The EU’s latest agreement on amending the anti-money laundering directive: at the vanguard of trust transparency, but still further to go

Our view on the EU’s latest agreement on amending the anti-money laundering directive is that it’s at the vanguard of trust transparency, but there’s still further to go…

The EU Parliament and Council recently reached an agreement on an amendment to the 4^th Anti-Money Laundering (AML) Directive of 2015 that required central beneficial ownership registries for companies and some trusts. Given this agreement, it is likely that the proposed amendment will become the text of the 5^th AML Directive (if finally approved by all EU relevant legislative actors). Not only did the 4^th Directive (to be amended) suffer from loopholes in relation to companies and trusts, but as the Financial Secrecy Index 2018 edition showed, not all EU countries even managed to transpose it to domestic law on time, or were not compliant with the Directive’s requirements.

Trusts, as we explained here and here, are enormously problematic legal vehicles that can easily be abused to hide the identity of criminals and their ill-gotten assets, evade and avoid taxes, or shield property from legitimate creditors. So we were hoping the EU would follow its own PANA Committee’s recommendations and improve transparency of trusts by requiring them to be subject to the same transparency provisions as demanded of companies and other legal entities – after all, all legal vehicles can be abused for money laundering and other illicit purposes.  Trusts are generally more slippery than companies to deal with, but not impossible.

While the EU agreement on a proposed amendment reached last December is a big step towards effective trust registration, it fell short in two key ways: first, on public access to beneficial ownership of trusts; and second, on the need to trigger registration of trusts’ beneficial owners  if a trust is created or governed by the laws of an EU country.

The EU Directive will impose minimum transparency standards, though EU countries can go beyond them. However, we were expecting these minimum standards to be much higher.

Summary table of beneficial ownership registration if the proposed amendment to the 4^th AML Directive is approved

In detail

Figure 1. What currently triggers registration of either companies/legal entities or trusts under the proposed amendment

Under the proposed amendment, companies and legal entities will have to register if they are incorporated in the EU. In the case of trusts, registration will be triggered if either the trust’s trustee, business relationships or real estate is located in the EU. Ideally, however, registration of both companies and trusts should be triggered if any of their elements are in the EU. For example, if the company is incorporated in the EU or the trust is created/governed according to the laws of an EU country; if the company or trust has any type of operations  (wide interpretation of “business relationships”) or real estate (or ideally, any registrable asset) in the EU, or if any party of the company (e.g. shareholder, CEO, Director, etc.) or of the trust (e.g. settlor, trustee, protector, beneficiary, etc.) is located/resident in the EU.

1- What triggers registration of beneficial owners: All legal entities (e.g. companies, partnerships, foundations, etc.) created according to the laws of an EU country are required to register their beneficial owners in a central register [Art. 30 of the Directive already required this back in 2015], but for trusts, the requirement for registration is triggered only when the trust is administered in the EU or when the trusts engages in business relationships or acquires real estate in the EU [proposed amendment to Art. 31 of the Directive[1], yet to be approved].

In other words, if legal entities were subject to the above trust provisions, companies and similar legal persons wouldn’t need to incorporate in order to exist. They would only need to register their beneficial owners if their CEO or manager was located in the EU, or if the company engaged in any business relationship within the EU.

However, the proposed amendment is an improvement from the 4^th AML Directive. The latter triggered registration of trusts’ beneficial owners under ambiguous conditions (it wasn’t clear if the trust or the trustee had to be located in the EU) and only if the trust generated tax consequences, without defining what that meant. The new provisions for the first time set out a clear registration requirement of any trust managed in the EU, regardless of fiscal consequences.

In what can be characterised as a huge policy breakthrough, trust beneficial ownership registration will now also be triggered in cases where the trust engages in business relationships or acquires real estate within the EU.  This is a very important provision that all countries should follow to prevent trusts from posing risks to their territories. As the Financial Secrecy Index shows, most countries require no comprehensive registration of trusts (trusts have to register at most, under specific circumstances). Therefore, if say a Cayman or US trust operating in the EU is engaged in illicit activities, it may be impossible for the EU to get any beneficial ownership information about that trust from Cayman or the US. The EU rightly requires these trusts to register too, so as not to depend on other countries for information. However, the term “business relationships” should be given the widest possible interpretation, to include for instance opening a bank account, providing goods or services, or having any type of operations in the EU.

The remaining risk for the EU, however, refers for example to a trust whose settlor or beneficiary are from the EU, but where the trust’s trustee, operations and assets are outside the EU. While the EU settlor or beneficiary could be engaging in tax evasion or money laundering through such a trust, the EU will have no information about the trust’s beneficial owners because neither the trustee nor the trust’s assets or operations are in the EU (so their beneficial ownership registration will not be triggered).

