Changes to EU anti-money laundering initiatives: conducting due diligence

A recent decision by the ECJ seems to contradict 20 years of anti-money laundering initiatives. We consider the impact on investors and the teams conducting due diligence on their behalf.

The beneficial owner register requirement of the EU’s Money Laundering Directive has always divided opinion. For those whose data was now made easily accessible to the public, it was a potential source of intrusion. However, for those countering money laundering and terrorist financing, it has proved invaluable in navigating the complex relationships of multi-jurisdictional businesses and understanding where the power truly lies.

The risk and compliance sector was understandably surprised when the European Court of Justice (ECJ) recently declared the provisions ensuring public access to beneficial ownership of legal entities invalid, when it pronounced them “a serious interference with the fundamental rights to respect for private life, and to the protection of personal data”. With the increasing scrutiny on regulatory compliance in the UK, for many investors this announcement was concerning.

The legislative framework

The UK’s due diligence requirements are taken directly from the EU’s fourth and fifth Money Laundering Directives (4MLD and 5MLD), which were adopted in 2017 and 2020 respectively. Obliged entities must conduct, and provide evidence of, appropriate levels of due diligence at various stages of a client relationship, but particularly when onboarding at the outset. Under 4MLD, the mandatory creation of a national registry of beneficial owner information would facilitate due diligence. 5MLD went further and made it available to the public.

Not everyone appreciated the additional resource, time and money required to meet these obligations. There were also numerous instances of objections levelled against the national registers by beneficial owners, who resented the public’s heightened level of insight into their affairs. This often resulted in requests for exemption. For example, in Luxembourg individuals and entities made a total of 2,049 exemption requests following the launch of the Luxembourg Business Register in 2019. By February 2022, only 40% of these had been accepted.

One such failed request has since triggered the ECJ’s investigation into access to beneficial owner registers. According to the ECJ, it questioned whether indiscriminate and open access represented “a disproportionate risk of interference with the fundamental rights of the beneficial owners concerned”, and whether the anti-money laundering benefits outweighed the potential contradiction of Articles 7 and 8 of its Charter of Fundamental Human Rights.

It was determined that the anti-money laundering benefits do not outweigh these rights.

How will this impact businesses?

Following the decision, several member states – including Luxembourg and the Netherlands – have taken their registers offline. Doing so removes a powerful weapon in the fight against money laundering, and a key means for facilitating comprehensive due diligence.

In addition to unravelling complex business structures (such as the offshore accounts exposed by the Panama Papers) beneficial owner registers can expose corruption, conflicts of interest, and fraud, helping compliance teams identify any associated risks posed by potential clients.

The Luxembourg Business Register was instrumental in identifying the beneficial owners of a major corporate shareholder in a German real estate company that was accused of selling properties below market value. The shareholder’s owners included three relatives, one of whom also happened to own the real estate company to which the under-valued properties were sold.

Transparency groups have also used registers to hold public officials and big business to account. In addition to the revelations of the Panama Papers and the FinCen leaks, registers have helped groups expose corrupt politicians as sole beneficiaries in funds owning shares in national conglomerates, for example.

Such exposés have been recognised by the ECJ, which accepts that access to registers must still be available to parties with a legitimate interest. At the time of writing it is not certain how ‘legitimate interest’ will be defined, but the ECJ has mentioned that civil society and the media will both continue to have access.

What next steps should teams take?

Compliance teams should expect delays, and plan accordingly. For those relying on beneficial owner registers as a key source of information, now is the time to consider engaging the expertise of professional investigators, who can advise on legitimate alternatives. Paid-for databases, corporate registers, annual filings, media reports, social media accounts and interviews are all useful, but the cost, labour and scrutiny required to analyse these data mean it is highly unlikely that in-house compliance teams will be able to manage without support.

Whilst public access to beneficial ownership databases may be suspended, due diligence requirements are not. Businesses must therefore develop contingency plans now to meet their regulatory obligations, without the use of this key tool.

Reworked from the original article in International Investment.