Anti-money Laundering Report

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Financial Conduct Authority 3

Anti-money laundering annual report 2012/13

July 2013

Introduction

This report sets out our obligations relating to anti-money laundering, our approach tocarrying out those obligations, and the trends and emerging risks in money laundering thatwe are seeing in the irms we regulate.

The discussion o trends and risks ocuses on the ways in which the irms we regulate maybe vulnerable to being used by money launderers, rather than on the types o crime (such asdrug smuggling) rom which the illicit unds are derived.

We intend to publish more reports on these issues in uture.


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4 Financial Conduct Authority


July 2013

1.

Background

1.1 The Financial Conduct Authority (FCA) was established on 1 April 2013. Our overall objectiveis to ensure that relevant markets work well. This is supported by three operational objectives,which are to:

protect and enhance the integrity o the UK fnancial system

secure an appropriate degree o protection or consumers, and

promote competition in the interests o consumers.

1.2 We are also the anti-money laundering (AML) regulator o many o the irms subject to theMoney Laundering Regulations 2007 (the MLR 20071). So we are responsible or supervisinghow those irms comply with their AML obligations.

1.3 While carrying out our work we have a duty under the Financial Services and Markets Act 2000(FSMA) to have regard to the importance o minimising how possible it is or irms to be used

or inancial crime.

1.4 This is our irst annual report on these issues. It explains our responsibilities, our approach tocarrying out our anti-money laundering duties, and the current and emerging trends we haveobserved recently in the irms we regulate. We will publish annual reports on these issues,looking at the sectors that we regulate.

1.5 As we noted in our Risk Outlook 2013, there has been increasing public interest in money laundering.In its report Drugs: Breaking the Cycle, published in December 2012, the House o CommonsHome Aairs Select Committee suggested that we produce annual reports showing the prevalenceo money laundering within the UK inancial sector. In response, we proposed publishing a reporton the perormance o our duties under the MLR 2007, including some inormation on broader

money laundering trends aecting those sectors o the industry that we regulate. These reportswill complement those published by the Treasury on anti-money laundering supervision in the UK.

1.6 We will increase the transparency o our work where appropriate.2 Two new regulatoryprinciples given to us by FSMA make transparency a particular priority or us:

the desirability o publishing inormation about regulated frms and individuals, and

the requirement to carry out our unctions as transparently as possible.

1.7 We are also committed to carrying out our responsibilities using a risk-based and proportionateapproach. We use this approach in all our work, at the authorisation or approval stage, as well asin our supervision and enorcement work. We explain in Section 4 how we use this approach in

our anti-money laundering work.

1 The MLR 2007 implement the requirements o the Third EU Money Laundering Directive in the UK.

2 See Journey to the FCA.
http://www.fca.org.uk/your-fca/documents/fca-risk-outlook-2013http://www.fca.org.uk/static/documents/fsa-journey-to-the-fca.pdfhttp://www.fca.org.uk/static/documents/fsa-journey-to-the-fca.pdfhttp://www.fca.org.uk/your-fca/documents/fca-risk-outlook-2013


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July 2013

2.

What are the sources of money laundering risk?

2.1 The most important risks that inancial crime currently pose to our objectives are rom moneylaundering, breaches o the UKs and other countries inancial sanctions, terrorist inancing,investment raud (boiler rooms and similar rauds, including the associated risk that theraudulent proceeds are then laundered) and bribery and corruption. This report ocuses onmoney laundering, inancial sanctions breaches and terrorist inancing.

2.2 The international nature o the UK inancial markets, and the range o inancial servicesthey oer, mean they are attractive to all types o business, both illegitimate and legitimate.Globalisation has reinorced Londons position as a leading international inancial centre. Also,as we noted in the Risk Outlook, in current economic circumstances irms may opt or higherrisk unding sources, such as shareholdings rom international sources where there may belower compliance with anti-money laundering standards.