On top of this, the proposed provisions leave some back doors open for abuse from trusts originated in the EU, but affecting other countries: there may be EU trusts (trusts created according to the laws of EU countries, say the UK) that operate and are managed outside the EU. These EU trusts may be engaging in illegal activities, money laundering, tax evasion, etc. However, since they will be operating (having business relationships) and be managed outside of the EU, they won’t need to register any beneficial ownership information in the EU. The EU could solve this loophole by triggering registration also when a trust is created or governed according to the laws of an EU country.  The Financial Secrecy Index shows that some countries already require registration of all trusts created according to their laws (e.g. Dominican Republic, France, Hungary, Puerto Rico, San Marino) and in some cases registration also includes beneficial ownership information (e.g. Costa Rica, Czech Republic, Uruguay).

To sum up, the EU should improve the current amendment and require that trusts (and actually also companies and other legal entities) register their beneficial owners in a central registry, whenever:

a) they are created according to the laws of an EU country;

b) they are operating in the EU in any way (determine that “business relationships” should include opening a bank account, providing or acquiring goods or services, or having any interest either through ownership, lease, etc. in real estate or registrable assets located in the EU); or

c) Any EU person/entity is related to such company or trust, e.g. as a shareholder, beneficial owner, director, settlor, trustee, beneficiary, protector, etc.

2-Access to beneficial ownership information: the proposed amendment to the 4^th AML Directive rightly requires beneficial ownership of companies and other legal entities to be publicly available in a national central register[2] to be interconnected with other country registers. Here, the EU is pioneering a worldwide standard of company beneficial ownership transparency. However, it falls short by not requiring this information to be available online, for free[3] and in open data format, as some EU countries already offer (e.g. the UK and Denmark).

When it comes to trusts, proposed provisions have failed to keep up with the improved rules applicable to companies. While competent authorities and obliged entities will have direct access, any person or organisation from the general public will be able to access – partial, but very likely enough – beneficial ownership information by demonstrating a legitimate interest[4]. Worryingly – to say the least – to include civil society organisations and investigative journalists within the scope of those with a legitimate interest is not prescriptive in the legally binding text, but a mere suggestion of the recital section of the proposed Directive. On top of this, the Directive could have been more explicit and determined here, instead of giving countries too much discretion or flexibility:

Whereas 35: “Member States shall define legitimate interest […]. In particular, those definitions […] should enable to take into account the preventive work in the field of anti-money laundering, terrorist financing and associate predicate offences undertaken by non-governmental organisations and investigative journalists, where appropriate”[5]

Another concern: beneficial ownership information of trusts that should already be public

In relation to those who may have access to trusts’ beneficial ownership information, the proposed Art. 31, paragraph 4 includes (a) competent authorities and FIUs, (b) obliged entities, (c) any person or organisation that can demonstrate a legitimate interest, and a new case “(d)” is added, creating some confusion:

“(d) any person that files a written request in relation to a trust or similar legal arrangement which holds or owns a controlling interest in any corporate or other legal entity other than those referred to in Article 30(1), through direct or indirect ownership, including through bearer shareholdings, or through control via other means”[6]

Both the proposed amendment[7] and the EU Council press release explain that this clause refers to a trust (very likely administered or with business relationships in the EU) that owns or controls a company or legal entity incorporated outside of the EU (since a company incorporated outside of the EU wouldn’t be covered by Art. 30(1)).

This special provision for trusts owning non-EU companies (implicitly) suggests that trusts that do own EU companies or legal entities should disclose their beneficial owners to the general public. The EU Directive should be explicit about this to avoid cases of non-compliance. For instance, when the UK decided to establish a public beneficial ownership register for companies (consistent with what the 5^th AML Directive will require, but beyond what the 4^th Directive currently requires), it failed to require comprehensive public disclosure of trusts that own UK companies.

[Parenthesis]: a trust cannot be the beneficial owner of a company because “beneficial owners” must always be natural persons. In the case of a trust, the FATF AML Recommendations[8] and the EU Directive (already in 2015) consider that all of the parties to the trust (settlors, protectors, trustees, beneficiaries, etc.) must always be considered beneficial owners of the trust. Applying basic logics: when a trust owns a company, the beneficial owners of the trust (all of the parties to the trust) must be considered the beneficial owners of the company.

Therefore, once the new Directive becomes applicable, it should be expected that when any trust owns or controls an EU company, information about all of the trust’s beneficial owners (settlors, protectors, trustees, beneficiaries, etc.) should be publicly available, just as any other beneficial owner of an EU company would have to be. What shouldn’t happen is the UK (current) approach, which considers that when a trust owns a UK company, only the trustee and any other person with control over the trust (instead of all the parties to the trust) are to be considered the beneficial owners of the company.

Source: Knobel, “Regulation of Beneficial Ownership in Latin America and the Caribbean”, Inter-American Development Bank, Washington DC, November 2017, page 14.

