Despite fierce resistance from the art world, January 2020 is likely to see the Fifth EU Money Laundering Directive take effect in the UK, requiring auction houses and art dealers to undertake anti-money laundering checks on customers. Establishing systems to carry out such checks will carry significant resourcing implications, and any failure to undertake checks with sufficient rigor can attract criminal penalty, for both institutions and their directors.
Anyone who has opened a bank account, bought a house or instructed a solicitor will have experienced anti-money laundering checks. Typically, as a new customer of a firm that is subject to the Money Laundering Regulations, you will need to provide evidence of your identity, in the form of a passport, driving licence and / or recent utility bill. Such identity checks – called "Know Your Client" or "KYC" checks – have been mandatory for financial and credit institutions since the first European Money Laundering Directive entered into force in the UK in 1993.
From 2007 the implementation of the Third Money Laundering Directive extended KYC obligations to lawyers, accountants, real estate agents and socalled "high value dealers" (on which see below).
In January 2020, the entry into force of the Fifth Money Laundering Directive will bring art dealers and auction houses into the regulated sector for antimoney laundering ("AML") purposes.
The current position
The Fourth Money Laundering Directive entered into force in the UK as recently as June 2017. As was the case under the predecessor (2007) Money Laundering Regulations, art dealers and auction houses are not specifically within scope of the Regulation.
At present, the only way an art dealer or auction house is likely to fall within the scope of the regulations is as a so-called "high value dealer", a concept which was expanded in the 2017 Regulations to include:
- any firm or sole trader;
- who by way of business trades in goods, including an auctioneer dealing in goods;
- when the trader makes or receives, in respect of any transaction, a payment or payments in cash of at least 10,000 euros in total;
- whether the transaction is executed in a single operation or in several operations which appear to be linked.
An auction house or art dealer who meets the definition of a "high value dealer" is obliged under the 2017 Regulations to put in place a system of policies, procedures and training, all based on a documented money laundering risk assessment, to ensure customers' identities are checked and (in higher risk cases) verified.
Aside from the Money Laundering Regulations any art dealer, whether a "high value dealer" or not, may be required to report suspicions of money laundering to the National Crime Agency, in order to avoid criminal liability for money laundering.
We recently advised an art dealer who was approached by email in respect of a work which was offered for sale on the firm's website. The potential buyer was not known to the dealer, did not ask the sort of questions one would expect a purchaser of a high-value work to ask, and wanted to pay for the piece by way of a series of electronic transfers from a high-risk jurisdiction. The dealer in this case suspected that the buyer may be attempting to launder money. Had the dealer received the money, having formed a suspicion, s/he may have committed a criminal offence of money laundering under the Proceeds of Crime Act 2002. In the event, we advised the dealer make a report to the National Crime Agency, which created a defence to the criminal offence of money laundering.
The Fifth Money Laundering Directive and (likely) position in the future
The Fifth EU Money Laundering Directive was formally adopted by the European Parliament in April 2018. EU Member States have until 10 January 2020 to give effect to its provision.
The Fifth Regulation amends the Fourth Regulation to include the following within the definition of "obligated entities":
- "persons trading or acting as intermediaries in the trade of works of art, including when this is carried out by art galleries and auction houses, where the value of the transaction or a series of linked transactions amounts to EUR 10 000 or more".
Noteworthy is the fact that the monetary threshold is not limited by payment type. So any art dealer or auctioneer, trading in works of art valued at €10,000 or more, will be caught, whether they are paid by cash, cheque, bank transfer, or otherwise.
Despite uncertainty as to the nature and legal status of the UK's relationship with the European Union after 31 October 2019, the UK has committed to adopting the Fifth Money Laundering Directive along with the rest of Europe, either as part of the proposed transitional arrangement or some other deal which requires regulatory convergence in return for preferential access to the Single Market.
Even in the event of a "no deal" outcome, the UK – as a leading member of the Financial Action Task Force on Money Laundering (which sets the standards which underpin EU anti-money laundering law) – is unlikely to let UK AML standards fall behind those applicable elsewhere in Europe. This much was acknowledged by the Department for Business, Energy and Industrial Strategy in a widely-reported letter to Margaret Hodge MP in July 2018.So when the Fifth Money Laundering Directive takes effect in January 2020, how will art dealers and auction houses be affected, and what can be done to prepare?
Practical implications and preparations
As indicated above, compliance with the money laundering regulations require a significant commitment of resources and exposes a firm – along with its directors and officers – to potential criminal liability for any compliance failing.
