How to solve the Beneficial Ownership Mystery | Blog | EastNets

How much do financial institutions (FIs) need to know about the beneficial ownership controlling business interests (entities) and the relationships connecting them to these entities? Early 2018, the EU enforced its 4th AML Directive and the US did the same with its Final Rule for Customer Due Diligence (CDD). They now require FIs to identify the ultimate beneficial owners of entities. But as with every new regulation, compliance teams tasked with introducing and managing these compliance requirements need to understand them first. To do that, the compliance team needs to discover the business customers, partners, suppliers and other businesses that are directly and indirectly connected to an entity.

Identity ambiguity is the enemy. Know whom you are doing business with.

Beneficial ownership (BO), refers to the individuals or enterprises who have effective control and benefit from an entity’s operation. The BO regulation requires FIs to know who they are doing business with, as persons or a group of persons. The scope of this knowledge is best sought through customer due diligence (CDD), which effectively identifies a customer’s activities and assesses money laundering risks.

When on-boarding a new customer, the compliance team needs to analyze the source of customer funds as a first stage in assessing their money laundering risks. While customer due diligence might seem a simple and straightforward operation, it could become a complex undertaking to identify the direct and indirect relationships of beneficial ownership.

As the Panama papers have recently proved, investigating and detecting the ownership structure of legal entities could be quite difficult.  Planned ambiguity and obscurity is an act criminals commit intentionally to hide their identities and their links to an entity’s illicit activities. Such ownership ambiguity is orchestrated through multi-layered ownership structures.  Two major ownership structures are used to this end: Direct and indirect ownership. In some cases, such ownership structure complexity makes it quite hard to identify which natural or legal person has an ultimate control over a legal entity.  

Key Challenges of Beneficial Ownership Identification:

Naturally, the first order of business when performing due diligence procedures is to identify and screen the names of an entity against all kinds of published sanctions and watch lists. These lists include politically exposed persons (PEPs), close associates, family members, adverse media, and other official, national or internal lists. The ownership structure is about who owns what; about what the ownership nature is, and to what extent ownership interests extend in any one entity.

Compliance officers should not become content with identifying only direct ownership or shareholder interests; but seek deeper Intel about indirect ownership interests. They need to uncover cases where any individual has indirect ownership or controlling interest over a pre-defined ownership threshold.

According to the new regulatory amendments by the Financial Action Task Force (FATF), the compliance officer needs to find a person or a group of persons who have taken control, whether through contracts, debts, intermediary, convertible stocks, or through senior managing officials and managing directors.

One of the more challenging cases is where a legal entity is owned by another legal entity, which in turn is owned by a third entity, and so forth in a chain of entities spread over different jurisdictions. In such a multi-layered ownership structure, compliance officers are required to perform deeper due diligence processes on the ultimate individuals who control the legal entity.

Money launderers and fraudsters mostly prefer to establish passive non-financial entities, shell or shelf-companies in tax havens or offshore jurisdictions. This is because they can access advanced levels of secrecy, completely or partially, hiding the beneficial owner information. The data leaked by the Panama Papers has shown to what extent the ultimate owners of entities go to bury their identities. The 11.5 million secret files have exposed 140 politicians from more than 50 countries as ultimate owners of offshore entities across 21 tax havens.

Countries are now establishing Central Register of Beneficial Ownership (RBO), offices that simplify the process of ownership identification. The RBO officers verify and extract the needed information about legal entities and their beneficial owners, starting with minimum information; e.g., name, date of birth and address. For more disclosure, the information required includes financial activities and other assets held by the entity. The EU’s AMLD4 now obliges member states to create and maintain such registers, granting access to eligible concerned parties, including financial institutions and other investigating entities. 

Difficult but not impossible:

Overcoming the ownership-identification challenge:

Navigating complex and multi-layer ownership structures is difficult but not impossible. A financial institution needs to begin with enhanced due diligence procedures, which requires obtaining the sufficient documentation on entities. FATF elaborates on these recommendations, as do national regulators, especially as related to complex structures with ambiguities regarding beneficial owners and controlling persons.

For compliance teams, the best and surest way to ensure a best practice approach to the beneficial ownership compliance is to visualize entities and their beneficial ownerships. This means mapping the ownership chain on a chart. Such visualization approach, used by security agencies, allows for the discovery of relationships, ownerships and controlling interests associated with the entities investigated. Integrating a solution with link analysis capabilities makes it even easier to manage beneficial ownership issues and discover undeclared hidden relationships.

The issue of identifying ultimate beneficial ownership is becoming the principal driver of good AML compliance. Ignoring it could almost certainly lead to hefty penalties and institutional exposure to massive reputational damage.