Recommendations to Credit Institutions for Determining the Source of Customer Funds and Wealth
Contents
Introduction...... 1
1. Understanding of concepts "source of funds" and "source of wealth" ...... 2
2. Determining the source of wealth and funds through legal and natural person due diligence.....3
3. Determining the source of wealth ...... 4
3.1. Determining the source of wealth when establishing a business relationship...... 4
3.2. Determining the source of wealth during a business relationship...... 5
4. Determining the source of funds ...... 6
4.1. Determining the source of funds when establishing a business relationship...... 6
4.2. Determining the source of funds during a business relationship...... 7
5.Recognising and accepting outcomes of customer fund source due diligence...... 10
Introduction
1. Financial and Capital Market Commission (hereafter – Commission) has developed recommendations for credit institutions and foreign bank branches (hereafter – credit institutions) for determining the source of customer funds and wealth (hereafter – Recommendations) to promote unified credit institution understanding of the implementation of measures when determining the source of customer funds and wealth, and to prevent credit institution involvement and attempted involvement in Money Laundering and Terrorist Financing (hereinafter – ML/TF).
2. Commission issues the recommendations in order to:
2.1. clarify the measures provided in the normative acts for determining the source of customer funds and wealth;
2.2 provide recommendations based on the best practice in the field of the prevention of money laundering and terrorism financing.
3. Recommendations were developed by collecting the shortcomings and positive examples of determining the source of customer funds and wealth observed by the Commission, as well as foreign organisation recommendations (Financial Action Task Force (hereafter – FATF) recommendations and guidelines, World Bank recommendations),also taking into account the requirements of international normative acts and the normative acts of the Republic of Latvia (e.g. Law On the Prevention of Money Laundering and Terrorism Financing, Regulation No. 125 of 27.08.2008 of the Financial and Capital Market Commission On Enhanced Customer Due Diligence (hereinafter – Regulation)).
1. Understanding of concepts "source of funds" and "source of wealth"
4. Section 19 of the Law On the Prevention of Money Laundering and Terrorism Financing (hereafter – OPMLTF Law) provides that, if required, when establishing a business relationship, the subject of the Law shall determine the source of the customer’s funds and source of wealth representing customer’s financial conditions. It should be emphasised that the concept "source of wealth" was introduced to the OPMLTF Law with amending laws of 13 August 2014 "Amendments to Law On the Prevention of Money Laundering and Terrorism Financing". Before the aforementioned amendments to the OPMLTF Law, concepts "source of funds" and "source of wealth" were not directly separated, but a general concept "origin of funds" was used (Section 19 and Clause 3 of the first part of Section 30 of the OPMLTF Law) or similar concepts "origin of money or other funds" (part five of Section 32 of the OPMLTF Law), "origin of the funds" (Paragraph 27.1 and 27.2 of the Regulation).Whereas only in Article 41 of the OPMLTF Law in respect of the request of information from the registers, "financial status", was a similar concept to "source of wealth" used.
5. Section 19 of the OPMLTF Law establishes that "source of wealth" characterises customer’s financial conditions, however, to clarify a more exact meaning of the concepts "source of wealth" and "source of funds", the explanations given in international documents should be used. In respect of the obligation of the subject of Law for customer due diligence, separate concepts "source of funds" and "source of wealth" are also used in international documents[1]. Explanations of the concepts "source of funds" and "source of wealth" are provided in World Bank recommendations for banks on Politically Exposed Persons, as well as in FATF guidelines on Politically Exposed Persons[2].
6. The concept "source of customer’s funds" refers to funds that a customer has acquired in connection with particular business relationships or particular transactions, and are the basis for requiring a business relationship between the customer and credit institution. For example, they can be funds that the customer has acquired by selling a property and then decided to further invest in financial products. Whereas the concept "source of customer’s wealth" refers to funds that the customer has acquired during a prolonged period of time and that make up the customer’s entire body of wealth (total funds). When determining the source of wealth, the main focus is the acquisition of information on customer’s activities that indicate how the customer acquired the wealth. For example, the source of the customer’s wealthmay consist of inherited funds and savings accumulated from salary during the previous 10 years. The obligation of customer fund due diligence in normative acts is provided both when applying initial due diligence (see Section 19 of the OPMLTF Law, and Paragraph 22.1 of the Regulation), and when applying due diligence during the business relationship (see implicitly Clause 1 and 2 of the first part of Section 20 of the OPMLTF Law, and Paragraph 23.3 of the Regulation). Taking into account that the information and its amount acquired in each of customer due diligence stages may differ, the content of customer fund and wealth source due diligence will be discussed separately by stages – when establishing the business relationship and during the business relationship.