Should the 2017 Regulations be extended to cover art dealers and auction houses, the following (nonexhaustive) list of requirements will apply:
Policies and procedures:
- Regulated firms must register with the relevant supervisor (at present, for High Value Dealers, this is HMRC);
- Regulation 18 of the 2017 Regulations requires firms to conduct a Money Laundering Risk Assessment, which considers specific heads of risk – customer, geographic, products, transactions and delivery channels – when carrying out the risk assessment;
- Once drafted, the 2017 Regulations envisage the Risk Assessment as fundamental to day–to-day conduct of a “risk based approach” to compliance;
- Regulation 19 of the 2017 Regulations clearly envisages that AML policies and procedures will be drafted with reference to the risk assessment;
- The 2017 Regulations also specifically mandate that "the ways in which a relevant person complies with the requirement to take customer due diligence measures, and the extent of the measures taken must reflect the risk assessment carried out by the relevant person under regulation 18(1)" (Regulation 28(12) 2017 Regulations).
Customer Due Diligence:
- When entering into a relationship / transaction, Customer Due Diligence ("CDD") must be conducted to identify the customer;
- Unlike the 2007 Regulations, the 2017 Regulations do not allow any automatic departure from CDD requirements, based on customer type alone. Instead, firms will be able to "adjust the extent" of CDD measures where a business relationship / transaction is determined to present a lower risk of money laundering.
- The 2017 Regulations also expand on the 2007 Regulations by requiring the application of Enhanced Due Diligence Measures ("EDD") where:
- a transaction or business relationship involves "a person established in a high risk third country" (as defined by the European Commission); or
- the customer is a Politically Exposed Person ("PEP") "or a family member or known close associate of a PEP" including a domestic PEP (Regulation 35, 2017 Regulations).
- The Fifth Money Laundering Directive adds to the existing list of "higher risk situations" (which require the application of EDD):
- “transactions related to… cultural artefacts and other items of archaeological, historical, cultural and religious importance, or of rare scientific value, as well as ivory and protected species.”
Training and "screening" of Employees:
- The 2017 Regulations will create an obligation on larger firms to conduct initial and periodic "screening" of "relevant employees" (Regulation 21(1)(b) 2017 Regulations);
- “Relevant employee” is defined to catch not only compliance staff, but also employees in the front office, who introduce business and engage with clients;
- Screening of relevant employees means an assessment of the skills, knowledge and expertise of the individual to carry out their functions effectively, and the conduct and integrity of the individual.
Checks on intermediaries:
- Of particular relevance to the art market is Regulation 38(10) of the 2017 Regulations, which requires verification checks to be undertaken in respect of any intermediary who is making a purchase on behalf of somebody else.
Consultation Paper on the transposition of Fifth EU Money Laundering Directive
Regardless of the outcome of Brexit, the extension of the AML regulation to encompass art market participants remains likely. A Consultation Paper on the extension was published by HM Treasury on 15 April 2019, providing an opportunity for auction houses and art dealers to offer views and seek clarifications where necessary. For example, views are sought on a number of scenarios that demonstrate the difficulties in practically applying the Regulations, including the application of CDD measures to auctions where the buyer and final sale price may not be known until the sale has concluded.
An interesting point of consultation is whether the scope of "art intermediaries" should be widened to other intermediaries that are not making or receiving the payment. This would extend the obligations and liabilities under the Fifth EU Money Laundering Directive to other professionals within the art market including art curators, consultants, appraisers, and specialists in art storage and shipment.
The Consultation Paper also identifies HMRC as a likely supervisor, given that the tax authority already supervises high value dealers. HMRC, together with the Office of Professional Body Anti-Money Laundering Supervisors, has taken a notably active role in the prevention and sanctioning of moneylaundering offences. However, in a recent report on anti-money laundering supervision and sanctions implementation, the Treasury Committee queried whether HMRC should retain its AML supervisory role. Such a move would allow the authority to focus on its tax responsibilities and create a more centralised AML supervisory landscape.
Regardless of the outcome of Brexit, the extension of the AML regulation to encompass art market participants remains likely. A Consultation Paper on the extension will likely be published by HM Treasury in the summer or autumn of 2019, at which point the precise nature and extent of the obligations that will apply to auction house and art dealers will become clear. Importantly, such firms will have an opportunity to respond to any Consultation, offering views and seeking clarifications where necessary.
Establishing a compliance system to meet the Money Laundering Regulations is no easy undertaking. Given that the Regulations could be extended to auction houses and art dealers as soon as January 2020, such firms would be well advised to begin to consider how the requisite elements of compliance – risk assessment policies, CDD measures, training – will be built into their business and given effect.