2.3 Many o the irms we regulate have a global presence, with business and customers in manycountries. Some o those countries are assessed by non-governmental organisations3 as highrisk or inancial crime. And the UK is seen as sae and attractive or many wealthy individuals,

including some rom those high risk countries. This means that regulated irms may take morerisks over the sources o the unds they are prepared to accept, increasing the possibility thatthey may be handling the proceeds o corruption or other crime.

2.4 At the same time, domestic organised crime continues to be a major concern. In 2012 the HomeOice estimated that domestic organised criminal gangs generated 20 billion to 40 billiona year rom the sale o narcotics, people smuggling and traicking, and other illicit activities.

2.5 In 2007 the Treasury estimated that each year 10 billion o illicit unds passed through theregulated sector. The regulated sector is all irms subject to the MLR 2007. Many o these,e.g. lawyers, accountants and many money service businesses, are regulated by bodies otherthan the FCA (see Section 5). Developments in technology and international travel have also

increased the risk o illicit unds being transmitted through FCA-regulated irms.

3 Such as Transparency International and Global Witness.


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July 2013

3.

What are our responsibilities on AML?

3.1 The Financial Services Authority (FSA) had a statutory objective to reduce the extent to whichit was possible or a inancial business to be used or inancial crime. We do not have areestanding objective to reduce inancial crime, but reducing the extent to which irms can beused or inancial crime is a priority as part o our objective to enhance the integrity o the UKinancial system. All irms authorised under FSMA are required to take steps to reduce the riskthat they may be used or inancial crime.

3.2 As explained in section 1 above, the FCA is a supervisor under the MLR 2007. We are responsibleor ensuring that most authorised irms and all e-money institutions comply with the MLR2007, with the exception o the likes o those undertaking purely general insurance business, ormortgage or general insurance intermediary activity, which are not subject to the Regulations.

3.3 We are also responsible or what are known as Annex I Financial Institutions such as inancialleasing companies, sae custody services and money broking. These are not authorised activitiesbut are subject to standalone anti-money laundering supervision by the FCA. There are around

350 Annex I Financial Institutions.

3.4 The Oice o Fair Trading (OFT) is responsible or regulating consumer credit institutions until1 April 2014. HM Revenue and Customs (HMRC) are the AML supervisors o money servicebusinesses (MSBs), including money transmitters and currency exchangers (where theseactivities are not carried out by an FCA-authorised irm).

3.5 All the irms we regulate or anti-money laundering purposes are, under the MLR 2007, requiredto operate the same AML standards in their businesses outside the European Economic Area(EEA) as they do in the UK, to the extent permitted by local law. We supervise how they dothat, and we cooperate on this with other authorities.


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Carrying out thematic reviews on high risk issues, assessing around 20 frms each time.We usually publish these reviews, assessing how well frms in general identiy and mitigatethe money laundering risks they ace, as well as guidance on good and poor practice. Ourrecent thematic work on AML includes: Banks management o high money launderingrisk situations (June 2011); Banks deences against investment raud (June 2012); andBanks control o fnancial crime risks in trade fnance (July 2013). In addition, we are dueto publish a review oAML and anti-bribery and corruption controls in asset managementfrms later this summer.

Assisting with the fnancial crime aspects o frm risk assessments carried out by frmsupervisors.

4.5 The specialist teams work assesses inancial crime systems and controls in around 150 irms ayear. Most o this ocuses on anti-money laundering systems and controls.

4.6 As well as supervising anti-money laundering controls in individual irms, we also provideguidance. Our Financial crime: a guide or irms sets out what irms can do to reduce theirinancial crime risk and brings together all our guidance on inancial crime, rom our thematicreviews and other work.

4.7 In the past twelve months we also have published newsletters and held external presentationsand brieing sessions to present the detailed indings o our thematic reviews and to hearirsthand rom irms. We will continue to hold these sessions, and we encourage irms tocontinue to contribute to this process. We are also consulting on updating our inancial crime

guide to relect the good and poor practice that we ound rom this years thematic reviews

Engaging with frms and other organisations

4.8 Every two years we host a inancial crime conerence. The theme this year was The inancialcrime regime and the FCA. The key messages were that:

We will work in partnership with our law enorcement partners and with other regulators.