2. Determining the Source of Wealth and Funds through Legal and Natural Person Due Diligence
7. In international documents[3] the concept "source of wealth" is generally applied in cases when speaking of natural person (politically exposed person) income, along with the concept "source of funds". According to the explanation provided in a Latvian explanatory dictionary, wealth is living and financial conditions characterised by prosperity and also security[4].
8. Taking into account the aforementioned and the fact that the source of wealth forms during a prolonged period of time, the concept "source of wealth" should apply to the income obtained by a natural person. Whereas the purpose of a legal person (company) is to gain profit, accordingly channelling the profit for company development or its owners’ income (wealth), and the direct purpose is not to create the wealth or financial conditions of the company, but to ensure income to its owners. Company serves as an asset for its owner for obtaining wealth. Consequently, the movement of a company’s assets during a prolonged period of time and the account turnover compliance with company’s activities shall be assessed not from the viewpoint of the source of wealth, but by assessing the customer’s economic activity. Societies and foundationsestablished with the purpose of reaching the goal set in the statutes or by the founder, are not characterised by the purpose of making a profit, and in this case the purpose is not to directly provide wealth for the society or foundation.
9. It should be emphasised that, also during legal person due diligence, when assessing the conformity of the beneficial owner declared by the customer, the credit institution may be required to determine the source of wealth of the beneficial owner, as Paragraph 26.1 of the Regulation provides that to ascertain the beneficial owner declared by the customer is the true beneficial owner, the credit institution may acquire additional information on the beneficial owner’s property status.
10. Whereas the concept "source of funds" is applicable to both natural and legal persons, as it refers to particular funds that the person has acquired in connection with particular business relationship or a particular transaction. For example, the credit institution acquires information on a company that has only recently become active and is planning a large purchase of goods, and confirms that funds were obtained as a loan or from another source. Similarly, in respect of a natural person, when assessing large sums of money received in the customer’s account, the credit institution shall acquire information that confirms the source of these funds. The degree of detailed elaboration of the attainable information and due diligence shall be applied according to the money laundering and terrorism financing risk level.
3. Determining the source of wealth
3.1. Determining the source of wealth when establishing a business relationship
11. Section 19 of the OPMLTF Law provides that, when establishing a business relationship, the credit institution shall, taking the assessment of money laundering and terrorism financing risk as a basis, obtain and document information on the purpose and intended nature of the business relationship, including, if required, the source of the customer's funds and source of wealth representing the customer’s financial conditions. First, the credit institution shall assess the risk (e.g. customer’s country risk, legal form, economic or personal activity risk) to understand the degree of possibility of the customer involving the credit institution in money laundering or terrorism financing, as well as the risk of product or service use for money laundering or terrorism financing. Then, depending on the risk assessment, the credit institution shall decide on the required measures for determining the source of funds and source of wealth.
12. Initial customer due diligence depending on the customer’s risk level is essential to timely identify money laundering and terrorism financing risks and make decisions according to the determined customer’s ML/TF risk level, as well as manage, prevent or reduce these risks.If sufficient information, which allows valid conclusions to be made on the source of customer wealth and funds, has not been acquired about a high risk customer when establishing the business relationship, during the business relationship,when assessing the customer based only on general information, it may be complicated to ascertain thatthe customer’stransactions do not support money laundering, terrorism financing or attempts of such activities, and the adequate transaction due diligence is only possible by requesting information post factum. Adequate initial customer due diligence reduces the possibility that the customer might send and receive large cash payments for transactions in a short period of time that may be associated with money laundering, and after the transaction due diligence initiated by the credit institution – close the account and open an account in another credit institution.
Examples
Situation No.1:
Politically exposed Person A arrives at a credit institution to open a current account. It is known that Person A is from a European Union Member State and wishes to open an account in a credit institution of Latvia, as he/she often visits Latvia and has bought a summer cottage in Latvia.
Actions of credit institution:
Credit institution acquires information on the source of wealth of Person A by determining which activities of Person A have accumulated the wealth, e.g. whether Person A is engaged in entrepreneurial activities or lives off paid employment income. If the country of Person A provides for officials to submit an income statement, the credit institution may ask person A to submit a copy of the income statement.Both public sources and inquiry forms may be used to acquire information.
By assessing the planned account turnover of Person A, and the information acquired from the customer inquiry form and public sources, the credit institution decides on the necessity to verify the information (e.g. acquire information from registers about the property, companies or securities of the person).
Situation No.2:
Politically exposed person B arrives at a credit institution to open a current account. It is known that politically exposed Person B represents a country with a high corruption risk, and Person B wishes to open an account to receive earnings from his/her company operations amounting to several million euros.
