Robert Payne Rebecca Welman November 19 2020 Anti-money laundering rules: impact on art market Forsters LLP | Private Client & Offshore Services - United Kingdom Robert Payne, Rebecca Welman Private Client & Offshore Services IntroductionPractical impact of 5AMLD on art sectorIntroductionThe EU Fifth Anti-money Laundering Directive (5AMLD) was enacted into UK law with effect from 10 January 2020. It requires art businesses to implement systems intended to prevent their potential use in money laundering or for various other offences (in addition to those systems already required under the Proceeds of Crime Act 2002).The rules apply to those trading, storing or acting as intermediaries in 'works of art' (as defined in the Value Added Tax Act 1994), where the value involved is more than €10,000 (either for a single work of art or as part of a series of transactions). This is a significant extension to the existing rules, both in terms of those that are being made subject to additional regulation and the level of compliance required.Those affected will be expected to register with Her Majesty's Revenue and Customs (HMRC). Senior management and beneficial owners will be subject to approval as part of this process. The deadline for registration was originally 10 January 2021, but it has now been proposed that this be extended to 10 June 2021 (although the other requirements are already in force).The penalties for non-compliance are significant and senior management may be personally liable. Breaches may incur a maximum sentence of up to two years' imprisonment.Affected businesses should have implemented systems and checks to address the new rules. This is potentially difficult for an industry that has emphasised discretion and whose clients may be unused to the level of due diligence information required.Practical impact of 5AMLD on art sectorGiven the high values involved, the portability of works, the clandestine nature of the market and the lack of regulation to date, it is easy to see why the art market has historically been vulnerable to money laundering. Many therefore consider this legislation to be long overdue and view it as a belated (and welcome) application of normal regulatory standards to the art world.Who is affected?As discussed briefly above, this legislation applies to any firm or sole practitioner that "by way of business trades in, or acts as an intermediary in the sale or purchase of, works of art" or who "is the operator of a free port when it, or any other firm or sole practitioner, by way of business stores works of art in the free port". It therefore applies to agents, auction houses, galleries, dealers, warehouses and any other individual or firm involved in the buying, selling or storing of art.This wide definition, together with the low threshold of applicability (ie, €10,000), means that the majority (if not all) of those operating in the art world have been (or will be) in some way affected by the new rules.What do they need to do?Those caught by the new regulatory framework will need to take a number of steps, including:carrying out an internal risk assessment (including understanding the rationale for complex transactions, which will ultimately involve a level of judgment);creating an anti-money laundering (AML) policy (which must cover a list of specified criteria and should be relevant and proportionate to the business in question);carrying out client due diligence (CDD) both at the outset and on an ongoing basis (see below);maintaining appropriate records in line with the above;registering with HMRC;training staff (with such training being appropriate to the staff in question and training records being maintained);appointing a nominated officer to make reports to the National Crime Agency (there are also increased responsibilities for senior management); andreporting suspicious transactions.CDD requires:clients (including beneficial owners) to be identified;their identities to be verified with independent documents;this information to be documented; andrecords to be kept.The source of funds and the transaction as a whole must also be understood.For some businesses, the new rules merely formalise practices already in place (many already carry out due diligence – for example, for provenance and title purposes). However, for others (particularly smaller entities dealing in high volumes), the measures that must be taken are burdensome and expensive. The legislation applies to businesses regardless of their size and the penalties for non-compliance are severe (see above).Although regulated entities are expected to have started taking steps to comply with the new rules, they have been given a grace period for registration. This was initially one year, to 10 January 2021, but it appears likely that it will be extended to 10 June 2021. A spokesperson for Her Majesty's Treasury said that the proposed extension is intended to "mitigate the risks of an application backlog due to Covid-19 pressures on HMRC's and businesses' resources". In part, this may be an acknowledgement that the burden being placed on newly regulated entities may be heavy in some circumstances, particularly in view of the fact that for many, resources are greatly reduced due to the impact of the COVID-19 pandemic.Collectors tend to be familiar with AML procedures (not least because they are a prerequisite to legal and other types of professional advice). While for many the new measures are probably little more than an inconvenience (in view of delays to