Comply with new anti-money laundering regulations or face penalties - Trident Trust serves a timely reminder to Cayman Funds
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The regulatory tide is shifting in the Cayman Islands and one demonstration of this has been the AML Regulations, which detail guidance to the industry on the requirements to conduct customer due diligence, says Sharon Williams of US Bancorp Fund Services.
In today’s ever-changing financial landscape, the Cayman Islands remains the preferred jurisdiction for investment fund domicile. The industry grew up enjoying vast flexibility, at the product development and the compliance levels. It is now clear that the regulatory tide is shifting in the Cayman Islands.
In keeping with its commitment to achieve international best standards set by the Financial Action Task Force (FATF), the Cayman Islands has in recent months made changes to its legal and regulatory regime by closing a few of the gaps and augmenting its existing framework. All this was done in an effort to enhance its ability to detect and prevent money laundering, counter the financing of terrorism and demonstrate its commitment to meeting global standards.
In December 2017, the Cayman Islands Monetary Authority (CIMA) issued new Guidance Notes pursuant to section 34 of the Monetary Authority Law (2016 Revision). In addition, new Cayman Islands Anti-Money Laundering Regulations, 2017 (the AML Regulations) have been approved by the Cayman cabinet and published.
This applies to persons carrying on relevant financial business, as defined in the Proceeds of Crime Law (revised). Investment funds, both regulated and unregulated, are directly impacted by certain new obligations which go live on May 31, 2018.
Among these developments, the AML Regulations provide detailed guidance to the industry on the requirements to conduct customer due diligence and the circumstances when it is appropriate to employ either simplified or enhanced measures. There has been an overall expansion of the requirements surrounding client identification and verification.
One particular development that stands out is a change to the exemption that facilitated operational ease of accepting subscriptions into investment vehicles and making distribution and redemption payments. This exemption was commonly referred to as the ‘Reg 8 exemption’. The newly enhanced requirements are set out in regulation 23 of the AML Regulations. Until now, Cayman Islands investment funds and their fund administrators have relied heavily on the Reg 8 exemption from the requirement to conduct full due diligence and know your customer (KYC) verification procedures on fund investors.
Under the Reg 8 exemption, it was permissible to apply simplified due diligence measures where subscriptions were funded from a bank account held in the name of the investor in a country recognized by Cayman as having an equivalent AML regime (previously referred to as a Schedule 3 Country). Obtaining basic customer identification information along with the details of the bank account was sufficient.
The Reg 8 exemption was also used when redemption monies were paid to a bank account held in the name of the investor in a Schedule 3 Country. In practice, although most fund administration houses were, in keeping with internal policies and procedures, carrying out the checks, no verification of the customer’s identification was mandated. This enhanced the efficiency of client services and operational ease for the administrators.
The new regulation 23 retains an avenue for using simplified due diligence measures where payments of subscription funds are received from investors in person or electronically. Significantly, this adds circumstances in which verification must ultimately be conducted and cannot be waived. Subsequent payment to an investor (eg, fund distributions, or redemption proceeds) is one such circumstance.
The precursors for the application of Regulation 23 are the following:
The assessment of a low level of AML/CFT risk;
The proper identification of the customer or investor;
The identification of the beneficial owner or owners of legal structures and arrangements; and
That there is no reason to doubt the identities established above.
When these four elements exist, it remains generally permissible not to require verification of the identity at the time of accepting payment electronically. However, on onward payment to the investor, or any third party, blind reliance on the funds being returned to an account in the payee’s name, located in a country approved to have similar AML measures as those of the Cayman Islands, cannot be made.
The shift has been met with mixed reaction in the industry as increasing compliance costs is a real consequence of regulatory developments. While it may be the case that the new requirements are already standard for fund administrators operating across borders, in some instances these developments will represent a significant step change. This forces administrators to amend policies and procedures, and update operational and compliance processes as they relate to the authorisation for payment of distributions and redemption proceeds.
During the lifetime of an investment, the circumstances of an investor may change, resulting at the time an onward payment is due in a higher risk rating than initially assessed. That investor may now be subject to sectorial or geographic international sanctions, or may have become a designated person for purposes of the Terrorism Law (2017 Revision).
The verification process before onward payment provides what may be the final opportunity to assess the risk exposure an investor poses to a fund, its operators and service providers, and ensure compliance with obligations, including disclosure obligations, where money laundering or terrorist financing is suspected or actually uncovered.
All this is in keeping with other changes in the AML Regulations that formalise a “risk-based approach” which is the new standard required of the financial services industry in carrying out its anti-money laundering duties and obligations.
Under the risk-based approach, a financial services provider must take a variety of steps to meet the demands of the requirements. They need to identify, continually assess and understand the money laundering and terrorist financing risks in relation to customers or investors, the country or geographic area in which the customer or investor operates, its own products, services and transactions, as well as any risk created by delivery channels.
Static risk assessment is no longer acceptable. Ongoing periodic scrubs, the frequency of which depends on the risk assessment, including against sanctions lists and designated persons list, is the expectation and regulatory requirement.
While these developments are only one small part of the changes resulting from the revised AML Regulations, when coupled with the increased penalties that will apply to breaches and CIMA’s new ability to issue administrative fines, the industry is keen to get its collective house in order.
Violation of the AML Regulations can have negative consequences ranging from fines to imprisonment.
Further clarification, including on regulation 23, has been sought from the regulator through industry associations. The responses will provide further transparency on regulatory expectations in this shifting tide.
Sharon Williams is head of Registered Office Services at U.S. Bancorp Fund Services.
She can be contacted at: firstname.lastname@example.org
Cayman Islands, regulation, US Bancorp Fund Services