We are closely involved in ormulating policy, both in the UK and internationally. We are

particularly interested in promoting the risk-based approach to anti-money launderingsupervision. We believe this approach helps frms use their resources most eectively toaddress the highest risks.

4.9 We host regular meetings with a number o the Money Laundering Reporting Oicers (MLROs)and Financial Crime Directors rom a variety o FCA-authorised irms. The Treasury and theBritish Bankers Association also attend. These meetings are useul or all involved, and wewant to expand them to ensure that all irms and sectors are represented. We also meet tradeassociations to discuss emerging trends and policy issues.

4.10 We are a member o the Money Laundering Advisory Committee, co-chaired by the Treasuryand the Home Oice, which brings together representatives rom law enorcement, government,industry and regulators to advise the Government on its approach to preventing money laundering

in the UK. This committee also reviews industry guidance beore it is approved by the Treasury.We also work with the Joint Money Laundering Steering Group, which produces guidance or theinancial services industry on preventing money laundering/combating terrorist inancing.


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July 2013

International

5.6 We support the Treasury, which leads the UK delegation to the Financial Action Task Force(FATF the global AML standard setting body), and the FATF itsel. Our aim is to ensure thatinternational standards, including the FATFs Recommendations, assessment methodologies,guidance and typologies papers, promote an eective, proportionate and risk-based approachto AML and combating terrorist inancing (CTF).

5.7 Over the past year we have supported the Treasury on a number o initiatives at the FATF,such as developing methodologies to assess how FATF member states comply with the FATFsRecommendations, and best practice and guidance papers on Politically Exposed Persons (PEPs,i.e. individuals holding prominent public positions in jurisdictions other than the UK), corruptionand new payment products and services.6

5.8 At European level we are supporting the Treasury in the negotiation o the Fourth MoneyLaundering Directive. We are also a member o the Anti-Money Laundering Committee (AMLC),a sub-committee o the Joint Committee o the Joint European Supervisory Authorities (ESAs).The AMLC helps the ESAs meet their obligations by supporting supervisory convergenceacross the EU, providing expert input into the Commissions AML/CTF work, and providing aorum to exchange inormation and good practice. The AMLC is currently chaired by a seniorFCA employee. In 2012 the FSA chaired an AMLC working group that published a report onthe implementation o the anti-money laundering aspects o the Second E-Money Directive.The proposed Fourth Money Laundering Directive will delegate to the AMLC the drating oguidelines and binding technical standards on key parts o Europes AML/CTF regime.

5.9 In addition to our work in international AML orums, we also work closely with AML supervisorsin other jurisdictions. This may be through discussions in colleges o supervisors, where thevarious supervisors o a globally active bank discuss key issues, which may include anti-moneylaundering controls. We also have bilateral discussions with our overseas counterparts aboutindividual irms. For example, we worked very closely with the US authorities in 2012 overtheir investigations into HSBC and Standard Chartered Bank. When we review banks overseasoperations, we work closely with the local supervisors.

5.10 However, we recognise that supervising global irms compliance with AML requirements ischallenging. Our SAMLP reviews, together with increasing our cooperation with overseassupervisors, should help us in achieving this.

6 Section 7 explains how we are supporting the Government in their preparation o the National Risk Assessment, as part o the UKs

compliance with the FATF Recommendations.


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July 2013

6.

Levels of compliance

6.1 We supervise a large and diverse industry and cannot monitor all transactions in all irms, oreven in a single irm. However, our risk-based supervisory techniques (set out in Section 4) haveled us to conclude that the level o anti-money laundering compliance in inancial services irmsis a serious concern.

Our thematic review fndings

6.2 Our 2011 thematic review o Banks management o high money laundering risk situationsound that three quarters o the banks reviewed, including a number o major banks, were notmanaging this risk eectively. Around a third o banks, including the private banking arms osome major banking groups, appeared willing to accept very high levels o money launderingrisk i the immediate reputational and regulatory risk was acceptable.