transactions), for some the new rules give rise to confidentiality issues and threaten to damage longstanding relationships by injecting a feeling of mistrust.What other practical issues arise?In terms of the legislation's applicability, the term 'intermediary' can be interpreted widely. For example, does this cover someone who introduces parties to a transaction but does not receive any commission?Since regulated entities must carry out CDD on ultimate clients, in the first instance, they must consider who the ultimate clients are. In the context of the art world, this is not necessarily straightforward.For example, where regulated dealers sell works via an agent, they must carry out CDD on both the agent and the ultimate buyer. Agents are understandably reluctant to disclose the identities of their principal (since this risks them being sidestepped and losing their fee). The alternative is for the dealer to trust that the agents have carried out satisfactory CDD on the ultimate buyer, which is obviously not without risk: the British Art Market Federation (BAMF) guidance reminds regulated entities that while they are permitted to rely on CDD carried out by other regulated entities, the party "conducting the sale retains responsibility, and is liable for any failure to comply with CDD obligations". This therefore puts regulated agents and dealers in a difficult position.Compliance with these rules at art fairs may be difficult on the basis of the high volume of impulse purchases and the fact that CDD must generally be completed before transactions are finalised. Although it is possible for transactions to be agreed subject to CDD, works cannot be released until the relevant AML procedures have been completed. While most of 2020's art fairs have unfortunately fallen victim to the pandemic, these appear to be returning cautiously (Berlin Art Fair took over venues including Berlin airport and the Berghain in September 2020). UK dealers must therefore turn their minds to this issue.The widespread impact and practical issues discussed above have led some to question whether the new rules will push transactions to more favourable jurisdictions and could risk London losing its place as one of the global art market's leading international hubs. However, given that 5AMLD applies across the European Union, the United Kingdom is not alone in tightening regulation of the art market. Further, following a recent report by a US Senate subcommittee describing the international art market as "the largest, legal unregulated industry in the United States", many are expecting renewed pressure to be placed on Congress to pass AML legislation targeting the art sector.How will the legislation be implemented?There have been complaints about the clarity of the drafting and the lack of detailed guidance accompanying the legislation. Since the consequences of misunderstanding the rules are severe and can lead to registration being refused (in which case regulated entities will be prevented from transacting), clear rules are essential.However, there is an appeals process where registration has been refused. Further, the BAMF guidance clarifies that regulated entities will be allowed to proceed with any transactions within the scope of the regulations while they are awaiting confirmation that their registration has been approved (provided that they are meeting all of their other obligations under the new rules). Although this is expressed in the context of the January 2021 deadline for registration, this is expected to apply similarly if the proposed extension is passed into law.It is unclear whether HMRC will show any leniency following the registration deadline to enable interpretation and other issues to be resolved. For example, will HMRC take a more sympathetic approach to small businesses for which the costs and complexity of introducing the measures are proportionately greater than for larger businesses, particularly in view of the financial impact of the pandemic?What next?It is not surprising that the art world is now subject to similar regulatory standards as other sectors. Notwithstanding this, the drastic widening of the regulatory net has not been met with universal applause.In the short term, it is hoped that more detailed guidance will be forthcoming and (assuming registration is extended as proposed) that HMRC will take a more sympathetic approach to non-compliance during the period following 10 June 2021. In the long term, it will be interesting to see how the art market reacts and whether this legislation will cause a cultural shift in an industry which is notorious for its lack of transparency and regulation. The BAMF guidance notes that:[w]hile confidentiality and discretion will continue to be a feature of the art market, the changes introduced by the new regulations may in some cases result in a degree of increased transparency between art market participants.Given the economic downturn facing the United Kingdom, the government will be considering how to balance the need to recoup the funds that have been spent as a result of the pandemic against the need to avoid over-taxation in order to encourage spending. As such, the wealth lodged in the international art market may be a politically attractive target.For further information on this topic please contact Robert Payne or Rebecca Welman at Forsters LLP by telephone (+44 20 7863 8333) or email ([email protected] or [email protected]). The Forsters LLP website can be accessed at www.forsters.co.uk.