#6: Beneficial ownership - Part I

Ultimate beneficial ownership (“UBO”) is one of the most debated concepts in the prevention of money laundering and terrorist financing in recent years, while becoming one of the cornerstones of today’s KYC processes at the same time. As part of customer due diligence, obliged entities are required to identify the UBO(s) of a customer and to take reasonable measures to verify their identity. The background to this requirement is that criminals may abuse ownership and control structures and conceal or obscure their identities through a myriad of businesses. Thus, the concept of #UBO is to ensure effective transparency of legal persons, trusts and similar legal arrangements. ?Today’s blog focuses on the definition of UBO and the determination thereof; tomorrow I will discuss the UBO register obligations.

UBO under the current regime and identified issues

UBOs are those natural persons who ultimately own or control the customer and/or the natural person(s) on whose behalf a transaction or activity is being conducted. The current regime stipulates that, in general, ownership is established when an UBO has a direct or indirect ownership interest (incl. shares or voting rights) of "25% plus one" or through control of other means. If, after having exhausted all possible means and provided there are no grounds for suspicion, no UBO based on ownership or control can be identified, the senior managing officials of entities are to be considered pseudo-UBOs. This EU framework is in line with the beneficial ownership rules as laid down in the #FATF Recommendations.

One of the current issues the EU faces is that not all legal entity structures are the same across the EU and, thus, that similar legal structures are subject to different UBO rules. For example, a “foundation”?(stichting) in the Netherlands is subject to the UBO rules for (other) legal entities – whereas in Luxembourg and Belgium a foundation is to be treated as a trust-like structure. Depending on where the foundation is incorporated, different UBO rules apply and (potentially) resulting in different UBOs. ?Also, Member States sometimes have unique legal entity structures that are not known elsewhere, like a Dutch STAK (stichting administratiekantoor). Another issue is that the #AMLD does not include any requirements as to ‘how’ to calculate the ownership interest in case of ownership and control structures involving multiple layers of ownership, thus resulting in different approaches. Whereas the Netherlands – and to my knowledge Luxembourg and Belgium – apply a ‘diluted’ approach, i.e. looking through an ownership and control structure and multiplying the interests held by a natural person on the various layers, Germany and Austria apply a partial diluted approach (i.e. more than 25% ownership in the first layer; and more than 50% in the layers above); and in Italy ownership is calculated ‘on every level of ownership’. Based on my experience, the ‘Dutch’ and ‘German’?approaches are the most commonly applied UBO determination approaches across Europe.

Future UBO framework

The AMLR is meant to bring further clarity and harmonisation in the UBO requirements. The Council’s position is clear and it is very welcome after the sometimes unrealistic and unpragmatic Commission proposal, as well as the proposed amendments by the European Parliament ECON and LIBE committees earlier this year regarding the ownership interest percentages and calculation method for indirect ownership.

Without any proper motivation in my view, the Commission proposed to deviate from the most the common practice and required UBO ownership interest to be calculated at ‘every level of ownership’. According to the preamble this should apply to “every link in the ownership structure and that every link in the ownership structure and the combination of them should be properly examined”. This would lead to very strange situations. For example: in a three-layered ownership structure, this would mean that a natural person owning no more than 1.76% in a customer (through 26% x 26% x 26% ownership interest) would have to be identified as UBOs, while at the same time a person owing 19.2% in that same customer (80% x 24% x 100%) would not be – because on one level the person wouldn’t meet the 25% threshold. In its position paper, the Dutch Banking Association (#NVB) presented some in-depth examples of the consequences of the Commission proposal and argued that “(t)his would significantly reduce the value of the concept of UBO as efforts would need to be put in UBO investigations on individuals with a very small diluted interest in the customer instead of on the UBOs that actually have a larger ownership interest”. Steering towards (near) full transparency, the ECON and LIBE committees would even go beyond the Commission proposal. The Committees ?proposed to keep the determination “on every level of ownership”, but to lower the threshold to “more than 5%”. Taking the above example of a three-layered ownership structure, natural persons owing as little as 0.02% in a company (6% x 6% x 6%) would need to be identified as UBOs. This would become totally impracticable as obliged entities would be required to do a full in-depth research into the ownership and control structure of their customers – which goes beyond the objective of ensuring effective transparency of legal persons, trusts and similar legal arrangements in order to prevent money laundering and terrorist financing. ?

+/- The Council deviates from the above proposals from the Commission and EP committees, although it doesn’t go back to the AMLD text of “more than 25%” but formulates it as “25 % or more”. The difference is that under the current regime natural persons with an ownership interest of exactly 25% do not qualify as UBO, whereas under the Council position they would qualify as such. ?I do hope that this in an inadvertent writing error, because the impact is potentially huge if this were to change. After all, obliged entities would have to re-assess for all their customers if there are UBOs with exactly 25% ownership and would have to take reasonable measures to verify their identity. I don’t think that this 1% difference will outweigh the costs to be made to implement this change. Therefore I hope that the AMLR text will go back to “more than 25%” during the trilogue phase. As a sidenote, the Council does empower the Commission to identify categories of legal entities that should be subject to a lower ownership threshold (Article 42(8) and (9) AMLR) as well as more generically assess costs, benefits and impacts of lowering the ownership interest threshold (recital 96).