Actions of credit institution:
Considering the high level of risk, when establishing a business relationship, the credit institution shall acquire information on both the source of wealth and source of funds of Person B.
For example, by implementing the following measures:
1. Information on the financial conditions of Person B (which activities of Person B have accumulated the wealth) should be acquired.
2. Information on the business of Person B and its profitability (how long Person B is engaged in the business, how Person B launched the business, has Person B got the corresponding business experience) should be acquired.
3. Information on companies from which the customer is planning to receive payments should be acquired; the actual economic activity of these companies and the fact that they have performed economic activities with such income should be verified (e.g. by obtaining the annual report).
13. Taking into account that, when determining the source of wealth, information on person’s financial conditions is acquired, substantial assistance for credit institutions when acquiring information on politically exposed persons may be declarations of public officials, if the respective country provides for the persons to fill out such declarations. World Bank has conducted individual research on the obligations of declaration filling for public officials in different countries that may help credit institutions to determine jurisdictions that establish an obligation for public officials to fill out declarations[5].
3.2. Determining the source of wealth during a business relationship
14. OPMLTF Law does not directly establish an obligation for credit institutions to determine the source of customer wealth during a business relationship, however, such an obligation arises from Clause 4 of the first part of Section 17 of the OPMLTF Law which provides that credit institutions shall ensure the storage and regular updating of the documents, data and information obtained in the process of customer due diligence.Consequently, while monitoring the customer’s transactions, the credit institution shall assess the customer’s transaction compliance with customer’s financial conditions (source of wealth), and, when establishing a discrepancy with or uncertainty of the initially acquired information of the customer’s financial conditions, additional information on the source of wealth or funds shall be acquired. There is a possibility that the credit institution, during initial due diligence according to the risk level, has acquired general information on the source of the customer’s wealth, but, while monitoring the customer’s transactions or in respect of other conditions when the risk level increases, the credit institution may be required to verify the initially acquired information on the source of wealth or acquire additional information.
15. At the same time, within the framework of updating information on the source of the customer’s wealth, the credit institution should keep track of the public information, and, in the case of negative publicity of the customer, e.g. about suspicion of a politically exposed person’s involvement in a criminal offence, enhanced customer due diligence should be applied.
4. Determining the source of funds
4.1. Determining the source of funds when establishing a business relationship
16.Section 19 of the OPMLTF Law provides that, when establishing a business relationship, the credit institution shall, taking the assessment of money laundering and terrorism financing risk as a basis, obtain and document information on the purpose and intended nature of the business relationship, including, if required, the source of the customer's funds. Whereas Paragraph 22.1 of the Commission Regulation in respect of enhanced due diligence provides that, when establishing that a customer complies with any characteristics referred to in Paragraphs 13, 15, 16 and 18of this Regulation, the financial institution shall acquire additional information on the origin of funds, when establishing a business relationship with the customer.
17.Consequently, in respect of customers that comply with the characteristics referred to in Paragraphs 13, 15, 16 and 18 of the Regulation, the source of funds should be determined in all cases before establishing the business relationship, but, in respect of customers that do not comply with the characteristics, - taking into account the risk assessment that involves other acquired information on the customer as well (e.g. customer’s economic activity, planned transaction amount etc.). At the same time it should be mentioned that the amount of documents and information required from the customer for determining the source of funds depends on the customer’s risk level.
Examples
Situation No.1:
Customer A, who is a resident of the Republic of Latvia arrives at credit institution and wishes to open a current account to receive a salary and make everyday payments.
Actions of the credit institution:
Credit institution acquires information from the customer about the purpose of opening the account via the customer inquiry form, but, considering the relatively low risk level, may not apply additional measures to determine the source of the customer’s funds. Credit institution assesses the necessity to request additional information on the source of the customer’s funds while conducting transaction monitoring.
Situation No.2:
Representative of company B arrives at the credit institution and wishes to open a current account to carry out economic activities. Company B is registered in a low tax country, it is just established and it has no accounts in other credit institutions.
Actions of the credit institution:
First, the credit institution shall acquire information on the company, its planned economic activities and business partners to understand the economic nature of the company’s planned transactions and determine its actual activities.Taking into account the fact that the legal person is recently established, the credit institution should determine the source of funds for the company’s economic activity. In compliance with Paragraph 22 of the Regulation, the credit institution shall acquire additional information on the source of funds. Depending on the information submitted by the customer and the risk assessment, the credit institution assesses whether the information and explanations from the customer’s form, and the information available from public sources is sufficient, or specific documents on the source of funds (e.g. copy of credit agreement) should be requested. After assessing the whole information, the credit institution decides upon establishing or refusing a business relationship with the company.