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Hong Kong set for mixed FATF Mutual Evaluation in 2018, Cross-border Chinese cash remains a danger

BIScom Subsection: 
Editorial Staff

In this article, Ajay Shamdasani , Thomson Reuters Regulatory Intelligence, takes soundings on what might be expected from the FATF's Mutual Examination of Hong Kong, the results of which are expected soon.

Hong Kong's mutual evaluation report from the Financial Action Task Force next year is likely to give the territory a mixed result, officials in the city said. The report is likely to show the territory is largely compliant and has improved since its previous assessment in 2007.

A major vulnerability, however, is the lack of cross-border currency reporting requirements in the Special Administrative Region (SAR). Other concerns that are likely to drag down Hong Kong's international ranking are the limitations in transparency regarding beneficial ownership and the broader application of anti-money laundering (AML) and know-your-customer (KYC) rules to non-financial sector businesses.

"Hong Kong will get a mixed scorecard from the FATF next year," said Bill Majcher, president of EMIDR, a local risk management and cyber security firm. Majcher cited the city's lack of a cross-border cash reporting requirement, the primary threat of which comes from daily visitors from mainland China, purely because of their vast numbers.

"Hong Kong will be chastened for the lack of currency controls on its borders. It will be criticised for taking a draconian risk-based approach that sees banking access effectively shut down for many business startups and banking closed down for existing legitimate businesses due to the banks in Hong Kong taking the 'no business [equals] no risk' approach to everyone but the most saccharine of clients, thus driving many legitimate people and businesses into the grey or shadow banking realm in order to survive," he said.


The local banking regulator, the Hong Kong Monetary Authority (HKMA), has warned the city's banks against adopting an indiscriminate de-risking approach and making it tougher for new companies — particularly limited liability companies and/or startups with overseas directors or founders — to open accounts. Wholesale de-risking has also been eschewed by regulators in Washington and London, as well as the Financial Stability Board (FSB) and the International Monetary Fund (IMF) as not being the same as adopting a risk-based approach to AML, KYC and countering terrorist financing (CTF) compliance. This practice runs counter to the global policy goal of financial inclusion and banking the vast "unbanked".

Wholesale de-risking did not spare the city from embarrassing breaches of its financial crime regime in recent times, Majcher said.

"The ease at which funds from the Russian 'Global Laundromat' operation came in and out of Hong Kong, combined with the revelations of millions in dirty cash flowing in from the smart automated teller machines (ATM) from Commonwealth Bank of Australia, will expose the lack of counter-party oversight by many of Hong Kong's largest institutions," Majcher said.

"As for the scorecard, it should generally be compliant. Our controls and the Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (AMLO) have largely been shown to be effective, so I would be surprised if the evaluation was not, for the most part, positive," said Christopher Tung, partner at law firm K&L Gates in Hong Kong.

The AMLO came into force in 2012 and was intended to modernise and consolidate the SAR's existing AML laws. It was further amended this year to impose statutory customer due diligence (CDD) and recordkeeping requirements on designated non-financial businesses and professions (DNFBPs), and to enhance the transparency of Hong Kong companies' beneficial ownership. While the AMLO amendments cover solicitors, barristers and dealers in precious metals and stones were excluded from similar such reporting requirements.

"With the recent supervisory and enforcement actions by Hong Kong authorities … changing the requirement on non-face-to-face account opening, coupled with the HKMA's AML Enhanced Competency Framework and the Hong Kong Association of Banks' guidance paper on trade-based laundering in early-February 2016, along with the enforcement actions on banks and securities companies, we see that good effort had been made which will considerably aid Hong Kong's result in the next year," said Manhim Yu, partner at EY in Hong Kong.

Overall, the FATF should give Hong Kong credit for improvements from its last mutual evaluation.

"We expect that the FATF will acknowledge the important improvements to Hong Kong's AML and CTF framework since the last mutual evaluation in 2008. In particular, Hong Kong is likely to get credit for the introduction of the AMLO … and the amendments [earlier in the year] to [local] United Nations (Anti-Terrorism) Measures Ordinance (UNATMO), both of which were introduced following the last mutual evaluation in response to FATF recommendations," said Paul Dorrans, consultant at law firm Simmons & Simmons in Hong Kong.