+ In addition to the above, I am pleased with the following additional changes and clarifications:

• The Council disagrees with the Commission’s proposal to calculate ownership “at every level”, and clarifies that in case of indirect shareholding, the beneficial owners should be identified “by multiplying the shares in the ownership chain. To this end, all shares directly or indirectly owned by the same natural person should be added together.” (recital 66b). Thus the Council aligns to one of the most common UBO determination practices, which is the diluted approach.
• The Council makes explicit that both ownership interests and (factual) control have to be assessed in parallel, and that these are not mutually exclusive. In other words: control must be assessed, even if?one or more natural persons qualify as UBO based on their ownership interests.
• The Council introduces a regime for bodies governed by public law in the EU/EEA Member States (e.g. municipalities and central government bodies). These will not be subject to the requirement to determine their beneficial owner (article 45a AMLR). As a consequence, for bodies governed by public law in the EU/EEA (e.g. municipalities, Central Government) and that are customers of obliged entities, it should be sufficient within CDD “to conclude that there is no beneficial owner” (recital 32d). While this new regime is a good step forward, I do think it would be helpful for large internationally operating financial and credit institutions to get guidance on how to deal with UBO obligations related to public law bodies in third countries, and especially where these third countries are high-risk third countries and/or autocratic regimes.

- At the same time, I do think that the Council need to reconsider or further clarify some aspects related to UBO identification and determination, particularly in relation to:

• The Council’s clarification that that obliged entities are not allowed to solely rely on the UBO register for the identification and verification of beneficial owners, except where simplified due diligence is permissible. In other cases, obliged entities are expected to “use other reliable sources like business register or reliable information provided by the customer”. I do not see the added value of a multiprong approach as part of standard CDD, simply because the information in the trade register and UBO register also stem from the customer itself. It is also difficult to establish what “reliable information” means for the purposes of this article. In my opinion, it is key that owners of UBO registers are tasked with the verification of beneficial ownership information held in the register, and the veracity of that information. Given the already existing challenges for gatekeepers in keeping up with their AML/CTF obligations, I think that it should be possible for them to solely rely on UBO register information, with the exception of high-risk customers for which enhanced CDD is required. I would urge the Council to reconsider its position in this regard.
• The exemption of UBO identification for EU/EEA listed entities ‘or subject to equivalent standards’ as included in article 45a AMLR. While it builds on the current exemption in the AMLD, there are several unclarities. First, who determines what 'equivalent international standards'?to the EU Transparency Directive are? To my knowledge, there are a number of equivalence decisions under the EU Transparency Directive but none are about shareholder disclosure or transparency of ownership. Does this mean that at present there are no equivalent regimes outside the EU/EEA? Second, does the exemption apply only in case of 100% listings, or also to listed entities with a partial (free float) listing? If the latter, is there a specific threshold and would the exemption apply in whole or only to the listed part of the structure? Third, what do the conditions (“control over the company is exercised exclusively by the natural person with the voting rights” and “no other legal persons or legal arrangements are part of the company’s ownership or control structure”) mean? Aren’t UBOs also those may receive “a benefit”, e.g. in the form of a share of profits? And why can no other legal persons or legal arrangements be part of the company’s ownership and control structure? Does this relate to parent entities and subsidiaries? Finally, I disagree with the statement that “the exemption for legal entities from the obligation to determine their own beneficial owner and to register it should not affect the obligation of obliged entities to identify the beneficial owner of a customer in customer due diligence when performing due diligence”. This basically puts the full burden on obliged entities– requiring them to identify and verify the identity of UBOs. I do not understand why one would exempt listed entities from identifying their beneficial owners, only then to require the identification of beneficial owners by obliged entities that have business relationships with them.

? Before I mentioned the fact that legal entity structures and their treatment diverge between Member States. Under the AMLR, Member States are to notify the Commission of a list of corporate and other legal entities where the beneficial owners are identified in line with the rules for the identification of beneficial owners for corporate entities (article 42(7) AMLR). It is going to be interesting to see how the Commission will deal with different approaches by Member States, for example in relation to the aforementioned treatment of foundations in the context of UBO determinations. Could this lead to a change in the Dutch approach?

What do you think of the Council’s position regarding the UBO threshold and determination rules? Good way forward or is more required?

#AMLR #AMLA #AML #moneylaundering #newyearsresolutions #sanctions #2022 #Council #EUAMLPackage #UBO #effectivetransparency