6.3 Over hal the banks we visited ailed to apply meaningul enhanced due diligence (EDD)measures in higher risk situations and so ailed to identiy or record adverse inormation aboutthe customer or the customers beneicial owner. Around a third o them dismissed seriousallegations about their customers without adequate review. More than a third o the banksvisited ailed to put eective measures in place to identiy customers as PEPs.

6.4 Three quarters o the banks in our sample ailed to take adequate measures to establish thelegitimacy o the source o wealth and source o unds to be used in the business relationship.This was o particular concern where the bank was aware o signiicant adverse inormationabout the customers or beneicial owners integrity.

6.5 Some banks had inadequate saeguards in place to mitigate relationship managers conlicts

o interest. At more than a quarter o banks visited, relationship managers appeared to betoo close to the customer to take an objective view o the business relationship. Many wereprimarily rewarded on the basis o proit and new business, regardless o their anti-moneylaundering perormance. There were indications that some banks were willing to enter into veryhigh risk relationships without adequate controls when there were large proits to be made.We concluded that it was likely that some banks were handling the proceeds o corruption andother inancial crime.

6.6 More recently, our thematic review o Banks control o inancial crime risks in trade inanceound that most banks, including a number o major UK banks, were not giving adequateattention to money laundering red lags in trade inance transactions. There was an inconsistentapproach to risk assessment and only a ew banks had conducted a speciic trade inancemoney laundering risk assessment.

6.7 About hal o the banks had no clear policy or procedures document or dealing with trade-based money laundering risks. As a result, some banks ailed to implement adequate controls


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to identiy potentially suspicious transactions. Many banks were unable to demonstrate thatmoney laundering risk had been taken into account when processing particular transactions. Inparticular, trade processing sta in most banks made inadequate use o customer due diligenceinormation gathered by relationship managers or trade sales teams. In addition, systems andcontrols over dual-use goods7 were inadequate at most banks. However, a minority o banksused some innovative and eective techniques to assess money laundering risk in trade inancetransactions, which other banks could useully ollow.

6.8 The root cause o these problems is oten a ailure in governance o money laundering risk,which leads, among other things, to inadequate anti-money laundering resources and a lack o(or poor quality) assurance work across the irm. This oten ocuses on whether processes havebeen ollowed rather than on the substance o whether good AML judgements are being made.

6.9 The weakness we see in irms dealings with high risk customers and PEPs is a serious andpersistent problem in irms o all sizes. However, this issue maniests itsel in dierent ways indierent types o irm. Small irms oten ail to collect enhanced due diligence inormation, asrequired under the MLR 2007. Large irms, including those that have been subject to SAMLPexaminations, oten collect adequate inormation but ail to assess it properly and/or makepoor judgements about the money laundering risk this inormation exposes, particularly wherepotential proits are high.

6.10 We also ind weaknesses in irms o all sizes when they should be establishing and corroboratinghigh risk customers sources o wealth or unds. Too much reliance is oten placed on customersown explanations, even when they are subject to serious and credible allegations o criminalactivity.

Our tools

6.11 We use a range o tools to ensure irms improve. These include: setting remedial plans; seekingattestations rom senior management that weaknesses have been remediated; using a SkilledPerson to test systems and controls, identiy weaknesses, and, in some cases, remediate theweaknesses identiied; and considering enorcement action in appropriate cases.

Enorcement and intervention6.12 We will use our enorcement powers in money laundering cases, where this is an eective

and proportionate use o our powers. We have taken the ollowing recent enorcement actionagainst several irms and one individual or ailing to manage the money laundering riskpresented by high risk customers and PEPs:

Coutts & Co: 8.75m fne in March 2012 or weaknesses in AML controls over high riskand PEP customers.