Enforcement-wise, both the HKMA and the local capital markets regulator, the Securities and Futures Commission (SFC), have ratcheted up their efforts in recent years. The SFC, for example, has expressly made AML and CTF an enforcement priority and a focal point for its supervisory activities. This has generated positive results with instances of identified non-compliance with AML guidelines falling significantly in recent years. For its part, the HKMA has issued its second big-ticket fine for AML failures earlier this year.

These were significant developments which had attracted ample attention in the market "which is taking AML compliance very seriously indeed," Dorrans said. He pointed to the city's three-fold increase in suspicious transaction reports (STR) filed since the AMLO came into effect in 2012 "for evidence of the solid progress made in this area".

"Major stakeholders, especially financial institutions, are very much alive to AML risks and have demonstrated a good understanding of their reporting obligations," he said.


Some financial crime experts suggest there needs to be more reporting from local firms — particularly from the legal, accounting, company secretarial and trust services sectors.

"I expect there to be some criticism of the very low levels of suspicious transaction reports (STRs) from professional firms," said Nigel Morris-Cotterill, a counter-money laundering specialist. "Hong Kong is a major offshore centre and, as such, might expect to see opportunistic use of corporate structures. Hong Kong is the first major offshore centre to have a mutual evaluation report since the release of the so-called Panama Papers and Paradise Papers. The fact that Mossack Fonseca, in particular, had an active office in Hong Kong will mean that inspectors will have in mind questions as to effective KYC and CDD, especially in relation to non-resident shareholders and directors," he said.

The FATF might draw a distinction between legitimate holding companies and companies that have no significant commercial purpose, he said. "I expect at least a note about the company services sector and the need for stricter policing of their activities."

While there is a good story to tell in relation to self-reporting, the recent downward trend in both the value of assets confiscated by law enforcement agencies and the number of individuals ultimately convicted for money laundering offences paints a less sanguine picture, Dorrans said.

"While this could be said to reflect the strong deterrent effect of Hong Kong's AML prevention and detection regime, a less favourable interpretation would be that money launderers are becoming more sophisticated and are increasingly circumventing existing measures," he said.

Whatever the reason — and it could simply be a blip — this trend may warrant careful consideration by the FATF.

The international standard setter may query the deterrent effect of the fines imposed for regulatory breaches of Hong Kong's AML framework, which have, for the SFC at least, tended to range around HK$2 million ($255,983) to HK$3 million ($383,990) in recent years. While the fines imposed by the HKMA have tended to be slightly higher, there have only been two enforcement actions by the HKMA since the AMLO was introduced in 2012 which have resulted in public censure or fines.


Cash and bearer negotiable instruments brought over across the border, primarily from mainland China are likely to require attention.

"Addressing this specific issue will present a challenge, as Hong Kong does not have customs declarations for these and there is obviously a lot of cash crossing the border," Tung said.

The territory remains an attractive commercial area for mainland Chinese tourists, much of which is fuelled by cash. Additionally, Hong Kong housing prices have, to a large degree, been driven up by funds from north of the border.

"I expect the FATF inspectors to draw attention to the fact that the economy is being distorted by money that, according to official Chinese figures, does not exist. Of course, there is a borrowing boom in China which accounts for part of the cash influx but equally there are substantial borrowings in Hong Kong for property where the repayments come from China, where salaries are, generally, far lower than in Hong Kong. The level of KYC relating to purchasers, especially where loans are arranged via brokers, may be seen as inadequate," Morris-Cotterill said. "Non-bank lenders are of particular concern."


In addition to the greater transparency in beneficial ownership, the amendments to the local Companies Ordinance and the AMLO are expected to come into force before the next evaluation, as well expanding AMLO's new reporting requirements to DNFBPs.

"In terms of beneficial ownership transparency and extending the AMLO to cover designated non-financial businesses and professionals, Hong Kong will be compliant by early next year when the amendments to the Companies Ordinance and the AMLO are enacted. However, mutual evaluation assessors may be critical of the amount of time it took the government to implement these changes," Tung said.

The widening of the regulatory ambit for AML compliance will no doubt be seen as a positive development by the FATF.

If administered properly, it may put Hong Kong in a better light when compared to other Asia-Pacific jurisdictions, Dorrans said

(reproduced with permission)