3-Other issues

a) Discretion to define trust-like entities

The proposed amendment lets EU countries decide[9] which local structures are similar to trusts and should be subject to trust regulations. It appears that if a country decides that such a structure is not like a trust (or like a company), it may not need to register.

Giving such carte blanche seems problematic considering current cases of non-compliance with even explicit requirements mentioned above (e.g. timeframe to transpose the Directive into national law) or incoherent applications of provisions for public registries (e.g. the UK treatment of trusts that own companies).

This discretion to decide whether a legal structure is similar to a trust or not would be less problematic if the default option (for any legal vehicle or structure) were to be registration of beneficial owners in a public register (as if they were similar to companies), unless it were determined that the structure is similar to a trust (and thus subject to trusts’ less transparent registration provisions).

As we have written here and here, there should be no differences between trusts and other legal entities when it comes to the registration of their beneficial owners, and public access to such information. However, if the difference is to remain, the residual “cover-all” clause mentioned above would ensure that if a country fails to identify a structure as similar to a trust, the consequence will not be that that structure would be exempt from registration, but rather that it will be considered a company and their beneficial owners will have to be publicly disclosed.

b) Discretion to determine sanctions

Both for registration of companies and trusts, the proposed amendment states:

“Member States shall ensure that breaches of this Article are subject to effective, proportionate and dissuasive measures or sanctions”[10]

Sanctions should not be subject to discretion. Only one sanction should apply: if a legal vehicle (company, entity, trust, etc.) hasn’t registered its beneficial ownership as required by the Directive, then that entity should not be allowed to incorporate (and legally exist) or to operate in the EU. If the vehicle or structure already existed but failed to register its beneficial ownership information, it should be struck off the register and prevented from operating in the EU. Any existing information about the entity should still be available to the public, but there should be a clear warning that this vehicle is non-compliant and is thus prohibited from operating in the EU.

c) Other EU-related territories

The EU should require that any country with a special treatment or agreement with the EU in terms of market access and other benefits (e.g. Andorra, Liechtenstein, Switzerland, as well as UK dependent territories) should be equally required to implement the beneficial ownership requirements for their legal vehicles.

[1] Art. 1 (10) (b) the following paragraph 3a is inserted: “3a. Member States shall require, that the beneficial ownership information of express trust and other types of legal arrangements when having a structure or functions similar to trusts shall be held in a central beneficial ownership register set up by the Member State where the trustee of the trust or similar legal arrangement is established or resides. Where the place of establishment or residence of the trustee of the trust or similar legal arrangement is outside the Union, the information referred to in paragraph 1 shall be held in a central register set up by the Member State where the trustee enters into a business relationship or acquires real estate in the name of the trust or similar legal arrangement.” (See page 41: http://data.consilium.europa.eu/doc/document/ST-15849-2017-INIT/en/pdf; 7.3.2018)

[2] Art. 1 (9)(a) paragraph 5 is replaced by the following: “5. Member States shall ensure that the information on the beneficial ownership is accessible in all cases to: (a) competent authorities and FIUs, without any restriction;

(b) obliged entities, within the framework of customer due diligence in accordance with Chapter II; (c) any member of general public.” (See page 37, idem link as above).

[3] Art. 1 (9)(aa) The following paragraph 5a is inserted: “5a. Member States may choose to make the information held in their national registers referred to in paragraph 3 available on the condition of online registration and the payment of a fee, which shall not exceed the administrative costs of making the information available, including costs to ensure the maintenance and developments of the register.” (See page 38, idem link as above).

[4] Art. 1 (10) (c) that modifies paragraph 4 (c) of Art. 31 of the 4th AML Directive (See page 41, idem link as above).

[5] Whereas (35), see page 21 (idem link as above)

[6] Art. 1 (10) (c) that modifies paragraph 4 (d) of Art. 31 of the 4th AML Directive (See page 41, idem link as above)

[7] Whereas (22a), see page 15 (idem link as above)

[8] Customer Due Diligence for legal persons and arrangements: “(b) Identify the beneficial owners of the customer and take reasonable measures to verify the identity of such persons, through the following information: (…) (ii) For legal arrangements: (ii.i) Trusts – the identity of the settlor, the trustee(s), the protector (if any), the beneficiaries or class of beneficiaries33, and any other natural person exercising ultimate effective control over the trust (including through a chain of control/ownership); (ii.ii) Other types of legal arrangements – the identity of persons in equivalent or similar positions.” (page 61-62, available here: http://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/FATF_Recommendations.pdf)

[9] See Whereas (22) and (22.b), pages 14 and 16 (idem link as above).

[10] Art. 1 (9) and (10), pages 36 and 40 (idem link as above)

Special thanks to Jacques Terray for his valuable input.