Habib Bank AG Zurich: 525,000 fne in May 2012 or weaknesses in AML controls overhigh risk and PEP customers. We also fned Habibs Money Laundering Reporting Ofcer17,500.

Turkish Bank (UK) Ltd: 294,000 fne in August 2012 or weaknesses in AML controls overcorrespondent banks.

7 Dual-use goods include sotware, technology, documents, diagrams and other goods that can be used or civil and military purposes.


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July 2013

7.

What are the current trends and emerging risks?

7.1 We are now helping the Government to produce the National Risk Assessment (NRA) requiredby one o the new Recommendations rom the FATF. Under the terms o the Recommendation,all FATF members must identiy, assess and mitigate their money laundering and terroristinancing risks. Work has already started on the NRA, which is due to be published in summer2014. Both the private and the public sector are involved. We are actively engaged in thisprocess, supporting the Home Oice and the Treasury. In uture we will be looking to see howto use the NRA in our own risk assessment work on money laundering and terrorist inancing.

7.2 We are already seeing a number o emerging risks, some o which arise directly in FCA-authorised irms, and some o which pose indirect threats to FCA-authorised irms.

Direct risks

E-money issuers7.3 Types o e-money include pre-paid cards and electronic pre-paid accounts or use online. A

number o e-money issuers are new market entrants and are not accustomed to the AMLregulatory and legal ramework or more traditional inancial services irms. In addition, theirbusiness model, where they segment (ie outsource) provision o the service to a third party makes it vulnerable to money laundering. This is because the e-money issuer has little or nooversight o the end to end use o the service, yet has legal responsibility or AML controls overit. A urther important risk ise-money issuers based in other jurisdictions that are subject tolimited regulatory oversight, or none at all.

7.4 Firms subject to the MLR 2007 are required to submit suspicious activity reports (SARs) to theSerious Organised Crime Agency i they suspect that their services are being used to launder

criminal proceeds. There are very ew SARs rom the e-money sector, which makes it diicultto see whether the products these irms oer are being used by criminals. Along with theirbusiness model, this gives rise to concerns or the FCA and or law enorcement about thesectors vulnerability to money laundering. We recognise there is limited evidence at present onthe extent o the problem, but we are also conscious o the risks this business model presents.

7.5 This is a ast growing market, and we do not want to stile innovation. But irms must haveadequate AML systems and controls, and understand the need to comply with their legalobligations on AML and to protect their own businesses against criminals. We have seen atleast one prepaid card/voucher issuer that did not apply systems and controls because theybelieved it would hurt their business model, and were seriously aected by criminals whotargeted their vulnerability. This institution subsequently improved its systems and controls, andwithin a ew weeks it had halved the inancial crime attacks against them and their customers.


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Cybercrime7.6 Cybercrime that is the exploitation o vulnerabilities in private or public telecommunicationnetworks through computer systems or mobile devices or criminal purposes is anotherimportant growing risk. The risk o exploitation o these vulnerabilities is heightened whereirms lack adequate controls and processes, and where sta and end-consumers lack awareness.According to Government data, the inancial services sector, which is regarded as an integralpart o the national inrastructure, suers the ith highest number o cyber-attacks againstits computer systems. Examples o cybercrime include internal and external raud, denial otechnology services and thet o data.

7.7 We are currently liaising with the Bank o England and the Prudential Regulation Authority(PRA) and government bodies, such as the Centre or the Protection o National Inrastructure(CPNI) on cyber resilience. We encourage irms to contact us i they come under a cyber-attack.

Indirect risks

MSBs7.8 The Money Service Business (MSB) sector as a whole is assessed by law enorcement as being

at particularly high risk o abuse by those seeking to launder money or inance terrorism, andsome MSBs have been seen to be complicit in these activities.

7.9 We have observed a recent trend or banks to remove banking services rom their MSB customersbecause o the money laundering and terrorist inancing risks posed by the sector. Those that

continue to provide services to MSBs have signiicantly expanded their ongoing monitoring othese customers, or instance by conducting onsite visits to check AML/CTF systems and controls,sometimes quarterly, which may have a signiicant eect on the cost o providing these services.But i bank accounts were to be denied to MSBs altogether, this would raise concerns about therisks being displaced to businesses operating outside the regulated sector.

