The Fight Against Money Laundering and Terrorist Financing - The HKMA Viewpoint

1. The Fight Against Money Laundering and Terrorist Financing -The HKMA Viewpoint David Carse Deputy Chief Executive Hong Kong Monetary Authority 17 March 2003

2. Background • Heightened concern about money laundering (ML) post- 9/11 • Extension of that concern to cover terrorist financing (TF) • Naming and shaming of Non-Cooperative Countries and Territories (NCCTs) • US Patriot Act • Intensified monitoring of observance of FATF’s recommendations by IMF etc

3. Implications for banks • Must regard anti-ML and TF systems as an essential means of self-preservation • Involvement in a ML or TF scandal could mean - • damage to reputation • breach of the law • financial penalties • exclusion from the US payment system

4. What is terrorist financing? • TF refers to the carrying out of transactions involving funds that are owned by terrorists or that have been/intended to be used for terrorist acts • Source of funds in TF may be legitimate • But there is still the same need to disguise the source of funds - and their potential use • Therefore terrorists still need to launder funds like conventional criminals • Characteristics of TF transactions are similar to suspicious transactions generally

5. Importance of customer due diligence • It may be possible to detect terrorist-linked transactions directly through links to the names of terrorist suspects • requires particular controls to be put in place to achieve this • But in other cases the terrorist link may only emerge after the event • It is important therefore to have the general ability to detect and report suspicious transactions • This requires effective customer due diligence within an overall anti-ML system

6. The role of the HKMA • As regulator, our role is to verify that banks have in place adequate policies, procedures and controls to combat ML and TF - • identify suspicious customers and transactions • report suspicious transactions to JFIU • assist the law enforcement authorities through providing an audit trail • This is consistent with our role to promote the stability of the system and protect depositors

7. The HKMA Guideline • The HKMA has published a statutory Guideline on anti-ML which sets out the standards expected of banks • This Guideline is presently being updated through a Supplement

8. Objectives of presentation • Concentrate on the proposed Supplement to our Guideline • Highlight the main areas of change taking account of - • Basel Committee’s paper on “Customer Due Diligence for Banks” • the proposed revisions to the Financial Action Task Force (FATF) Forty Recommendations • the FATF’s Eight Special Recommendations on Terrorist Financing • the new anti-terrorism legislation in Hong Kong

9. Customer due diligence (1) • First priority is for banks to have effective systems for customer due diligence (CDD) • This involves the following steps - • identify the direct customer • verify the customer’s identity • identify the person with beneficial ownership and control (if different from the direct customer) • verify the identity of the beneficial owner • conduct ongoing due diligence and scrutiny (requires knowledge of customer’s business as well as identity)

10. Customer due diligence (2) • Don’t establish a business relationship until the CDD process is satisfactorily completed - • or at least don’t allow any funds to be paid out of the account to a third party until identity is verified • Close the account and return the funds to original source if process of verification cannot be successfully completed - • consider report to JFIU • return of funds is subject to any request from JFIU to freeze the funds

11. Customer acceptance policies • Banks should adopt policies and procedures to identify higher risk customers - • apply enhanced due diligence • approve at senior management level • Need to apply appropriate risk factors - • who the customer is • what he does • where he comes from • where he does business • how he operates the account

12. Examples of high risk customers • Politically exposed persons (PEPs) - individuals holding important public positions or those related to them • Other types of private banking customer • Correspondent banks - particularly “shell banks” or those from NCCTs • Corporate vehicles - including offshore companies and trusts (need to verify the identity of trustees, settlors, beneficiaries)

13. Reliance on intermediaries for CDD • OK for banks to rely on intermediaries to perform CDD procedures on their behalf, BUT - • ultimate responsibility for knowing the customer remains with the bank • bank must satisfy itself that its intermediaries are “fit and proper” and use adequate CDD procedures • CDD procedures should be as rigorous as those of the bank, and bank must be able to verify this • preferable to rely on regulated intermediaries from FATF jurisdictions • all relevant customer identification data should be submitted to the bank for review

14. Client accounts • Bank must establish the identity of the underlying client(s) unless funds for individual clients are co-mingled at the bank - • not permissible to rely on professional secrecy as a reason for not disclosing identity of the client • With co-mingled accounts, bank must satisfy itself about the CDD procedures of the intermediary and that the intermediary has systems and controls to allocate funds in the pooled account to the individual underlying clients

15. Non-face-to-face customers • Banks should conduct a face-to-face interview wherever possible - • particularly important for higher risk customers • Where an interview is not held (e.g. for internet accounts), banks should adopt additional risk mitigation measures, e.g. - • require additional documentation • third party introduction through a reliable intermediary • first payment into account to be made from an account with a respectable bank

16. Existing accounts • Banks should review existing accounts in line with the new standards - • where necessary obtain additional verification of identity • Should adopt a risk-based approach focusing on higher risk customers • Review other accounts based on certain trigger events, e.g. a large or unusual transaction

17. Risk management • Banks need to be able to conduct effective on-going monitoring of accounts - • not sufficient to rely on ad hoc reports of suspicious transactions from front line staff • also need regular MIS reports to identify patterns of unusual or suspicious activity • Banks need to appoint a compliance officer to be in direct charge of their anti-ML effort - • compliance officer needs to be proactive and to have sufficient status and resources • Internal audit should independently evaluate the bank’s anti-ML policies and procedures

18. Terrorist financing • United Nations Sanctions (Afghanistan) Regulation • United Nations (Anti-Terrorism Measures) Ordinance - • prohibits the supply of funds to terrorists • requires the reporting of knowledge or suspicion that any property is terrorist property • Lists of terrorist names have been gazetted

19. Best practices for anti-TF (1) • Be aware of legal obligations under anti-terrorist legislation in Hong Kong • Extend systems for identification of suspicious transactions to cover terrorist suspects • Provide adequate guidance and training to staff • Be aware of the characteristics of TF • Establish criteria for identifying high risk customers

20. Best practices for anti-TF (2) • Maintain and update in a timely fashion a centralised and easily accessible database of terrorist names • Check names of both new and existing customers • Check names of the counterparties of customers and the beneficiaries/originators of remittances • look back to past transactions • Report suspicious transactions to both the JFIU and the HKMA

21. Remittances • Revised guidance in the Supplement based on the relevant FATF Recommendation on TF • Ordering bank in a remittance should include - • name of customer and account no (if it exists) • address or other unique identifier • Intermediary bank should ensure that the information remains with the message • Beneficiary bank should scrutinise remittances that contain incomplete originator information

22. Way forward • Waiting for final comments from the industry on our proposals • Intending to finalise the Supplement by 31 March • Six month period for implementation • Case-by-case extension for needed system changes • Industry forum to be set up to produce further interpretative guidance • Full revision of the Guideline when FATF produces its revised Recommendations