anti-money laundering requirements cost $1.92bn in the US. Other settlements ranged from $298m to $667m.

On the back of these fines, banks strengthened their processes and added significant numbers of resources to their internal teams. Being under such regulatory scrutiny meant that few, if any, banks were interested in exploring industry-wide utilities.

Over the next few years the compliance costs grew several fold [1]  and this led to discussions in the industry around mutualizing some of the activities.

Ultimately, KYC utilities were created by banks together with large providers like DTCC, Thomson Reuters, Swift and IHS Markit. Although, these have had some commercial penetration, their benefit to the overall industry has been more muted There are a number of reasons for this but two of the principle ones were that it was difficult to align standards across banks that had invested heavily in their internal processes over many years.  Perhaps more significant was the reluctance of multi-banked clients to sign up to the multiple, competing utility offerings that appeared at the same time.

Conclusions

The real estate industry is at a crossroads with increased regulatory pressure and a unique opportunity to explore a cooperative solution that can potentially lower the compliance costs while mitigating some of the regulatory risk. A solution that leverages pre-existing checks, make better use of data and applies industry defined ‘best practice’ processes will not take away individual firms’ AML responsibilities. It will however support senior management’s decision making and adherence to internally defined risk appetite.

Moreover, new technologies such as block chain were not yet available or at least not democratized enough when banks started to remediate their internal issues. In addition, digital capabilities facilitate better interactions and user experiences e.g. by empowering clients to be in control of their own data and documents.

The potential economies of scale could also mean that the solution could be economical for the industry over time while supporting the important fight against money laundering and terrorism financing.

[1] Banks typically pay $300 to $450 per customer for client-checking services [FT August 2nd 2018]

About the authors

Alex Ktorides Partner and Head of Risk Management and Ethics at Ince, advises and supports clients on regulatory issues in sectors including accountancy, legal, property and gaming and on FCA authorisations. He deals with anti-money laundering, sanctions, bribery and corruption, defence to investigations and responding to unauthorised visits and any criminal and/or civil aspects arising. Alex also takes the lead for ethics and risk management functions across Gordon Dadds Group plc, for which he is the MLRO, Head of Legal Practice, and reportable to the board.. You can contact him at alexktorides@incegd.com
Clarisse Mallem is a Senior Project Manager with over 12 years experience in the Finance Industry. She has overseen multiple projects with regulatory impact; including the build of a multi-million pound facility to support regulatory reporting transactions for the London Metal Exchange. You can contact her at clarissemallem@gordondadds.com.
James Fraser is a business analyst with GD Financial Markets. Since joining GDFM, he has been involved in a number of regulatory related projects, including assisting in producing a RICS professional standard concerning money laundering. James graduated in History and Politics from the University of Oxford in 2018.

 

To download the full article click here

Gordon Dadds