Digital currencies7.10 Digital currencies are those where there is no issuing central authority and they are not backed

by ordinary currency or anything o intrinsic value. Reports suggest that a large proportion otrade in these currencies may be rom lows o illicit money. There is no irm evidence o thisso ar, though we do have concerns about these products, both because they sit outside anyregulatory remit and because they are presented as inancial instruments.

7.11 We do not regulate digital currencies, but we will keep them under review because o theindirect risks they pose to our objectives. They could also pose risks to consumers. We continueto liaise with the Government about their emerging view o these products.

Alternative banking platorms7.12 Another indirect risk is alternative banking platorms, also known as a payment platorm or

virtual bank. These are systems that provide the unctionality o a bank but sit outside theregulatory system.

7.13 Recent cases suggest that the irms that oer these services are incorporated, and operating,in jurisdictions that do not have robust anti-money laundering oversight. We understand thatthey present real risks to the irms we regulate, especially in relation to customer take-on and

third party payments.


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8.

Future work

Consumer credit

8.1 On 1 April 2014 we will take over the regulation o consumer credit rom the OFT. This willinclude taking over supervision o consumer credit businesses that all within the deinition oconsumer credit inancial institutions in the MLR 2007.

8.2 Consumer credit irms will also need to ollow our rules, requiring them to take steps to preventthemselves or their customers rom being exploited by criminals. We published a consultationpaper on our regulation o consumer credit in March 2013 and will publish more detailedproposals in the autumn, including on our approach to tackling inancial crimes like raud,money laundering, breaches o inancial sanctions and data security ailings.

EU legislation

8.3 In February 2013, the European Commission published proposals or a Fourth Money LaunderingDirective and a new Wire Transer Regulation. The main purpose o the Directive and Regulationis to provide a common EU basis or implementing the revised FATF Recommendations. Butthe drat Directive also takes account o new risks and practices that have developed since thepresent Directive. The Directive will strengthen the risk-based approach to AML/CTF by requiringMember States and regulated irms to assess the money laundering and terrorist inancing risks towhich they are exposed and base their AML/CTF policies and procedures on those assessments.

8.4 We are supporting the Treasury in negotiating the Directive through European Council workinggroups. Once the Directive is inalised we will also support the Treasury in legislating toimplement the Directive in the UK and will take the lead or the UK at the AMLC, which is

tasked with producing guidelines to support implementation o the Directive across Europe.

Supervisory approach

8.5 Our supervisory techniques continue to evolve. In particular, we are exploring the extent towhich our approach, including our SAMLP reviews, can be reined to allow us to use ourexisting resources to examine a larger sample o irms and/or review irms more requently,particularly smaller irms that might present high levels o money laundering risk. We are alsoconscious that money laundering risks may be particularly important in resolution and othersituations, and we are working with the PRA to ensure that these risks are tackled appropriately.

8.6 We will also continue our thematic work, with reviews o e-money/new payment methodsplanned, along with some ollow up work on anti-money laundering controls over high risk/PEP customers in smaller banks.


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9.

Conclusion

9.1 We have a clear remit rom the Government, with an overarching objective o making themarkets work well, and our three operational objectives, including protecting and enhancingthe integrity o the UK inancial system. Our anti-money laundering agenda is at the hearto that objective, as we aim to keep as much dirty money as possible out o the industry weregulate.

9.2 To achieve that, we will continue to apply our risk-based approach, and encourage irms to dothe same, to ensure that resources are used most eectively to mitigate the biggest risks. Andour remit asks us to make judgements and intervene early. As this report shows, we are alreadystarting to do that on anti-money laundering issues as we are in other areas. We will continueto develop this approach as we work with Government, law enorcement and the industryto spread better understanding o the risks we all ace rom criminals attempting to use ourinancial system.

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